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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
---------------------------
(Mark One)
[ X ] FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended December 31, 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 0-13084
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WARRANTECH CORPORATION
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(Exact name of registrant as specified in its charter)
Delaware 13-3178732
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2220 Highway 121, Suite 100 Bedford, TX 76021
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
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(Former name, former address and former fiscal year, if changed since last year)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [ X ] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at January 31, 2003
- ---------------------------------------- --------------------------------
Common stock, par value $.007 per share 15,318,353 shares
WARRANTECH CORPORATION AND SUBSIDIARIES
I N D E X
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Page No.
--------
PART I - Financial Information:
Item 1: Financial Statements
Condensed Consolidated Statements of Operations -
For the Three Months and Nine Months Ended
December 31, 2002 and 2001 (Unaudited)................................ 3
Condensed Consolidated Balance Sheets at December 31, 2002
(Unaudited) and March 31, 2002........................................ 4
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended December 31, 2002
and 2001 (Unaudited)................................................... 6
Notes to Condensed Consolidated Financial Statements (Unaudited)............. 7
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations ........................ 11
Item 3: Quantitative and Qualitative Disclosures about Market Risk .............. 17
Item 4: Controls and Procedures................................................. 17
PART II - Other Information
Item 1: Legal Proceedings....................................................... 18
Item 2: Changes in Securities................................................... 20
Item 3: Defaults Upon Senior Securities......................................... 20
Item 4: Submission of Matters to a Vote of Security Holders..................... 20
Item 5: Other Information....................................................... 20
Item 6: Exhibits and Reports on Form 8-K........................................ 20
Certification of Financial Report................................................ 21
Signature ....................................................................... 23
2
ITEM 1. FINANCIAL STATEMENTS
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
---------------------------------- --------------------------------------
2002 2001 2002 2001
---------------- --------------- ------------------ -----------------
Earned administrative fee (net of amortization $9,339,050 $8,549,955 $28,303,751 $27,043,540
of deferred costs)
Costs and expenses
Service, selling, and general and
administrative 7,404,622 7,394,418 22,501,844 23,242,498
Legal settlement - - - (824,332)
Depreciation and amortization 835,427 737,360 2,880,081 3,439,123
---------------- --------------- ------------------ -----------------
Total costs and expenses
8,240,049 8,131,778 25,381,925 25,857,289
---------------- --------------- ------------------ -----------------
Income from operations 1,099,001 418,177 2,921,826 1,186,251
Other income 228,900 357,627 795,409 698,623
---------------- --------------- ------------------ -----------------
Income before provision for income taxes 1,327,901 775,804 3,717,235 1,884,874
Provision for income taxes 306,049 284,600 1,097,456 714,200
---------------- --------------- ------------------ -----------------
Net income $1,021,852 $491,204 $2,619,779 $1,170,674
================ =============== ================== =================
Earnings per share:
Basic $0.07 $0.03 $0.17 $0.08
================ =============== ================== =================
Diluted $0.07 $0.03 $0.17 $0.08
================ =============== ================== =================
Weighted average number of shares outstanding:
Basic 15,359,337 15,243,095 15,341,936 15,221,757
================ =============== ================== =================
Diluted 15,643,719 15,243,095 15,484,687 15,221,757
================ =============== ================== =================
See accompanying notes to condensed consolidated financial statements.
3
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31 March 31,
2002 2002
------------- --------------
A S S E T S
-----------
Current assets:
Cash and cash equivalents $3,258,656 $7,033,448
Investments in marketable securities 693,652 954,653
Accounts receivable, (net of allowances of $163,366 and $256,019,
respectively) 22,775,967 18,442,135
Other receivables, net 12,116,857 4,931,749
Income tax receivable - 1,129,076
Deferred income taxes 1,582,100 2,653,000
Prepaid expenses and other current assets 1,059,929 600,944
------------- --------------
Total current assets 41,487,161 35,745,005
------------- --------------
Property and equipment, net 8,646,736 9,299,713
Other assets:
Excess of cost over fair value of assets acquired
(net of accumulated amortization of $5,825,405) 1,637,290 1,637,290
Deferred income taxes 2,329,315 2,329,315
Deferred direct costs 13,121,964 22,570,930
Investments in marketable securities 1,720,616 1,376,619
Restricted cash 825,000 825,000
Split dollar life insurance policies 1,025,171 904,172
Notes receivable 3,788,071 2,818,639
Other assets 51,324 44,546
------------- --------------
Total other assets 24,498,751 32,506,511
------------- --------------
Total Assets $74,632,648 $77,551,229
============= ==============
See accompanying notes to condensed consolidated financial statements
4
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31 March 31,
2002 2002
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Current maturities of long-term debt and capital lease
obligations $636,711 $801,788
Insurance premiums payable 32,847,847 26,470,265
Income taxes payable 99,153 -
Accounts and commissions payable 6,381,011 6,960,465
Accrued expenses and other current liabilities 3,843,572 3,168,666
------------- --------------
Total current liabilities 43,808,294 37,401,184
------------- --------------
Deferred revenues 22,319,528 33,559,379
Long-term debt and capital lease obligations 587,682 957,159
Deferred rent payable 106,077 190,260
------------- --------------
Total liabilities 66,821,581 72,107,982
------------- --------------
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.0007 par value authorized - 15,000,000
Shares
issued - none at December 31, 2002 and March 31, 2002 - -
Common stock - $.007 par value authorized - 30,000,000
Shares
issued - 16,530,324 shares at December 31, 2002 and
16,525,324 shares at March 31, 2002 115,714 115,679
Additional paid-in capital 23,748,009 23,745,944
Loans to directors and officers (10,391,920) (10,163,875)
Accumulated other comprehensive income, net of taxes (78,546) (52,028)
Retained earnings (deficit) (1,358,053) (3,977,832)
------------- --------------
12,035,204 9,667,888
Treasury stock - at cost, 1,211,969 shares at December 31,
2002 and 1,212,159 shares at March 31, 2002 (4,224,137) (4,224,641)
------------- --------------
Total Stockholders' Equity 7,811,067 5,443,247
------------- --------------
------------- --------------
Total Liabilities and Stockholders' Equity $74,632,648 $77,551,229
============= ==============
See accompanying notes to condensed consolidated financial statements.
