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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
--------------- --------------
Commission File Number 000-20202
CREDIT ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1999511
(State or other jurisdiction of (IRS Employer Identification)
incorporation or organization)
25505 WEST TWELVE MILE ROAD, SUITE 3000
SOUTHFIELD, MICHIGAN 48034-8339
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: 248-353-2700
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes /X/. No / /.
Indicate the number of shares outstanding of each of the issuer's class
of common stock, as of the latest practicable date.
The number of shares outstanding of Common Stock, par value $.01, on November 1,
2002 was 42,382,344.
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Income Statements -
Three and nine months ended September 30, 2002
and September 30, 2001 1
Consolidated Balance Sheets -
As of September 30, 2002 and December 31, 2001 2
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2002 and
September 30, 2001 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 9
AND RESULTS OF OPERATIONS
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 26
ITEM 4. CONTROLS AND PROCEDURES 26
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 27
SIGNATURE 28
CERTIFICATIONS 29
INDEX OF EXHIBITS 31
EXHIBITS
PART I. - FINANCIAL INFORMATION
ITEM 1. - CONSOLIDATED FINANCIAL STATEMENTS
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED INCOME STATEMENTS
(Dollars in thousands, except per share data) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------- --------------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(Unaudited) (Unaudited)
REVENUE:
Finance charges $ 23,783 $ 23,289 $ 74,190 $ 66,183
Lease revenue 3,614 5,728 13,201 16,368
Other income 15,036 7,850 32,489 26,332
------------ ------------ ------------ ------------
Total revenue 42,433 36,867 119,880 108,883
------------ ------------ ------------ ------------
COSTS AND EXPENSES:
Operating expenses 16,389 15,585 49,446 46,208
Provision for credit losses 7,048 2,632 13,599 8,352
Depreciation of leased assets 2,251 3,172 7,758 9,270
Interest 2,364 3,887 7,126 11,708
------------ ------------ ------------ ------------
Total costs and expenses 28,052 25,276 77,929 75,538
------------ ------------ ------------ ------------
Operating income 14,381 11,591 41,951 33,345
Foreign exchange gain (loss) (25) (9) 2 (41)
------------ ------------ ------------ ------------
Income before provision for income taxes 14,356 11,582 41,953 33,304
Provision for income taxes 4,925 3,937 17,658 11,341
------------ ------------ ------------ ------------
Net income $ 9,431 $ 7,645 $ 24,295 $ 21,963
============ ============ ============ ============
Net income per common share:
Basic $ 0.22 $ 0.18 $ 0.57 $ 0.52
============ ============ ============ ============
Diluted $ 0.22 $ 0.18 $ 0.56 $ 0.51
============ ============ ============ ============
Weighted average shares outstanding:
Basic 42,363,895 41,997,434 42,457,425 42,153,090
Diluted 43,122,046 43,594,725 43,517,380 43,027,573
See accompanying notes to consolidated financial statements.
1
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands) AS OF
-------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
------------------ -----------------
ASSETS: (Unaudited)
Cash and cash equivalents $ 12,443 $ 15,773
Investments -- held to maturity 175 173
Automobile loans receivable 795,581 762,031
Allowance for credit losses (5,479) (4,745)
--------- ---------
Automobile loans receivable, net 790,102 757,286
--------- ---------
Floor plan receivables, net 5,261 6,446
Notes receivable, net 8,492 11,167
Investment in operating leases, net 23,222 42,774
Property and equipment, net 20,532 19,646
Other assets 6,080 8,169
--------- ---------
Total Assets $ 866,307 $ 861,434
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Lines of credit $ 96,811 $ 73,215
Secured financing 30,257 122,396
Mortgage note 6,381 6,918
Capital lease obligations 1,029 -
Accounts payable and accrued liabilities 32,496 39,307
Dealer holdbacks, net 361,177 315,393
Deferred income taxes, net 18,059 10,668
Income taxes payable 2,489 5,098
--------- ---------
Total Liabilities 548,699 572,995
--------- ---------
SHAREHOLDERS' EQUITY:
Common stock 417 422
Paid-in capital 107,571 109,000
Retained earnings 209,451 185,156
Accumulated other comprehensive income (loss)-cumulative translation adjustment 169 (6,139)
--------- ---------
Total Shareholders' Equity 317,608 288,439
--------- ---------
Total Liabilities and Shareholders' Equity $ 866,307 $ 861,434
========= =========
See accompanying notes to consolidated financial statements.
2
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands) NINE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2002 2001
--------- ---------
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 24,295 $ 21,963
Adjustments to reconcile net cash provided by operating activities:
Provision for credit losses 13,599 8,352
Depreciation 3,719 3,276
Depreciation of leased assets 7,758 9,270
Gain on securitization clean-up - (1,082)
Loss on retirement of property and equipment 276 -
Provision (credit) for deferred income taxes 7,391 (1,455)
Tax benefit from exercise of stock options 1,571 -
Change in operating assets and liabilities:
Accounts payable and accrued liabilities (6,758) 8,762
Income taxes payable (2,609) 7,365
Income taxes receivable - 351
Lease payment receivable 872 (486)
Unearned insurance premiums, insurance reserves and fees (2,314) (467)
Deferred dealer enrollment fees, net (53) 933
Other assets 2,089 (1,360)
--------- ---------
Net cash provided by operating activities 49,836 55,422
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Principal collected on automobile loans receivable 255,038 228,811
Advances to dealers (223,591) (288,189)
Payments of dealer holdback (25,746) (22,716)
Operating lease acquisitions (874) (21,399)
Deferred costs from lease acquisitions (201) (2,866)
Operating lease liquidations 7,977 8,743
Decreases in floor plan receivables 1,185 1,379
Decrease (increase) in notes receivable 2,675 (4,477)
Purchases of property and equipment (4,881) (4,748)
--------- ---------
Net cash provided by (used in) investing activities 11,582 (105,462)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds under lines of credit, net 23,596 25,146
Proceeds from secured financings 28,551 165,412
Repayments of secured financings (120,690) (107,782)
Net proceeds under capital lease obligation 1,029 -
Repayment of senior notes and mortgage note (537) (8,453)
Repurchase of common stock (6,588) (3,224)
Proceeds from stock options exercised 3,583 1,094
--------- ---------
Net cash (used in) provided by financing activities (71,056) 72,193
--------- ---------
Effect of exchange rate changes on cash 6,308 (1,051)
--------- ---------
Net (decrease) increase in cash and cash equivalents (3,330) 21,102
Cash and cash equivalents, beginning of period 15,773 21,316
--------- ---------
Cash and cash equivalents, end of period $ 12,443 $ 42,418
========= =========
See accompanying notes to consolidated financial statements.
3
CREDIT ACCEPTANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or "GAAP")
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The results of operations for interim periods
are not necessarily indicative of actual results achieved for full fiscal years.
The consolidated balance sheet at December 31, 2001 has been derived from the
audited financial statements at that date but does not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 2001.
Certain amounts have been reclassified to conform to the 2002 presentation.
The Company changed its accounting methods in the United Kingdom with
respect to certain ancillary products. This change was the result of a complete
review of the Company's revenue recognition policies. This review confirmed the
Company's revenue recognition methods in North America and determined that,
while conservative, the policies relative to ancillary product revenue
recognition in the United Kingdom were inconsistent with those employed in North
America.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
2. ACCOUNTING STANDARDS
Pursuant to SFAS No. 144, an impairment analysis is performed on the
net asset value of the leasing operation on a quarterly basis. This analysis
compares the undiscounted forecasted future net cash flows relating to the
automobile leasing operation to the net asset value of this operation at the
balance sheet date. Due to the Company's limited experience in the leasing
business, a substantial amount of uncertainty exists in the forecast of the
future net cash flows that will be generated by this operation. Based upon
management's analysis, no write down of the net asset value of the leasing
operation was necessary at September 30, 2002. In future periods, if
management's analysis indicates that future cash flows from the leasing
operation are less than the leasing operation's net asset value, an expense to
reduce the net asset value of the operation will be recorded.
