UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended March 31, 2005
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
for the transition period from _______ to _______
Commission File No. 0-13084
WARRANTECH CORPORATION
(Exact name of registrant as specified in its charter)
Nevada 13-3178732
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(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization
2200 Highway 121, Suite 100 Bedford, Texas 76021
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(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
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Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class Name of Each Exchange on Which Registered
- ---------------------------- -----------------------------------------
Common Stock $.007 par value None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.007 par value
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(Title of Class)
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [ ].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting and non-voting common equity held
by non-affiliates of the registrant as of September 30, 2004, based upon the
closing price of the registrant's common stock on September 30, 2004, was
$10,933,059 (For purposes of calculating the preceding amount only, all
directors and executive officers of the registrant are assumed to be
affiliates.)
The number of shares outstanding of the registrant's common stock as of May
31, 2005 was 15,452,008.
Documents Incorporated By Reference
Part III - Portions of the registrant's proxy statement for its 2005
Annual Meeting of Shareholders are incorporated by reference into Part III of
this report
WARRANTECH CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
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Page No.
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PART I
Item 1. Business...................................................................... 3
General.................................................................. 3
Sales and Marketing...................................................... 6
Significant Customers.................................................... 7
Competition.............................................................. 7
Contract Obligors........................................................ 7
Insurance Coverage....................................................... 8
Federal and State Regulation............................................. 9
Intellectual Property.................................................... 10
Employees................................................................ 10
Item 2. Properties.................................................................... 11
Item 3. Legal Proceedings............................................................. 11
Item 4. Submission of Matters to a Vote of Security Holders........................... 11
PART II
Item 5. Market of the Warrantech's Common Equity and Related Stockholder Matters .... 12
Item 6. Selected Financial Data....................................................... 12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations......................................................... 13
SEC Review of Company's Filings........................................... 14
Butler Contracts.......................................................... 14
Dealer-Obligor Contracts.................................................. 14
Insurer in Liquidation.................................................... 16
Butler Financial Solutions, Inc........................................... 17
Significant Customer in Bankruptcy........................................ 18
Results of Operations..................................................... 19
Agreements................................................................ 21
Liquidity and Capital Resources........................................... 22
Loans to Directors........................................................ 23
Commitments............................................................... 24
Critical Accounting Policies.............................................. 24
Item 7A. Qualitative and Quantitative Disclosures About Market Risk.................... 26
Item 8. Financial Statements and Supplementary Data................................... 27
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures..................................................... 54
Item 9A. Controls and Procedures....................................................... 54
Item 9B. Other Information............................................................. 54
PART III
Item 10. Directors and Executive Officers of the Registrant ........................... 55
Item 11. Executive Compensation........................................................ 55
Item 12. Security Ownership of Certain Beneficial Owners and Management................ 55
Item 13. Certain Relationships and Related Transactions................................ 55
Item 14. Principle Accounting Fees and Services........................................ 55
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K............... 55
Index to Exhibits............................................................. 58
Signatures.................................................................... 59
Certifications of the CEO and CFO............................................. 61
Index to Consolidated Financial Statements.................................... 27
Financial Statement Schedules................................................. 54
2
PART I
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Item 1. Business
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General
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Warrantech Corporation, a Nevada corporation, and its subsidiaries
(collectively, "Warrantech" or the "Company") maintains executive offices and
operating facilities at 2200 Highway 121 Suite 100 Bedford, Texas 76021, where
the telephone number is (800) 544-9510. Prior to February 28, 2005 and since its
inception, the Company had been incorporated in Delaware.
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 in the Automotive and Consumer Products segments,
the Company contracts with highly rated independent insurance companies or risk
retention groups 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. In the Home segment, the
Company is self insured.
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 for the Automotive and Consumer Products segments 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 under
these plans is generally paid by the insurance company. Notwithstanding the
forgoing, however, certain Plans were insured by Reliance Insurance Company
("Reliance") which was placed in liquidation in 2002. For a more detailed
discussion of claims handling under Plans insured by Reliance, see "Management's
Discussion and Analysis-Insurer in Liquidation" below. Plans for the Home
segment are generally for twelve months. The cost of any repair or replacement
for plans in the Home segment is paid for by the Company. For a more detailed
discussion of the responsibilities of obligors and insurers under the Plans, see
"Contract Obligors" and "Insurance" below.
Essential to the Company's success is its ability to capture, maintain,
track and analyze all relevant information regarding its Plans. The Company has
internally developed, and continues to develop and operate proprietary computer
software that allows it to maintain millions of Plans. The software includes
custom designed relational databases with interactive capabilities. The
Company's computer systems provide ample capacity and processing speed for its
current and future requirements. Additionally, Warrantech's web-enabled
applications such as VSCOnline(R) and WCPSOnline(R) facilitate information
exchange with outside businesses such as clients and service centers via the
Internet. These applications optimize the data acquisition, service processing
and claims processing functions. The software programs also allow for the
analysis of current and historical statistical data which the Company uses to
monitor its Programs and support future growth.
The Company operates in three major business segments: Automotive, Consumer
Products and International, each of which is discussed below.
3
Warrantech Automotive Segment
- -----------------------------
The Company's Automotive segment designs, develops, markets and acts as a
third party administrator for vehicle service contract ("VSC") 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.
As a result of the Company's leadership in the use of advanced technology
for processing and adjudicating of claims, Warrantech has also become a supplier
of choice for several Insurance Companies for their claims runoff projects and
for providing administrative services to the provider companies of automotive
products. VSCOnline, a complete front-end business rating and processing system,
teams with VSC Claims Online to make available a totally paperless environment
for all of Warrantech Automotive's clients.
Warrantech Automotive utilizes the services of approximately one hundred
fifty (150) independent sales representatives to call on clients to solicit
their use of the VSC Programs. At this time, VSC's are being sold in forty-nine
(49) states
The VSC is a contract between the dealer/lessor or third party obligor
(except in California and Florida, where the contract is between Warrantech
Automotive and the vehicle purchaser/lessee) and the vehicle purchaser/lessee
that offers coverage for a term extending up to one hundred twenty (120) months
or, in the case of mileage based VSC's, up to one hundred fifty thousand
(150,000) miles. Coverage is available in the event of the failure of a broad
range of mechanical components occurring during the term of the VSC, other than
failures covered by a manufacturer's warranty.
Although each VSC sold or issued under a Program designates an obligor that
is legally responsible for the cost of valid repairs or replacements made
thereunder, those liabilities are fully insured by an independent insurance
company that is ultimately responsible for such costs. Currently, Great American
Insurance Company ("GAIC") is the primary insurer of Warrantech Automotive's VSC
Programs. On reinsurance Programs offered to automobile dealerships and other
specialty marketers, the Company has an agreement with Heritage Warranty
Insurance Risk Retention Group, Inc. ("Heritage") and an agreement with
Automotive Underwritwers Insurance Company, Inc., a Risk Retention Group
("AUIC"). During the immediately preceding five-year period, a portion of the
Warrantech VSC Programs were insured by either Reliance (see "Management's
Discussion and Analysis - Insurer in Liquidation" below), the New Hampshire
Insurance Company or other American International Group, Inc. companies.
In 2005, 2004 and 2003 the Automotive segment received $0, $7.6 million and
$9.7 million, respectively in gross revenues from one significant client, which
accounted for 0%, 7% and 9% of the Automotive segment's total gross revenues,
respectively. Additionally, in 2005, 2004 and 2003 the Automotive segment
received from a second client, gross revenues of $5.8 million, $12.1 million and
$13.6 million, respectively, which accounted for 8%, 12% and 13% of the
Automotive segment's total gross revenues. Additionally, in 2005, 2004 and 2003
the Automotive segment received from a third client, gross revenues of $7.1
million, $9.6 million and $8.8 million, respectively, which accounted for 10%,
9% and 8% of the Automotive segment's total gross revenues. Additionally, in
2005, 2004 and 2003 the Automotive segment received from a fourth client, gross
revenues of $7.1 million, $0 and $0, respectively, which accounted for 10%, 0%
and 0% of the Automotive segment's total gross revenues.
Warrantech Consumer Products Segment
- ------------------------------------
The Company's 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. Warrantech 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. It also offers call center and technical computer services. The
4
extended warranties and product replacement plans administered by Warrantech
Consumer Products are service contracts between the purchaser and the
retailer/dealer and/or the insurance company that typically offers coverage
ranging from twelve (12) to sixty (60) months.
The Consumer Products segment also develops, markets and administers
service contract programs in the United States and Canada covering mechanical
breakdowns of the working systems and components in homes. These programs
protect homeowners against the cost of repairs in case of a breakdown of one or
more of the major home systems including heating and air conditioning, plumbing,
electrical and built-in appliances.
The programs marketed and administered by Warrantech Consumer Products
require that the selling dealer, distributor or manufacturer enter into an
agreement outlining the duties of each party. Those duties specifically assumed
by Warrantech Consumer Products include the development and distribution of
marketing materials, sales and motivational training, processing of service
contracts, operating a call center and the adjustment and payment of claims. It
has also entered into service center agreements with independent third party,
authorized repair facilities located throughout the United States and Canada.
These service center agreements bind the amount of reimbursement the repair
facility will receive for performance on a repair claim.
Effective February 12, 2000, the Company entered into an agreement with
GAIC pursuant to which GAIC insures any new service contracts issued in North
America or Puerto Rico. Insurance for service contracts issued between August 1,
1997 until February 12, 2000 are covered by Cigna Insurance Company. On
September 1, 2004, the Company began offering one-year extended home product
warranties which will not be insured by third party insurance companies, but
will be obligations solely of the Company.
In 2005, 2004 and 2003 the Consumer Products segment received $4.1 million,
$5.8 million and $4.5 million, respectively, in gross revenues from a
significant client which accounted for 9%, 15% and 13% of the segment's gross
revenues, respectively. Additionally, in 2005, 2004 and 2003 the Consumer
Products segment received from a second client, gross revenues of $14.3 million,
$15.3 million and $13.8 million, respectively, which accounted for 32%, 39% and
41% of the Consumer Products segment's total gross revenues, respectively.
Finally, in 2005, 2004 and 2003 the Consumer Products segment received from a
third client, gross revenues of $9.5 million, $11.2 million and $9.4 million,
respectively, which accounted for 21%, 29% and 28% of the Consumer Products
segment's total gross revenues. The Company has extended its contracts with two
of its significant clients through 2006. On January 11, 2005, the other
significant client for the Consumer Products segment filed a voluntary petition
for reorganization under the Chapter 11 Bankruptcy Code. Subsequently in April
2005 it announced it sold the assets of 32 of its locations to a third party and
would be liquidating its assets from its remaining 30 stores. The third party is
continuing its relationship with the Company and has until August 2005 to decide
whether it will assume the contract from the predecessor company or enter into a
new agreement with the Company.
Warrantech International Segment
- --------------------------------
Warrantech International 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.
Warrantech International conducts its efforts on a direct basis and has
developed relationships with retailers and distributors throughout the
Caribbean, Central America and South America. It is currently doing business in
Puerto Rico, Guatemala, El Salvador, Chile and Peru. The Company believes its
expansion in Latin American markets will be facilitated by its strategic
alliance with Atento, a multi-national call center owned by Spain's Grupo
Telefonica, which should allow Warrantech International to readily enter markets
in Latin America where Atento has existing call center operations. It is
actively pursuing leads in other Latin American markets.
The Programs administered by Warrantech International consist of Plans
between the purchaser and the retailer/dealer or the insurance company and
typically offer coverage similar to that offered by Warrantech Automotive and
Warrantech Consumer Products. Coverage is available in the event of the failure
5
of a broad range of mechanical components occurring during the term of the Plan,
other than failures covered by a manufacturer's warranty.
Warrantech International has fewer direct competitors in Central and South
America than the Company's other segments face in the United States and Canada.
Its competitive position is also enhanced by experienced local management,
flexibility, prompt reaction to client needs and strategic alliances such as the
one with Atento described above.
Although a Plan sold or issued under a Program may designate an obligor,
other than the applicable insurance company, that is legally responsible for the
cost of valid repairs or replacements made thereunder, those liabilities, are
fully insured by an independent insurance company that is ultimately responsible
for such costs. Insurance coverage has been and/or continues to be provided by
Cruz del Sur in Chile, La Positiva in Peru, Universal Insurance Company and GAIC
in Puerto Rico and GAIC in Guatemala and El Salvador. Effective September 2003,
as a result of terminating its relationship with Universal Insurance Company,
the Company suspended its Automotive program in Puerto Rico. The Company is in
the process initiating a new automotive warranty plan in Puerto Rico. 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.
In 2005, 2004 and 2003 the International segment received $2.9 million,
$1.5 million and $0.7 million, respectively, in gross revenues from one
significant client, which accounted for 38%, 19% and 14% of the International
segment's total gross revenues, respectively. Additionally, in 2005, 2004 and
2003 the International segment received from a second client, that did not renew
its agreement with the Company during fiscal 2005, gross revenues of $1.7
million, $1.9 million and $1.4 million, respectively, which accounted for 22%,
25% and 27% of the segment's gross revenues, respectively. Finally, in 2005,
2004 and 2003 the International segment received from a third client, that did
not renew its agreement with the Company during fiscal 2004, gross revenues of
$0, $1.0 million and $1.5 million, respectively, which accounted for 0%, 12% and
28% of the International segment's total gross revenues.
Sales and Marketing
- -------------------
Each business segment is responsible for its own sales and marketing
activities. These activities are managed by the segment's own personnel. In
certain circumstances, the business segments have entered into marketing
agreements with independent organizations that solicit clients at their own
expense, and receive a commission on all Plans sold by such clients.
The Warrantech business segments endeavor to improve Program performance
through participation in cooperative marketing programs that may be jointly
funded by Warrantech and the client or independent sales representatives.
Training and motivational programs are an important form of the specialized
assistance provided by the Company to increase the effectiveness and
profitability of Program sales efforts. The Company also develops informational
and promotional materials and conducts informational meetings either at the
client's place of business or an offsite facility with the goal of improving
Program effectiveness. The Company also uses its modern training facility,
located at its Bedford, Texas corporate offices, to provide a variety of
training and educational programs to its internal personnel, thereby increasing
their effectiveness and efficiency.
Warrantech also markets directly to the ultimate consumer on behalf of the
retailer and for manufacturer's programs through telemarketing and direct mail
campaigns. These direct marketing campaigns generate sales through renewals of
expiring Plans and initiating sales to customers who did not buy a Plan at the
time of product purchase.
6
Significant Customers
- ---------------------
During the fiscal year ended March 31, 2005, the Company had one customer
which accounted for more than 10% of the Company's consolidated gross revenues.
In 2005, 2004 and 2003 gross revenues from this significant customer were $14.3
million, $15.3 million and $13.8 million, respectively, which accounted for 10%,
11% and 9% of the Company's total gross revenues, respectively. On January 11,
2005, this significant customer filed a voluntary petition for reorganization
under the Chapter 11 Bankruptcy Code. Subsequently in April 2005 it announced it
sold the assets of 32 of its locations to a third party and would be liquidating
its assets from its remaining 30 stores. The third party is continuing its
relationship with the Company and has until August 2005 to decide whether it
will assume the contract from the predecessor company or enter into a new
agreement with the Company.
Competition
- -----------
Although accurate information on private companies is difficult to obtain,
the Company believes it is among the ten (10) largest independent third party
administrators in the United States. All of the Company's business segments
compete with subsidiaries and/or divisions of major financial institutions and
insurance companies such as Aon and American International Group. The segments
also compete against programs offered by product manufacturers. This is
particularly true for the Automotive segment which competes against VSC programs
offered by major manufacturers such as General Motors, Ford and Chrysler. The
Company acknowledges that a number of these competitors have significantly more
employees, greater financial resources and more immediate name recognition than
the Company. It believes, however, that its broad client base and the
competitive strengths and advantages described above have allowed it to compete
effectively and will enable it to grow its business in the future.
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 for the Automotive and Consumer Products segments. As
a result, the insurance company is then ultimately responsible for paying the
cost of any and all valid claims submitted under these Plans. 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. 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. Furthermore,
Butler has 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. 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.
Certain of the Plans under which Butler is the designated obligor were
insured by Reliance. The liquidation of Reliance (see "Management's Discussion
and Analysis - Insurer in Liquidation" below) 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
7
Funding to cover these uninsured claims is provided by a special surcharge,
which is payable on certain VSC's sold after November 19, 2001. This surcharge
will be paid by clients through which Reliance-insured VSC's were sold. These
funds will be used to pay valid claims submitted under VSC's previously insured
by Reliance.