5
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
December 31,
--------------------------------------------
2002 2001
-------------------- --------------------
Cash flows from operating activities:
Net income $ 2,619,779 $ 1,170,674
Total adjustments to reconcile net income to net cash
provided by operating activities: (2,380,165) 4,621,385
-------------------- --------------------
Net cash flows provided by operating activities 239,614 5,792,059
-------------------- --------------------
Cash flows from investing activities:
Property and equipment purchased (2,179,395) (1,179,920)
Purchases of marketable securities (990,000) (330,000)
(Increase) decrease in notes receivable 188,558 366,037
Proceeds from sales of marketable securities 945,000 1,315,304
-------------------- --------------------
Net cash provided (used) by investing activities (2,035,837) 171,421
-------------------- --------------------
Cash flows from financing activities:
Exercise of common stock options and stock grants 2,100 -
Purchases treasury stock (196,698) -
Increase in notes receivable (1,157,990) (1,748,362)
Repayments, notes and capital leases (625,981) (561,087)
-------------------- --------------------
Net cash (used) by financing activities (1,978,569) (2,309,449)
-------------------- --------------------
Net decrease in cash and cash equivalents (3,774,792) 3,654,031
Cash and cash equivalents at beginning of period 7,033,448 3,001,924
-------------------- --------------------
Cash and cash equivalents at end of period $ 3,258,656 $ 6,655,955
==================== ====================
Supplemental Cash Flow Information:
Cash payments (receipts) for:
Interest $ 161,501 $ 163,924
==================== ====================
Income taxes $ (1,244,556) $ -
==================== ====================
Non-Cash Investing and financing activities:
Property and equipment financed through capital leases $ 115,745 $ 443,232
Capital leases refinanced $ - $ 151,727
Increase in loans to officers and directors $ (228,045) $ (249,794)
Issuance of treasury stock for services rendered $ 197,202 $ 75,927
See accompanying notes to condensed consolidated financial statements.
6
WARRANTECH CORPORATION AND SUBSIDIARIES
---------------------------------------
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
----------------------------------------------------
December 31, 2002
(Unaudited)
1. THE COMPANY
Warrantech, through its wholly owned subsidiaries, markets and administers
service contracts and extended warranties. The Company is a third party
administrator for a variety of dealer/clients in selected industries and
offers call center and technical computer services. The Company assists
dealer/clients in obtaining insurance policies from highly rated
independent insurance companies for all contracts and programs offered. The
insurance company is then responsible for the cost of repairs or
replacements for the contracts administered by Warrantech.
The Company's service contract programs benefit consumers by providing them
with expanded and/or extended product coverage for a specified period of
time (and/or mileage in the case of automobiles and recreational vehicles),
similar to that provided by manufacturers under the terms of their product
warranties. Such coverage generally provides for the repair or replacement
of the product, or a component thereof, in the event of its failure. The
Company's service contract programs benefit the dealer/clients by providing
enhanced value to the goods and services they offer and by providing them
with the opportunity for increased revenue and income while outsourcing the
costs and responsibilities of operating an extended warranty program.
The terms of the service contracts, extended warranties and replacement
contracts generally range from three (3) to eighty-four (84) months. Since
the Company acts solely as a third party administrator on behalf of the
dealer/clients and insurance companies, the actual repairs and/or
replacements required under the agreements are performed by independent
third party authorized repair facilities or dealers. The cost of these
repairs is generally paid for by the insurance companies which have the
ultimate responsibility for the claims or by Butler Financial Solutions,
LLC ("Butler"), where Reliance Insurance Company ("Reliance") or the
Company are the obligor. The insurance policy indemnifies the
dealer/clients against losses resulting from service contract claims and
protects the consumer by ensuring their claims will be paid.
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by
management and are unaudited. These interim financial statements have been
prepared on the basis of accounting principles generally accepted in the
United States of America ("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 information and footnotes required by
accounting principles generally accepted in the United States of America
for complete financial statements. In the opinion of management, all
adjustments (consisting of normal recurring accruals) considered necessary
for a fair presentation of the financial position and operating results of
the Company for the interim period have been included. Operating results
for the three months and nine months ended December 31, 2002 are not
necessarily indicative of the results that may be expected for the fiscal
year ending March 31, 2003. For further information, refer to the
consolidated financial statements and footnotes thereto included in the
Company's Annual Report on Form 10-K for the year ended March 31, 2002.
3. NOTES RECEIVABLE
Butler serves as the ultimate obligor under all service contracts
administered by the Company in exchange for a fee. Some of the service
contracts under which Butler is the obligor were insured by Reliance, and
the liquidation of Reliance has eliminated the insurance coverage to Butler
under those contracts. The Company was also the obligor under some of the
7
service contracts insured by Reliance, but, pursuant to an agreement
entered into between the Company and Butler, Butler agreed to assume the
obligations of the Company under those service contracts.
In order to assist Butler in addressing its potential obligations under the
service contracts previously insured by Reliance for which Butler is or
Warrantech was the obligor, the Company has made a loan to Butler and will
make further loans to Butler, as required, for claim obligations in excess
of Butler's fee revenues. All of Warrantech's loans to Butler bear or will
bear interest at the rate of prime plus 2% per annum and will begin to be
paid down once Butler's fee revenues exceed the claims obligations.
Additionally, funding will be provided by a special surcharge on all
vehicle service contracts administered by the Company sold after November
19, 2001. This funding will be utilized by Butler to pay the claims
previously insured by Reliance and will also be available to repay Butler's
loans from Warrantech.
As of the period ended December 31, 2002, Warrantech has loaned Butler
$11,949,123, including $190,277 of interest. Pursuant to the GAIC agreement
(see Liquidity and Financial Resources), the Company expects to receive
$8,110,178 of that amount prior to the end of fiscal 2003. This amount is
reflected in "Other Receivables" on the Consolidated Balance Sheet. The
remaining $3,838,945 of loans due from Butler is reflected as "Notes
Receivable" on the Consolidated Balance Sheet.