3. AUTOMOBILE LOANS RECEIVABLE
Automobile loans receivable consisted of the following (in thousands):
AS OF
-----------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
----------------------- ----------------------
(Unaudited)
Gross automobile loans receivable $ 941,107 $ 906,808
Unearned finance charges (141,596) (138,533)
Unearned insurance premiums, insurance reserves and fees (3,930) (6,244)
--------- ---------
Automobile loans receivable $ 795,581 $ 762,031
========= =========
Non-accrual automobile loans $ 220,050 $ 181,759
========= =========
Non-accrual automobile loans as a percent of total
gross automobile loans 23.4% 20.0%
========= =========
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
3. AUTOMOBILE LOANS RECEIVABLE - (CONCLUDED)
A summary of changes in gross automobile loans receivable is as follows
(in thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- ---------------------------------
2002 2001 2002 2001
--------------- -------------- --------------- ---------------
(Unaudited) (Unaudited)
Balance, beginning of period $ 944,170 $ 807,281 $ 906,808 $ 674,402
Gross amount of automobile loans accepted 146,263 200,698 485,164 612,243
Legal and repossession fees 5,366 5,680 17,710 17,711
Gross automobile loans reacquired from securitization - - - 2,918
Cash collections on automobile loans accepted (113,149) (110,853) (351,852) (322,953)
Charge-offs (46,058) (28,392) (127,582) (97,875)
Currency translation 4,515 8,406 10,859 (3,626)
--------------- -------------- --------------- ---------------
Balance, end of period $ 941,107 $ 882,820 $ 941,107 $ 882,820
=============== ============== =============== ===============
A summary of the allowance for credit losses is as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- -------------- --------------- ---------------
(Unaudited) (Unaudited)
Balance, beginning of period $ 5,028 $ 3,784 $ 4,745 $ 4,640
Provision for loan losses 1,374 537 2,325 537
Charge-offs (952) (127) (1,685) (926)
Currency translation 29 47 94 (10)
--------------- -------------- --------------- ---------------
Balance, end of period $ 5,479 $ 4,241 $ 5,479 $ 4,241
=============== ============== =============== ===============
4. INVESTMENT IN OPERATING LEASES
The composition of net investment in operating leases consisted of the
following (in thousands):
AS OF
--------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
--------------------- --------------------
(Unaudited)
Gross leased assets $ 34,100 $ 50,054
Accumulated depreciation (12,624) (11,657)
Gross deferred costs 4,589 6,831
Accumulated amortization of deferred costs (2,808) (2,786)
Lease payments receivable 2,420 3,308
--------------- ---------------
Investment in operating leases 25,677 45,750
Less: Allowance for lease vehicle losses (2,455) (2,976)
--------------- ---------------
Investment in operating leases, net $ 23,222 $ 42,774
=============== ===============
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
4. INVESTMENT IN OPERATING LEASES - (CONCLUDED)
A summary of changes in the investment in operating leases is as
follows (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
-------------- --------------- --------------- ---------------
(Unaudited) (Unaudited)
Balance, beginning of period $ 31,526 $ 49,872 $ 45,750 $ 44,944
Gross operating leases originated - 5,105 1,075 24,265
Depreciation of operating leases (2,251) (3,172) (7,758) (9,270)
Lease payments due 3,670 5,664 13,067 16,125
Collections on operating leases (3,506) (4,925) (12,147) (14,171)
Charge-offs (501) (476) (1,792) (1,468)
Operating lease liquidations (3,054) (3,943) (12,571) (12,329)
Currency translation (207) (164) 53 (135)
-------------- --------------- --------------- ---------------
Balance, end of period $ 25,677 $ 47,961 $ 25,677 $ 47,961
============== =============== =============== ===============
A summary of the allowance for lease vehicle losses (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
--------------- -------------- --------------- ---------------
(Unaudited) (Unaudited)
Balance, beginning of period $ 2,280 $ 2,332 $ 2,976 $ 2,023
Provision for lease vehicle losses 1,250 1,688 4,020 4,498
Charge-offs (1,075) (1,256) (4,541) (3,757)
--------------- -------------- --------------- ---------------
Balance, end of period $ 2,455 $ 2,764 $ 2,455 $ 2,764
=============== ============== =============== ===============
5. DEALER HOLDBACKS AND RESERVE FOR ADVANCE LOSSES
Dealer holdbacks consisted of the following (in thousands):
AS OF
----------------------------------------------
SEPTEMBER 30, 2002 DECEMBER 31, 2001
---------------------- ----------------------
(Unaudited)
Dealer holdbacks $ 752,027 $ 721,365
Less: advances (net of reserve of $12,089 and $9,161
at September 30, 2002 and December 31, 2001, respectively) (390,850) (405,972)
---------------- -----------------
Dealer holdbacks, net $ 361,177 $ 315,393
================ =================
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
5. DEALER HOLDBACKS AND RESERVE FOR ADVANCE LOSSES - (CONCLUDED)
A summary of the change in the reserve for advance losses (classified
with net dealer holdbacks in the accompanying balance sheets) is as follows (in
thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- --------------------------------
2002 2001 2002 2001
-------------- --------------- -------------- ---------------
(Unaudited) (Unaudited)
Balance, beginning of period $ 10,197 $ 8,050 $ 9,161 $ 6,788
Provision for advance losses 4,424 407 7,254 3,317
Charge-offs (2,604) (43) (4,578) (1,557)
Currency translation 72 83 252 (51)
-------------- --------------- -------------- ---------------
Balance, end of period $ 12,089 $ 8,497 $ 12,089 $ 8,497
============== =============== ============== ===============
6. NET INCOME PER SHARE
Basic net income per share has been computed by dividing net income by
the weighted average number of common shares outstanding. Diluted net income per
share has been computed by dividing net income by the total of the weighted
average number of common shares and common stock equivalents outstanding. Common
stock equivalents included in the computation represent shares issuable upon
assumed exercise of stock options that would have a dilutive effect.
7. RELATED PARTY TRANSACTIONS
In the normal course of its business, the Company regularly accepts
assignments of automobile loans originated by affiliated dealer-partners owned
by: (i) the Company's majority shareholder and Chairman; (ii) the Company's
President; and (iii) a member of the Chairman's family. Automobile loans
accepted from these affiliated dealer-partners were approximately $4.1 million
and $15.6 million or 2.8% and 3.2% of total automobile loan originations for the
three and nine months ended September 30, 2002, respectively, and $5.6 million
and $17.3 million or 2.8% of total automobile loan originations for the same
periods in 2001. Automobile loans receivable from affiliated dealer-partners
represented approximately 2.7% and 2.6% of the gross automobile loans receivable
balance as of September 30, 2002 and December 31, 2001, respectively. The
Company accepts automobile loans from affiliated dealer-partners and
nonaffiliated dealer-partners on the same terms. Based upon management's
analysis, the average return on capital on the business originated by affiliated
dealer-partners is currently higher than the average return on capital for
non-affiliated dealer-partners. Affiliated dealer-partners' advances were $10.8
million or 2.2% of total advances and $10.8 million or 2.3% of total advances as
of September 30, 2002 and December 31, 2001, respectively. The Company received
fees for marketing services provided to affiliated dealer-partners owned by the
Company's majority shareholder and Chairman and the Company's President totaling
$6,000 and $33,000 for the three and nine months ended September 30, 2002,
respectively.
The Company receives interest income and fees from: (i) a note
receivable of $1.5 million as of September 30, 2002 and December 31, 2001,
respectively, from the Company's President; and (ii) a working capital loan to
the Company's majority shareholder and Chairman with a balance of zero and
$66,000 as of September 30, 2002 and December 31, 2001, respectively. Total
income earned on the note receivable and working capital loan was $19,000 and
$58,000 for the three and nine months ended September 30, 2002 and $13,000 and
$37,000 for the same periods in 2001.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
8. INCOME TAXES
The Company's effective tax rate was 34.3% and 42.1% for the three and
nine months ended September 30, 2002 compared to 34.0% and 34.1% for the same
periods in 2001. For the three and nine months ended September 30, 2002, this
increase is primarily due to the amount recorded for additional income taxes
that would be due upon the repatriation of the cumulative undistributed earnings
of the Company's United Kingdom business unit. For the three months ended
September 30, 2002, the increase was also a result of a re-characterization of
the Company's revenue for state tax reporting purposes.
9. BUSINESS SEGMENT INFORMATION
The Company is organized into three primary business segments: the
North America Operation ("North America"), the United Kingdom Operation ("United
Kingdom") and the Automobile Leasing Operation ("Automobile Leasing"). Selected
segment information is set forth below (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- ------------------------------
2002 2001 2002 2001
------------- ------------- -------------- --------------
(Unaudited) (Unaudited)
Revenue:
North America $ 31,809 $ 24,898 $ 88,542 $ 73,707
United Kingdom 6,688 5,878 17,132 17,841
Automobile Leasing 3,936 6,091 14,206 17,335
------------- ------------- -------------- --------------
Total revenue $ 42,433 $ 36,867 $ 119,880 $ 108,883
============= ============= ============== ==============
Income before provision for income taxes:
North America $ 10,776 $ 9,054 $ 36,127 $ 28,321
United Kingdom 4,285 3,242 7,897 7,853
Automobile Leasing (705) (714) (2,071) (2,870)
------------- ------------- -------------- --------------
Total income before provision for income taxes $ 14,356 $ 11,582 $ 41,953 $ 33,304
============= ============= ============== ==============
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
GENERAL
The Company's business model relies on its ability to forecast loan
performance. The Company's forecasts impact loan pricing and structure as well
as the required reserve for advance losses. The following table presents
forecasted collection rates, advance rates, the spread (the forecasted
collection rate less the advance rate), and the percentage of the forecasted
collections which have been realized through September 30, 2002. The amounts
presented are expressed as a percent of total loan value by year of loan
origination.
September 30, 2002
------------------------------------------------------------------
Forecasted % of Forecast
Year Collection % Advance % Spread % Realized
- --------- ---------------- --------------- -------------- ----------------
1992 81% 35% 46% 100%
1993 75% 37% 38% 100%
1994 62% 42% 20% 100%
1995 56% 46% 10% 99%
1996 56% 49% 7% 98%
1997 59% 49% 10% 98%
1998 68% 50% 18% 98%
1999 72% 54% 18% 94%
2000 72% 53% 19% 83%
2001 69% 49% 20% 50%
The risk of a forecasting error declines as loans age. For example, the
risk of a forecasting error for business written in 1995 is very small, with
98.7% of the total amount forecasted already realized. In contrast, the
Company's forecast for recent loan originations is much less precise. If the
Company produces disappointing operating results, it will likely be because the
Company overestimated future loan performance.
The spread between the forecasted collection rate and the advance rate
reduces the Company's risk of advance losses. Because collections are applied to
advances on an individual dealer-partner basis, a wide spread does not eliminate
the risk of advance losses, but it does reduce them significantly.
The Company first published forecasted collection rates in its 2001
Annual Report. One method for evaluating the reasonableness of the Company's
forecast is to examine the trends in forecasted collection rates over time. The
following table compares the Company's current forecast with the forecast
published at year end.
December 31, 2001 September 30, 2002
Year Forecasted Collection % Forecasted Collection % Variance
- --------- -------------------------- --------------------------- ----------
1992 81% 81% 0%
1993 76% 75% (1%)
1994 62% 62% 0%
1995 56% 56% 0%
1996 57% 56% (1%)
1997 60% 59% (1%)
1998 69% 68% (1%)
1999 73% 72% (1%)
2000 73% 72% (1%)
2001 70% 69% (1%)
During the quarter the Company experienced a decline in loan
performance in North America. The Company believes the decline is temporary and
is primarily due to the installation of a new collection system late in the
second quarter of 2002. However, it is impossible to determine whether external
factors, such as economic conditions, also may have contributed to the decline.
The Company regularly forecasts future collections on its portfolio of loans.
Based on current forecasts, the Company believes that future collections on the
Company's portfolio of loans in North America which were originated prior to the
quarter
9
declined by approximately 5% from approximately $620 million to approximately
$598 million from that expected at the start of the quarter.
The Company believes the new collection system will ultimately provide
operational efficiencies which could not have occurred without the new system.
The Company has identified and corrected a large number of issues which, while
outstanding, very likely had a meaningful impact on recent loan performance.
Provided that future collection results equal the Company's forecast, the
decline will result in a reduction in future finance charges of approximately
$6.0 million in addition to any advance losses which occur. There can be no
assurance that the Company's collections will meet or exceed forecasted amounts.