For financial reporting purposes, for the reasons stated in Footnote 2 of
the Financial Statements annexed to this Report, the Company has adopted a
policy to treat the Butler-obligor contracts as if they were contracts in which
Warrantech was the legal obligor. As a result, the Company recognizes revenues
under such contracts pursuant to FASB Technical Bulletin 90-1. The Company also
includes, as its own liabilities, liabilities of Butler relating to such
contracts. Additionally, because the Company is treating the Butler-obligor
contracts as Warrantech obligor contracts for financial purposes, the Company
excludes from its financial statements the transactions between Warrantech and
Butler. Adopting these policies for accounting 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.
Insurance Coverage
- ------------------
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.
For each Plan sold or issued, the insurance company is entitled to receive
a contractually fixed amount that is included in the selling price of the Plan.
Generally, this amount is collected by the retailer/dealer at the time of sale
and forwarded to the Company at contractually agreed intervals. The Company then
holds this amount until required to remit it to the insurance company at
contractually agreed intervals. The Company's obligations with respect to such
amounts are purely administrative and it acquires no rights in or to such
amounts by the performance of its obligations. The calculation of these amounts
is based upon the insurance company's actuarial analysis of claims data
collected and maintained for each type of coverage and Plan term. Once the
retailer/dealer has remitted such contractually fixed amount to the Company, the
insurer is fully liable for all valid claims submitted under the applicable
Plan, even if such contractually fixed amount is insufficient to cover the cost
of such claims.
Currently, GAIC is the primary insurer of Warrantech Automotive's VSC
Programs. On reinsurance Programs offered to automobile dealerships and other
specialty marketers, the Company also has an agreement with Heritage, a risk
retention group that is not rated by any nationally recognized rating agency.
One or more reinsurance companies, contracted by Heritage, participate in this
Program as well. During the immediately preceding five-year period, portions of
the Warrantech VSC Programs were insured by Reliance (see "Management's
Discussion and Analysis - Insurer in Liquidation" below), the New Hampshire
Insurance Company and other member companies of American International Group,
Inc. ("AIG").
GAIC also insures Plans issued under Programs marketed and administered by
Warrantech Consumer Products after February 12, 2000. During the immediately
preceding five-year period, insurance for Plans issued under such Programs was
8
provided by Reliance (see "Management's Discussion and Analysis - Insurer in
Liquidation" below) and CIGNA Insurance Company.
Except as otherwise noted herein, current insurance coverage is provided by
highly rated independent insurance companies. As noted above, in the United
States and Canada providers include GAIC which is rated A (Excellent) and
Heritage which is an unrated risk retention group. Certain Programs have been or
are currently insured by (i) New Hampshire Insurance Company and/or other AIG
member companies and Tokio Marine & Fire Insurance Company, each of which is
rated A++ (Superior) and (ii) CIGNA Insurance Company (acquired by ACE Insurance
Company) which is rated A (Excellent). Internationally, insurance coverage was
provided by Universal Insurance Company in Puerto Rico on non-automotive
programs through August 2004, rated A - (Excellent), ING beginning January 1,
2005 and Cruz del Sur prior to January 1, 2005 in Chile, and La Positiva in
Peru. All ratings for the United States, Canada and Puerto Rico are made by A.M.
Best Company. The Home warranty program is self insured by the Company.
Agreements between the Company and the insurers may contain profit-sharing
features that permit the Company to share in underwriting profits earned under
the Programs. The amounts to be received, if any, are determined in accordance
with certain specified formulas based upon the type of program and the policy
year. Certain of these agreements require interim calculations and distributions
for various Programs, with final calculations being made as Plan terms expire.
The Company recognized $41,920, $173,610 and $71,784 in profit sharing through
its International segment in the fiscal years-ended March 31, 2005, 2004 and
2003, respectively.
Federal and State Regulation
- ----------------------------
The Programs designed, developed and marketed by the Company's subsidiaries
and their related operations are regulated by federal law and the statutes of a
significant number of states. The Company continually reviews all existing and
proposed statutes and regulations to ascertain their applicability to its
existing operations, as well as to new Programs that the Company is developing.
Generally, these statutes apply to the scope of service contract coverage
and the content of the service contract or limited warranty document. Statutes
typically require specific wording that expressly states the consumer's rights
in the event of a claim, how the service contract may be canceled, and
identification of the insurance company that insures the named obligors against
the cost of valid claims submitted under the service contract.
Insurance departments in some states have sought to interpret the consumer
product service contract, or certain specific items covered under such contract,
as a form of insurance requiring that the issuer be a duly licensed and
chartered insurance company. The Company does not believe that it or any of its
subsidiaries is an insurer and has no intention of filing the documents or
meeting the capital and surplus requirements that are necessary to obtain a
license as an insurance company.
There are instances where the applicability of statutes and regulations to
Programs and/or compliance therewith, involve issues of interpretation. The
Company uses its best efforts including, but not limited to, consultation with
legal and regulatory professionals to comply with applicable statutes and
regulations. It cannot, however, be certain that its interpretations, if
challenged, would be upheld by a court or regulatory body. In any situation in
which the Company has been specifically notified by a regulatory body that its
methods of doing business were not in compliance with applicable laws or
regulations, the Company has taken the steps necessary to comply.
If the Company's right to operate in a state is challenged successfully,
the Company may be required to cease operations in such state and, in certain
circumstances, financial sanctions may be imposed against the Company. These
actions, should they occur, could have an adverse impact on the Company's
operations. Within the framework of currently known statutes and regulations,
however, the Company does not believe that this is a material concern at this
time.
In order to reduce its operating costs, the Company has reorganized its
corporate structure that involves the transfer of some of the Company's
operations from corporate entities to limited partnerships. This reorganization
had no effect on the Company or its operations other than a reduction of its
franchise tax obligations and other operating costs.
9
Intellectual Property
- ---------------------
The Company holds numerous registered United States trademarks, the most
important of which are the "Warrantech" and its stylized "W" logo service marks.
Additional service marks are registered covering subsidiary and Program names
and descriptions such as "Repairmaster(R)," "RepairGuard(R)," "Xchange Card(R),"
"WCPSOnline(R)", "OneWorld(R)" and "VSCOnline(R)." The Company has kept, and
intends to keep, the registration for all service marks current.
The Company has developed proprietary computer software that consists of
custom designed relational databases with interactive capabilities. Essential to
the success of the Company is its ability to maintain all relevant data
regarding the Plans administered by the Company's business segments. Development
costs associated with this proprietary software have been capitalized and are
being amortized over the expected useful life of the software.
The Company has deployed, and continues to refine, Speech Recognition IVR
telephone applications to speed the claims process. These telephone applications
allow a caller to speak their input, such as a VIN or contract number, rather
than key the entry on their phone. Additionally, the Fast-Track Automotive
claims telephone application has the capability to establish a claim, issue a
reference number, and read back payment information to the repair facility so
the caller does not need to hold for, or speak to, a call center representative.
Both of these advances help the Company continue to provide better service to
its customers and reduce time and costs involved with handling claims while
providing better service.
Employees
- ---------
As of March 31, 2005 the Company and its subsidiaries had approximately 366
employees, an increase of approximately five employees from the preceding fiscal
year. None of the Company's employees are covered by a collective bargaining
agreement. The Company considers its relations with its employees to be good.
10
Item 2. Properties
----------
The Company's executive office is located at 2200 Highway 121 Airport
Centre II, Bedford, Texas. The premises, consisting of approximately 67,800
square feet, is leased pursuant to a lease agreement expiring February 28, 2013,
which provides for an annual base rent of $1.2 million. These premises also
accommodate the Company's Automotive, Consumer Products, Home, International and
Direct Marketing operations.
Warrantech International's Puerto Rico operations are located in leased
premises at 1225 Ponce de Leon Avenue, Santurce, Puerto Rico pursuant to a month
to month lease. The lease provides for annual base rent payments of $75,526 for
3,433 square feet.
Warrantech International's Chile operations are located in leased premises
at Avenida 11 de Septembre No. 1881 Officia No. 1619 Providencia, Santiago,
Chile. This office supports the operations in Chile, and is Warrantech
International's flagship operation to pursue and help implement the Company's
international expansion strategies throughout South America. The lease provides
for annual base rent payments of $20,913 for 145 square meters.
Warrantech International's Peru operations are located in leased premises
at Avenida Paseo de la Republica #3691 Officina No 501 San Isidro Peru. This
office supports the operations in Peru. The lease provides for annual base rent
payments of $6,000 for 323 square feet
Item 3. Legal Proceedings
-----------------
Information regarding legal proceedings is set forth in Note 11 in the
Notes to Consolidated Financial Statements set forth in "Item 8. - Consolidated
Financial Statements and Supplementary Data" under the subheading "Litigation,"
which is hereby incorporated by reference.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
No matters were submitted to a vote of the Company's Stockholders, through
the solicitation of proxies or otherwise, during the fourth quarter of the
Company's fiscal year ended March 31, 2005.
11
PART II
Item 5. Market for Warrantech's Common Equity and Related Stockholder
-------------------------------------------------------------
Matters
-------
The Company's common stock, $.007 par value per share (the "Common Stock")
trades under the symbol "WTECE.OB." Trades are reported on the Over-The-Counter
("OTC") electronic quotation service of the National Association of Securities
Dealers Market Makers.
As of March 31, 2005, there were 15,398,673 shares of outstanding Common
Stock and approximately 847 stockholders of record. On that date, the closing
bid price for the Common Stock, as reported on the OTC was $0.61. The Company
did not purchase any of its equity securities during the fiscal quarter ending
March 31, 2005.
Following is a summary of the price range of the Company's Common Stock
during fiscal years 2005 and 2004:
Fiscal 2005 Fiscal 2004
Quarter High & Low Bid High & Low Bid
First $ 1.05 $ 0.76 $ 1.68 $ 0.96
Second $ 0.87 $ 0.63 $ 1.50 $ 1.05
Third $ 0.82 $ 0.61 $ 1.42 $ 1.01
Fourth $ 0.78 $ 0.57 $ 1.25 $ 0.91
No cash dividends have been paid to holders of Common Stock since inception
of the Company. The Company anticipates that earnings, if any, will be retained
for use in the business or for other corporate purposes and it is not
anticipated that cash dividends will be paid in the foreseeable future.
Item 6. Selected Financial Data
-----------------------
The Selected Financial Data should be read in conjunction with the
consolidated financial statements and related notes as of and for the years
ended March 31, 2005, 2004 and 2003.
For The Years Ended March 31,
----------------------------------------------------------------------------
2005 2004 2003 2002 2001
------------ ------------ ------------ ------------ ------------
Gross Revenues $119,767,729 $149,328,267 $146,754,611 $118,137,862 $130,504,455
Net (increase) decrease in
deferred revenues (6,632,830) (29,366,988) (48,517,264) (23,379,415) (32,982,493)
------------ ------------ ------------ ------------ ------------
Net revenues $113,134,899 $119,961,279 $ 98,237,347 $ 94,758,447 $ 97,521,962
============ ============ ============ ============ ============
Gross Profit $ 28,226,654 $ 32,533,661 $ 35,688,007 $ 27,735,000 $ 26,906,576
============ ============ ============ ============ ============
Profit (loss) from operations ($ 5,106,613) ($ 1,268,123) $ 1,079,234 ($25,785,314) ($18,924,065)
============ ============ ============ ============ ============
Net income (loss) ($ 3,607,793) ($ 516,371) $ 1,466,892 ($16,513,704) ($11,908,073)
============ ============ ============ ============ ============
Basic earnings (loss) per
common share ($ 0.23) ($ 0.03) $ 0.10 ($ 1.08) ($ 0.78)
============ ============ ============ ============ ============
Diluted earnings (loss) per
common share ($ 0.23) ($ 0.03) $ 0.10 ($ 1.08) ($ 0.78)
============ ============ ============ ============ ============
Cash dividend declared None None None None None
------------ ------------ ------------ ------------ ------------
Total assets $263,663,839 $257,184,550 $260,245,877 $209,631,605 $163,454,040
============ ============ ============ ============ ============
Long-term debt and capital
lease obligations $ 923,984 $ 980,903 $ 1,218,670 $ 957,159 $ 1,209,853
============ ============ ============ ============ ============
Common stockholders' equity
(deficiency) ($29,609,684) ($25,798,951) ($25,471,901) ($26,460,501) ($ 9,715,827)
============ ============ ============ ============ ============
12
WARRANTECH CORPORATION AND SUBSIDIARIES
Item 7. Management's Discussion and Analysis of Financial Condition
-----------------------------------------------------------
and Results of Operations
-------------------------
Cautionary Statement Regarding Risks and Uncertainties That May Affect Future
- -----------------------------------------------------------------------------
Results
- -------
Except for the historical information contained herein, the matters
discussed below or elsewhere in this Quarterly Report on Form 10-K 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-K, 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.
13
SEC Review of the Company's Filings
- -----------------------------------
In March of 2003, the staff of the Division of Corporation Finance of
the Securities and Exchange Commission selected the Company's periodic reports
for review. The reports reviewed were the Annual Report on Form 10-K for the
fiscal year ended March 31, 2002 and the Quarterly Reports on Form 10-Q for the
periods ended June 30, 2002, September 30, 2002 and December 31, 2002. The SEC
Staff informed the Company that the purpose of the review was to assist the
Company in its compliance with applicable disclosure requirements and to enhance
the overall disclosure in the Company's reports. In the course of its review,
the SEC Staff requested clarification of certain of the Company's disclosures
and items in its financial statements.
Butler Contracts
- ----------------
As a result of discussions with the SEC's Division of Corporation
Finance, the Company requested guidance from the SEC's Office of the Chief
Accountant ("SEC Staff") concerning, the appropriate revenue recognition policy
which should be applied by the Company with respect to the Butler-obligor
contracts. After considering the guidance received from the SEC Staff, the
Company has restated its financial statements for the fiscal years ending on
March 31, 2001, 2002 and 2003 in order to change the method of recognizing
revenue from service contracts in which Butler is the named obligor and to give
effect to certain transactions which relate to Butler. These changes which are
reflected in Footnote 2 to the Financial Statements in this Annual Report,
include the following:
o The Company has recognized revenues from contracts in which
Butler was the obligor on a straight-line basis over the life
of the service contracts.
o The Company has set up a loss reserve for the estimated cost
of all claims under service contracts previously insured by
Reliance.
o The Company has eliminated any contractual obligations
recorded with Butler.
o Additionally, the Company now presents line items for Gross
Revenue, Direct Costs and Gross Profit in its financial
statements. Previously, the Company had only recognized
revenue on a net basis.
The Company, with the concurrence of its outside auditors, had previously
accounted for the Butler-related transactions based upon the legal obligations
of the parties and the regulatory requirements which applied to the
transactions. The changes which the Company has adopted are solely for financial
reporting purposes. Butler will remain responsible for the same obligations
under the service contracts which existed prior to the change in financial
presentation. The obligations of Butler under all service contracts sold after
July 25, 2000 were, and continue to be, assumed by an A-rated insurance carrier
which is a subsidiary of a New York Stock Exchange Company with over $19 billion
in assets. Butler also remains the licensed entity which is recognized as the
obligor under the service contracts regulated by the insurance departments in
all the states in which Butler does business.
Dealer-Obligor Contracts
- ------------------------
Historically, the Company has recognized the major portion of the revenues
from the dealer-obligor contracts upon a sale to the consumer by the
dealer/retailer and has deferred a minor portion of those revenues.
With the issuance of EITF 00-21, the Company and its accountants, with the
guidance of the SEC Staff in early 2004, have determined that, in order to
continue to recognize income under the dealer-obligor contracts in the same
manner as it has done historically, the Company must develop adequate evidence
of the fair value of the two elements of its services - the sale and structuring
of the contracts and the claims adjudication services. Without this evidence,
the Company would be required to recognize all of the income associated with the
dealer-obligor contracts over the life of the contracts. This would have the
effect of deferring to later periods the substantial portion of these revenues
14
which the Company has previously recognized up front. This would then have the
further effect of substantially deferring the current year's income to future
periods and may in fact cause the Company to recognize a current net loss.
The SEC Staff offered its guidance that the Company's evidence to date has
not been sufficient to meet the standards of EITF Abstracts Issue No. 00-21
"Revenue Arrangements with Multiple Deliverables".