If Butler is unable to cover the claims previously insured by Reliance, or
if the Company's current insurance carrier ceases to provide credit to the
Company in order to fund shortfalls required, Warrantech Automotive may
ultimately be required to honor the claims under those service contracts in
which Warrantech Automotive was the obligor, which could have an adverse
effect on the Company's business. As Butler has assumed all the obligations
and since management is not able to determine the Company's potential
claims liability, if any, under such contracts, the Company has not taken a
reserve for claims losses for which the Company may ultimately be liable.
4. OTHER RECEIVABLES, NET
The nature and amounts of other receivables, net as of December 31, 2002
and March 31, 2002 are as follows:
December 31, March 31,
2002 2002
---------------- ----------------
Due from Reliance Warranty Corporation $8,110,178 $2,754,691
Due from insurance companies/dealers 3,575,887 1,795,972
Employee/agent advances 229,570 334,198
Other 201,222 46,888
---------------- ----------------
Total Other Receivables, net $12,116,857 $4,931,749
================ ================
The Company advanced $8,110,178 and $2,754,691, at December 31, 2002 and
March 31, 2002, respectively, to Butler on certain claims which it expects
to receive reimbursement prior to the end of fiscal year 2003.
5. COMPREHENSIVE INCOME
Comprehensive income includes net income and certain items recorded
directly to stockholders' equity and classified as Other Comprehensive
Income. The following table illustrates the calculation of comprehensive
income for the three month and nine month periods ended December 31, 2002
and 2001, respectively. During the three months ending December 31, 2002,
the foreign currency rate in Chile increased and resulted in a $72,307
unrealized loss to comprehensive income for foreign currency translation
adjustments.
8
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
---------------------------------------- --------------------------------------
2002 2001 2002 2001
------------------ -------------------- ------------ -----------
Net income $1,021,852 $491,204 $2,619,779 $1,170,674
Other Comprehensive Income, net of tax
Unrealized gain (loss) on investments (10,086) 36,054 20,123 8,700
Foreign currency translation adjustments 72,307 (31,915) (46,641) (2,052)
------------------ ----------------- ------------ -----------
Comprehensive Income $1,084,073 $495,343 $2,593,261 $1,177,322
================== ================= ============ ===========
Comprehensive income per share: $0.07 $0.03 $0.17 $0.08
================== ================= ============ ===========
The components of accumulated comprehensive income, net of related tax, for the
periods ended December 31, 2002 and March 31, 2001, are as follows:
December 31, March 31,
2002 2002
------------------ --------------------
Unrealized gain/ (loss) on investments $24,456 $4,333
Accumulated translation adjustments (103,002) (56,361)
------------------ -----------------
Accumulated other comprehensive income ($78,546) ($52,028)
================== =================
6. EARNINGS PER SHARE
The computations of earnings per share are as follows:
For the Three Months Ended For the Nine Month Ended
December 31, December 31,
---------------------------------- -----------------------------
2002 2001 2002 2001
---------------- --------------- ------------ -------------
Numerator:
Net income applicable to common stock $1,021,852 $491,204 $2,619,779 $1,170,674
================ =============== ============ =============
Denominator:
Average outstanding shares used in the
computation of per share earnings:
Common Stock issued-Basic shares 15,359,337 15,243,095 15,341,936 15,221,757
Stock Options (treasury method) 284,382 - 142,751 -
---------------- --------------- ------------ -------------
Diluted shares 15,643,719 15,243,095 15,484,687 15,221,757
================ =============== ============ =============
Earnings Per Common Share:
Basic $0.07 $0.03 $0.17 $0.08
================ =============== ============ =============
Diluted $0.07 $0.03 $0.17 $0.08
================ =============== ============ =============
7. DIRECTOR LOANS
On July 6, 1998, Joel San Antonio, Warrantech's Chairman and Chief
Executive Officer, and William Tweed and Jeff J. White, members of the
Board of Directors, exercised options to purchase an aggregate of 3,000,000
shares of Common Stock in consideration for the delivery of secured
recourse promissory notes totaling $8,062,500 with interest payable over
three years at an annual interest rate of 6%. On March 22, 1999, Mr. San
Antonio signed an additional promissory note for $595,634, the amount
funded by the Company for payroll taxes payable by him as a result of his
exercise of these options.
9
In February 2000, the Company agreed to restructure the loans to Messrs.
Tweed and White by capitalizing the interest due and extending the loan
maturity date from July 5, 2001 until January 31, 2005. Interest on the
restructured loans accrued annually at the applicable federal rate of 6.2%.
Under the restructuring, interest first became payable on the third
anniversary of the restructuring and was payable annually thereafter. In
July 2002, the Company extended the loan maturity dates until February 1,
2007 (the "loan extension"). The interest which accrued on the notes up to
the time of the loan extension was added to the principal of the notes. The
new principal amount of Mr. Tweed's note is $3,189,675 and of Mr. White's
note is $2,912,430. The applicable federal interest rate on the notes
following the loan extension is 4.6%. Under the loan extension, interest on
the notes will accrue until February 1, 2005 and, at that time, the accrued
interest will be added to the principal of the notes. Interest on the new
principal amounts will thereafter become payable annually until maturity.
In February 2000, the Company also agreed to restructure the two existing
loans to Mr. San Antonio (as restructured, the "Combined Loan"). The
Combined Loan, finalized in March 2001, was due on January 31, 2005 and
accrued interest annually at 5.2%. In July 2002, the Company extended the
loan maturity date until February 1, 2007 and the interest rate was changed
to the now applicable federal rate of 4.6%. The principal amount of Mr. San
Antonio's note is $4,165,062. Interest will be forgiven and included as
compensation as long as Mr. San Antonio continues to be employed by the
Company
8. SEGMENT INFORMATION
The Company operates in three major business segments: Automotive, Consumer
Products and International. Other includes general corporate income and
expenses, inter-segment sales and expenses and other corporate assets not
related to the three business segments.