To the extent that the Company's forecast of future collections continues to
decline, the Company's financial condition and results of operations may be
materially and adversely affected. (Refer to "Results of Operations -- North
America -- Provision for Credit Losses" and "Forward Looking Statements")
RESULTS OF OPERATIONS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE AND NINE MONTHS
ENDED SEPTEMBER 30, 2001
For purposes of assisting shareholders in interpreting the current and
year to date financial results, the Company presents income statement and
limited balance sheet data on a consolidated basis as well as for the Company's
three operating units, North America, United Kingdom and Automobile Leasing. The
presentation includes the results as reported under generally accepted
accounting principles ("GAAP") and also includes the Company's results after
adjusting for current and prior period items that the Company believes are
important to consider when evaluating the results. The Company's presentation of
financial results and subsequent analysis is based on analyzing the income
statement as a percent of capital invested and are presented on an annualized
basis.
Consolidated
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
-------------------------------------------- -----------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
------------- ------------ --------------- ------------- ------------- ------------
REVENUE:
Finance charges $ 23,783 $ 23,783 19.0% $ 23,289 $ 23,289 18.1%
Lease revenue 3,614 3,614 2.9 5,728 5,728 4.5
Other income (1) 15,036 8,720 7.0 7,850 7,850 6.1
------------- ------------ -------------- -------------- ------------- ------------
Total revenue 42,433 36,117 28.9 36,867 36,867 28.7
COSTS AND EXPENSES:
Operating expenses (2) 16,389 17,144 13.7 15,585 15,585 12.1
Provision for credit losses (3) 7,048 6,608 5.3 2,632 2,632 2.0
Depreciation of leased assets 2,251 2,251 1.8 3,172 3,172 2.5
Interest 2,364 2,364 1.9 3,887 3,887 3.0
------------- ------------ -------------- -------------- ------------- ------------
Total costs and expenses 28,052 28,367 22.7 25,276 25,276 19.6
------------- ------------ -------------- -------------- ------------- ------------
Operating income 14,381 7,750 6.2 11,591 11,591 9.1
Foreign exchange loss (25) (25) - (9) (9) -
------------- ------------ -------------- -------------- ------------- ------------
Income before provision for income taxes 14,356 7,725 6.2 11,582 11,582 9.1
Provision for income taxes (4) 4,925 2,658 2.1 3,937 3,937 3.1
------------- ------------ -------------- -------------- ------------- ------------
Net income $ 9,431 $ 5,067 4.1% $ 7,645 $ 7,645 6.0%
============= ============ ============== ============= ============= ============
Return on capital ("ROC") (5) 5.3% 7.9%
Weighted average cost of capital ("WACC") (6) 9.6% 9.7%
------------ -------------
Spread (4.3%) (1.8%)
Average capital (7) $ 500,322 $ 513,992
Economic loss (8) $ (5,443) $ (2,301)
Adjusted weighted average shares outstanding (9) 46,964,660 47,062,038
------------ -------------
Economic loss per share (10) $ (0.12) $ (0.05)
10
(Dollars in thousands, except per share data) NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
--------------------------------------------- -----------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
--------------- ------------ -------------- ------------ ------------- ------------
REVENUE:
Finance charges $ 74,190 $ 74,190 19.4% $ 66,183 $ 66,183 18.1%
Lease revenue 13,201 13,201 3.5 16,368 16,368 4.5
Other income (1) 32,489 26,173 6.9 26,332 25,250 6.9
--------------- ------------ -------------- ------------ ------------- -----------
Total revenue 119,880 113,564 29.8 108,883 107,801 29.5
COSTS AND EXPENSES:
Operating expenses (2) 49,446 49,775 13.0 46,208 45,559 12.5
Provision for credit losses (3) 13,599 13,159 3.4 8,352 8,352 2.3
Depreciation of leased assets 7,758 7,758 2.0 9,270 9,270 2.5
Interest 7,126 7,126 1.9 11,708 11,708 3.2
--------------- ------------ -------------- ------------ ------------- -----------
Total costs and expenses 77,929 77,818 20.3 75,538 74,889 20.5
--------------- ------------ -------------- ------------ ------------- -----------
Operating income 41,951 35,746 9.5 33,345 32,912 9.0
Foreign exchange gain (loss) 2 2 - (41) (41) -
--------------- ------------ -------------- ------------ ------------- -----------
Income before credit for income taxes 41,953 35,748 9.5 33,304 32,871 9.0
Provision for income taxes (4) 17,658 12,726 3.3 11,341 11,189 3.1
--------------- ------------ -------------- ------------ ------------- -----------
Net income $ 24,295 $ 23,022 6.2% $ 21,963 $ 21,682 5.9%
=============== ============ ============== ============ ============= ===========
ROC (5) 7.2% 8.0%
WACC (6) 9.5% 10.0%
------------ -------------
Spread (2.3%) (2.0%)
Average capital (7) $ 509,217 $ 487,040
Economic loss (8) $ (8,698) $ (7,243)
Adjusted weighted average shares outstanding (9) 47,058,190 47,217,694
Economic loss per share (10) $ (0.18) $ (0.15)
(1)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ---------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported other income $ 15,036 $ 7,850 $ 32,489 $ 26,332
Interest income from Internal Revenue Service (4,810) - (4,810) -
Ancillary product revenue recognition policy change (1,506) - (1,506) -
Gain on securitization related to clean-up call - - - (1,082)
----------- ------------ ------------ -----------
Adjusted other income $ 8,720 $ 7,850 $ 26,173 $ 25,250
=========== ============ ============ ===========
(2)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ---------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported operating expense $ 16,389 $ 15,585 $ 49,446 $ 46,208
State tax expense resulting from re-characterization
of income - - 329 -
Executive severance expense - - - (649)
Stock option expense (i) 755 - - -
----------- ------------ ------------ -----------
Adjusted operating expense $ 17,144 $ 15,585 $ 49,775 $ 45,559
=========== ============ ============ ===========
i) Refer to "Stock Options".
(3)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported provision for credit losses $ 7,048 $ 2,632 $ 13,599 $ 8,352
Ancillary product revenue recognition policy change (440) - (440) -
----------- ------------ ------------ -----------
Adjusted provision for credit losses $ 6,608 $ 2,632 $ 13,159 $ 8,352
=========== ============ ============ ===========
11
(4)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported provision for income taxes $ 4,925 $ 3,937 $ 17,658 $ 11,341
United Kingdom repatriation tax expense - - (3,564) -
State tax expense resulting from re-characterization
of income - - 634 -
Tax impact of adjustments described in footnotes (1) - (3) (2,267) - (2,002) (152)
----------- ------------ ------------ -----------
Adjusted provision for income taxes $ 2,658 $ 3,937 $ 12,726 $ 11,189
=========== ============ ============ ===========
(5) Return on capital is equal to net income plus interest expense after
tax divided by average capital.
(6) Weighted average cost of capital is equal to the sum of: (i) the
after-tax cost of debt multiplied by the ratio of average debt to
average capital, plus (ii) the cost of equity multiplied by the ratio
of average equity to average capital. The cost of equity is assumed to
be equal to the 30-year Treasury bond rate plus 6% plus two times the
ratio of the Company's interest bearing debt to equity. For purposes of
computing economic profit, the Company has added to shareholders'
equity as reported under GAAP $34,319,000 and $34,535,000 in the three
and nine months ended September 30, 2002, respectively, and $34,438,000
and $32,904,000 in the three and nine months ended September 30, 2001,
respectively. The amounts added to shareholders' equity represent the
average options outstanding for the period multiplied by the weighted
average exercise price.
(7) Average capital is equal to the average amount of debt and equity
during the period.
(8) Economic loss equals the Spread (ROC minus WACC) multiplied by average
capital.
(9) Includes actual weighted average shares outstanding plus total stock
options outstanding. Differs from shares used for GAAP earnings per
share, which include only a portion of options outstanding.
(10) Economic loss per share equals the economic loss divided by the
adjusted weighted average shares outstanding.
The Company's profitability models indicate that business originated
year to date in 2002 will generate greater returns on capital for the Company
than business originated for the same periods in prior years. The Company's 2002
reported results do not reflect this profitability for reasons discussed in the
North America and United Kingdom sections. The Company's profitability models
are based in part on forecasts of future events. Actual results could differ
materially from these forecasts.
The Company's economic loss increased to ($5,443,000) and ($8,698,000)
or ($0.12) and ($0.18) per adjusted share for the three and nine months ended
September 30, 2002 compared to ($2,301,000) and ($7,243,000) or ($0.05) and
($0.15) per adjusted share for the same periods in 2001. These increases in
economic loss were a result of the decrease in the return on capital to 5.3% and
7.2% for the three and nine months ended September 30, 2002 compared to 7.9% and
8.0% for the same periods in 2001. The decrease in return on capital for the
three months ended September 30, 2002 is primarily the result of a decrease in
the return on capital in North America. The decrease in return on capital for
the nine months ended September 30, 2002 is the result of a decrease in the
return on capital in North America and the United Kingdom. These decreases in
return on capital were partially offset by the lower weighted average cost of
capital, which was a result of lower interest rates during the period.
The results of operations for the Company as a whole are attributable
to changes described in the North America, United Kingdom, and Automobile
Leasing business segments. The following discussion of the results of operations
for interest expense is provided on a consolidated basis, as the explanation is
not meaningful by business segment.
Interest expense. Interest expense, as a percent of average capital,
decreased to 1.9% for the three and nine months ended September 30, 2002 from
3.0% and 3.2% for the same periods in 2001. The decrease in interest expense, as
a percent of average capital, was primarily the result of the decrease in the
weighted average interest rate to 5.7% and 5.3% for the three and nine months
ended September 30, 2002 from 7.5% and 8.4% for the same periods in 2001, which
was the result of a decrease in the average interest rate on the Company's
variable rate debt, including the lines of credit and secured financing, and the
repayment of the senior note debt.