Based on the SEC Staff's 2004 guidance, the Company recognizes all of the
income from the Dealer-Obligor Contracts over the life of the contracts.
These accounting changes do not have an impact on Warrantech's cash flows
or its cash balances which the Company believes drives its business. The
deferral of revenues to future periods results in a significant negative net
worth and a corresponding increase in Deferred Income on the Balance Sheet.
However, the revenue recognition accounting change will also have a positive
effect on the results for future periods.
General
- -------
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 in the Automotive and
Consumer Products segments, the Company contracts with highly rated independent
insurance companies or risk retention groups 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. In
the Home segment, the Company is self insured.
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 for the Automotive and Consumer Products segments 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 these Plans are performed by independent
third party repair facilities or dealers. The cost of any repair or replacement
under these plans is generally paid by the insurance company. Notwithstanding
the forgoing, however, certain Plans were insured by Reliance which was placed
in liquidation in 2002. For a more detailed discussion of claims handling under
Plans insured by Reliance, see "Management's Discussion and Analysis-Insurer in
Liquidation" below. For a more detailed discussion of the responsibilities of
obligors and insurers under the Plans, see "Contract Obligors" and "Insurance"
in Item I of this Annual Report on Form 10 K. Plans for the Home segment are
generally for twelve months. The cost of any repair or replacement for plans in
the Home segment is paid for by the Company.
The Company operates in three major business segments: Automotive, Consumer
Products and International. The Automotive segment designs, develops, markets
and acts as a third party administrator for vehicle service contract ("VSC")
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 and
motorcycle dealers, leasing companies, repair facilities, retail stores,
financial institutions and other specialty marketers.
15
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. Warrantech 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. It also 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.
Insurer in Liquidation
- ----------------------
During the second fiscal quarter of 2002, the Pennsylvania Insurance
Commissioner informed the Company that Reliance would be liquidated and cease
making payments on claims. The Pennsylvania Insurance Commissioner determined
that Reliance was not likely to be able to satisfy all of the claims that would
be submitted to it due to the circumstances arising out of the September 11,
2001 terrorist attacks on the World Trade Center. Reliance underwrote
approximately 48% of the automotive service contracts that were sold by
Warrantech Automotive during approximately one and one-half years ending in
November 2001. Approximately 52% of the automotive service contracts sold by
Warrantech Automotive during that period are not affected by the Reliance
liquidation. Service contracts sold before and after that period are not
affected because they are underwritten by other insurance companies.
Warrantech Automotive was the named obligor, as well as the administrator,
under some of the vehicle service contracts insured by Reliance. As the obligor,
Warrantech Automotive would ultimately be responsible for paying for the repairs
under such contracts. Additionally, for financial reporting purposes only,
Warrantech is treated as the obligor under the service contracts in which Butler
is the named obligor. While Warrantech is not obligated to pay claims under such
service contracts, it has treated the claims obligations under the
Butler-obligor contracts, including the service contracts which were insured by
Reliance, as obligations of the Company for accounting purposes.
Prior to Reliance's liquidation, Reliance covered the cost of the repairs
under the insurance policies it provided. Because of Reliance's liquidation,
insurance coverage for the Company's obligations under those service contracts
ceased to exist. However, a non-insurance affiliate of Reliance, Reliance
Warranty Company ("RWC"), which was not placed in liquidation, held premiums
totaling approximately $15,892,635 relating to a portion of the service
contracts in which Butler, the retailer/dealers and Warrantech Automotive were
the named obligors. The Company received $15,892,635 from RWC during the fourth
quarter of fiscal 2004, as part of a settlement for claims paid by the Company
on behalf of RWC
Funding to cover these uninsured claims is provided by a special surcharge,
which is payable on applicable VSC's sold under a Program after November 19,
2001. This surcharge will be paid by clients through which Reliance-insured
VSC's were sold. These funds will be used to pay valid claims submitted under
VSC's previously insured by Reliance.
To mitigate its claims liability expense resulting from Reliance's
liquidation, the Company is attempting to ascertain if any recovery is available
on Federal subsidies as a result of the terrorist attacks to the insurance
industry in general or Reliance specifically, to pay vehicle service contract
claims. If such subsidies are available, it could take years before recovery, if
any, is obtained. In February 2005, the Company also began legal proceedings for
recovery of approximately $3 million against certain state guaranty funds. In
June 2005, the Company made its first state guaranty settlement with one of the
defendants in its action.
16
Butler Financial Services, LLC
- ------------------------------
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 for the Automotive and Consumer Products segments. As
a result, the insurance company is ultimately responsible for paying the cost of
any and all valid claims submitted under the Plans. 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, 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.
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. Furthermore, Butler has 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. 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.
Certain of the Plans under which Butler is the designated obligor were
insured by Reliance. The liquidation of Reliance (see "Management's Discussion
and Analysis - Insurer in Liquidation" above) has eliminated Butler's insurance
coverage under those Plans. 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.
For financial reporting purposes, for the reasons stated in Footnote 2 of
the Financial Statements annexed to this Report, the Company has adopted a
policy to treat the Butler-obligor contracts as if they were
administrator-obligor contracts and recognizes revenues under such contracts
pursuant to TB 90-1. The Company also includes, as its own liabilities,
liabilities of Butler relating to such contracts. Additionally, because the
Company is treating the Butler-obligor contracts as Warrantech-obligor contracts
for financial 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
17
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.
Significant Customer Bankruptcy
- -------------------------------
On January 11, 2005, Ultimate Electronics, Inc. and six of its
subsidiaries ("Ultimate") filed individual voluntary petitions for relief under
Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court for the
District of Delaware. Sales to Ultimate represent 10% and 32% of the Company's
and its Consumer Products segment's total gross revenues during fiscal 2005,
making it the Company's and Consumer Products segment's largest customer.
Pursuant to the provisions of Chapter 11, Warrantech was obligated to honor its
existing contact with Ultimate and Ultimate continued to sell service contracts
during this period of reorganization. At present, Ultimate is current in its
payments to Warrantech with respect to sales subsequent to January 11, 2005 "
post-petition sales " . At the time of filing, however, Warrantech believes that
Ultimate owed it approximately $3.27 million for sales up to January 11, 2005 "
pre-petition sales" and Warrantech has filed a "proof of claim" in this amount
with the Court. At this time, it is impossible to estimate what Warrantech will
recover on its claim. Final Bankruptcy Court settlements are expected to take
place during the third fiscal 2006 quarter.
In separate orders dated April 19, 2005, the Court approved the
following two actions. Thirty (30) of Ultimate's stores were scheduled for
closing and a liquidator was retained to dispose of existing inventory. The
liquidator was authorized by the Court to sell Warrantech service contracts
during the liquidation period in accordance with the terms of the existing
Ultimate contract. At this time, the liquidation has been substantially
completed. The remaining stores were purchased by Mark Wattles, the principal
shareholder of Ultimate, through an entity named Ultimate Acquisition Partners,
L.P. ("Acquisition"). As part of the Purchase Agreement, Acquisition was given
until August 31, 2005, to decide if it wants to assume Ultimate's contract with
Warrantech. If it chooses to assume the contract, it must reach an agreement
with Warrantech with respect to satisfaction of Warrantech's pre-petition claim.
Until such decision is made, Acquisition can continue to sell Warrantech service
contracts in accordance with the terms of the Ultimate contract. If Acquisition
elects not to assume the existing Ultimate contract, it can negotiate a new
agreement with Warrantech (in which no cure payment would be legally required)
or it can select a new service contract provider. At this time, no such decision
has been made.
At March 31, 2005, the Company was owed $3.7 million by Ultimate, in
which the Company has filed a proof of claim for $3.27 million with the
bankruptcy court. The remaining balance has subsequently been paid. No provision
for bad debts has been recorded as of the fiscal year ended March 31, 2005.
18
Results of Operations
- ---------------------
The following information should be read in conjunction with the
information contained in the Consolidated Financial Statements and the Notes
thereto included in "Item 8 - Financial Statements and Supplementary Data" of
this Annual Report.
Gross Revenues
--------------
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Automotive segment $ 69,374,933 $103,494,113 $108,025,461
Consumer Products segment 43,769,810 38,912,282 33,613,253
International segment 6,622,986 6,921,872 5,115,897
Other -- -- --
------------ ------------ ------------
Gross revenues $119,767,729 $149,328,267 $146,754,611
============ ============ ============
Gross revenues for the year ended March 31, 2005 decreased $29,560,538 or
25% over fiscal 2004. The Consumer Products segment reported increased gross
revenues of 12% in the year ended March 31, 2005 over 2004, while the Automotive
segment reported a decrease in gross revenues of 33%, during the same period.
Gross revenues for the year ended March 31, 2004 increased $2,573,656 or 2% over
fiscal 2003. The Consumer Products and International segments reported increased
gross revenues of 16% and 35% respectively, in the year ended March 31, 2004
over 2003, while the Automotive segment reported a decrease in gross revenues of
4% during the same period. The decrease in gross revenues in the Automotive
segment was due to the downturn in sales of new cars and a reduction in volume
arising from premium rate increases. 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 decrease in gross revenues during fiscal year
2005, resulted from lower sales volumes in Puerto Rico due to the suspension of
auto warranty sales, partially offset by higher sales volume from customers in
South America.
Direct Costs
------------
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Direct costs $ 84,908,247 $ 87,427,618 $ 62,549,340
============ ============ ============
Direct costs are those costs directly related to the production and
acquisition of service contracts. These costs consist primarily of insurance
premiums and commission expenses. Direct costs for the fiscal year ended March
31, 2005 of $84,908,247, decreased $2,519,371 or 3% as compared with $87,427,618
during the fiscal year ended March 31, 2004. Direct costs for the fiscal year
ended March 31, 2004 of $87,427,618, increased $24,878,278 or 40% as compared
with $62,549,340 during the fiscal year ended March 31, 2003.
SG&A
----
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Service, selling and general administrative $ 26,738,026 $ 29,931,180 $ 30,573,275
============ ============ ============
Service, selling and general and administrative expenses ("SG&A") for 2005
decreased $3,193,154 or 11% compared to 2004. Legal expenses increased $369,750
for the year ended March 31, 2005 compared to 2004, primarily due to legal costs
associated with the SEC review in early 2005. Employee costs decreased
$1,461,171 from $17,843,137 in fiscal 2004 to $16,381,966 for the year ended
March 31, 2005, primarily due to the deferral of employee sales related
19
compensation to future years. Rent and related costs expense decreased $528,720
from $2,174,973 for the year ended March 31, 2004 to $1,646,253 for the year
ended March 31, 2005, reflecting lower deferred rent charges as a result of the
Company's move to its new corporate headquarters in Bedford, Texas.
Service, selling and general and administrative expenses ("SG&A") for 2004
decreased $642,095 or 2% compared to 2003. Legal expenses decreased $1,336,499
for the year ended March 31, 2004 compared to 2003, primarily due to the
settlement of several lawsuits during fiscal 2003. Employee costs increased from
$17,499,958 in fiscal 2003 to $17,843,137 for the year ended March 31, 2004,
primarily due to an increase in health care costs. Rent expense increased
$312,319 from $1,862,654 for the year ended March 31, 2003 to $2,174,973 for the
year ended March 31, 2004, reflecting the Company's move to its new corporate
headquarters in Bedford, Texas.
Depreciation and amortization
-----------------------------
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Depreciation and amortization $ 2,549,970 $ 3,280,604 $ 3,885,054
============ ============ ============
Depreciation and amortization expenses were reduced by $730,634 or 22%
during 2005 compared to 2004 and by $604,450 or 16% during 2004 compared to
2003. The decrease in depreciation and amortization is the result of the
Company's assets maturing and a reduced requirement for capital expenditures for
the past few years.
Provision for bad debts
-----------------------
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Provision for bad debts $ 4,045,271 $ 590,000 $ 150,444
============ ============ ============
Provision for bad debts increased $3,455,271 during the fiscal year
2005. During fiscal year ending March 31, 2005 and March 31, 2004, the Company
incurred $1,865,399 and $1,853,555, respectively, in legal expenses related to
the Lloyd's litigation. The Company, in anticipation of receiving reimbursement
for these expenses from its insurance company under a professional liability
insurance policy, deferred the legal fees. In January 2005, as a result of a
summary judgment, the court ruled that the insurance company was not responsible
for payment of the Company's legal costs. The Company has appealed the court's
decision. As a result of the lower court's ruling, the Company has provided for
this potential bad debt of $3,718,954 during the year ended March 31, 2005.
Other income
------------
For the Years Ended March 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Interest and dividend income $ 592,562 $ 615,248 $ 647,372
Interest expense (586,665) (690,019) (275,185)
Gain (loss) on sale of assets 635 1,195 (70,463)
Credit card usage rebate 778,124 541,345 453,760
Miscellaneous income 73,204 106,691 18,789
------------ ------------ ------------
Total other income $ 857,860 $ 574,460 $ 774,273
============ ============ ============
20
Other income for 2005 increased $283,690 or 49% compared to 2004, primarily
due to higher rebates from usage by the Company of its credit card transactions
Other income for 2004 decreased $199,814 or 26% compared to 2003. Higher
interest expense, primarily due to the Company's extended payment terms for its
insurance premium payable, was partially offset by higher miscellaneous income
resulting from the sublease of the Company's former location which ceased in
March 2004.
Provision for income taxes
--------------------------
For the Years Ended March 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Provision for income taxes ($ 640,960) ($ 177,292) $ 386,616
============ ============ ============
The net deferred tax asset as of March 31, 2005, 2004 and 2003 contained a
benefit of $725,544, $137,456, and $205,470, respectively, related to foreign
losses. Management does not believe the amount of this benefit is more likely
than not to be realized. Accordingly, management has reserved the amount of this
benefit.
Comprehensive Income
--------------------
For the Years Ended March 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Net income (loss) ($ 3,607,793) ($ 516,371) $ 1,466,892
Other comprehensive income (loss), net of tax
Unrealized gain (loss) on investments (5,254) (17,083) 13,713
Foreign currency translation adjustments 86,909 364,858 (158,659)
------------ ------------ ------------
Comprehensive income (loss) ($ 3,526,138) ($ 168,596) $ 1,321,946
============ ============ ============
Comprehensive income (loss) per share: ($ 0.23) ($ 0.01) $ 0.09
============ ============ ============
Gains from foreign currency translation adjustments decreased $277,949 for
the year ended March 31, 2005 compared to 2004 and foreign currency translation
adjustments gains were $364,858 for the year-ended March 31, 2004 compared to
losses of $158,659 for 2003, primarily due to Peru and Chile foreign currency
translation fluctuations.
Agreements
- ----------
The Company entered into agreements with Butler and GAIC to arrange for the
coverage of claims filed under the service contracts previously insured by
Reliance. Under these agreements, Butler agreed to assume all the obligations to
pay the claims under the service contracts which were covered by the premiums
being held by RWC. The Company executed an agreement with GAIC that provides the
Company with extended payment terms and a $3 million line of credit ("GAIC
Agreement"). All of the Company's obligations to GAIC pursuant to the GAIC
Agreement are secured by all of the Company's Automotive and Consumer Products
segment's accounts receivable, which were $19,118,161 and $21,946,394 at March
31, 2005 and 2004, respectively. Further, GAIC received options to purchase up
to 1,650,000 shares of Warrantech's common stock at an exercise price of $1.00
per share subject to certain adjustments. In the event that GAIC exercises all
of these options, it would own approximately 9.7% of the Company's outstanding
shares.
Under an agreement between Butler and RWC that was finalized in the fourth
quarter of 2004, $15,892,635 of funds held by RWC were remitted to the Company
in repayment of the money which the Company had advanced to pay claims on
certain service contracts that had been insured by Reliance and its affiliates.
The Company agreed, as a condition of RWC remitting the $15,892,635, to
guarantee certain indemnification obligations of Butler under its agreement with
Reliance.
21
Funding to cover the uninsured claims is provided by a special
surcharge, which is payable on applicable VSC's sold under a Program after
November 19, 2001. This surcharge will be paid by clients through which
Reliance-insured VSC's were sold. These funds will be used to pay valid claims
submitted under VSC's previously insured by Reliance.
During the years ended March 31, 2005, 2004, 2003 and 2002, the Company
paid $4,727,643, $9,262,407, $10,959,364 and $5,770,999, respectively, in claims
related to Reliance obligations. Remaining amounts are expected to be paid out
as set forth in the following table.