Consumer Reportable
Three Months Ended Automotive Products International Segments Other Total
- --------------------------- ----------- --------- ------------- ---------- ------ -----
December 31, 2002
- -----------------
Earned administrative fee $4,080,070 $4,458,680 $872,352 $9,411,102 ($72,052) $9,339,050
Profit (loss) from operations 2,052,235 1,011,842 55,025 3,119,102 (2,020,101) 1,099,001
Pretax Income (Loss) 614,976 452,516 53,820 1,121,312 206,589 1,327,901
Net Interest Income 11,050 4,879 726 16,655 207,320 223,975
Depreciation/Amortization 89,623 399,608 21,721 510,952 324,475 835,427
December 31, 2001
- -----------------
Earned administrative fee $4,085,973 $4,334,599 $252,948 $8,673,520 ($123,565) $8,549,955
Profit (loss) from operations 2,371,997 384,187 (422,394) 2,333,790 (1,915,613) 418,177
Pretax Income (Loss) 1,267,119 (221,108) (374,944) 671,067 104,737 775,804
Net Interest Income 15,298 38,119 6,981 60,398 136,702 197,100
Depreciation/Amortization 84,768 376,195 18,059 479,022 258,338 737,360
Nine Months Ended
- -----------------------------
December 31, 2002
- -----------------
Earned administrative fee $14,591,575 $11,600,939 $2,349,442 $28,541,956 ($238,205) $28,303,751
Profit (loss) from operations 8,656,133 1,571,488 75,092 10,302,713 (7,380,887) 2,921,826
Pretax income (loss) 3,287,457 (275,002) 69,565 3,082,020 635,215 3,717,235
Net interest income 20 (8,818) 7,567 (1,231) 524,160 522,929
Depreciation/amortization 284,360 1,276,497 64,480 1,625,337 1,254,744 2,880,081
Total Assets 40,231,095 25,268,416 3,314,225 68,813,736 5,818,912 74,632,648
December 31, 2001
- -----------------
Earned administrative fee $12,512,742 $12,767,819 $2,166,643 $27,447,204 (403,664) $27,043,540
Profit (loss) from operations 7,013,121 (839,925) (236,419) 5,936,777 (4,750,526) 1,186,251
Pretax Income (Loss) 4,510,382 (2,683,592) (491,873) 1,334,917 549,957 1,884,874
Net Interest Income 49,510 44,268 18,177 111,955 553,481 665,436
Depreciation/Amortization 288,674 1,234,189 55,810 1,578,673 1,860,450 3,439,123
Total Assets 32,988,790 36,384,644 3,693,341 73,066,775 4,466,249 77,533,024
10
WARRANTECH CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
EXCEPT FOR THE HISTORICAL INFORMATION CONTAINED HEREIN, THE MATTERS DISCUSSED
BELOW OR ELSEWHERE IN THIS QUARTERLY REPORT MAY CONTAIN FORWARD-LOOKING
STATEMENTS THAT INVOLVE RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS
TO DIFFER MATERIALLY FROM THOSE CONTEMPLATED BY THE FORWARD-LOOKING STATEMENTS.
THE COMPANY MAKES SUCH FORWARD-LOOKING STATEMENTS UNDER THE PROVISIONS OF THE
"SAFE HARBOR" SECTION OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.
FORWARD-LOOKING STATEMENTS REFLECT THE COMPANY'S VIEWS AND ASSUMPTIONS, BASED ON
INFORMATION CURRENTLY AVAILABLE TO MANAGEMENT. SUCH VIEWS AND ASSUMPTIONS ARE
BASED ON, AMONG OTHER THINGS, THE COMPANY'S OPERATING AND FINANCIAL PERFORMANCE
OVER RECENT YEARS AND ITS EXPECTATIONS ABOUT ITS BUSINESS FOR THE CURRENT AND
FUTURE FISCAL YEARS. ALTHOUGH THE COMPANY BELIEVES THAT THE EXPECTATIONS
REFLECTED IN SUCH FORWARD-LOOKING STATEMENTS ARE REASONABLE, IT CAN GIVE NO
ASSURANCE THAT SUCH EXPECTATIONS WILL PROVE TO BE CORRECT. SUCH STATEMENTS ARE
SUBJECT TO CERTAIN RISKS, UNCERTAINTIES AND ASSUMPTIONS, INCLUDING, BUT NOT
LIMITED TO, (A) PREVAILING ECONOMIC CONDITIONS WHICH MAY SIGNIFICANTLY
DETERIORATE, THEREBY REDUCING THE DEMAND FOR THE COMPANY'S PRODUCTS AND
SERVICES, (B) AVAILABILITY OF TECHNICAL SUPPORT PERSONNEL OR INCREASES IN THE
RATE OF TURNOVER OF SUCH PERSONNEL, RESULTING FROM INCREASED DEMAND FOR SUCH
QUALIFIED PERSONNEL, (C) CHANGES IN THE TERMS OR AVAILABILITY OF INSURANCE
COVERAGE FOR THE COMPANY'S PROGRAMS,(D) REGULATORY OR LEGAL CHANGES AFFECTING
THE COMPANY'S BUSINESS, (E) LOSS OF BUSINESS FROM, OR SIGNIFICANT CHANGE IN
RELATIONSHIPS WITH, ANY MAJOR CUSTOMER OF THE COMPANY, (F) THE ABILITY TO
SUCCESSFULLY IDENTIFY AND CONTRACT NEW BUSINESS OPPORTUNITIES, BOTH DOMESTICALLY
AND INTERNATIONALLY, (G) THE ABILITY TO SECURE NECESSARY CAPITAL FOR GENERAL
OPERATING OR EXPANSION PURPOSES,(H) ADVERSE OUTCOMES OF LITIGATION,(I) IF THE
DIRECTOR(S) NOTES DUE IN 2007 CANNOT BE COLLECTED, (J) IF ANY OF THE INSURANCE
COMPANIES WHICH INSURE THE SERVICE CONTRACTS MARKETED AND ADMINISTERED BY THE
COMPANY WERE UNABLE TO PAY THE CLAIMS UNDER THE SERVICE CONTRACTS, IT COULD HAVE
AN ADVERSE EFFECT ON THE COMPANY'S BUSINESS, (K) IF BUTLER IS UNABLE TO COVER
THE CLAIMS PREVIOUSLY INSURED BY RELIANCE, OR IF THE COMPANY'S CURRENT INSURANCE
CARRIER CEASES TO PROVIDE CREDIT TO THE COMPANY IN ORDER TO FUND ANY SHORTFALLS
REQUIRED, WARRANTECH AUTOMOTIVE MAY ULTIMATELY BE REQUIRED TO HONOR THE CLAIMS
UNDER THOSE SERVICE CONTRACTS IN WHICH WARRANTECH AUTOMOTIVE WAS THE OBLIGOR
WHICH COULD HAVE A MATERIALLY ADVERSE EFFECT ON THE COMPANY'S BUSINESS; SINCE
MANAGEMENT IS NOT ABLE TO DETERMINE THE COMPANY'S POTENTIAL CLAIMS LIABILITY, IF
ANY, THE COMPANY MAY ULTIMATELY BE LIABLE; (L) PAYMENT OF THE COMPANY'S "OTHER
RECEIVABLES" IN THE AMOUNT OF $8,110,178 BY THE END OF THE COMPANY'S FISCAL YEAR
THAT IS CONTINGENT ON GREAT AMERICAN INSURANCE COMPANY CONSUMMATING CERTAIN