12
North America
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
-------------------------------------------- --------------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
------------- ------------ --------------- ------------ ------------- ---------------
REVENUE:
Finance charges $ 19,351 $ 19,351 19.8% $ 17,903 $ 17,903 8.7%
Other income (1) 12,458 7,648 7.8 6,995 6,995 7.3
------------- ------------ -------------- ------------ ------------- --------------
Total revenue 31,809 26,999 27.6 24,898 24,898 26.0
COSTS AND EXPENSES:
Operating expenses (2) 14,069 14,824 15.2 12,594 12,594 13.2
Provision for credit losses 5,069 5,069 5.2 735 735 0.8
Interest 1,881 1,881 1.9 2,509 2,509 2.6
------------- ------------ -------------- ------------ ------------- --------------
Total costs and expenses 21,019 21,774 22.3 15,838 15,838 16.6
------------- ------------ -------------- ------------ ------------- --------------
Operating income 10,790 5,225 5.3 9,060 9,060 9.4
Foreign exchange loss (14) (14) - (6) (6) -
------------- ------------ -------------- ------------ ------------- --------------
Income before provision for income taxes 10,776 5,211 5.3 9,054 9,054 9.4
Provision for income taxes (3) 3,978 2,030 2.1 3,214 3,214 3.4
------------- ------------ -------------- ------------ ------------- --------------
Net income $ 6,798 $ 3,181 3.2% $ 5,840 $ 5,840 6.0%
============= ============ ============== ============ ============= ==============
ROC * 4.5% 7.8%
WACC * 9.6% 9.6%
------------ -------------
Spread (5.1%) (1.8%)
Average capital (4) $ 391,392 $ 382,147
Economic loss * $ (4,877) $ (1,664)
Adjusted weighted average shares outstanding * 46,964,660 47,062,038
Economic loss per share * $ (0.10) $ (0.04)
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
-------------------------------------------- --------------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
------------- ------------ --------------- ------------ ------------- ---------------
REVENUE:
Finance charges $ 60,249 $ 60,249 20.5% $ 50,095 $ 50,095 18.8%
Other income (1) 28,293 23,483 8.0 23,612 22,530 8.4
------------- ------------- ------------- ------------- ------------- -------------
Total revenue 88,542 83,732 28.5 73,707 72,625 27.2
COSTS AND EXPENSES:
Operating expenses (2) 41,262 41,591 14.1 36,629 36,629 13.7
Provision for credit losses 6,265 6,265 2.1 1,543 1,543 0.6
Interest 4,887 4,887 1.7 7,177 7,177 2.7
------------- ------------- ------------- ------------- ------------- -------------
Total costs and expenses 52,414 52,743 17.9 45,349 45,349 17.0
------------- ------------- ------------- ------------- ------------- -------------
Operating income 36,128 30,989 10.6 28,358 27,276 10.2
Foreign exchange loss (1) (1) - (37) (37) -
------------- ------------- ------------- ------------- ------------- -------------
Income before provision for income taxes 36,127 30,988 10.6 28,321 27,239 10.2
Provision for income taxes (3) 16,230 11,617 3.9 10,002 9,623 3.6
------------- ------------- ------------- ------------- ------------- -------------
Net income $ 19,897 $ 19,371 6.7% $ 18,319 $ 17,616 6.6%
============= ============= ============= ============= ============= =============
ROC * 7.7% 8.3%
WACC * 9.4% 9.9%
------------- -------------
Spread (1.7%) (1.6%)
Average capital (4) $ 392,419 $ 356,067
Economic loss * $ (4,810) $ (4,190)
Adjusted weighted average shares outstanding * 47,058,190 47,217,694
Economic loss per share * $ (0.10) $ (0.09)
* For further explanation see corresponding footnotes in the Consolidated
section.
(1)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ---------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported other income $ 12,458 $ 6,995 $ 28,293 $ 23,612
Interest income from Internal Revenue Service (4,810) - (4,810) -
Gain on securitization related to clean-up call - - - (1,082)
----------- ------------ ------------ -----------
Adjusted other income $ 7,648 $ 6,995 $ 23,483 $ 22,530
=========== ============ ============ ===========
13
(2)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported operating expense $ 14,069 $ 12,594 $ 41,262 $ 36,629
State tax expense resulting from re-
characterization of income - - 329 -
Stock option expense (i) 755 - - -
----------- ------------ ------------ -----------
Adjusted operating expense $ 14,824 $ 12,594 $ 41,591 $ 36,629
=========== ============ ============ ===========
i) Refer to "Stock Options".
(3)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported provision for income taxes $ 3,978 $ 3,214 $ 16,230 $ 10,002
United Kingdom repatriation tax expense
- - (3,564) -
State tax expense resulting from re-
characterization of income - - 634 -
Tax impact of adjustments described in
footnotes (1) - (2) (1,948) - (1,683) (379)
----------- ------------ ------------ -----------
Adjusted provision for income taxes $ 2,030 $ 3,214 $ 11,617 $ 9,623
=========== ============ ============ ===========
(4) Average capital is equal to the average amount of debt and equity during
the period. For purposes of computing economic profit, the Company has
added to shareholders' equity as reported under GAAP $32,946,000 and
$33,362,000 in the three and nine months ended September 30, 2002,
respectively, and $34,183,000 and $32,802,000 in the three and nine months
ended September 30, 2001, respectively. The amounts added to shareholders'
equity represent the average options outstanding for the period multiplied
by the weighted average exercise price.
Finance charges. Finance charges, as a percent of average capital,
increased to 19.8% and 20.5% for the three and nine months ended September 30,
2002 from 18.7% and 18.8% for the same periods in 2001. The increase was
primarily due to a reduction in the amount advanced to dealer-partners as a
percent of the gross loan amount. This increase was partially offset by an
increase in the percent of non-accrual loans to 22.2% as of September 30, 2002
from 17.7% for the same period in 2001. For the three months ended September 30,
2002 the increase was also partially offset by a decrease in collections on
non-accrual loans.
Other income. Other income, as a percent of average capital, increased
to 7.8% for the three months ended September 30, 2002 from 7.3% for the same
period in 2001. This increase was primarily due to an increase in: (i) revenue
from fees paid by dealer-partners for the use of the Company's internet based
origination system due to an increase in the number of dealer-partners using the
system and (ii) revenue earned from service contract products offered by
dealer-partners. These increases were partially offset by a decrease in (i)
revenue from secured lines of credit offered to certain dealer-partners, due to
the Company beginning to reduce its investment in this product in the third
quarter of 2001.
Other income, as a percent of average capital, decreased to 8.0% for
the nine months ended September 30, 2002 from 8.4% for the same period in 2001.
This decrease was primarily due to a decrease in: (i) premiums earned on the
Company's credit life insurance programs due to a decrease in loan originations;
(ii) premiums earned on the Company's collateral protection program, which was
discontinued in April 2001; and (iii) revenue from secured lines of credit
offered to certain dealer-partners, due to the Company beginning to reduce its
investment in this product in the third quarter of 2001. These decreases were
partially offset by an increase in revenue from fees paid by dealer-partners for
the use of the Company's internet origination system due to an increase in the
number of dealer-partners using the system.
Operating expenses. Operating expenses, as a percent of average
capital, increased to 15.2% and 14.1% for the three and nine months ended
September 30, 2002 from 13.2% and 13.7% for the same periods in 2001. These
increases were primarily due to an increase in the provision for floorplan and
dealer-partner loan losses to $1.8 million and $2.4 million for the three and
nine months ended September 30, 2002 from $900,000 and $1.4 million for the same
periods in 2001. As a percent of average capital, the provision for floorplan
and dealer-partner loan losses increased to 1.8% and 0.8% for the three and nine
months ended September 30, 2002 from 0.9% and 0.5% for the same periods in 2001.
In addition, the increase for the three and nine months ended September 30, 2002
was due to an increase in salaries and wages to $6.0 million and $18.4 million
for the three and nine months ended September 30, 2002 compared to $5.3 million
and $14.3 million for the same periods in 2001. As a percent of average capital,
salaries and wages increased to 6.1% and 6.3% for the three and nine months
ended September 30, 2002 from 5.5% and 5.4% for the same periods in 2001. These
increases were primarily due to increased spending on infrastructure such as
Information Technology, Human Resources, Accounting, Risk, Corporate Legal,
Internal Audit and a new Six Sigma initiative. The Company believes that these
investments will (i) support a much larger organization and (ii) enable the
Company to achieve its long-term return on capital goals.
14
As of September 30, 2002, the Company had $12.2 million of floorplan
and dealer-partner loans outstanding. The Company has significantly reduced its
investment in floorplan and dealer loan portfolios since the start of 2002 after
concluding such businesses were not likely to generate acceptable returns on
capital. The Company intends to continue to work to reduce the amount of capital
committed to these businesses.
Provision for credit losses. Provision for credit losses, as a percent
of average capital, increased to 5.2% and 2.1% for the three and nine months
ended September 30, 2002 from 0.8% and 0.6% for the same periods in 2001. The
provision for credit losses consists of two components: (i) a provision for
losses on advances to dealer-partners that are not expected to be recovered
through collections on the related automobile loan portfolio and (ii) a
provision for earned but unpaid revenue on automobile loans which were
transferred to non-accrual status during the period. The increases in the
provision for credit losses, as a percent of average capital, for the three and
nine months ended September 30, 2002 compared the three and nine months ended
September 30, 2001 were primarily due to: (i) an increase in the provision for
advance losses due to a reduction in forecasted future collections which the
Company believes is primarily the result of deterioration in collection results
relating to the installation of a new collection system late in the second
quarter of 2002 and (ii) an increase in the provision for earned but unpaid
revenue due to an increase in the percent of non-accrual loans to 22.2% as of
September 30, 2002 from 17.7% for the same period in 2001.
Additional reductions in the Company's forecast of future collections
will create increased provisions for losses on advances. Should the Company
experience a similar decline in its forecast in the fourth quarter of 2002, an
additional provision for advance losses of approximately $4.5 million would be
required in the fourth quarter. A decline in the Company's forecast of this
magnitude in both the fourth quarter of 2002 and the first quarter of 2003 would
result in increased provisions for advance losses of approximately $13.0
million.
Provision for income taxes. The provision for income taxes, as a
percent of average capital, decreased to 2.1% for the three months ended
September 30, 2002 from 3.4% for the same period in 2001 as a result of a
decrease in pre-tax profitability. This decrease was partially offset by an
increase in the effective tax rate to 39.0% for the three months ended September
30, 2002 from 35.5% for the same period in 2001 as a result of the amount
recorded for additional income taxes that would be due upon the repatriation of
the cumulative undistributed earnings of the Company's United Kingdom business
unit. The provision for income taxes, as a percent of average capital, increased
to 3.9% for the nine months ended September 30, 2002 from 3.6% for the same
period in 2001 as a result of an increase in pre-tax profitability. To a lesser
extent, the increase for the nine months ended September 30, 2002 was due to an
increase in the effective tax rate due to the amount recorded for additional
income taxes that would be due upon the repatriation of the cumulative
undistributed earnings of the Company's United Kingdom business unit.