Expected Payment Date
---------------------------------------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total
---------- ---------- ---------- ---------- ---------- ---------- ----------
Claims loss liability $2,930,559 $1,682,400 $ 120,891 $ 16,614 $ 10,466 $ 3,014 $4,763,944
Liquidity and Capital Resources
- -------------------------------
As of March 31, 2005, total cash and short-term investments totaled
$6,030,092, a decrease of $570,412 or 9% from $6,600,504 at March 31, 2004.
During the fiscal year ended March 31, 2005, the Company generated net cash from
operations totaling $280,170, compared to $324,252 for the fiscal year ended
March 31, 2004. The change in net cash from operations is due to an increase in
insurance premiums payable, reflecting the use of a $3 million line of credit
from GAIC. The unfavorable changes in its working capital from a negative $7.2
million at March 31, 2004 to a negative $15.1 million at March 31, 2005 was due
primarily due to an increase in insurance premium payable. During fiscal year
2005, the Company decreased its accounts receivable by $3.1 million as a result
of lower sales from its automotive business and the Company's other receivables
were reduced by a net $1.1 million, primarily as a result of a write down to bad
debt. The Company offset the use of those funds with a $7.1 million increase in
its insurance premiums payable, primarily, due to extended payment terms and the
use of a $3 million line of credit from GAIC.
The Company believes that internally generated funds and the $3 million
line of credit from GAIC, 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.
The Company plans 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.
During the fiscal year ended March 31, 2005, the Company used $239,443 in
cash in investing activities compared to the use of $683,822 in investing
activities in the prior year. This decrease in use of funds of $444,379 is
primarily due to an increase in proceeds from the sale of marketable securities.
The Company used slightly more funds from the purchase of property and equipment
during the current fiscal year. The Company has ongoing relationships with
equipment financing companies and intends to continue financing certain future
equipment needs through leasing transactions. The total amount financed through
leasing transactions during the fiscal year ended March 31, 2005 amounted to
$538,609 compared to $487,060 during the fiscal year ended March 31, 2004. At
fiscal year end 2005, the Company had $1,465,610 in debt from capital lease
obligations compared to $1,645,309 at fiscal year-end 2004.
During the fiscal year ended March 31, 2005, the Company used $678,754 in
cash from financing activities compared to $833,187 in fiscal year 2004. The
variance was primarily due a decrease in the Company's capital leases.
22
During the fiscal year ended March 31, 2005 the Company repurchased 32,500
shares of its common stock for an aggregate amount of $23,956 compared to the
previous year when it did not repurchase any common stock
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.
Loans to Directors
- ------------------
On July 6, 1998, Joel San Antonio, Warrantech's Chairman and Chief
Executive Officer, and William Tweed and Jeff J. White, members of Warrantech's
Board of Directors, exercised an aggregate of 3,000,000 of their vested options
to purchase Warrantech common stock. Promissory notes totaling $8,062,500 were
signed with interest payable over three years at an annual rate of 6%. The
promissory notes, which were with recourse and secured by the stock certificates
issued, matured July 5, 2001. The value of the collateral for the Notes, which
consists of a total of 3,040,000 shares of the Company's common stock, is
currently $1,824,000, as of May 31, 2005, based upon the market price of the
stock on that date. Under the loan documents, the Company does not have a right
to require the payors to increase the loan collateral. On March 22, 1999, Joel
San Antonio delivered an additional promissory note for $595,634, payable to the
Company, representing the amounts funded by the Company for the payroll taxes
payable by him upon the exercise of these options. The exercise of these stock
options and the anticipated tax benefit from this transaction represented
approximately $10 million. .
In February 2000, the Company agreed to restructure the loans to Mr. Tweed
and Mr. White by capitalizing the interest due and extending the loan maturity
from July 5, 2001 until January 31, 2005. Interest on the restructured loans
accrued annually at the applicable federal rate of 6.2%. Under the
restructuring, interest first became payable on the third anniversary of the
restructuring and was payable annually thereafter. In July 2002, the Company
extended the loan maturity dates until February 1, 2007 (the "loan extension").
The interest, which accrued on the notes up to the time of the loan extension,
was added to the principal of the notes. The new principal amount of Mr. Tweed's
note is $3,189,675 and of Mr. White's note is $2,912,430. The applicable federal
interest rate on the notes following the loan extension is 4.6%. Under the loan
extension, interest on the notes will accrue until February 1, 2005 and, at that
time, the accrued interest will be added to the principal of the notes.
Commencing on February 1, 2005, interest on the new principal amount of the
loans to Mssr. Tweed and White is payable annually in arrears, with the first
interest payment becoming due on February 1, 2006.
In February 2000, the Company also agreed to restructure the two
existing loans to Mr. San Antonio (as restructured, the "Combined Loan"). The
Combined Loan, finalized in March 2001, was due on January 31, 2005 and accrued
interest annually at 5.2%. In July 2002, the Company extended the loan maturity
date until February 1, 2007 and the interest rate was changed to the then
applicable federal rate of 4.6%. The principal amount of Mr. San Antonio's note
is $4,165,062. Interest will be forgiven as long as Mr. San Antonio continues to
be employed by the Company. The $194,786, $194,786 and $200,506 of interest
which accrued on the note during fiscal years 2005, 2004 and 2003, respectively
has been forgiven. The interest was charged to operations as additional
compensation in the respective fiscal years the interest income was accrued.
The total amount of the restructured loans to Mr. Tweed, Mr. White and Mr.
San Antonio at March 31, 2005 and March 31, 2004, including the capitalized
interest of $764,899 and $480,303, is $ 11,032,065 and $10,747,470,
respectively.
23
Commitments
- -----------
Set forth below is information about the Company's commitments outstanding
at March 31, 2005.
Payments due by period
------------------------------------------------------------------------
Less than 1 - 3 3 - 5 More than
Commitment Type Total 1 year Years Years 5 years
- ------------------------- ------------ ------------ ------------ ------------ ------------
Capital lease obligations $ 1,706,794 $ 660,589 $ 855,531 $ 190,674 $ --
Operating leases 10,082,662 1,268,616 2,479,369 2,576,818 3,757,859
Employment agreements 6,614,957 2,484,937 3,638,770 491,250 --
Claims loss liability 4,763,944 2,930,559 1,803,291 27,080 3,014
------------ ------------ ------------ ------------ ------------
Total commitments $ 23,168,357 $ 7,344,701 $ 8,776,961 $ 3,285,822 $ 3,760,873
============ ============ ============ ============ ============
The effect of inflation has not been significant to the Company.
Critical Accounting Policies
- ----------------------------
Revenue Recognition Policy
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 the "Item 8. - Financial Statements and
Supplementary Data," 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.
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
24
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's 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" 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, 2005 and 2004,
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 March 31, 2005, the Company had deferred tax assets of
$23,426,366, net of a valuation allowance of $1,255,462.
25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
----------------------------------------------------------
As of March 31, 2005, 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 March 31, 2005 of marketable
securities are as follows:
Expected Maturity Date
---------------------------------------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Available for sale
securities $1,425,000 $ 595,000 $ -- $ -- $ -- $ -- $2,020,000 $2,043,758
Interest rate 3.51% 4.09%
Principal amounts by expected maturity as of March 31, 2004 of marketable
securities are as follows:
Expected Maturity Date
---------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Available for sale
securities $1,355,000 $925,000 $ 120,000 $ -- $ -- $ -- $2,400,000 $2,454,131
Interest rate 4.36% 3.95% 1.99%
The following table sets forth the carrying amounts and fair values of the
Company's other receivables at March 31, 2005.
Expected Maturity Date
---------------------------------------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Other Receivables -
0% interest $6,211,793 $ -- $ -- $ -- $ -- $ -- $6,211,793 $6,211,793
The following table sets forth the carrying amounts and fair values of the
Company's other receivables at March 31, 2004.
Expected Maturity Date
---------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Other Receivables -
0% interest $7,322,289 $ -- $ -- $ -- $ -- $ -- $7,322,289 $7,322,289
26
Item 8. Financial Statements and Supplementary Data
-------------------------------------------
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND
FINANCIAL STATEMENT SCHEDULES
Page No.
--------
Report of Independent Auditors........................................... 28
Consolidated Financial Statements:
Statements of Operations and Comprehensive Income
For the Fiscal Years Ended March 31, 2005, 2004 and 2003........ 29
Balance Sheets as of March 31, 2005 and 2004.................... 30
Statements of Common Stockholders' Equity (Capital Deficiency)
For the Fiscal Years Ended March 31, 2005, 2004 and 2003........ 32
Statements of Cash Flows
For the Fiscal Years Ended March 31, 2005, 2004 and 2003........ 33
Notes to Consolidated Financial Statements............................... 34
Consolidated Financial Statement Schedules:
Schedule VIII - Valuation and Qualifying Accounts........................ 54
All other schedules for which provision is made in applicable accounting
regulations of the Securities and Exchange Commission are not required under the
related instructions or are inapplicable and therefore have been omitted or the
information is presented in the consolidated financial statements or
accompanying notes.
27
[GRAPHIC OMITTED] WEINICK
SANDERS 1375 BROADWAY
LEVENTHAL & CO. LLP NEW YORK, N.Y. 10018-7010
-------------------------------------------------------------
CERTIFIED PUBLIC ACCOUNTANTS 212-869-3333
FAX: 212-764-3060
WWW.WSLCO.COM
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Warrantech Corporation
We have audited the accompanying consolidated balance sheets of
Warrantech Corporation and Subsidiaries as of March 31, 2005 and 2004 and its
related consolidated statements of operations and comprehensive income, common
stockholders' equity (capital deficiency) and cash flows for the fiscal years
ended March 31, 2005, 2004 and 2003. Our audits also included the financial
statement schedules listed in the index. These consolidated financial statements
and schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules based on our audits.
We conducted our audits in accordance with the standards of the Public
Company Accounting Oversight Board (Unites States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Warrantech Corporation and Subsidiaries at March 31, 2005 and 2004 and the
consolidated results of their operations and comprehensive income and their cash
flows for the years ended March 31, 2005, 2004 and 2003, in conformity with
accounting principles generally accepted in the United States of America. Also,
in our opinion, the related consolidated financial statement schedules, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information set forth therein.
/s/ Weinick Sanders Leventhal & Co., LLP
----------------------------------------
New York, NY
June 15, 2005
28
WARRANTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
For the Twelve Months Ended
March 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
Gross revenues $ 119,767,729 $ 149,328,267 $ 146,754,611
------------- ------------- -------------
Net (increase) decrease in deferred revenues (6,632,830) (29,366,988) (48,517,264)
------------- ------------- -------------
Net revenues 113,134,899 119,961,279 98,237,347
Direct costs 84,908,245 87,427,618 62,549,340
------------- ------------- -------------
Gross Profit $ 28,226,654 $ 32,533,661 $ 35,688,007
------------- ------------- -------------
Operating expenses
Service, selling, and general and administrative 26,738,026 29,931,180 30,573,275
Provision for bad debt expense 4,045,271 590,000 150,444
Depreciation and amortization 2,549,970 3,280,604 3,885,054
------------- ------------- -------------
Total costs and expenses 33,333,267 33,801,784 34,608,773
------------- ------------- -------------
Income (loss) from operations (5,106,613) (1,268,123) 1,079,234
Other income 857,860 574,460 774,274
------------- ------------- -------------
Income (loss) before provision for income taxes (4,248,753) (693,663) 1,853,508
Provision for income taxes (640,960) (177,292) 386,616
------------- ------------- -------------
Net income (loss) ($ 3,607,793) ($ 516,371) $ 1,466,892
============= ============= =============
Earnings (loss) per share:
Basic ($ 0.23) ($ 0.03) $ 0.10
============= ============= =============
Diluted ($ 0.23) ($ 0.03) $ 0.10
============= ============= =============
Weighted average number of shares outstanding:
Basic 15,396,342 15,344,563 15,317,881
============= ============= =============
Diluted 15,469,074 15,569,608 15,398,910
============= ============= =============
Comprehensive Income
- --------------------
For the Years Ended March 31,
-----------------------------------------------
2005 2004 2003
------------- ------------- -------------
Net income (loss) ($ 3,607,793) ($ 516,371) $ 1,466,892
Other comprehensive income (loss), net of tax
Unrealized gain (loss) on investments (5,254) (17,083) 13,713
Foreign currency translation adjustments 86,909 364,858 (158,659)
------------- ------------- -------------
Comprehensive income (loss) ($ 3,526,138) ($ 168,596) $ 1,321,946
============= ============= =============
Comprehensive income (loss) per share: ($ 0.23) ($ 0.01) $ 0.09
============= ============= =============
See report of independent auditors and accompanying notes to
consolidated financial statements.
29
WARRANTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, March 31,
2005 2004
------------ ------------
A S S E T S
-----------
Current assets:
Cash and cash equivalents $ 4,591,746 $ 5,229,773
Investments in marketable securities 1,438,346 1,370,731
Accounts receivable, (net of allowances of $576,832 and $233,667,
respectively) 20,297,743 23,369,612
Other receivables, (net of allowances of $3,718,954 and $0,
respectively) 6,211,793 7,322,289
Employee receivables 42,912 70,908
Deferred income taxes 5,786,881 3,478,250
Prepaid taxes 41,530 --
Prepaid expenses and other current assets 945,786 728,265
------------ ------------
Total current assets 39,356,737 41,569,828
------------ ------------
Property and equipment, net 4,356,537 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 17,639,485 18,879,171
Deferred direct costs 198,333,403 186,513,417
Investments in marketable securities 605,412 1,083,400
Restricted cash 800,000 825,000
Split dollar life insurance policies 900,145 900,145
Other assets 34,830 29,448
------------ ------------
Total other assets 219,950,565 209,867,871
------------ ------------
Total Assets $263,663,839 $257,184,550
============ ============
See report of independent auditors and accompanying notes to
consolidated financial statements.
30
WARRANTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
March 31, March 31,
2005 2004
------------- -------------
LIABILITIES AND STOCKHOLDERS' EQUITY (CAPITAL DEFICIENCY)
- ---------------------------------------------------------
Current liabilities:
Current maturities of long-term debt and capital lease obligations $ 541,626 $ 664,406
Insurance premiums payable 38,721,325 31,613,047
Income taxes payable -- 48,099
Accounts and commissions payable 7,952,621 7,083,459
Claims loss liability 2,930,559 5,608,893
Accrued expenses and other current liabilities 4,341,754 3,776,199
------------- -------------
Total current liabilities 54,487,885 48,794,103
------------- -------------
Deferred revenues 235,588,801 228,955,971
Claims loss liability 1,833,385 3,882,685
Long-term debt and capital lease obligations 923,984 980,903
Deferred rent payable 439,468 369,839
------------- -------------
Total liabilities 293,273,523 282,983,501
------------- -------------
Commitments and contingencies -- --
Stockholders' equity (capital deficiency):
Preferred stock - $.0007 par value authorized - 15,000,000 Shares
issued - none at March 31, 2005 and March 31, 2004 -- --
Common stock - $.007 par value authorized - 30,000,000 Shares
issued - 16,586,283 shares at March 31, 2005 and March 31, 2004
16,586,283 shares at March 31, 2004 116,106 116,106
Additional paid-in capital 23,800,228 23,800,228
Loans to directors and officers (11,032,065) (10,747,470)
Accumulated other comprehensive income, net of taxes 232,456 150,801
Retained earnings (deficit) (38,538,852) (34,931,059)
------------- -------------
(25,422,127) (21,611,394)
Treasury stock - at cost, 1,187,606 shares at March 31, 2005 and
March 31, 2004 (4,187,557) (4,187,557)
------------- -------------
Total Stockholders' Equity (Capital Deficiency) (29,609,684) (25,798,951)
------------- -------------
Total Liabilities and Stockholders' Equity (Capital Deficiency) $ 263,663,839 $ 257,184,550
============= =============
See report of independent auditors and accompanying notes to
consolidated financial statements.