TRANSACTIONS WITH THIRD PARTIES; AND SHOULD ONE OR MORE OF THESE OR ANY OTHER
RISKS OR UNCERTAINTIES MATERIALIZE OR DEVELOP IN A MANNER ADVERSE TO THE
COMPANY, OR SHOULD THE COMPANY'S UNDERLYING ASSUMPTIONS PROVE INCORRECT, ACTUAL
RESULTS OF OPERATIONS, CASH FLOWS OR THE COMPANY'S FINANCIAL CONDITION MAY VARY
MATERIALLY FROM THOSE ANTICIPATED, ESTIMATED OR EXPECTED.
11
Results of Operations
- ---------------------
THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THE THREE MONTHS ENDED DECEMBER
31, 2001
Gross Revenues for the quarter ended December 31, 2002 were $37,386,939 compared
to $29,516,536 for the same period last year, increasing 27%. All business
segments reported increased gross revenues for the three month quarter ended
December 31, 2002 versus the same period last year.
Net earned administrative fees are gross revenues less the combined sum of
premiums, commissions, sales allowances and deferred revenue. For the three
month period ended December 31, 2002, net earned administrative fees increased
to $9,339,050 as compared to $8,549,955 for the same period last year, an
increase of $789,095 or 9%. The Consumer Products and International segments
recorded increases in net earned administrative fees, while the Automotive
segment remained flat.
Although the Automotive segment net earned administrative fees from existing
customers was up $351,292 for the quarter ending December 31, 2002 compared to
the same quarter last year, it was offset by lower deferred revenues from prior
periods recognized this quarter versus the same quarter last year of $357,195.
The Consumer Products segment net earned administrative fees increased $124,081
to $4,458,680 for the three month period ended December 31, 2002 as compared to
$4,334,599 for the same period last year. Gross revenue increases from the
segment's top five customers were partially offset by the loss of a customer and
from lower deferred revenues from prior periods recognized this quarter versus
the same quarter last year.
The International segment net earned administrative fees increased to $872,352
for the three month period ended December 31, 2002 from $252,948 for the same
period a year ago. Increased market penetration from existing customers in South
America offset the loss of a large customer in Chile. Puerto Rico net earned
administrative fees increased 32% during the quarter on the strength of
increased market penetration from existing automotive customers.
Service, selling and general and administrative expenses (SG&A), for the three
months ended December 31, 2002 were flat at $7,404,622 as compared to $7,394,418
for the three months ended December 31, 2001. Legal fees were $139,669 higher
for the three months ended December 31, 2002 as compared to the prior year
quarter, primarily due to ongoing litigation expenses related to several
lawsuits. Reflecting the Company's continued cost containment measures,
consulting fees were down $379,709 or 64% from $595,400 in the quarter ended
December 31, 2001 to $215,691 in the current quarter and telephone expenses were
reduced 42% from $604,815 in the quarter ended December 31, 2001 as compared to
$347,027 in the current quarter.
Depreciation and amortization expenses increased by $98,067 to $835,427 for the
three months ended December 31, 2002 as compared to $737,360 for the same period
last year.
Income from operations for the third fiscal quarter 2003 was $1,099,001 as
compared to $418,177 for the third fiscal quarter 2002, as the Company's
Consumer Products and International segments increased their volumes and net
earned administrative fees.
Other income for the three months ended December 31, 2002 was $228,900 as
compared to $357,627 for the three months ended December 31, 2001. The decrease
was primarily due to the receipt of a rebate from the use of the Company's
purchase card in the quarter ended December 31, 2001.
Net income for the three months ended December 31, 2002 was $1,021,852 or $0.07
per diluted share as compared to net income of $491,204 or $0.03 per diluted
share for the comparable period last year; a 108% increase. This change is the
result of factors as described above
12
NINE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THE NINE MONTHS ENDED DECEMBER
31, 2001
Gross Revenues for the nine months ended December 31, 2002 were $109,745,414
compared to $84,054,968 for the same period last year, increasing 31%.
Automotive, Consumer Products and International segments reported increased
gross revenues of 45%, 3% and 18% respectively, in the nine months period ended
December 31, 2002 over the same period last year.
Net earned administrative fees are gross revenues less the combined sum of
premiums, commissions, sales allowances and deferred revenue. Net earned
administrative fees for the nine month period ended December 31, 2002 increased
to $28,303,751 as compared with $27,043,540 for the same period last year, an
increase of $1,260,211 or 5%. A 45% increase in the Automotive segment gross
revenue was reduced by lower deferred revenues from prior periods recognized in
the first nine months of fiscal 2003 versus the same period in fiscal 2002.