The Company has completed a restructuring of certain subsidiaries,
which may result in a lower effective tax rate. Since the reduction in the
effective tax rate is contingent upon the completion of certain events, the
Company has not recorded a benefit relating to this restructuring. Once the
contingencies are satisfied, the tax benefit from the restructuring will be
recognized. Recognition of this benefit may have a material favorable impact on
the Company's results of operations.
Return on capital. The return on capital decreased to 4.5% and 7.7% for
the three and nine months ended September 30, 2002 from 7.8% and 8.3% for the
same periods in 2001. This decrease was primarily due to: (i) an increase in the
provision for credit losses, as a percent of average capital, and (ii) an
increase in operating expenses, as a percent of average capital, as described
above.
Average capital. Average capital increased to $391.4 million and $392.4
million for the three and nine months ended September 30, 2002 from $382.1
million and $356.1 million for the same periods in 2001, representing increases
of 2.4% and 10.2%. The increase was a result of increased loan origination
volumes in 2001. While loan origination volumes declined 21.0% and 12.9% during
the three and nine months ended September 30, 2002 compared to the same periods
in 2001, loan origination volumes increased significantly in 2001. The following
is a summary of loan origination volumes and dealer-partner information over the
past three years and the interim periods of 2002 and 2001:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------- -------- -------- --------------------- ----------------------
1999 2000 2001 2001 2002 2001 2002
--------- -------- -------- -------- -------- -------- --------
Originations $386,713 $384,743 $659,485 $173,708 $137,190 $515,947 $449,188
Number of loans originated 47,759 47,620 62,675 15,329 11,746 50,168 39,838
Dealer-partners:
Number of active dealer-partners (1) 1,236 1,202 1,170 848 588 1,121 779
Loans per active dealer-partner 38.6 39.6 53.6 18.1 20.0 44.8 51.1
Average loan size $ 8.1 $ 8.1 $ 10.5 $ 11.3 $ 11.7 $ 10.3 $ 11.3
(1) Active dealer-partners are dealer-partners who submitted at least one
loan during the period.
15
The reduction in loan origination volume in North America was a result
of the Company's increased focus on improving the return on capital. As a
result, the Company has experienced reduced loan originations due to a reduction
in the number of active dealer-partners, partially offset by an increase in the
number of loans per active dealer-partner. The reduction in active
dealer-partners was primarily due to the Company exiting dealer-partner
relationships that did not meet its return on capital goals. This occurred most
dramatically in the fourth quarter of 2001 and first quarter of 2002. The number
of active dealer-partners remained relatively constant during the second and
third quarters of 2002.
The Company's profitability models indicate that business originated
year to date in 2002 will generate greater returns on capital for the Company
than business originated for the same periods in prior years. The Company's 2002
reported results do not reflect this profitability due to: (i) the Company's
reported results reflecting the profitability of the Company's portfolio of
automobile loans which includes both 2002 originations and less profitable loans
originated prior to 2002, (ii) the reported results including losses from
businesses which the Company is exiting or reducing its investment in, (iii) the
impact of the collection system conversion, which the Company believes will not
have a long term adverse impact on the Company's results, and (iv) investments
which the Company has made in corporate infrastructure which have produced very
little short term financial benefit but are necessary to enable the Company to
meet its long term goals.
The Company has recently shifted from primarily focusing on the return
on capital to an effort to improve both returns and volume simultaneously. The
Company intends to continue to be disciplined with respect to terminating its
relationship with unprofitable dealer-partners. Loan origination growth in
future periods will occur only if return on capital objectives are being met.
16
United Kingdom
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------------------------------- --------------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
------------ ------------ --------------- ------------- ------------ ---------------
REVENUE:
Finance charges $ 4,432 $ 4,432 20.4 % $ 5,386 $ 5,386 22.4 %
Other income (1) 2,256 750 3.5 492 492 2.0
------------ ------------ --------------- ------------- ------------ ---------------
Total revenue 6,688 5,182 23.9 5,878 5,878 24.4
COSTS AND EXPENSES:
Operating expenses 1,587 1,587 7.3 1,851 1,851 7.7
Provision for credit losses (3) 728 288 1.3 209 209 0.9
Interest 87 87 0.4 576 576 2.4
------------ ------------ --------------- ------------- ------------ ---------------
Total costs and expenses 2,402 1,962 9.0 2,636 2,636 11.0
------------ ------------ --------------- ------------- ------------ ---------------
Operating income 4,286 3,220 14.9 3,242 3,242 13.4
Foreign exchange loss (1) (1) - - - -
------------ ------------ --------------- ------------- ------------ ---------------
Income before credit for income taxes 4,285 3,219 14.9 3,242 3,242 13.4
Provision for income taxes (4) 1,215 896 4.1 964 964 4.0
------------ ------------ --------------- ------------- ------------ ---------------
Net income $ 3,070 $ 2,323 10.8 % $ 2,278 $ 2,278 9.4 %
============ ============ =============== ============= ============ ===============
ROC * 11.0% 11.1%
WACC * 10.3% 10.4%
------------ ------------
Spread 0.7% 0.7%
Average capital (5) $ 86,869 $ 96,309
Economic profit * $ 140 $ 190
Adjusted weighted average shares outstanding * 46,964,660 47,062,038
Economic profit per share * $ 0.00 $ 0.00
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------------------------------- --------------------------------------------
REPORTED ADJUSTED % OF CAPITAL REPORTED ADJUSTED % OF CAPITAL
------------ ------------ --------------- ------------- ------------ ---------------
REVENUE:
Finance charges $ 13,941 $ 13,941 21.1% $ 16,088 $ 16,088 22.6%
Other income (1) 3,191 1,685 2.5 1,753 1,753 2.5
------------- ------------ --------------- ------------ ------------- -----------
Total revenue 17,132 15,626 23.6 17,841 17,841 25.1
COSTS AND EXPENSES:
Operating expenses (2) 5,361 5,361 8.1 5,974 5,325 7.5
Provision for credit losses (3) 3,234 2,794 4.2 2,311 2,311 3.2
Interest 642 642 1.0 1,703 1,703 2.4
------------- ------------ --------------- ------------ ------------- -----------
Total costs and expenses 9,237 8,797 13.3 9,988 9,339 13.3
------------- ------------ --------------- ------------ ------------- -----------
Operating income 7,895 6,829 10.3 7,853 8,502 12.0
Foreign exchange gain 2 2 - - - -
------------- ------------ --------------- ------------ ------------- -----------
Income before credit for income taxes 7,897 6,831 10.3 7,853 8,502 12.0
Provision for income taxes (4) 2,206 1,887 2.8 2,346 2,573 3.6
------------- ------------ --------------- ------------ ------------- ----------
Net income $ 5,691 $ 4,944 7.5% $ 5,507 $ 5,929 8.4%
============= ============ ============== ============ ============= ===========
ROC * 8.1% 10.0%
WACC * 10.5% 10.3%
------------ -------------
Spread (2.4%) (0.3%)
Average capital (5) $ 88,299 $ 95,019
Economic loss * $ (1,562) $ (247)
Adjusted weighted average shares outstanding * 47,058,190 47,217,694
Economic loss per share * $ (0.03) $ (0.01)
* For further explanation see corresponding footnotes in the Consolidated
section.
(1)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported other income $ 2,256 $ 492 $ 3,191 $ 1,753
Ancillary product revenue recognition
policy change (1,506) - (1,506) -
----------- ------------ ------------ -----------
Adjusted other income $ 750 $ 492 $ 1,685 $ 1,753
=========== ============ ============ ===========
17
(2)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported operating expense $ 1,587 $ 1,851 $ 5,361 $ 5,974
Executive severance expense - - - (649)
----------- ------------ ------------ -----------
Adjusted operating expense $ 1,587 $ 1,851 $ 5,361 $ 5,325
=========== ============ ============ ===========
(3)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported provision for credit losses $ 728 $ 209 $ 3,234 $ 2,311
Ancillary product revenue recognition
policy change (440) - (440) -
----------- ------------ ------------ -----------
Adjusted provision for credit losses $ 288 $ 209 $ 2,794 $ 2,311
=========== ============ ============ ===========
(4)
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
2002 2001 2002 2001
----------- ------------ ------------ -----------
Reported provision for income taxes $ 1,215 $ 964 $ 2,206 $ 2,346
Tax impact of adjustments described in
footnotes (1) - (3) (319) - (319) 227
----------- ------------ ------------ -----------
Adjusted provision for income taxes $ 896 $ 964 $ 1,887 $ 2,573
=========== ============ ============ ===========
(5) Average capital is equal to the average amount of debt and equity during
the period. For purposes of computing economic profit, the Company has
added to shareholders' equity as reported under GAAP $1,373,000 and
$1,173,000 in the three and nine months ended September 30, 2002,
respectively, and $255,000 and $102,000 in the three and nine months ended
September 30, 2001, respectively. The amounts added to shareholders' equity
represent the average options outstanding for the period multiplied by the
weighted average exercise price.
Finance charges. Finance charges, as a percent of average capital,
decreased to 20.4% and 21.1% for the three and nine months ended September 30,
2002 from 22.4% and 22.6% for the same periods in 2001. This decrease was
primarily due to an increase in the percent of non-accrual loans to 29.3% as of
September 30, 2002 from 20.4% for the same period in 2001 due to a reduction in
automobile loan originations in 2002.
Other income. Other income, as a percent of average capital, increased
to 3.5% for the three months ended September 30, 2002 from 2.0% for the same
period in 2001. This increase, as a percent of average capital, was due
primarily to an increase in revenue under an ancillary products profit sharing
agreement with an insurance provider. Other income, as a percent of average
capital, remained consistent at 2.5% for the nine months ended September 30,
2002 compared to the same period in 2001.
Operating Expenses. Operating expenses, as a percent of average
capital, decreased to 7.3% for the three months ended September 30, 2002 from
7.7% for the same period in 2001. This decrease was due primarily to a decrease
in salaries and wages, as a percent of average capital. Operating expenses, as a
percent of average capital, increased to 8.1% for the nine months ended
September 30, 2002 from 7.5% for the same period in 2001. This increase was
primarily due to: (i) an increase in unrecoverable value added tax expense due
to the timing of refunds and (ii) an increase in legal expense due to additional
fees relating to the restructuring of legal entities within this business
segment in 2001.