31
WARRANTECH CORPORATION AND SUBSIDIARIES
---------------------------------------
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY (CAPITAL DEFIECINCY)
For the Years Ended March 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Common Stock Outstanding (shares)
- ---------------------------------
Balance, beginning of year 16,586,283 16,530,324 16,525,324
Exercise of common stock options -- 48,667 5,000
Issuance of common stock -- 7,292 --
------------ ------------ ------------
Balance, end of year 16,586,283 16,586,283 16,530,324
============ ============ ============
Common Stock (amount)
- ---------------------
Balance, beginning of year $ 116,106 $ 115,714 $ 115,679
Exercise of common stock options -- 341 35
Issuance of common stock -- 51 --
------------ ------------ ------------
Balance, end of year $ 116,106 $ 116,106 $ 115,714
============ ============ ============
Additional Paid-In Capital
- --------------------------
Balance, beginning of year $ 23,800,228 $ 23,760,809 $ 23,745,944
Exercise of unrestricted common stock options -- -- 2,065
Exercise of restricted common stock options -- -- 12,800
Issuance of common stock -- 39,419 --
------------ ------------ ------------
Balance, end of year $ 23,800,228 $ 23,800,228 $ 23,760,809
============ ============ ============
Loans to Directors and Officers
- -------------------------------
Balance, beginning of year ($10,747,470) ($10,462,094) ($10,163,875)
Current year interest on loans (284,595) (285,376) (298,219)
------------ ------------ ------------
Balance, end of year ($11,032,065) ($10,747,470) ($10,462,094)
============ ============ ============
Accumulated Other Comprehensive Income
- --------------------------------------
Balance, beginning of year $ 150,801 ($ 196,974) ($ 52,028)
Foreign currency translation adjustments 86,909 364,858 (158,659)
Unrealized gain (loss) on investments (5,254) (17,083) 13,713
------------ ------------ ------------
Balance, end of year $ 232,456 $ 150,801 ($ 196,974)
============ ============ ============
Retained Earnings (Accumulated Deficit)
- ---------------------------------------
Balance, beginning of year ($34,931,059) ($34,414,688) ($35,881,580)
Net income (loss) (3,607,793) (516,371) 1,466,892
------------ ------------ ------------
Balance, end of year ($38,538,852) ($34,931,059) ($34,414,688)
============ ============ ============
Common stock in treasury (shares)
- ---------------------------------
Balance, beginning of year (1,187,606) (1,249,690) (1,212,159)
Purchase of treasury shares (32,500) -- (259,753)
Issuance of treasury shares 32,500 62,084 222,222
------------ ------------ ------------
Balance, end of year (1,187,606) (1,187,606) (1,249,690)
============ ============ ============
Common stock in treasury (amount)
- ---------------------------------
Balance, beginning of year ($ 4,187,557) ($ 4,274,670) ($ 4,224,641)
Purchase of treasury shares (23,956) -- (155,774)
Issuance of treasury shares 23,956 87,113 105,745
------------ ------------ ------------
Balance, end of year ($ 4,187,557) ($ 4,187,557) ($ 4,274,670)
============ ============ ============
------------ ------------ ------------
Total Stockholders' Equity (Capital Deficiency) ($29,609,684) ($25,798,951) ($25,471,901 )
- ----------------------------------------------- ============ ============ ============
See report of independent auditors and accompanying notes to
consolidated financial statements.
32
WARRANTECH CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended March 31,
--------------------------------------------
2005 2004 2003
------------ ------------ ------------
Cash flows from operating activities:
Net income (loss) ($ 3,607,793) ($ 516,371) $ 1,466,892
------------ ------------ ------------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,549,970 3,280,604 3,885,054
Compensatory element of stock options -- -- 12,800
Provision for bad debt expense 4,045,271 590,000 150,444
Deferred revenues 6,632,830 12,235,343 48,890,474
Deferred direct costs (11,819,986) (12,956,068) (47,285,192)
Deferred income taxes (1,068,945) (466,872) 348,098
Deferred rent payable 69,629 (47,881) 227,460
Other (4,234,284) (245,130) (513,039)
Increase (decrease) in cash flows as a result of
changes in asset and liability balances:
Accounts receivable 3,071,869 (1,361,004) (3,566,473)
Other receivables 1,138,492 (2,019,477) (3,150,220)
Receivable from Reliance Warranty, Inc. -- 15,892,635 --
Income taxes (89,629) (33,137) 1,210,312
Prepaid expenses and other current assets (217,521) 490,127 (617,448)
Split dollar life insurance policies -- (23,019) 27,046
Other assets (5,382) 17,674 (2,576)
Insurance premiums payable 7,108,278 (4,457,945) 9,600,727
Accounts and commissions payable 869,162 (1,034,912) 1,157,906
Claims loss liability - Reliance (4,727,634) (9,262,407) (10,959,364)
Accrued expenses and other current liabilities 565,554 242,093 365,440
------------ ------------ ------------
Total Adjustments to reconcile net income to net cash
provided by operating activities: 3,887,673 840,624 (218,551)
------------ ------------ ------------
Net cash flows provided by operating activities 280,170 324,252 1,248,341
------------ ------------ ------------
Cash flows from investing activities:
Property and equipment purchased (619,443) (418,822) (1,818,224)
Purchase of marketable securities (1,245,000) (1,455,000) (790,000)
Decrease in notes receivable -- -- 137,683
Proceeds from sales of marketable securities 1,625,000 1,190,000 945,000
------------ ------------ ------------
Net cash (used) by investing activities (239,443) (683,822) (1,525,541)
------------ ------------ ------------
Cash flows from financing activities:
Exercise of common stock options and stock grants -- 18,868 2,100
Purchase treasury stock (23,956) -- (155,774)
Repayments, notes and capital leases (654,799) (852,055) (845,874)
------------ ------------ ------------
Net cash (used by) financing activities (678,754) (833,187) (999,548)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents (638,027) (1,192,757) (1,276,748)
Cash and cash equivalents at beginning of year 5,229,773 6,422,530 7,699,278
------------ ------------ ------------
Cash and cash equivalents at end of year $ 4,591,746 $ 5,229,773 $ 6,422,530
============ ============ ============
Supplemental Cash Flow Information:
Cash payments (receipts) for:
Interest $ 149,200 $ 148,358 $ 275,185
============ ============ ============
Income taxes $ 566,644 $ 48,650 ($ 1,218,916)
============ ============ ============
Non-cash investing and financing activities:
Property and equipment financed through capital leases $ 538,609 $ 487,060 $ 1,120,273
Increase in loans to officers and directors ($ 284,595) ($ 285,376) ($ 298,219)
Issuance of treasury stock for services rendered $ 23,956 $ 87,113 $ 105,745
See report of independent auditors and accompanying notes to
consolidated financial statements.
33
WARRANTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- --------------------------------------------------------------------------------
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Business - 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 in the Automotive and Consumer Products segments, the
Company contracts with highly rated independent insurance companies or
risk retention groups 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. In
the Home segment, the Company is self insured.
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 for the Automotive and Consumer Products segments 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 these Plans are
performed by independent third party repair facilities or dealers. The
cost of any repair or replacement under these plans is generally paid by
the insurance company or retention group with which the Company has
contracted to provide coverage for the Plan. Plans for the Home segment
are generally for twelve months. The cost of any repair or replacement
for plans in the Home segment is paid for by the Company.
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 for the Automotive
and Consumer Products segments. As a result, the insurance company is
then ultimately responsible for paying the cost of any and all valid
claims submitted under these Plans. 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. 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. 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. 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.
34
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.
Basis of Presentation and Principles of Consolidation - 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 to
the Company. All intercompany accounts and transactions have been
eliminated in consolidation.
Risks and Uncertainties - 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
which affect the reporting of assets and liabilities as of the dates of
the financial statements and revenues and expenses during the reporting
period. Actual results could differ from these estimates.
Revenue Recognition Policy - 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, and has not assumed the obligations of
35
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's
financial condition and are reflected in the Statements of Cash Flows
which are part of these financial statements.
Direct Costs - Direct costs, which consist primarily of insurance
premiums and commissions, are those costs directly related to the
production and acquisition of service contracts. Effective with the
application of the revenue recognition policy 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". This requires that insurance premium costs be
ratably expensed over the life of the service contract.
Profit Sharing Arrangement - Pursuant to certain agreements with its
insurers, the Company may be eligible to share a portion of the insurers'
profits on the Company's service contract programs. The amounts to be
received, if any, are determined based upon the residual value of the
premiums set aside by the insurer to pay losses (the "Loss Fund"). The
residual value is comprised of underwriting profits and investment income
earned on the monies in the Loss Fund. Subsequent adjustments to original
estimates are solely changes in estimates based upon current information,
affording the Company better determination of ultimate profit sharing
revenues and are reflected in income when known. The Company recognized
$41,920, $173,610 and $71,784 in profit sharing on its International
business in the fiscal years ended March 31, 2005, 2004 and 2003,
respectively.
Provision for Bad Debt Expense - The Company's policy is to establish an
allowance for doubtful accounts when receivables are determined to be
uncollectible or impaired.
Earnings Per Share - The Company has adopted Statement of Financial
Accounting Standards No. 128, "Earnings per Share", which modified the
calculation of earnings per share ("EPS".) This Statement replaced the
previous presentation of primary and fully diluted EPS to basic and
diluted EPS. Basic EPS is computed by dividing income available to common
stockholders by the weighted average number of common shares outstanding
for the period. Diluted EPS includes the dilution of common stock
equivalents, and is computed similarly to fully diluted EPS pursuant to
Accounting Principle Board ("APB") Opinion 15. All prior periods
presented have been restated to reflect this adoption.
36
Cash and Cash Equivalents - Cash and cash equivalents for the purpose of
reporting cash flows for all periods presented include cash on deposit
and certificates of deposit. There were no other cash equivalents at
March 31, 2005 and 2004.
At March 31, 2005 and 2004, respectively, the Company had cash on deposit
in excess of federally insured limits of $376,818 and $596,879.
Additionally, at March 31, 2005 and 2004, the Company had cash on deposit
in foreign bank accounts not covered by United States insurance limits of
$1,893,013 and $2,212,626, respectively.
Included in the cash and cash equivalent balances as reported at March
31, 2005 and 2004, respectively, is $1,354,497 and $2,591,419 of cash
related to Butler. Since Butler is a private company, the Company has no
means to determine the disposition of this cash, if any, and, accordingly
management disclaims any knowledge of the existence of this cash or
related assets, liabilities or expenses. As part of its agreement to
receive monies received from RIC, Butler agreed to restrict its cash
received from RWC related to such settlement to be used to pay future
Reliance claims. At March 31, 2005 and March 31, 2004, of the $1,982,012
received from RWC, Butler had $0 and $1,390,064 in such restricted cash
on deposit.
Investments in Marketable Securities - All investments in marketable
securities have been classified as available-for-sale and are carried at
fair value with changes in unrealized gains and losses being reflected as
a separate component of accumulated other comprehensive income, net of
tax.
Property and Equipment - Property and equipment are stated at cost.
Depreciation is provided using the straight-line method over the
estimated useful lives of the related assets ranging between 3 and 7
years.
Capitalization Policy - In accordance with Statement of Position 98-1,
the Company capitalizes purchased software or software development and
implementation costs incurred internally or through independent
consultants related to the Company's state of the art proprietary
relational database and interactive operating software for warranty
tracking and sales. These systems are only available for internal uses
and are not available for purchase by outside parties. All direct
implementation costs and purchased software costs are capitalized and
amortized using the straight-line method over their estimated useful
lives not to exceed a five-year period. Of the $1,793,937 and $2,849,015
of net unamortized software development costs at March 31, 2005 and March
31, 2004, respectively, the Company capitalized $540,388 and $441,300
during these periods, respectively.
Once annually or as events or circumstances indicate that an asset may be
impaired, 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. The Company determines such impairment by measuring the
undiscounted future cash flow generated by the assets, comparing the
result to the assets carrying value and adjusting the asset to the lower
of its carrying value or fair value and charging current operations for
the measured impairment. At years ended March 31, 2005 and 2004, the
Company found no impairment to its property and equipment or its other
identifiable intangibles.
Excess of Cost Over Fair Value of Assets Acquired - The excess of cost
over fair value of the assets acquired ("Goodwill") is a result of the
purchases of Dealer Based Services, Inc. in 1989, and certain assets of
Distributors & Dealers Service Co., Inc. in October 1997. Prior to the
early adoption of Statement of Financial Accounting Standard No. 142
"Goodwill and Intangible Assets" on April 1, 2001, the excess of cost
over fair value of assets acquired was being amortized on a straight-line
basis over 15, 10 and 4.5 years, respectively.
37
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.
Advertising Costs - The Company expenses advertising costs as incurred.
Advertising expenses for the years ended March 31, 2005, 2004 and 2003
were $216,737, $197,833 and $261,182, respectively.
Stock Based Compensation - The Company applies Accounting Principles
Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB
25") and related interpretations in accounting for its stock-based
compensation plans. Under APB 25, compensation expense for stock option
and award plans is recognized as the difference between the fair values
of the stock at the date of the grant less the amount, if any, the
employee or director is required to pay. Certain operating officers have
been issued shares of the Company's common stock as part of their
compensation under their employment agreements. This compensation is to
be earned by the officers and charged to operations over five years, the
term of the employment agreements. In addition, certain employees have
been issued restricted shares of the Company's common stock as
compensation. Such compensation is amortized over the restriction period,
which is generally two years. Certain non-employees have been issued
options to purchase stock in lieu of compensation. The intrinsic value of
these options at the time of grant has been charged to expense.
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.
Foreign Currency Translation - Financial statement accounts expressed in
foreign currencies are translated into United States dollars in
accordance with Statement of Financial Accounting Standards ("SFAS") No.
52 "Foreign Currency Translation". The functional currency for the
Company's Chilean and Peruvian operations are their respective local
currencies. Transaction gains and losses are reflected in operations,
while translation gains and losses are reflected as a separate component
of accumulated other comprehensive income, net of tax.
Comprehensive Income - The Company has adopted SFAS No. 130 "Reporting
Comprehensive Income". SFAS No. 130 establishes rules for the reporting
and display of comprehensive income and its components; however, the
adoption of this Statement had minimal impact on the Company's net income
or stockholders' equity. SFAS No. 130 requires unrealized gains or losses
to be recorded on the Company's available for sale securities and foreign
currency translation adjustments, which prior to the adoption were
reported separately in stockholders' equity, to be included in other
comprehensive income.
Contingent Liability Policy - In accordance with SFAS No. 5 and Financial
Accounting Standards Interpretation ("FIN") 14, the Company may have
certain contingent liabilities with respect to material existing or
potential claims, lawsuits and other proceedings. The Company accrues
liabilities when it is probable that future costs will be incurred and
such costs can be reasonably estimated and measured.
38
2. CLAIMS LOSS LIABILITY
During the second fiscal quarter of 2002, the Pennsylvania Insurance
Commissioner informed the Company that Reliance would be liquidated and
cease making payments on claims. The Pennsylvania Insurance Commissioner
determined that Reliance was not likely to be able to satisfy all of the
claims that would be submitted to it due to the circumstances arising out
of the September 11, 2001 terrorist attacks on the World Trade Center.
Reliance underwrote approximately 48% of the automotive service contracts
that were sold by Warrantech Automotive during approximately one and
one-half years ending in November 2001. Approximately 52% of the
automotive service contracts sold by Warrantech Automotive during that
period are not affected by the Reliance liquidation. Service contracts
sold before and after that period are not affected because they are
underwritten by other insurance companies.
Warrantech Automotive was the named obligor, as well as the
administrator, under some of the vehicle service contracts insured by
Reliance. As the obligor, Warrantech Automotive would ultimately be
responsible for paying for the repairs under such contracts.
Additionally, for financial reporting purposes only, Warrantech is
treated as the obligor under the service contracts in which Butler is the
named obligor. While Warrantech is not obligated to pay claims under such
service contracts, it has treated the claims obligations under the
Butler-obligor contracts, including the service contracts which were
insured by Reliance, as obligations of the Company for accounting
purposes. Prior to Reliance's liquidation, Reliance covered the cost of
the repairs under the insurance policies it provided. Because of
Reliance's liquidation, insurance coverage for the Company's obligations
under those service contracts ceased to exist. However, a non-insurance
affiliate of Reliance, Reliance Warranty Company ("RWC"), which was not
placed in liquidation, held premiums totaling approximately $15,892,635
relating to a portion of the service contracts in which Butler, the
retailer/dealers and Warrantech Automotive were the named obligors. The
Company received $15,892,635 from RWC during the fourth quarter of fiscal
2004, as part of a settlement for claims paid by the Company on behalf of
RWC. As a result of the Reliance liquidation, the Company recorded a
claims liability expense for $19,591,713 during fiscal 2002, which was
net of the $15,892,632 receivable from RWC.