The Automotive segment net earned administrative fees increased $2,078,833 or
17% to $14,591,575 for the nine month ending December 31, 2002 from the same
period last year. A 46% increase in the number of contracts sold contributed to
this increase. The increase generated by higher volume was partially offset by
higher premium cost and lower deferred revenues from prior periods recognized in
the nine months ended December 31, 2002 versus the same period last year.
The Consumer Products segment net earned administrative fees decreased
$1,166,880 or 9% to $11,600,939 for the nine month period ended December 31,
2002 as compared to $12,767,819 for the same period last year. The change was
primarily attributed to lower deferred revenues from prior periods recognized in
the current fiscal year versus the same period in the prior year.
The International segment net earned administrative fees increased to $2,349,442
for the nine month period ended December 31, 2002 from $2,166,643 for the same
period a year ago. Increased market penetration from existing customers in South
America and Puerto Rico offset the loss of a large customer in Chile.
SG&A for the nine months ended December 31, 2002 were down 3% to $22,501,844 as
compared to $23,242,498 for the nine months ended December 31, 2001, excluding
an $824,332 legal settlement the Company received in the prior year. Increased
legal expenses of $1,771,747 for the nine months ended December 31, 2002 as
compared to the nine months ended December 31, 2001, primarily due to ongoing
litigation expenses related to several lawsuits were offset by lower employee
cost and telephone cost this year. Reflecting the Company's continued cost
containment measures, employee costs were down $575,170 or 4% from $13,776,370
in the nine months ended December 31, 2001 to $13,201,200, while telephone
expenses were reduced 40% or $788,500 from $1,968,964 in the nine months ended
December 31, 2001 as compared to $1,180,464 in the nine months ended December
31, 2002.
Depreciation and amortization expenses were reduced by $559,042 to $2,880,081
for the nine months ended December 31, 2002 as compared to $3,439,123 for the
same period last year. The decrease in depreciation and amortization is the
result of the Company's assets maturing and continued reduction of capital
expenditures for the past few years.
Income from operations for the nine month ended December 31, 2002 was $2,921,826
as compared to a $1,186,251 for the same period in 2001, as the Company's
Automotive segment increased its volumes and the Company reduced its
depreciation and amortization expense.
Other income for the nine months ended December 31, 2002 was $795,409 as
compared to $698,623 for the nine months ended December 31, 2001. The increase
was primarily due to interest earned on the Butler note receivable.
13
Net income for the nine months ended December 31, 2002 was $2,619,779 or $0.17
per diluted share as compared to net income of $1,170,674 or $0.08 per diluted
share for the comparable period last year; a 224% increase. This change is the
result of factors as described above.
Liquidity and Financial Resources
- ---------------------------------
During the nine months ended December 31, 2002, the Company had a net decrease
in cash and cash equivalents of $3,774,792. Working capital was a negative
$2,321,133 at December 31, 2002 compared to a negative $1,656,179 at March 31,
2002. The Company believes that internally generated funds, resulting primarily
from maintaining its average days outstanding accounts, the $3 million line of
credit secured from GAIC and the payment of the $8,110,178 other receivable
(which the Company anticipates receiving pursuant to the GAIC agreement
described below), will be sufficient to finance its current operations for at
least the next twelve months. The Company is aggressively pursuing new business
both domestically and internationally to fund future working capital. The
Company plans to continue to contain its SG&A costs and utilize technologies for
operational efficiencies to further enhance both its operating income and cash
flows from operating activities.
On October 9, 2002, the Company executed an agreement with Great American
Insurance Company ("GAIC") that will provide it with extended payment terms and
a $3 million line of credit ("GAIC Agreement"). Under the terms of the GAIC
Agreement, the receivable of $8,110,178 reflected in "Other Receivables" on the
Consolidated Balance Sheet will be paid to Warrantech by GAIC in the event that
certain contingencies set forth in the GAIC Agreement are satisfied. While
GAIC's payment of the "Other Receivable" is contingent on the consummation of a
transaction to which Warrantech is not a party, and certain other contingencies
set forth in the GAIC Agreement, Warrantech's management has been monitoring the
negotiation of the transaction and currently expects the transaction to be
completed and the receivable amount to be paid by the end of fiscal 2003. All of
the Company's obligations to GAIC pursuant to the GAIC Agreement are secured
with the Company's accounts receivable.
If the proceeds acquired by GAIC from RWC are not sufficient to cover the RWC
("Reliance Warranty Corporation") claims obligations, Warrantech will use its
restricted cash to indemnify GAIC for any further obligations which GAIC incurs
to pay the RWC claims obligations and to fund further loans to Butler covering
Butler's obligations under the Reliance claims obligations. (See Notes to the
Condensed Consolidated Financial Statements.) The Reliance claims obligations as
well as the RWC obligations, are covered under the Butler arrangement described
in Note 3 of the Notes to the Condensed Consolidated Financial Statements.
In consideration of GAIC entering into the GAIC Agreement, Warrantech granted
GAIC an option to purchase up to 1,650,000 common shares of Warrantech
Corporation at an exercise price of $2 per share. The option is exercisable no
earlier than January 1, 2006 nor later than December 31, 2006 and does not
contain antidilution provisions. In the event that Warrantech stock does not
trade above $2 per share for 10 consecutive trading days prior to January 1,
2004, the exercise price will be reduced automatically to $1 per share.
The Company entered into a new ten year office lease during the second quarter
of fiscal 2003 and consolidated its domestic operations into one facility
located in Bedford, Texas, which is within one mile of its former facilities. As
a result, the Company's rent expense will increase slightly beginning in the
fourth fiscal quarter, which will be partially offset by efficiencies gained in
some personnel and telephone costs.
As a condition of obtaining the office lease, the Company negotiated an
irrevocable standby letter of credit in the amount of $750,000 expiring in
January 2004. In conjunction with the letter of credit, the Company entered into
a collateral pledge agreement with a financial institution and transferred
long-term investments to a trust account in amounts sufficient to support the
letter of credit.
The Company has ongoing relationships with equipment financing companies and
intends to continue financing certain future equipment needs through
lease/purchase transactions. The total amount financed through these
transactions during the nine months ended December 31, 2002 was $115,745 as
14
compared to $443,232 during the nine months ended December 31, 2001. The Company
anticipates that amounts to be financed in the remainder of fiscal 2003 are
expected to increase, due to the Company's move into its new facilities.