Provision for credit losses. Provision for credit losses, as a percent
of average capital, increased to 1.3% and 4.2% for the three and nine months
ended September 30, 2002 from 0.9% and 3.2% for the same periods in 2001. The
provision for credit losses consists of two components: (i) a provision for
losses on advances to dealer-partners that are not expected to be recovered
through collections on the related automobile loan portfolio; and (ii) a
provision for earned but unpaid revenue on automobile loans which were
transferred to non-accrual status during the period. The increases in the
provision for the three and nine months ended September 30, 2002 were primarily
due to an increase in the provision for losses on advances to dealer-partners.
The increase in advance provisions was due to the deterioration in credit
quality of loans originated in 2001. As a result of this deterioration, the
Company stopped originating automobile loans in Ireland and decreased the amount
advanced to dealer-partners in the United Kingdom.
Provision for income taxes. The provision for income taxes, as a
percent of average capital, remained relatively consistent at 4.1% for the three
months ended September 30, 2002 compared to 4.0% for the same period in 2001.
The provision for income taxes, as a percent of average capital, decreased to
2.8% for the nine months ended September 30, 2002 from 3.6% for
18
the same period in 2001 due primarily to a decrease in pre-tax profitability for
the nine months ended September 30, 2002 compared to the same period in 2001.
Refer to "North America - Provision for income taxes"
Return on capital. The return on capital decreased to 11.0% and 8.1%
for the three and nine months ended September 30, 2002 from 11.1% and 10.0% for
the same periods in 2001. These decreases were primarily due to a reduction in
finance charge revenue, as a percent of average capital, as described above.
Average capital. Average capital decreased to $86.9 million and $88.3
million for the three and nine months ended September 30, 2002 from $96.3
million and $95.0 million for the same periods in 2001, representing decreases
of 9.8% and 7.1%, respectively. The decrease in average capital was a result of
decreased loan origination volumes. As a result, the United Kingdom has repaid
its outstanding debt and has begun to repatriate previously undistributed
earnings to North America. The following is a summary of loan origination
volumes and dealer-partner information over the past three years and for the
interim periods of 2002 and 2001:
(Dollars in thousands) THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------- ------------- ------------- ---------------------- ---------------------
1999 2000 2001 2001 2002 2001 2002
-------- -------- -------- -------- -------- -------- --------
Originations $121,999 $142,228 $122,817 $ 26,990 $ 9,073 $ 96,296 $ 35,976
Number of loans originated 9,432 10,664 9,121 1,938 605 7,201 2,560
Dealer-partners:
Number of active dealer-partners (1) 196 205 215 126 69 204 138
Loans per active dealer-partner 48.1 52.0 42.4 15.4 8.8 35.3 18.6
Average loan size $ 12.9 $ 13.3 $ 13.5 $ 13.9 $ 15.0 $ 13.4 $ 14.1
(1) Active dealer-partners are dealer-partners who submitted at least
one loan during the period.
The reduction in loan origination volume for the three and nine months
ended September 30, 2002 was a result of the Company's increased focus on
improving return on capital. To improve the United Kingdom's return on capital
the Company has increased the spread between the advance rate and the forecasted
collection rate and stopped accepting business from a large dealer group whose
business did not meet the Company's return on capital objectives. In order for
these changes to result in improved returns on capital, increased unit volume
will be required in order to absorb fixed operating expenses.
19
Automobile Leasing
(Dollars in thousands, except per share data) THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, 2002 SEPTEMBER 30, 2001
------------------------------------ -----------------------------------
REPORTED % OF CAPITAL REPORTED % OF CAPITAL
--------------- ---------------- --------------- ---------------
REVENUE:
Lease revenue $ 3,614 65.5 % $ 5,728 64.5
Other income 322 5.8 363 4.1
--------------- ---------------- --------------- ----------------
Total revenue 3,936 71.3 6,091 68.6
COSTS AND EXPENSES:
Operating expenses 733 13.3 1,140 12.8
Provision for credit losses 1,251 22.7 1,688 19.0
Depreciation of leased assets 2,251 40.8 3,172 35.7
Interest 396 7.2 802 9.0
--------------- ---------------- --------------- ----------------
Total costs and expenses 4,631 84.0 6,802 76.5
--------------- ---------------- --------------- ----------------
Operating loss (695) (12.7) (711) (7.9)
Foreign exchange loss (10) (0.2) (3) -
--------------- ---------------- --------------- ----------------
Loss before credit for income taxes (705) (12.9) (714) (7.9)
Credit for income taxes (268) (4.9) (241) (2.7)
--------------- ---------------- --------------- ----------------
Net loss $ (437) (8.0) % $ (473) (5.2) %
=============== ================ =============== ================
ROC * (3.3%) 0.6%
WACC* 9.5% 9.9%
--------------- ---------------
Spread (12.8%) (9.3%)
Average capital * $ 22,061 $ 35,536
Economic loss * $ (706) $ (827)
Adjusted weighted average shares outstanding * 46,964,660 47,062,038
Economic loss per share* $ (0.02) $ (0.02)
(Dollars in thousands, except per share data) NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30
2002 2001
------------------------------------ -----------------------------------
REPORTED % OF CAPITAL REPORTED % OF CAPITAL
--------------- ---------------- --------------- ---------------
REVENUE:
Lease revenue $ 13,201 61.8 % $ 16,368 60.7 %
Other income 1,005 4.7 967 3.6
--------------- ---------------- --------------- ---------------
Total revenue 14,206 66.5 17,335 64.3
COSTS AND EXPENSES:
Operating expenses 2,823 13.2 3,605 13.4
Provision for credit losses 4,100 19.2 4,498 16.7
Depreciation of leased assets 7,758 36.3 9,270 34.4
Interest 1,597 7.5 2,828 10.5
--------------- ---------------- --------------- ---------------
Total costs and expenses
16,278 76.2 20,201 75.0
--------------- ---------------- --------------- ---------------
Operating loss (2,072) (9.7) (2,866) (10.7)
Foreign exchange gain (loss) 1 - (4) -
--------------- ---------------- --------------- ---------------
Loss before credit for income taxes (2,071) (9.7) (2,870) (10.7)
Credit for income taxes (778) (3.6) (1,007) (3.7)
--------------- ---------------- --------------- ---------------
Net loss $ (1,293) (6.1)% $ (1,863) (7.0)%
=============== ================ =============== ===============
ROC * (1.2%) (0.1%)
WACC* 9.7% 10.3%
--------------- ---------------
Spread (10.9%) (10.4%)
Average capital * $ 28,499 $ 35,954
Economic loss * $ (2,326) (2,806)
Adjusted weighted average shares outstanding * 47,058,190 47,217,694
Economic loss per share* $ (0.05) $ (0.06)
* For further explanation see corresponding footnotes in the Consolidated
section.
Lease revenue. Lease revenue, as a percent of average capital,
increased to 65.5% and 61.8% for the three and nine months ended September 30,
2002 from 64.5% and 60.7% for the same periods in 2001. This increase was
primarily due to the effect of recording revenue for operating leases on a
straight-line basis as the average capital invested per lease declines due to an
increase in the average age of the lease portfolio.
Other income. Other income, as a percent of average capital, increased
to 5.8% and 4.7% for the three and nine months ended September 30, 2002 from
4.1% and 3.6% for the same periods in 2001. The increases for the three months
and nine
20
months ended September 30, 2002 were primarily the result of an increase in
gains recognized on leases terminated before their maturity date.
Operating expenses. Operating expenses, as a percent of average
capital, increased to 13.3% for the three months ended September 30, 2002 from
12.8% for the same period in 2001. The increase is primarily a result of an
increase in the provision for uncollectible receivables, as a percent of average
capital, from dealer-partners for ancillary product charge backs on repossessed
leased vehicles. Operating expenses, as a percent of average capital, remained
relatively consistent at 13.2% for the nine months ended September 30, 2002
compared to 13.4% for the same period in 2001.
Provision for credit losses. Provision for credit losses, as a percent
of average capital, increased to 22.7% and 19.2% for the three and nine months
ended September 30, 2002 from 19.0% and 16.7% for the same periods in 2001.
These increases in the provision were primarily due to the frequency of lease
repossessions declining at a slower rate than the decline in average capital.
Depreciation of leased assets. Depreciation of leased assets, including
the amortization of indirect lease costs, is recorded on a straight-line basis
to the residual value of leased vehicles over their scheduled lease terms.
Depreciation expense, as a percent of average capital, increased to 40.8% and
36.3% for the three and nine months ended September 30, 2002 from 35.7% and
34.4% for the same periods in 2001. These increases were primarily due to: (i)
the effect of recording depreciation on a straight-line basis as the average
capital invested per lease declines due to an increase in the average age of the
lease portfolio and (ii) a reduction in the average residual value, as a percent
of original lease value, in the lease portfolio.
Credit for income taxes. The credit for income taxes, as a percent of
average capital, increased to (4.9%) for the three months ended September 30,
2002 from (2.7%) for the same period in 2001 as a result of the pre-tax loss
decreasing at a slower rate than the decline in average capital. The credit for
income taxes, as a percent of average capital, decreased to (3.6%) for the nine
months ended September 30, 2002 from (3.7%) for the same periods in 2001 as a
result of a reduction in the pre-tax loss for the nine months ended September
30, 2002 compared to the same period in 2001.
Return on capital. The return on capital decreased to (3.3%) and (1.2%)
for the three and nine months ended September 30, 2002 from 0.6% and (0.1%) for
the same periods in 2001. These decreases were primarily due to increases in the
depreciation of leased assets and provision for credit losses, as a percent of
average capital, as described above.
Average capital. Average capital decreased to $22.1 million and $28.5
million for the three and nine months ended September 30, 2002 from $35.5
million and $36.0 million for the same periods in 2001. This decrease was the
result of the Company's decision to stop originating automobile leases in
January 2002.
STOCK OPTIONS
In 1999, the Company began granting performance-based stock options to
employees. Performance-based options are options that vest solely based on the
achievement of performance targets, in the Company's case targets based on
either earnings per share or economic profit. GAAP requires companies to expense
performance-based options when it is likely that performance targets will be met
and a measurement date can be established. The amount of the reported expense is
the price of the Company's stock at the end of each reporting period less the
exercise price of the options. The Company's non-performance options are not
required to be expensed under GAAP.