To mitigate its claims liability expense resulting from Reliance's
liquidation, the Company is attempting to ascertain if any recovery is
available on Federal subsidies to the insurance industry in general or
Reliance specifically, as a result of the terrorist attacks to pay
vehicle service contract claims. If such subsidies are available, it
could take years before recovery, if any, is obtained. In February 2005,
the Company also began legal proceedings for recovery of approximately $3
million against certain state guaranty funds. In June 2005 the Company
made its first state guaranty settlement with one of the defendants in
its action.
During the years ended March 31, 2005, 2004, 2003 and 2002, the Company
paid $4,727,641, $9,262,407, $10,959,364 and $5,770,999, respectively, in
claims related to Reliance obligations. Remaining amounts are expected to
be paid out as set forth in the following table.
Expected Payment Date
---------------------------------------------------------------------------------------
2006 2007 2008 2009 2009 Thereafter Total
------------ ------------ ------------ ------------ ------------ ------------ ------------
Claims loss liability $ 2,930,559 $ 1,682,400 $ 120,891 $ 16,614 $ 10,466 $ 3,014 $ 4,763,944
39
3. RESTRICTED CASH
At March 31, 2005 and 2004, cash in the amount of $800,000 and $825,000,
respectively was on deposit with Florida and Ohio regulatory agencies to
comply with their state insurance laws. Additionally, Butler had $0, at
March 31, 2005 and $1,390,064 at March 31, 2004, which was restricted,
and held in trust by the Company, for use to pay Reliance claims.
4. INVESTMENTS IN MARKETABLE SECURITIES
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 March 31, 2005 of marketable
securities are as follows:
Expected Maturity Date
--------------------------------------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Available for sale
securities $1,425,000 $ 595,000 $ -- $ -- $ -- $ -- $2,020,000 $2,043,758
Interest rate 3.51% 4.09% -- -- -- --
Principal amounts by expected maturity as of March 31, 2004 of marketable
securities are as follows:
Expected Maturity Date
--------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Available for sale
securities $1,355,000 $ 925,000 $ 120,000 $ -- $ -- $ -- $2,400,000 $2,454,131
Interest rate 4.36% 3.95% 1.99% -- -- --
5. ACCOUNTS RECEIVABLE
Significant Customer Bankruptcy - On January 11, 2005, Ultimate
Electronics, Inc. and six of its subsidiaries ("Ultimate") filed
individual voluntary petitions for relief under Chapter 11 of the
Bankruptcy Code in the United States Bankruptcy Court for the District of
Delaware. Sales to Ultimate represent 10% and 32% of the Company's and
its Consumer Products segment's total gross revenues during fiscal 2005,
making it the Company's and Consumer Products segment's largest customer.
Pursuant to the provisions of Chapter 11, Warrantech was obligated to
honor its existing contact with Ultimate and Ultimate continued to sell
service contracts during this period of reorganization. At present,
Ultimate is current in its payments to Warrantech with respect to sales
subsequent to January 11, 2005 " post-petition sales ". At the time of
filing, however, Warrantech believes that Ultimate owed it approximately
$3.27 million for sales up to January 11, 2005 " pre-petition sales" and
Warrantech has filed a "proof of claim" in this amount with the Court. At
this time, it is impossible to estimate what Warrantech will recover on
its claim. Final Bankruptcy Court settlements are expected to take place
during the third fiscal 2006 quarter.
In separate orders dated April 19, 2005, the Court approved the following
two actions. Thirty (30) of Ultimate's stores were scheduled for closing
and a liquidator was retained to dispose of existing inventory. The
liquidator was authorized by the Court to sell Warrantech service
contracts during the liquidation period in accordance with the terms of
the existing Ultimate contract. At this time, the liquidation has been
substantially completed. The remaining stores were purchased by Mark
40
Wattles, the principal shareholder of Ultimate, through an entity named
Ultimate Acquisition Partners, L.P. ("Acquisition"). As part of the
Purchase Agreement, Acquisition was given until August 31, 2005, to
decide if it wants to assume Ultimate's contract with Warrantech. If it
chooses to assume the contract, it must reach an agreement with
Warrantech with respect to satisfaction of Warrantech's pre-petition
claim. Until such decision is made, Acquisition can continue to sell
Warrantech service contracts in accordance with the terms of the Ultimate
contract. If Acquisition elects not to assume the existing Ultimate
contract, it can negotiate a new agreement with Warrantech (in which no
cure payment would be legally required) or it can select a new service
contract provider. At this time, no such decision has been made.
At March 31, 2005, the Company was owed $3.7 million by Ultimate. The
Company has filed a proof of claim for $3.27 million with the bankruptcy
court. No provision for bad debts has been recorded as of the fiscal year
ended March 31, 2005.
Accounts Receivable Security - The Company has executed an agreement with
Great American Insurance Company ("GAIC") that provides the Company with
extended premium payment terms and a $3 million line of credit ("GAIC
Agreement"). All of the Company's obligations to GAIC pursuant to the
GAIC Agreement are secured by all of the Company's Automotive and
Consumer Products segment's accounts receivable, which were $19,118,161
and $21,946,394 at March 31, 2005 and 2004, respectively.
6. OTHER RECEIVABLES
During fiscal year ending March 31, 2005 and March 31, 2004, the Company
incurred $1,865,399 and $1,853,555, respectively, in legal expenses
related to the Lloyd's litigation. The Company, in anticipation of
receiving reimbursement for these expenses from its insurance company
under a professional liability insurance policy, deferred the legal fees.
In January 2005, as a result of a summary judgment, the court ruled that
the insurance company was not responsible for payment of the Company's
legal costs. The Company has appealed the court's decision. As a result
of the lower court's ruling, the Company has provided for this potential
bad debt of $3,718,954 during the year ended March 31, 2005. Some future
legal expenses are expected to be covered under the Company's Director's
and Officer's liability insurance policy.
The nature and amounts of Other Receivables as of March 31, 2005 and 2004
are as follows. :
March 31,
----------------------------
2005 2004
------------ ------------
Other receivables, net
Due from insurance companies $ 5,334,621 $ 4,494,331
Due from insurance companies - reimbursement of legal fees 3,718,954 1,865,399
Due from insurance companies - profit sharing 41,920 61,441
Due from dealers 384,304 464,436
------------ ------------
Due from insurance companies/dealers 9,478,799 6,885,607
Agent advances 61,787 109,604
Other 389,161 327,078
------------ ------------
9,930,747 5,299,889
Allowance for doubtful accounts (3,718,954) --
------------ ------------
Total Other receivables, net $ 6,211,793 $ 7,322,289
============ ============
The following table sets forth the carrying amounts and fair values of the
Company's other receivables at March 31, 2005.
Expected Maturity Date
--------------------------------------------------------------------------
2005 2006 2007 2008 2009 Thereafter Total Costs Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- ----------
Other receivables, net $6,211,793 -- -- -- -- -- $6,211,793 $6,211,793
41
The following table sets forth the carrying amounts and fair values of the
Company's loan and other receivables at March 31, 2004.
Expected Maturity Date
---------------------------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ---------- ----------
Other receivables, net $7,322,289 -- -- -- -- -- $7,322,289 $7,322,289
7. PROPERTY AND EQUIPMENT
Property and equipment consists of the following at March 31
March 31
---------------------------
2005 2004
------------ ------------
Automobiles $ 61,280 $ 61,280
Equipment, furniture and fixtures 9,945,239 9,867,191
Leasehold improvements 2,031,248 2,028,573
Software development costs 16,211,130 15,670,248
------------ ------------
28,248,897 27,627,292
Less: Accumulated depreciation and amortization 25,607,392 23,642,267
------------ ------------
2,641,505 3,985,024
------------ ------------
Assets under capital leases:
Cost 10,154,148 9,666,422
Less: Accumulated amortization 8,439,116 7,904,595
------------ ------------
1,715,032 1,761,827
------------ ------------
Total Property and Equipment, net $ 4,356,537 $ 5,746,851
============ ============
Amortization expense on assets under capital leases for the years ended
March 31, 2005, 2004 and 2003 was $434,300, $520,340 and $662,715,
respectively. Depreciation expense on property and equipment other than
under capital leases for the years ended March 31, 2005, 2004 and 2003
was $2,115,670, $2,760,264, and $3,222,339, respectively.
8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term debt and capital lease obligations consisted of the following:
March 31
---------------------------
2005 2004
------------ ------------
Capital lease obligations - for property and
equipment payable monthly with interest rates
ranging from 4.92% to 12.67% due through 2009 $ 1,465,610 $ 1,636,197
Other -- 9,112
Less: Current maturities 541,626 664,406
------------ ------------
Long-term portion $ 923,984 $ 980,903
============ ============
The aggregate amounts of maturities at March 31, 2005 were as follows:
Minimum Future
Fiscal Year Lease Payments
--------------
2006 $ 660,589
2007 458,955
2008 396,577
2009 148,107
2010 42,566
2011 and thereafter --
------------
1,706,794
Less: amount representing interest 241,184
------------
Net $ 1,465,610
============
42
The capital lease obligations are collateralized by the capitalized
property and equipment related to the underlying leases.
9. SPLIT DOLLAR LIFE INSURANCE POLICIES
Through April 2003, the Company made payments on split dollar life
insurance policies on the lives of six officers of the Company,
respectively. The Company suspended payment of premiums under these
policies until the permissibility of making such payments under the
Sarbanes-Oxley Act of 2002 is clarified. In lieu of these premium
payments, beginning in September of 2004 and going forward the Company
provides cash bonuses for the premium amount to these officers. The cash
surrender value of these policies was $900,145 as of March 31, 2005 and
March 31, 2004, respectively. The Company is the beneficiary of any
proceeds from the policies up to the amount of premiums paid.
10. INCOME TAXES
A reconciliation of the income tax provision to the amount computed using
the federal statutory rate is as follows:
For the years ended March 31,
-------------------------------------------------------------------------------------
2005 2004 2003
-------------------------- -------------------------- -------------------------
Income (loss) before income taxes $(4,248,753) $ (693,663) $ 1,853,508
----------- ----------- -----------
Federal statutory rate $(1,444,576) 34.0% $ (235,846) 34.0% $ 630,190 34.0%
State tax effect (17,221) 0.4% (96,037) 13.8% (187,141) -10.1%
Non deductible items 28,660 -.7% 55,073 -7.9% 34,657 1.9%
Foreign income taxed at rates other than (194,789) -10.5%
Federal 349,372 -8.2% (250,164) 36.1%
Foreign income tax withheld at the source 354,207 -8.3% (211,787) -30.5% 34,090 1.8%
Other 88,598 -2.1% 137,895 19.9% 69,609 3.8%
----------- ----------- ----------- ----------- ----------- ----------
Provision (benefit) for income taxes $ (640,960) 15.1% $ (177,292) 25.6% $ 386,616 20.9%
=========== =========== =========== =========== =========== ==========
The components of tax expense are as follows:
Provision
For the Year Ended March 31, 2005: Current Deferred (Benefit)
- ---------------------------------- ----------- ----------- -----------
Federal $ 2,466 $ (954,379) $ (951,913)
State 5,951 (32,044) (26,093)
Foreign 468,735 (131,689) 337,046
----------- ----------- -----------
Total $ 477,152 $(1,118,112) $ (640,960)
=========== =========== ===========
For the Year Ended March 31, 2004:
- ----------------------------------
Federal $ 8,703 $ (392,733) $ (384,030)
State (57,187) (88,324) (145,511)
Foreign 388,455 (36,206) 352,249
----------- ----------- -----------
Total $ 339,971 $ (517,263) $ (177,292)
=========== =========== ===========
For the Year Ended March 31, 2003:
- ----------------------------------
Federal $ 32,791 $ 482,370 $ 515,161
State (104,423) (179,124) (283,547)
Foreign 110,148 44,854 155,002
----------- ----------- -----------
Total $ 38,516 $ 348,100 $ 386,616
=========== =========== ===========
43
Deferred tax assets and liabilities reflect the net tax effect of
temporary differences between the carrying amounts of assets and
liabilities for financial reporting purposes and the amounts used for
income taxes. The components of the net deferred tax asset are as
follows:
----------------------------
For the Years Ended March 31,
----------------------------
2005 2004
------------ ------------
Deferred tax assets
Deferred revenue $ 76,961,754 $ 74,011,369
Deferred rent 149,419 125,745
Provision for doubtful accounts 1,387,867 76,047
Accrued bonus 123,961 92,155
Foreign loss benefit 725,544 137,456
Net operating loss 4,166,598 3,057,265
Net state benefit 771,599 795,864
Tax vs. book depreciation 147,605 70,750
Other 17,581 91,243
------------ ------------
Total assets 87,451,928 78,457,894
Deferred tax liabilities
Deferred direct costs (67,314,387) (60,320,142)
Section 174 expense (528,481) (736,243)
------------ ------------
Total liabilities (67,842,868) (61,056,385)
19,609,060 17,401,509
Less: Valuation allowance (1,255,462) (177,020)
------------ ------------
18,353,598 17,224,489
Plus: Tax effect of Butler transaction 5,072,768 5,132,932
------------ ------------
Net deferred tax asset $ 23,426,366 $ 22,357,421
============ ============
As of March 31, 2005, the Company had a United States net operating loss
carryforward of approximately $12.25 million, which is available to
reduce future regular federal taxable income. If not used, the entire
carryover will expire in the years 2020 to 2025. As of March 31, 2005,
the Company also had a foreign net operating loss carryforward of
approximately $2.1 million. Due to the uncertainty of the realization of
these foreign tax carryforwards, the Company established a valuation
allowance against these carryforward benefits of $1,255,462 and $177,020
at March 31, 2005 and 2004, respectively.
Section 174 expense represents research and experimental expenses related
to the development of a proprietary relational database and interactive
software.
11. COMMITMENTS AND CONTINGENCIES
Operating Lease Commitments - The Company leases office and warehouse
space under noncancellable operating leases expiring through 2013. These
leases include scheduled rent increases over their respective terms. The
accompanying consolidated statements of operations reflect rent expense
on a straight-line basis over the lease terms, which differ from the cash
payments required. Rent expense, net of sub-lease income, charged to
operations for the years ended March 31, 2005, 2004 and 2003 was
$1,646,252, $2,101,971 and $1,837,314, respectively.
Future minimum commitments under these leases that have initial or
remaining lease terms in excess of one year at March 31, 2005, are as
follows:
44
Fiscal Year Amount
2006 $ 1,268,616
2007 1,247,740
2008 1,231,629
2009 1,288,409
2010 1,288,409
Thereafter through 2013 3,757,859
-----------
Total future minimum lease payments $10,082,662
===========
Employment Contracts - The Company has employment contracts with its
officers and certain key employees. These employment contracts, expiring
on various dates through 2008, provide for aggregate minimum annual base
compensation of $2,484,937. Certain agreements also call for (i) annual
increases, (ii) cost of living increases, (iii) automobile allowances,
(iv) medical insurance, and (v) additional compensation if certain
defined performance levels are attained. This additional compensation is
to be paid in the form of cash and/or Company common stock. The Company
also agreed to forgive interest which has accrued annually on a note
between the Company and its CEO, for as long as the CEO remains in the
Company's employ.
Line of Credit and Extended Payment Terms - 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 agreed to allow a 30 day extension to its normal payment
terms as set forth in the service agreement. Interest is charged on
amounts within the extended payment term at 3% per annum, calculated on a
daily basis. GAIC also agreed to a separate line of credit for an amount
up to $3 million through further extensions of terms, subject to certain
adjustments. Funds provided by the line of credit are made available by
GAIC by further extending its premium payment terms. Interest is charged
on funds advanced from the line of credit at an annual rate equal to the
prime interest rate plus 2%. As of March 31, 2005, the $3 million
available line of credit from GAIC has been drawn down by the Company and
is reflected in premium payable.
Letters of Credit - 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, is automatically
renewed annually, as long as the agreement with the credit card company
is in place.
Equipment Financing - The Company has ongoing relationships with
equipment financing companies and intends to continue financing certain
future equipment needs through leasing transactions. The total amount
financed through leasing transactions during the fiscal year ended March
31, 2005 amounted to $538,609 compared to $487,060 during the fiscal year
ended March 31, 2004. At fiscal year end 2005, the Company had $1,465,609
in debt outstanding from capital lease obligations compared to $1,636,197
at fiscal year-end 2004.