On July 6, 1998, Joel San Antonio, Warrantech's Chairman and Chief Executive
Officer, and William Tweed and Jeff J. White, members of the Board of Directors,
exercised options to purchase an aggregate of 3,000,000 shares of Common Stock
in consideration for the delivery of secured recourse promissory notes totaling
$8,062,500 with interest payable over three years at an annual interest rate of
6%. On March 22, 1999, Mr. San Antonio signed an additional promissory note for
$595,634, the amount funded by the Company for payroll taxes payable by him as a
result of his exercise of these options.
In February 2000, the Company agreed to restructure the loans to Messrs. Tweed
and White by capitalizing the interest due and extending the loan maturity date
from July 5, 2001 until January 31, 2005. Interest on the restructured loans
accrued annually at the applicable federal rate of 6.2%. Under the
restructuring, interest first became payable on the third anniversary of the
restructuring and was payable annually thereafter. In July 2002, the Company
extended the loan maturity dates until February 1, 2007 (the "loan extension").
The interest, which accrued on the notes up to the time of the loan extension,
was added to the principal of the notes. The new principal amount of Mr. Tweed's
note is $3,189,675 and of Mr. White's note is $2,912,430. The applicable federal
interest rate on the notes following the loan extension is 4.6%. Under the loan
extension, interest on the notes will accrue until February 1, 2005 and, at that
time, the accrued interest will be added to the principal of the notes. Interest
on the new principal amounts will thereafter become payable annually until
maturity.
In February 2000, the Company also agreed to restructure the two existing loans
to Mr. San Antonio (as restructured, the "Combined Loan"). The Combined Loan,
finalized in March 2001, was due on January 31, 2005 and accrued interest
annually at 5.2%. In July 2002, the Company extended the loan maturity date
until February 1, 2007 and the interest rate was changed to the now applicable
federal rate of 4.6%. The principal amount of Mr. San Antonio's note is
$4,165,062. Interest will be forgiven as long as Mr. San Antonio continues to be
employed by the Company. The $223,460 interest, which accrued on the note during
the fiscal year 2002, and the $230,460 of interest, which accrued from February
1, 2001 through March 31, 2001, was forgiven and charged to operations as
additional compensation in the respective fiscal years the interest income was
accrued.
The effects of inflation have not been significant to the Company.
Critical Accounting Policies
- ----------------------------
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the dates of the
financial statements and the reported amounts of revenues and expenses during
the reporting periods. Note 1 to the Consolidated Financial Statements in the
Company's Annual Report on Form 10-K for the year ended March 31, 2002,
describes the significant accounting policies and methods used in the
preparation of the Consolidated Financial Statements. The following lists some
of the Company's critical accounting policies impacted by judgments, assumptions
and estimates.
Revenue Recognition
The Company's revenue recognition policy is segregated into two distinct methods
depending on whether the Company, a third party or the retailer/dealer is
designated as the obligor on the service contract sale.
Dealer/third party obligor service contracts are sales in which the
retailer/dealer or a third party is designated as the obligor. For these service
contract sales, the Company uses the proportional performance method to
recognize revenues in direct proportion to the costs incurred in providing the
service contract programs to the Company's clients. Revenues in amounts
15
sufficient to meet future administrative costs and a reasonable gross profit
thereon are deferred. Sales of dealer/third party obligor service contracts are
reflected in gross revenues net of premiums paid to insurance companies.
Administrator obligor service contracts are sales in which Warrantech is
designated as the obligor. For these service contract sales, the Company
recognizes revenues over the life of the contract on a straight-line basis,
unless sufficient, company-specific, historical evidence indicates that the cost
of performing services under these contracts are incurred on other than a
straight-line basis. In determining the amount of revenue to recognize on
administrative obligor contracts, the Company utilizes the historical data bases
to estimate Company specific historical claims experience over the life of the
contract.
Impairment of Long-lived Assets
The Company assesses potential impairment of its long-lived assets, which
include its property and equipment and its identifiable intangibles such as
software development costs, goodwill and deferred charges under the guidance of
SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets". The
Company continually determines if a permanent impairment of its long-lived
assets has occurred and the write-down of the assets to their fair values and
charge current operations for the measured impairment is required.
Income Taxes
Deferred tax assets and liabilities are determined using enacted tax rates for
the effects of net operating losses and temporary differences between the book
and tax bases of assets and liabilities. The Company records a valuation
allowance on deferred tax assets when appropriate to reflect the expected future
tax benefits to be realized. In determining the appropriate valuation allowance,
certain judgments are made relating to recoverability of deferred tax assets,
use of tax loss carryforwards, level of expected future taxable income and
available tax planning strategies. These judgments are routinely reviewed by
management. At December 31, 2002, the Company had deferred tax assets of
$3,911,415, net of a valuation allowance of approximately $473,130 based on
projected net loss carryforwards. For further discussion, see Note 11 to the
Consolidated Financial Statements in the Company's Annual Report on Form 10-K
for the year ended March 31, 2002.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
- ------------------
As of December 31, 2002, the Company did not have any derivatives, debt or
hedges outstanding and as such is not subject to interest rate risk. The Company
does maintain investments in fixed rate municipal bonds. As interest rates
fluctuate, the values of the bonds increase or decrease accordingly. The Company
adjusts the carrying value for the bonds to market rate each quarter. Due to the
limited amount of investments and the short term nature of the investment, the
Company considers its interest rate risk to be insignificant to its results of
operations and financial condition.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
- ----------------------------------
The Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO)
are primarily responsible for the accuracy of the financial information that is
presented in the Quarterly Report. Each of them has, within 90 days of the
filing date of this report evaluated the Company's disclosure controls and
procedures, as defined in the rules of the SEC and have determined that such
controls and procedures were effective in ensuring that material information
relating to the Company and its consolidated subsidiaries was made known to them
during the period covered by this Quarterly Report.