Regardless of the accounting, options represent a significant cost to
shareholders. The true cost is the business value transferred to the employee in
stock, less the exercise proceeds, a number that is difficult to calculate since
it depends on when options are exercised and the future performance of the
business. GAAP provides several alternatives for accounting for this cost. In
the Company's opinion, none of these alternatives provide a method that
accurately captures the true cost of options in all circumstances.
Because the Company believes that accurately understanding and managing
the cost of options is essential, the Company has developed the following
practices regarding stock options:
- Beginning in 2002, options are issued only after shares have first been
repurchased in the open market. In all cases, the option is priced at
or above the average price of the repurchased shares. For shareholders,
the impact of options therefore is the capital used to repurchase
shares is no longer available to invest in income producing assets.
This cost, the opportunity cost of the capital used to repurchase
shares until the capital is returned upon option exercise, reduces the
Company's reported earnings. Option grants are predominantly
performance-based, with appropriately aggressive vesting targets. The
Company believes that these options properly align the interests of
management and shareholders by rewarding management only for
exceptional business performance.
21
- The Company's reported economic profit (loss) includes three
adjustments to the Company's results reported under GAAP to reflect the
cost of options. First, to avoid double counting, the GAAP expense
recorded for performance options is added back. Second, all options
outstanding are included in the Company's fully diluted share base.
Finally, economic profit (loss) includes a charge for the capital used
to repurchase shares covering options grants. The Company's method of
measuring options in the calculation of economic profit (loss) is
conservative in two respects. First, the tax benefits of future option
exercises have not been included in the Company's calculation. Because
option expense is deducted for tax purposes upon exercise, more capital
will be returned to the Company upon exercise than is invested in
repurchased shares. Second, options may be cancelled due to turnover or
the failure to meet performance targets. Cancellations will be factored
in as they occur. One additional risk is assumed. Should options be
issued and shares repurchased above intrinsic value, and the options
subsequently expire unexercised, a loss equal to the amount paid above
intrinsic value would be incurred.
- The practice of repurchasing shares to cover option grants has evolved
over time. To date the Company has repurchased shares covering all
options granted since 1995. Because the Company's option program
pre-dates the current practice of repurchasing shares, as of September
30, 2002 approximately 1.7 million options granted prior to 1995 have
not been covered by repurchases. Depending upon capital availability
and other investment opportunities, the Company may repurchase shares
covering some or all of these uncovered options. Beginning this
quarter, for purposes of computing economic profit, the Company
includes a capital charge as if these options had been repurchased at
the option exercise price at the date of grant.
The Company views options as a significant but necessary cost. In the
Company's opinion, this cost is now accurately measured and charged to economic
profit per share, the number on which the Company's management incentive
compensation system is based. The Company believes the ability to measure the
cost of options, combined with an incentive compensation system that includes
this cost, enhances the probability that the Company's option program will
produce favorable results for shareholders.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial statements are prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires the Company to make
estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an on-going basis, the Company evaluates its
estimates, including those related to the reserve for advance losses, the
allowance for credit losses, and the allowance for lease vehicle losses. Item 7
of the Company's Annual Report on Form 10-K discusses several critical
accounting policies, which the Company believes involve a high degree of
judgment and complexity. There have been no material changes to that information
during the nine months ended September 30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are cash flows from operating
activities, principal collected on automobile loans receivable, borrowings under
the Company's credit agreements and secured financings. The Company's principal
need for capital is to fund cash advances made to dealer-partners in connection
with the acceptance of automobile loans, to pay dealer holdbacks to
dealer-partners who have repaid their advance balances.
When borrowing to fund the operations of its foreign subsidiaries, the
Company's policy is to borrow funds denominated in the currency of the country
in which the subsidiary operates, thus mitigating the Company's exposure to
foreign exchange fluctuations.
The Company's cash flow requirements are dependent on future levels of
automobile loan originations. In the three and nine months ended September 30,
2002, the Company experienced a decrease in originations over the same periods
in 2001. This decrease is the result of the Company's increased focus on
improving the return on capital. Once return on capital goals have been met and
collection forecasts stabilize, the Company intends to focus on increasing the
amount of capital invested through increasing the number of dealer-partners and
the number of loans originated per dealer-partner.
The Company currently finances its operations through: (i) a bank line
of credit facility; (ii) secured financings; and (iii) a mortgage note.
Line of Credit Facility - At September 30, 2002, the Company had a
$135.0 million credit agreement with a commercial bank syndicate. The facility
has a commitment period through June 9, 2003, with a one-year term option at the
request of the
22
Company provided that no event of default then exists. The agreement provides
that, at the Company's discretion, interest is payable at either the eurodollar
rate plus 140 basis points, or at the prime rate (4.75% as of September 30,
2002). The eurodollar borrowings may be fixed for periods of up to six months.
Borrowings under the credit agreement are subject to a borrowing base limitation
equal to 65% of advances to dealer-partners and leased vehicles (as reflected in
the consolidated financial statements and related notes), less a hedging reserve
(not exceeding $1,000,000), the amount of letters of credit issued under the
line of credit, and the amount of other debt secured by the collateral which
secures the line of credit. Currently, the borrowing base limitation does not
inhibit the Company's borrowing ability under the line of credit. The credit
agreement has certain restrictive covenants, including a minimum required ratio
of the Company's assets to debt, its liabilities to tangible net worth, and its
earnings before interest, taxes and non-cash expenses to fixed charges.
Additionally, the agreement requires that the Company maintain a specified
minimum level of net worth. Borrowings under the credit agreement are secured by
a lien on most of the Company's assets. The Company must pay an annual agent's
fee and a quarterly commitment fee of 0.60% on the amount of the commitment. As
of September 30, 2002, there was approximately $96.8 million outstanding under
this facility. Since this credit facility expires on June 9, 2003, the Company
will be required to renew the facility or refinance any amounts outstanding
under this facility on or before such date. The Company believes that the $135.0
million credit facility will be renewed with similar terms and a similar
commitment amount. The Company also maintains a small line of credit agreement
in Canada to fund daily cash requirements within this operation.
Secured Financing - The Company's wholly-owned subsidiary, CAC Funding
Corp. ("Funding"), has completed seven secured financing transactions with an
institutional investor through September 30, 2002, two of which remain
outstanding. The remaining secured financings include the July 23, 2001 and
November 5, 2001 transactions, in which Funding received $61.0 million and $62.0
million in financing, respectively. In connection with these transactions, the
Company contributed dealer-partner advances having a carrying amount of
approximately $83.0 million and $96.0 million for the July 2001 and November
2001 secured financings, respectively, to Funding, which, in turn, pledged them
as collateral to an institutional investor to secure loans that funded the
purchase price of the dealer-partner advances. The proceeds of the secured
financings were used by the Company to reduce outstanding borrowings under the
Company's credit facility. The secured financings created a loan for which
Funding is liable and is non-recourse to the Company, even though Funding and
the Company are consolidated for financial reporting purposes. Such loans bear
interest at a floating rate equal to the commercial paper rate plus 50 basis
points with a maximum of 7.5% and 6.5% for the July 23, 2001 and November 5,
2001 secured financings, respectively. As Funding is organized as a separate
legal entity from the Company, assets of Funding (including the contributed
dealer-partner advances) will not be available to satisfy the general
obligations of the Company. Substantially all the assets of Funding have been
encumbered to secure Funding's obligations to its creditors. In the six months
following the July 2001 and the four months following the November 2001
financings, the Company and Funding received additional proceeds by the Company
contributing additional dealer-partner advances to Funding, which were then used
by Funding as collateral to support additional borrowings. Funding then used the
proceeds to pay the purchase price of dealer-partner advances. Such financings
are secured primarily by Funding's dealer-partner advances and the Company's
servicing fee. The Company receives a monthly servicing fee paid by the
institutional investor equal to 6% of the collections on Funding's automobile
loans receivable for the July 2001 and November 2001 secured financings. Except
for the servicing fee and payments due to dealer-partners, the Company does not
receive, or have any rights in, any portion of collections on the automobile
loans receivable until Funding's underlying indebtedness is paid in full either
through collections on the related automobile loans or through a prepayment of
the indebtedness.
A summary of the secured financing transactions is as follows (dollars
in thousands):
Balance as
Secured Financing Secured Dealer Percent of
Issue Original Balance at Advance Balance at Original
Number Close Date Balance September 30, 2002 September 30, 2002 Balance
- ------------ ----------------- ------------- -------------------- ---------------------- ----------------
1998-A July 1998 $ 50,000 Paid in full Paid in full 0.0 %
1999-A July 1999 50,000 Paid in full Paid in full 0.0
1999-B December 1999 50,000 Paid in full Paid in full 0.0
2000-A August 2000 65,000 Paid in full Paid in full 0.0
2001-A March 2001 97,100 Paid in full Paid in full 0.0
2001-B July 2001 60,845 $11,647 * $57,003 19.1
2001-C November 2001 61,795 18,610 ** 64,528 30.1
------------- -------------------- ----------------------
$434,740 $30,257 $121,531
============= ==================== ======================
* Bears an interest rate of 2.6% and is anticipated to fully amortize within 4
months as of September 30, 2002
** Bears an interest rate of 2.6% and is anticipated to fully amortize within 6
months as of September 30, 2002
23
On September 27, 2002, the Company's wholly-owned subsidiary, CAC
Warehouse Funding Corp. ("Warehouse Funding"), completed a secured financing
transaction with another institutional investor, in which Warehouse Funding
received $75.0 million in financing, which was funded on October 3, 2002. In
connection with this transaction, the Company contributed dealer-partner
advances having a carrying amount of approximately $109.0 million to Warehouse
Funding, which, in turn, pledged them as collateral to an institutional investor
to secure loans that funded the purchase price of the dealer-partner advances.
The proceeds of the secured financings were used by the Company to reduce
outstanding borrowings under the Company's credit facility. The secured
financings create loans for which Warehouse Funding is liable and are
non-recourse to the Company, even though Warehouse Funding and the Company are
consolidated for financial reporting purposes. Such loans bear interest at a
floating rate equal to the commercial paper rate plus 75 basis points with a
maximum of 6.25%. As Warehouse Funding is organized as a separate legal entity
from the Company, assets of Warehouse Funding (including the contributed
dealer-partner advances) will not be available to satisfy the general
obligations of the Company. Substantially all the assets of Warehouse Funding
have been encumbered to secure Warehouse Funding's obligations to its creditors.