Litigation - The Company is from time to time involved in litigation
incidental to the conduct of its business.
Lloyd's Underwriters
--------------------
Certain Underwriters at Lloyd's, London and Other Reinsurers Subscribing
to Reinsurance Agreements F96/2992/00 and No. F97/2992/00 v. Warrantech
Corporation, Warrantech Consumer Product Services, Inc., Warrantech Help
Desk, Inc., and Joel San Antonio, United States District Court, Northern
District of Texas, Fort Worth Division.
During the period that Houston General was the underwriter of certain of
Warrantech's programs, it reinsured certain of the underwritten risks
with one or more Lloyd's insurance syndicates. At some point thereafter,
Houston General commenced an arbitration against the Lloyd's syndicates
45
seeking to recover approximately $46,000,000 under the reinsurance
treaties with respect to claims previously paid by Houston General on
warranty claims submitted by customers under Warrantech programs. The
Warrantech entities were not parties in the arbitration but were the
subject of extensive discovery by each of Houston General and the Lloyd's
syndicates. The arbitration concluded in August 2002 with an award of
approximately $39,000,000 in favor of Houston General.
The award supports the assertions of Houston General with respect to the
validity of the claims that it paid. Warrantech was not involved in the
selection of these re-insurers, has no contractual relationship with
them, and has had no reporting or other obligation to them. Despite these
facts, the Lloyd's syndicates now seek to recover some portion of the
arbitration award from the Warrantech entities on two theories of
liability. The first is that, at the time certain claims were presented
to Houston General for payment, the Warrantech entities either
fraudulently or negligently represented to Houston General that such
claims were valid. The second is that the Warrantech entities
intentionally failed to comply with their legal obligations to cooperate
with the parties during the discovery process for the arbitration. The
complaint seeks ordinary, punitive and exemplary damages although no
specific amount is requested. On January 6, 2004, the plaintiff filed an
amended complaint that added Joel San Antonio, Chairman and Chief
Executive Officer of Warrantech Corporation, as a party defendant in his
individual capacity.
Warrantech has filed a counterclaim against Lloyd's arising out of the
same set of facts that underlie the original litigation. Warrantech
alleges fraud, unfair claim settlement practices and bad faith and is
seeking damages of approximately $46 million. Warrantech is also asking
that treble damages for $138 million be awarded as permitted under
applicable Texas law.
This case was originally brought in the District Court of Tarrant County,
Texas, 17th Judicial District. On March 19, 2004, Defendant San Antonio
filed a notice of removal to the United States District Court which
motion was joined by all other defendants. Following removal, Lloyd's
filed a motion to remand the case to state court. Upon consideration of
the arguments and authorities submitted by all parties, Judge McBryde
denied Lloyd's motion with the result that the case will be tried in
United States District Court. At present, the parties are complying with
certain orders issued by Judge McBryde and are continuing their discovery
efforts.
Management continues to believe that Lloyd's case is without merit. At
this time, however, it is not able to predict the outcome of the
litigation. 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.
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
46
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.
12. SHARE BASED COMPENSATION AND OTHER BENEFIT PLANS
Stock Incentive Plans - Under the Company's 1998 Employee Incentive Stock
Option Plan, as amended (the "1998 amended Plan"), 1,041,987 shares of
the Company's common stock are reserved for issuance to employees
(including officers) upon exercise of options granted under the 1998
amended plan. Options are to be granted at an exercise price not less
than 100% of the fair market value of the Company's common stock at date
of grant. The number of shares granted, terms of exercise, and expiration
dates are to be decided at the date of grant of each option by the
Company's Board of Directors. The 1998 Amended Plan will terminate in
August 2008 unless sooner terminated by the Board of Directors.
Stock Awards - Restricted common stock of the Company may be awarded to
officers, key employees, non-employee directors and certain other
non-employees. Shares granted are subject to certain restrictions on
ownership and transferability. Such restrictions on current restricted
stock awards typically lapse one to three years after the award. The
deferred compensation expense related to restricted stock grants is
amortized to expense on a straight-line basis over the period of time the
restrictions are in place. Restricted common stock awards to employees
reduce stock options otherwise available for future grants. The common
stock awards are valued based on the opening price of the Company's stock
on the date the award is approved by the Board of Directors. During the
year end March 31, 2005 and 2004, 32,500 and 69,375 restricted shares
were awarded to directors and employees, respectively.
The Company recognized costs of $73,850, $100,000 and $126,505 for the
years ended March 31, 2005, 2004 and 2003, respectively, for stock-based
compensation to employees and directors. The Company recognized costs of
$0, $0, and $74,688 for the years ended March 31, 2005, 2004 and 2003,
respectively, for stock-based compensation to non-employees.
Stock Option Plans - At March 31, 2005, the Company had one stock option
plan, which is described above. SFAS No. 123, "Accounting for Stock-based
Compensation," defines a fair value method of accounting for an employee
stock option. SFAS No. 123 allows a company to continue to measure
compensation costs for these plans using APB No. 25 and related
interpretations. The Company has elected to continue using APB No. 25 for
accounting for its employee stock compensation plan. Accordingly, no
compensation cost has been recognized for its fixed stock option plan. If
Warrantech had determined compensation cost for its stock option plan
based on the fair value at the grant dates for awards under the plan,
consistent with the method prescribed by SFAS 123, the Company's net
income and earnings per share would have been reduced to the pro forma
amounts as follows:
47
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Net income (loss) as reported $ (3,607,793) $ (516,371) $ 1,466,892
Net income (loss) pro forma $ (3,705,352) $ (624,369) $ 1,399,608
Shares - Basic 15,396,342 15,344,563 15,317,881
Basic earnings per share as reported $ (0.23) $ (0.03) $ 0.10
Basic earnings per share pro forma $ (0.24) $ (0.04) $ 0.09
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 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. The
Company is currently evaluating its share-based employee compensation
programs, the potential impact of this statement on the consolidated
financial position and results of operations, and the alternative
adoption methods. Presented below is a summary of the status of the stock
options in the plan and the related transactions for the years ended
March 31, 2005, 2004 and 2003.
2005 2004 2003
--------------------------- --------------------------- ---------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ------------ ------------ ------------ ------------ ------------
Options outstanding at beginning of year 1,332,789 $ 1.23 1,306,380 $ 1.33 1,416,283 $ 1.54
Granted 353,532 0.67 278,040 1.38 664,048 0.73
Canceled/Surrendered (171,518) (0.52) (121,518) (1.44) (687,284) (2.13)
Exercised -- -- (20,000) (0.60) (5,000) (0.42)
Forfeited -- -- (110,113) (0.94) (81,667) (0.92)
------------ ------------ ------------ ------------ ------------ ------------
Options outstanding at end of year 1,514,803 $ 1.16 1,332,789 $ 1.23 1,306,380 $ 1.10
============ ============ ============ ============ ============ ============
Options exercisable at end of year 936,467 $ 1.30 764,604 $ 1.35 662,097 $ 1.33
============ ============ ============ ============ ============ ============
The weighted average fair value of stock options at date of grant,
calculated using the Black-Scholes option-pricing model, granted during
the years ended March 31, 2005, 2004 and 2003 was $0.38, $0.56 and $0.48,
respectively.
The following table summarizes the status of all Warrantech's stock
options outstanding and exercisable at March 31, 2005.
Stock Options Stock Options
Outstanding Exercisable
------------------------------------------ ---------------------------
Weighted Weighted Weighted
Average Average Average
Remaining Exercise Exercise
Range Of Exercise Prices Shares Life (Yrs) Price Shares Price
- ------------------------ ------------ ------------ ------------ ------------ ------------
$0.42 to $0.94 828,016 7.49 $ 0.76 433,308 $ 0.78
$1.00 to $1.02 1,728,432 1.02 $ 1.00 1,659,804 $ 1.00
$1.26 to $1.595 582,065 3.05 $ 1.41 467,065 $ 1.36
$3.25 to $3.375 101,290 0.97 $ 3.26 101,290 $ 3.26
------------ ------------ ------------ ------------ ------------
Total at March 31, 2005 3,239,803 2.87 $ 1.08 2,661,467 $ 1.11
============ ============ ============ ============ ============
Total at March 31, 2004 3,062,365 3.93 $ 1.68 2,489,605 $ 1.81
============ ============ ============ ============ ============
Total at March 31, 2003 6,096,380 4.52 $ 1.97 3,709,022 $ 1.89
============ ============ ============ ============ ============
48
Other Stock Options - The Company may issue options to purchase its
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 with weighted average assumptions identical to those used for
options granted to employees.
In addition to the options described below, during the year ended March
31, 2003, the Company issued options to purchase 18,667 shares of common
stock to vendors at a weighted average exercise price of $0.68 per share
and options to purchase 30,000 shares of Company common stock to
non-employee vendors at an exercise price of $0.73 per share. No stock
options have been issued to vendors or non-employees during fiscal 2005
or 2004.
The fair value of Warrantech 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 years ended March 31, 2005, 2004 and
2003, respectively: expected dividend yield of 0%; expected volatility of
30% - 50%; a risk free interest rate of 4.5% - 5.0%; and expected option
life of 3 to 5 years.
On October 1, 2002, as part of an agreement between the Company and GAIC
to provide extended credit terms, GAIC received options to purchase up to
1,650,000 shares of common stock. The GAIC options are exercisable no
earlier than January 1, 2006 nor later than December 31, 2006. Per the
terms of the agreement, since Warrantech's stock did not trade above $2
per share for ten consecutive trading days prior to January 1, 2004, the
exercise price of the option was automatically reduced to $1 per share
from $2 per share. The GAIC options are each exercisable for a period of
five years. Warrantech has the right to redeem these options at any time
if its shares trade at a price of $3.00 per share or more on any five
consecutive trading days. The redemption price is $.001 per share.
However, if Warrantech elects to redeem the options, GAIC will have the
right to exercise their respective options immediately prior to the
redemption. If GAIC exercises all of these options, it would own
approximately 9.7% of the Company's outstanding shares. As the options
had no value under the Black-Scholes option pricing model, no
compensation expense was recorded in the Company's results of operations
for the fiscal year ended March 31, 2005.
On July 6, 1998, Joel San Antonio, Warrantech's Chairman and Chief
Executive Officer, and William Tweed and Jeff J. White, members of
Warrantech's Board of Directors, exercised an aggregate of 3,000,000 of
their vested options to purchase Warrantech common stock. Promissory
notes totaling $8,062,500 were signed with interest payable over three
years at an annual rate of 6%. The promissory notes, which were with
recourse and secured by the stock certificates issued, matured July 5,
2001. The value of the collateral for the Notes, which consists of a
total of 3,040,000 shares of the Company's common stock, is currently
$1,824,000, as of May 31, 2005, based upon the market price of the stock
on that date. Under the loan documents, the Company does not have a right
to require the payors to increase the loan collateral. On March 22, 1999,
Joel San Antonio delivered an additional promissory note for $595,634,
payable to the Company, representing the amounts funded by the Company
for the payroll taxes payable by him for the exercise of these options.
The exercise of these stock options and the anticipated tax benefit from
this transaction represented approximately $10 million. The amounts of
these notes are recorded as a contra-equity account, which is a reduction
of stockholders' equity.
49
In February 2000, the Company agreed to restructure the loans to Mr.
Tweed and Mr. White by capitalizing the interest due and extending the
loan maturity from July 5, 2001 until January 31, 2005. Interest on the
restructured loans accrued annually at the applicable federal rate of
6.2%. Under the restructuring, interest first became payable on the third
anniversary of the restructuring and was payable annually thereafter. In
July 2002, the Company extended the loan maturity dates until February 1,
2007 (the "loan extension"). The interest, which accrued on the notes up
to the time of the loan extension, was added to the principal of the
notes. The new principal amount of Mr. Tweed's note is $3,189,675 and of
Mr. White's note is $2,912,430. The applicable federal interest rate on
the notes following the loan extension is 4.6%. Under the loan extension,
interest on the notes will accrue until February 1, 2005 and, at that
time, the accrued interest will be added to the principal of the notes.
Commencing on February 1, 2005, interest on the new principal amount of
the loans to Mssr. Tweed and White is payable annually in arrears, with
the first interest payment becoming due on February 1, 2006.
In February 2000, the Company also agreed to restructure the two existing
loans to Mr. San Antonio (as restructured, the "Combined Loan"). The
Combined Loan, finalized in March 2001, was due on January 31, 2005 and
accrued interest annually at 5.2%. In July 2002, the Company extended the
loan maturity date until February 1, 2007 and the interest rate was
changed to the then applicable federal rate of 4.6%. The principal amount
of Mr. San Antonio's note is $4,165,062. Interest will be forgiven as
long as Mr. San Antonio continues to be employed by the Company. The
$194,786, $194,786 and $200,506 of interest which accrued on the note
during fiscal years 2005, 2004 and 2003, respectively has been forgiven.
The interest was charged to operations as additional compensation in the
respective fiscal years the interest income was accrued.
The total amount of the restructured loans to Mr. Tweed, Mr. White and
Mr. San Antonio at March 31, 2005 and March 31, 2004, including the
capitalized interest of $764,899 and $480,303, is $ 11,032,065 and
$10,747,470, respectively.
Savings and Retirement Plan
The Company and its qualified employees also participate in a Savings and
Retirement Plan also known as the 401(k) Plan (the "Plan"). All of the
Company's domestic employees are eligible to participate in the Plan at
the first quarterly enrollment period following their date of employment.
All Plan participants who have completed one year of service with the
Company are eligible for the Company contribution. The Company
contributes 66% of an eligible employee's contribution to the Plan, with
a maximum up to 4% of the employee's compensation. The Company's
contribution, for the benefit of the employee, vests after an employee
has been employed by the Company for three years. The Company contributed
$197,265, $217,159 and $95,812 to the Plan during the fiscal years ended
March 31, 2005 2004 and 2003, respectively.
13. OTHER INCOME (EXPENSE)
Other income (expense) consists of the following:
2005 2004 2003
---------- ---------- ----------
Interest and dividend income $ 592,562 $ 615,248 $ 647,372
Interest expense (586,665) (690,019) (275,185)
Gain(loss) on sale of assets 635 1,195 (70,463)
Credit card usage rebate 778,124 541,345 453,760
Miscellaneous income (expense) 73,204 106,691 18,789
---------- ---------- ----------
Total Other Income (expense) $ 857,860 $ 574,460 $ 774,273
========== ========== ==========
50
14. SIGNIFICANT CUSTOMERS
During the fiscal year ended March 31, 2005, the Company had one customer
which accounted for more than 10% of the Company's consolidated gross
revenues fees. In 2005, 2004 and 2003 gross revenues fees from this
significant customer were $14.3 million, $15.3 million and $13.8 million,
respectively, which accounted for 10%, 11% and 9% of the Company's total
gross revenues fees, respectively. On January 11, 2005, the significant
client filed a voluntary petition for reorganization under the Chapter 11
Bankruptcy Code. Subsequently in April 2005 it announced it sold the
assets of 32 of its locations to a third party and would be liquidating
its assets from its remaining 30 stores. The third party is continuing
its relationship with the Company and has until August 2005 to decide
whether it will assume the contract from the predecessor company or enter
into a new agreement with the Company.
15. EARNINGS PER SHARE
The computations of earnings per share for the years ended March 31,
2005, 2004 and 2003 are as follows:
For the Years Ended March 31,
------------------------------------------
2005 2004 2003
------------ ------------ ------------
Numerator:
Net income (loss) applicable to common stock $ (3,607,793) $ (516,371) $ 1,466,892
Denominator:
Average outstanding shares used in the
computation of per share earnings:
Common Stock issued-Basic shares 15,398,677 15,344,563 15,317,881
Stock Options (treasury method) 161,448 225,045 81,029
------------ ------------ ------------
Diluted shares 15,560,125 15,569,608 15,398,910
============ ============ ============
Earnings (loss) per common share:
Basic $ (0.23) $ (0.03) $ 0.10
============ ============ ============
Diluted $ (0.23) $ (0.03) $ 0.10
============ ============ ============
16. ACCUMULATED OTHER COMPREHENSIVE INCOME
The components of accumulated other comprehensive income, net of related
tax, for the years ended March 31, 2005, 2004 and 2003 are as follows:
March 31, March 31,
2005 2004
------------ ------------
Unrealized gain/ (loss) on investments $ (4,291) $ 963
Accumulated translation adjustments 236,747 149,838
------------ ------------
Accumulated other comprehensive income $ 232,456 $ 150,801
============ ============
17. SEGMENT INFORMATION
The Company operates in three major business segments: Automotive,
Consumer Products and International. The Automotive segment markets and
administers extended warranties on automobiles, light trucks,
motorcycles, recreational vehicles and automotive components, which are
sold principally by franchised and independent automobile and motorcycle
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, home office equipment and homes which are sold
principally through retailers, distributors, manufacturers, utility
companies, financial institutions and other specialty marketers.