This financing is secured primarily by Warehouse Funding's dealer-partner
advances and the Company's servicing fee. The Company receives a monthly
servicing fee paid by the institutional investor equal to 6% of the collections
on Funding's automobile loans receivable for the secured financing. Except for
the servicing fee and payments due to dealer-partners, the Company does not
receive, or have any rights in, any portion of collections on the automobile
loans receivable until Warehouse Funding's underlying indebtedness is paid in
full either through collections on the related automobile loans or through a
prepayment of the indebtedness.
Mortgage Loan - The Company has a mortgage loan from a commercial bank
that is secured by a first mortgage lien on the Company's headquarters building
and an assignment of all leases, rents, revenues and profits under all present
and future leases of the building. The loan matures on May 1, 2004 and requires
monthly payments of $99,582, bearing interest at a fixed rate of 7.07%. The
Company believes that the mortgage loan repayments can be made from cash
resources available to the Company at the time such repayments are due.
A summary, as of September 30, 2002, of the total future contractual
obligations requiring repayments is as follows (in thousands):
PERIOD OF REPAYMENT
CONTRACTUAL OBLIGATIONS < 1 YEAR 1-3 YEARS > 3 YEARS TOTAL
-------------- --------------- ------------- --------------
Secured financings $ 30,257 $ - $ - $ 30,257
Lines of Credit 96,811 - - 96,811
Mortgage Note 763 5,618 - 6,381
Capital lease obligations 509 514 6 1,029
Non-cancelable operating lease obligations 605 736 411 1,752
-------------- --------------- ------------- --------------
Total contractual cash obligations $ 128,945 $ 6,868 $ 417 $ 136,230
============== =============== ============= ==============
Repurchase and Retirement of Common Stock - In 1999, the Company began
acquiring shares of its common stock in connection with a stock repurchase
program announced in August 1999. That program authorized the Company to
purchase up to 1,000,000 common shares on the open market or pursuant to
negotiated transactions at price levels the Company deems attractive. On each of
February 7, 2000, June 7, 2000, July 13, 2000, November 10, 2000, and May 20,
2002, the Company's Board of Directors authorized increases in the Company's
stock repurchase program of an additional 1,000,000 shares. As of September 30,
2002, the Company has repurchased approximately 4.9 million shares of the 6.0
million shares authorized to be repurchased under this program at a cost of
$30,211,000. The six million shares, which can be repurchased through the open
market or in privately negotiated transactions, represent approximately 13.0% of
the shares outstanding at the beginning of the program.
Based upon anticipated cash flows, management believes that cash flows
from operations, various financing alternatives available to the Company, and
amounts available under its credit agreement will provide sufficient financing
for debt maturities and for future operations. The Company's ability to borrow
funds may be impacted by many economic and financial market conditions. If the
various financing alternatives were to become limited or unavailable to the
Company, the Company's operations could be materially and adversely affected.
FORWARD-LOOKING STATEMENTS
The foregoing discussion and analysis contains a number of
forward-looking statements within the meaning of the Securities Act of 1933 and
the Securities Exchange Act of 1934, both as amended, with respect to
expectations for future periods. These forward-looking statements represent the
Company's outlook only as of the date of this report. While the Company believes
that its forward-looking statements are reasonable, actual results could differ
materially since the statements are based on
24
the Company's current expectations, which are subject to risks and
uncertainties. These risks and uncertainties are detailed from time to time in
reports filed by the Company with the Securities and Exchange Commission,
including forms 8-K, 10-Q and 10-K, and include, among others, increased
competition from traditional financing sources and from non-traditional lenders,
the unavailability of funding at competitive rates of interest or the Company's
potential inability to continue to obtain third party financing on favorable
terms, the Company's potential inability to generate sufficient cash flow to
service its debt and fund its future operations, adverse changes in applicable
laws and regulations, adverse changes in economic conditions, adverse changes in
the automobile or finance industries or in the non-prime consumer finance
market, the Company's potential inability to maintain or increase the volume of
automobile loans, the Company's potential inability to accurately forecast and
estimate future collections and collection rates and the associated default
risk, the Company's potential inability to accurately estimate the residual
values of leased vehicles, an increase in the amount or severity of litigation
against the Company, the loss of key management personnel, and the effect of
terrorist attacks and potential attacks.
Other factors not currently anticipated by management may also
materially and adversely affect the Company's results of operations. The Company
does not undertake, and expressly disclaims any obligation, to update or alter
its forward-looking statements whether as a result of new information, future
events or otherwise, except as required by applicable law.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2001 for a complete discussion of the Company's market risk. There
have been no material changes to the market risk information included in the
Company's 2001 Annual Report on Form 10-K, as previously modified by the
Company's 2002 Quarterly Reports on Form 10-Q filed on May 15, 2002 and August
14, 2002.
ITEM 4. CONTROLS AND PROCEDURES.
Within the 90 days prior to the date of this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of the
Company's disclosure controls and procedures pursuant to Rule 13a-15 of the
Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chief
Executive Officer and Chief Financial Officer concluded that the Company's
disclosure controls and procedures are effective to cause the material
information required to be disclosed by the Company in the reports that it files
or submits under the Securities Exchange Act of 1934 to be recorded, processed,
summarized and reported within the time periods specified in the Commission's
rules and forms. There have been no significant changes in the Company's
internal controls or in other factors which could significantly affect internal
controls subsequent to the date the Company carried out its evaluation.
26
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business and as a result of the
consumer-oriented nature of the industry in which the Company operates, industry
participants are frequently subject to various consumer claims and litigation
seeking damages and statutory penalties. The claims allege, among other theories
of liability, violations of state, federal and foreign truth in lending, credit
availability, credit reporting, consumer protection, warranty, debt collection,
insurance and other consumer-oriented laws and regulations, including claims
seeking damages for physical and mental damages relating to the Company's debt
collection activities, including the repossession and sale of the consumers
vehicle. The Company, as the assignee of automobile loans originated by
dealer-partners, may also be named as a co-defendant in lawsuits filed by
consumers principally against dealer-partners. Many of these cases are filed as
purported class actions and seek damages in large dollar amounts. While the
Company believes that the risk of loss associated with these matters to be
remote, an adverse ultimate disposition could have a material negative impact on
the Company's financial position, liquidity and results of operations.
The Company believes that the structure of its dealer-partner programs
and ancillary products, including the terms and conditions of its servicing
agreement, may mitigate its risk of loss in any such litigation and that it has
taken prudent steps to address the litigation risks associated with its business
activities. However, there can be no assurance that future litigation will not
have a material adverse impact on the Company's financial condition or results
of operations.
The Company is currently a defendant in a private attorney general
action in the Superior Court of the State of California, County of Alameda,
brought on behalf of the general public, pursuant to California's Unfair
Competition Law, Business and Professions Code Section 17200, et seq. On January
24, 2001, plaintiff filed this action alleging that the Company's notices of
repossession served within four years proceeding the filing of the complaint did
not comply with the statutory requirements of California's Rees-Levering
Automobile Finance Act, Civil Code Section 2981, et seq. Plaintiff, who is not a
debtor on any automobile loan assigned to the Company, contends that the alleged
violations of the Rees-Levering Act and the Company's efforts to collect the
balance due after sale of the repossessed vehicles constitute unfair and
fraudulent business practices for which the plaintiff seeks relief under
Business and Professions Code Section 17203. The plaintiff seeks restitution on
behalf of debtors on automobile loans assigned to the Company for the amounts
that the Company has collected on deficiency balances remaining after the
disposition of repossessed vehicles, interest and profit thereon, correction of
account balances and credit reporting, interest and attorney's fees. The Company
has answered the complaint generally denying all of its allegations and
asserting a number of affirmative defenses. On May 20, 2002, the court found
that the Company's notices did not comply with the Rees-Levering Act, awarded
restitution of all post sale collections made on accounts that were sent notices
between January 23, 1997 and July 5, 1999 in an amount to be determined in
further proceedings, and enjoined collection of any deficiency on such accounts.
On September 13, 2002, the parties reached an agreement to settle the action.
The settlement will not have a material impact on the Company's financial
position, liquidity and results of operations.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See Index of Exhibits following the signature page.
(b) Reports on Form 8-K
The Company was not required to file a current report on
Form 8-K during the quarter ended September 30, 2002 and
none were filed during that period.
27
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CREDIT ACCEPTANCE CORPORATION
(Registrant)
By: /s/ Douglas W. Busk
--------------------------
Douglas W. Busk
Chief Financial Officer and Treasurer
November 14, 2002
(Principal Financial, Accounting Officer
and Duly Authorized Officer)
28
CERTIFICATIONS
I, Brett A. Roberts, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Credit
Acceptance Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 14, 2002
/s/ Brett A. Roberts
- -------------------------
Chief Executive Officer
29
I, Douglas W. Busk, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Credit
Acceptance Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and
the audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent evaluation,
including any corrective actions with regard to significant
deficiencies and material weaknesses.
November 14, 2002
/s/ Douglas W. Busk
- --------------------------
Chief Financial Officer
30
INDEX OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
--------- ----------------------------------------------------------------
4(f)(42) Third Amendment dated August 30, 2002 to Second Amended and
Restated Security Agreement dated June 11, 2001 between Comerica
Bank, as Collateral Agent and the Company
4(f)(43) Loan and Security Agreement dated September 27, 2002 among the
Company, CAC Warehouse Funding Corp., Variable Funding Capital
Corporation, Wachovia Securities, Inc., Wachovia Bank, National
Association and OSI Portfolio Services, Inc.
4(f)(44) Contribution Agreement dated September 27, 2002 between the
Company and CAC Warehouse Funding Corp.
4(f)(45) Back-Up Servicing Agreement dated September 27, 2002 among the
Company, CAC Warehouse Funding Corp., OSI Portfolio Services,
Inc., Variable Funding Capital Corporation and Wachovia
Securities, Inc.
4(f)(46) Intercreditor Agreement, dated September 30, 2002, among the
Company, CAC Warehouse Funding Corp., CAC Funding Corp., Bank of
America, N.A., as agent, Wachovia Securities, Inc., as agent,
and Comerica Bank, as agent
99(a) Certification of Chief Executive Officer, Pursuant to 18 U.S.C.
Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99(b) Certification of Chief Financial Officer, Pursuant to 18 U.S.C.
Section 1350, as adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
31