51
Warrantech 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. The
International segment markets and administers outside the United States
and Canada predominately the same products and services of the other
business segments. The International segment is currently operating in
Central and South America, Puerto Rico and the Caribbean. Other includes
intersegment eliminations of revenues and receivables and net unallocated
Corporate expenses and Butler.
Consumer Reportable
Year Ended Automotive Products International Segments Other Total
- ----------------------------- ------------ ------------ ------------- ------------ ------------ ------------
March 31, 2005
- --------------
Revenues 69,374,933 43,769,810 6,622,986 119,767,729 -- 119,767,729
Intercompany revenues 828,951 1,587,332 1,082,877 3,499,160 (3,499,160) --
Profit (loss) from operations 1,003,585 2,980,850 (1,307,656) 2,676,779 (7,783,392) (5,106,613)
Pretax income (loss) (2,996,156) (1,298,677) (1,299,544) (5,594,377) 1,345,914 (4,248,463)
Net interest income (expense) (229,852) (119,292) 9,498 (339,646) 345,543 5,897
Depreciation/amortization 287,572 761,378 78,192 1,127,142 1,422,828 2,549,970
Total assets 182,566,590 69,642,147 9,383,193 261,591,930 2,071,909 263,663,839
March 31, 2004
- --------------
Revenues 103,494,113 38,912,282 6,921,872 149,328,267 -- 149,328,267
Intercompany revenues -- 61,897 804,069 865,965 (865,966) --
Profit (loss) from operations 2,074,521 2,815,524 887,640 5,777,685 (7,045,808) (1,268,123)
Pretax income (loss) (3,952,873) 925,735 896,177 (2,130,961) 1,437,298 (693,663)
Net interest income (expense) (381,282) (58,666) 14,599 (425,348) 350,577 (74,771)
Depreciation/amortization 386,794 1,291,273 82,484 1,760,551 1,520,053 3,280,604
Total assets 180,793,348 65,350,694 8,618,712 254,762,754 2,109,732 257,184,550
March 31, 2003
- --------------
Revenues 108,025,461 33,613,253 5,115,897 146,754,611 -- 146,754,611
Intercompany revenues -- 68,608 243,813 312,421 (312,421) --
Profit (loss) from operations 4,846,609 695,847 94,101 5,636,557 (4,557,323) 1,079,234
Pretax income (loss) (1,393,253) (344,476) 88,121 (1,649,608) 3,503,118 1,853,510
Net interest income (47,769) 1,936 8,680 (37,153) 409,341 372,188
Depreciation/amortization 382,361 1,688,070 86,885 2,157,316 1,727,738 3,885,054
Total assets 172,316,655 66,782,796 2,914,806 242,014,257 18,231,623 260,245,877
52
WARRANTECH CORPORATION AND SUBSIDIARIES
SUPPLEMENTAL QUARTERLY FINANCIAL DATA
(Unaudited)
The following fiscal 2005 and 2004 quarterly financial information for
each of the three month periods ended June 30, September 30, December 31,
2004 and 2003 and March 31, 2005 and 2004 is unaudited. However, in the
opinion of management, all adjustments (consisting of normal recurring
adjustments) necessary to present fairly the results of operations for
such periods have been made for a fair presentation of the results shown.
Quarter Ended Quarter Ended Quarter Ended Quarter Ended
June 30, September 30, December 31, March 31,
-------------------------- -------------------------- -------------------------- -------------------------
2004 2003 2004 2003 2004 2003 2005 2004
----------- ----------- ----------- ----------- ----------- ----------- ----------- -----------
Net revenues $23,861,491 $30,393,822 $24,817,090 $32,975,223 $28,925,959 $29,842,385 $35,530,359 $26,749,849
Gross profit 6,461,417 7,295,294 5,678,243 9,002,126 6,837,839 8,666,587 9,249,155 7,569,654
Income (loss)
from operations (1,363,558) (1,078,553) (1,826,541) 192,201 (1,859) 448,153 (1,914,655) (829,924)
Income (loss)
before provision
for income taxes (1,184,917) (874,232) (1,497,952) 707,864 272,629 779,748 (1,838,223) (1,307,043)
Net income (loss) (759,539) (474,992) (1,594,038) 528,142 (24,104) 503,049 (1,230,112) (1,072,570)
Earnings (loss)
per Share
Basic $ (0.05) $ (0.03) $ (0.10) $ 0.03 $ (0.00) $ 0.03 $ (0.08) $ (0.07)
Fully Diluted $ (0.05) $ (0.03) $ (0.10) $ 0.03 $ (0.00) $ 0.03 $ (0.08) $ (0.07)
53
WARRANTECH CORPORATION AND SUBSIDIARIES
FINANCIAL STATEMENT SCHEDULE
SCHEDULE VIII-VALUATION AND QUALIFYING ACCOUNTS
- ------------------------------------- ------------ ------------------------------------- ---------------- ------------
Column Column Column Column Column
A B C D E
- ------------------------------------- ------------ ------------------------------------- ---------------- ------------
Additions
Balance at ------------------------------------- Balance at
Beginning Charged to Costs Charged to Other Deductions- End of
Description of Year and Expense (a) Accounts-Describe Describe (b) Year
- ------------------------------------- ------------ ---------------- ----------------- ---------------- ------------
Year Ended March 31, 2005
Allowance for doubtful accounts:
Trade A/R $ 233,667 326,317 (16,848) $ 576,832
Other A/R 0 3,718,954 0 3,718,954
Year Ended March 31, 2004
Allowance for doubtful accounts:
Trade A/R $ 230,064 590,000 586,397 $ 233,667
Other A/R 0 0 0 0
Year Ended March 31, 2003
Allowance for doubtful accounts:
Trade A/R $ 256,019 150,444 176,399 $ 230,064
Other A/R 0 0 0 0
Profit Sharing --
(a) Amount of receivables charged to the allowance during the year.
(b) Recovery of prior year bad debts resulted in credit amount for the year
ended March 31, 2005.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
---------------------
None.
Item 9A. 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 Annual Report on Form 10-K. Each of them has, within 90 days
of the filing date of this report, evaluated the Company's disclosure controls
and procedures, as defined in the rules of the SEC 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 Annual 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 independent accountants to
support their audit work
THERE WERE NO SIGNIFICANT CHANGES IN 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.
Item 9B. Other Information
-----------------
None.
54
PART III
Item 10. Directors and Executive Officers of the Registrant
--------------------------------------------------
Information relating to executive compensation is set forth under the caption
"Directors and Executive Officers of the Registrant" in the Company's definitive
Proxy Statement in connection with its Annual Meeting of Shareholders. Such
information is incorporated herein by reference.
Item 11. Executive Compensation
----------------------
Information relating to executive compensation is set forth under the caption
"Executive Compensation" in the Company's definitive Proxy Statement in
connection with its Annual Meeting of Shareholders. Such information is
incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
--------------------------------------------------------------
Information relating to executive compensation is set forth under the caption
"Security Ownership of Certain Beneficial Owners and Management" in the
Company's definitive Proxy Statement in connection with its Annual Meeting of
Shareholders. Such information is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions
----------------------------------------------
Information relating to executive compensation is set forth under the caption
"Certain Relationships and Related Transactions" in the Company's definitive
Proxy Statement in connection with its Annual Meeting of Shareholders. Such
information is incorporated herein by reference.
Item 14. Principal Accountants Fees and Services
---------------------------------------
Information relating to executive compensation is set forth under the caption
"Principal Accountants Fees and Services" in the Company's definitive Proxy
Statement in connection with its Annual Meeting of Shareholders. Such
information is incorporated herein by reference.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
---------------------------------------------------------------
(a) 1. and 2. Financial Statements and Financial Statement Schedule:
see accompanying Index to Financial Statements and Financial
Statement Schedule, page F-1.
(b) Reports on Form 8-K during the last quarter:
None
(c) Exhibits
Exhibits not incorporated herein by reference to a prior filing are designated
by an asterisk (*) and are filed herewith; all exhibits not so designated are
incorporated herein by reference as indicated. Management contracts or
compensatory plans, contracts or arrangements with directors and executive
officers of the Company appear in Exhibits 10(p) through 10(bb).
55
EXHIBITS
Exhibit Description
- ------- -----------
*3(a) Certificate of Nevada Incorporation filed February 28, 2005.
*3(b) By-laws of Warrantech Corporation in the State of Nevada.
10(a) Form of Sales Distributor Agreement. Incorporated by reference to the
Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1985, file no. 0-13084.
10(b) Form of Service Center Agreement. Incorporated by reference to the
Company's Annual Report on Form 10-K for the fiscal year ended March
31, 1985, file no. 0-13084.
10(c) Form of Dealer Agreement. Incorporated by reference to the Company's
Annual Report on Form 10-K for the fiscal year ended March 31, 1985,
file no. 0-13084.
10(d) Form of Sales Agent Agreement. Incorporated by reference to the
Company's Registration Statement on Form S-1, filed on September 5,
1986, Registration No. 3-8517.
10(e) Amendment and supplement number one, dated January 16, 2004 to certain
Warrantech and Butler agreements. Incorporated by reference to Exhibit
10(2) to the Company's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2004, file no. 0-13084.
10(f) Warrantech Corp. Guaranty of Payment and Performance by RWC Corp.
Incorporated by reference to Exhibit 10(3) to the Company's Quarterly
Report on Form 10-Q for the quarter ended December 31, 2004, file no.
0-13084.
10(g) Security Agreement dated as of January 16, 2004, by Reliance Warranty
Company, in favor of Warrantech Corporation. Incorporated by reference
to Exhibit 10(4) to the Company's Quarterly Report on Form 10-Q for the
quarter ended December 31, 2004, file no. 0-13084.
10(h) 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)"). Incorporated by
reference to Exhibit 10(5) to the Company's Quarterly Report on Form
10-Q for the quarter ended December 31, 2004, file no. 0-13084.
10(i) General Agency Agreement between American International Group, Inc. and
Warrantech Automotive, Inc. Incorporated by reference to Exhibit 10(o)
to the Company's Annual Report on Form 10-K for the fiscal year ended
March 31, 1996, file no. 0-13084.
10(j) Master Agreement between American International Group, Inc. and
Warrantech Corporation. Incorporated by reference to Exhibit 10(q) to
the Company's Annual Report on Form 10-K for the fiscal year ended
March 31, 1996, file no. 0-13084.
56
10(k) Stock Option Agreement dated June 4, 2002, by and between Warrantech
Corporation and Staples, Inc. Incorporated by reference to Exhibit
10(a) to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2002, file no. 0-13084.
10(l) Warrantech Corporation 1998 Employee Incentive Stock Option Plan, as
amended and restated, effective September 25, 2001. Incorporated by
reference to Exhibit 10(a) to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001, file no. 0-13084.
10(m) Amendment No. 2 dated October 8, 2002, to the Warrantech Corporation
1998 Employee Incentive Stock Option Plan, as amended and restated,
effective September 25, 2001. Incorporated by reference to Exhibit 4(a)
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2002, file no. 0-13084.
10(n) Amendment No. 3, dated September 8, 2003, to the Warrantech Corporation
1998 Employee Incentive Stock Option Plan, as amended and restated,
effective June 12, 2003. Incorporated by reference to Exhibit 4(a) to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003, file no. 0-13084.
10(o) Amendment No. 3, dated October 7, 2003, to the Warrantech 401K plan.
Incorporated by reference to Exhibit 4(b) to the Company's Quarterly
Report on Form 10-Q for the quarter ended September 30, 2003, file no.
0-13084.
10(p) Employment Agreement dated April 1, 2003 between Warrantech Corporation
and Joel San Antonio. Incorporated by reference to Exhibit 10(b) to the
Company's Quarterly Report on Form 10-Q for the quarter ended September
30, 2003, file no. 0-13084.
10(q) Employment Agreement dated April 1, 2004, between Warrantech
Corporation and Richard F. Gavino. Incorporated by reference to Exhibit
10(x) to the Company's Annual Report on Form 10-K for the year ended
March 31, 2004, file no. 0-13084.
10(r) Schedule 10(u) identifying contracts that are substantially similar to
Exhibit 10(t), the Employment Agreement between Warrantech Corporation
and James F. Morganteen, in all material respects except as to the
parties thereto, the dates of execution, or other details, incorporated
by reference to Exhibit 10(h) to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2002, file no. 0-13084.
10(s) Employment Agreement dated March 15, 2004, between Warrantech
Corporation and Evan Rothman. Incorporated by reference to Exhibit
10(aa) to the Company's Annual Report on Form 10-K for the year ended
March 31, 2004, file no. 0-13084.
57
10(t) Employment Agreement dated June 1, 2004, between Warrantech Corporation
and Stephen R. Williams. Incorporated by reference to Exhibit 10(bb) to
the Company's Annual Report on Form 10-K for the year ended March 31,
2004, file no. 0-13084.
*10(u) Amendment #1, dated April 1, 2004 to the Employment Agreement dated
April 1, 2000 between Warrantech Corporation and Richard Rodriguez.
10(v) Employment Agreement dated July 9, 2003, between Warrantech Corporation
and Christopher L. Ford. Incorporated by reference to Exhibit 10(a) to
the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2003, file no. 0-13084.
10(w) Employment Agreement dated April 1, 2003 between Warrantech Corporation
and Randall San Antonio. Incorporated by reference to Exhibit 10(w) to
the Company's Annual Report on Form 10-K for the year ended March 31,
2003, file no. 0-13084.
10(x) Employment Agreement dated December 1, 2004, between Warrantech
Corporation and Laurence Tutt. Incorporated by reference to Exhibit
10(1) to the Company's Quarterly Report on Form 10-Q for the quarter
ended December 31, 2004, file no. 0-13084.
*10(y) Amendment #1, dated October 1, 2004 to the Employment Agreement dated
April 1, 2002 between Warrantech Corporation and Jeanine Folz.
10(z) Promissory Note, as amended July 24, 2002,between Warrantech
Corporation and William Tweed, incorporated by reference to Exhibit
10(a) to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002, file no. 0-13084.
10(aa) Promissory Note, as amended, July 24, 2002, between Warrantech
Corporation and Joel San Antonio,incorporated by reference to Exhibit
10(b) to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002, file no. 0-13084.
10(bb) Promissory Note, as amended July 24, 2002, between Warrantech
Corporation and Jeff J. White. Incorporated by reference to Exhibit
10(c) to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2002, file no. 0-13084.
10(cc) Code of Business Conduct and Ethics. Incorporated by reference to
Exhibit 10(ii) to the Company's Annual Report on Form 10-K for the year
ended March 31, 2004, file no. 0-13084.
*21 Subsidiaries of the Company.
*31.1 Certification by the Chief Executive Officer pursuant to Rule13a-14(a)
of the Securities Exchange Act of 1934, as amended.
*31.2 Certification by the Chief Financial Officer pursuant to Rule13a-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.
58
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned thereto duly authorized.
WARRANTECH CORPORATION
Dated: June 29, 2005 By: /s/ JOEL SAN ANTONIO
-------------------------------------
Joel San Antonio,
Chairman of the Board and
Chief Executive Officer
Dated: June 29, 2005 By: /s/ RICHARD F. GAVINO
-------------------------------------
Richard F. Gavino,
Executive Vice President and
Chief Financial Officer
59
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities indicated on June 29, 2005.
/s/ JOEL SAN ANTONIO Chairman, Chief Executive Officer and Director
- ------------------------ (Principal Executive Officer)
Joel San Antonio
/s/ RICHARD F. GAVINO Executive Vice President and Chief Financial Officer
- ------------------------ (Principal Accounting and Financial Officer)
Richard F. Gavino
/s/ WILLIAM TWEED Vice Chairman and Director
- ------------------------
William Tweed
/s/ JEFF J. WHITE Director
- ------------------------
Jeff J. White
/s/ DONALD SENDEROWITZ Director
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Donald Senderowitz
/s/ RICHARD RODRIGUEZ Director
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Richard Rodriguez
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