Internal Controls
- -----------------
To meet their responsibility for financial reporting, the CEO and CFO have
established internal controls and procedures, which they believe, are adequate
to provide reasonable assurance that the Company's assets are protected from
loss. These internal controls are reviewed by the independent accountants to
support their audit work. In addition, the Company's Audit Committee, which is
composed entirely of outside directors, meets regularly with management and the
independent accountants to review accounting, auditing and financial matters.
This Committee and the independent accountants have free access to each other,
with or without management being present.
There were no significant changes in Company's internal controls or in other
factors that could significantly affect internal controls subsequent to the date
of the CEO's and CFO's most recent evaluation.
17
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ACE Property and Casualty Insurance Company
- -------------------------------------------
IN THE MATTER OF THE ARBITRATION BETWEEN ACE PROPERTY AND CASUALTY INSURANCE
COMPANY F/K/A CIGNA PROPERTY AND CASUALTY INSURANCE COMPANY V. WARRANTECH
CORPORATION, WARRANTECH CONSUMER PRODUCT SERVICES, INC., WCPS OF FLORIDA, INC.
AND WARRANTECH HELP DESK, INC.
In accordance with an Administrative Agreement between the various named
Warrantech entities and CIGNA, ACE has made a demand for arbitration of a
variety of claims that ACE asserted against Warrantech. These claims can be
divided into two general categories. The first arises out of Warrantech's
administration of its service contract program with CompUSA prior to and
immediately following the termination of the relationship between Warrantech and
CompUSA. The remaining claims relate to Warrantech's general claims handling
procedures. Although all claims have not been set forth with specificity, it is
evident that ACE is seeking to recover damages in an amount in excess of twenty
million dollars ($20,000,000).
After a lengthy standstill period, the parties have resumed discovery in
preparation for the arbitration hearing. At this time, no date has been set for
the arbitration. The parties have engaged in exploratory settlement discussions
but, as of the date of this filing, no definitive agreement has been reached and
it is too early to assess the likelihood that these discussions will be
successful.
WARRANTECH CONSUMER PRODUCT SERVICES, INC. ET AL. ("WARRANTECH") V. ACE PROPERTY
AND CASUALTY INSURANCE COMPANY AND DOES 1-10, INCLUSIVE ("ACE"), SUPERIOR COURT
OF THE STATE OF CALIFORNIA, COUNTY OF LOS ANGELES.
In November 2002, Warrantech filed suit against ACE for (i) insurance bad faith
(aka breach of the implied covenant of good faith and fair dealing) and (ii)
breach of contract. This complaint arises out of ACE's alleged unreasonable
delay in paying, or failure to pay, claims submitted by service providers under
service contracts underwritten by ACE. In a number of instances, this delay
and/or failure has resulted in the service provider filing suit against
Warrantech to recover the relevant payments. Warrantech is seeking compensatory
and punitive damages although no specific amount has been specified.
As of December 13, 2002, this matter was removed by ACE to the United States
District Court, Central District of California, Western Division. ACE is now
moving to have the matter dismissed, claiming that the subject matter of the
complaint must be arbitrated in accordance with existing agreements between the
parties.
Michael A. Basone
- -----------------
Mr. Basone is a former Executive Vice President and Chief Operating Officer of
Warrantech, having resigned in February 2000. Several months after resigning,
Mr. Basone contacted the Company through his attorney and claimed that the
Company's conduct was such that he was forced to resign. For this alleged
"constructive termination" without cause, Mr. Basone sought an amount equal to
what he would have received had he completed the term of his employment
agreement. The Company believes this assertion is completely without merit and
has rejected Mr. Basone's demand for payment. Mr. Basone has filed a Demand for
Arbitration with the American Arbitration Association that seeks damages in the
amount of $300,000. An arbitration hearing was held on May 13 - 14, 2002 and, on
July 31, 2002, the arbitrator issued his decision. The arbitrator has denied Mr.
Basone's claim and has held that wages withheld by Warrantech shall be applied
18
to offset amounts owed to Warrantech by Mr. Basone pursuant to a promissory
note. Each party will be responsible for its own attorney's fees and for
one-half of the costs of the arbitrator.
Market West Computer Group
- --------------------------
M.W.C.G., INC., D/B/A/ MARKET WEST COMPUTER GROUP, ON BEHALF OF ITSELF AND ALL
OTHERS SIMILARLY SITUATED V. ACE PROPERTY AND CASUALTY INSURANCE COMPANY,
WARRANTY CORPORATION OF AMERICA ("WACA"), WARRANTECH CORPORATION AND WARRANTECH
CONSUMER PRODUCT SERVICES, INC. ("WCPS"), UNITED STATES DISTRICT COURT, CENTRAL
DISTRICT OF CALIFORNIA (WESTERN DIVISION).
Market West is one of many service providers used by WCPS to repair
computer-related equipment pursuant to its service contract program. When the
administration of those service contracts underwritten by ACE was transferred
from WCPS to WaCA, many service providers like Market West complained of
material changes in claim adjustment procedures and unreasonable delays in claim
payment. Market West filed suit in state court in California against the named
parties to recover monies it claims to be owed as a result of the repair work it
has performed.
The amount sought by Market West under its initial claim was approximately
$225,000. Warrantech believed that if the claim were successful, substantially
all of the amount that is awarded to Market West would be owed by the insurers
that underwrote the liability. Following removal of the lawsuit to federal
court, Market West attempted to have a national class of plaintiffs certified.
The class certification petition was denied by the court and Market West was
directed to proceed with its individual claim. Market West then entered into
settlement discussions with Warrantech and a settlement agreement was recently
executed. Under this agreement, Warrantech's maximum exposure is less than
one-half of the amount originally sought and will be further reduced as
Warrantech processes valid claims through the appropriate underwriters. As of
the date of this filing, Warrantech has made no additional payments to Market
West pursuant to its continuing obligations under the settlement agreement.
Lloyd's Underwriters
- --------------------
CERTAIN UNDERWRITERS AT LLOYD'S, LONDON AND OTHER REINSURERS SUBSCRIBING TO
REINSURANCE AGREEMENTS F96/2992/00 AND NO. F97/2992/00 V. WARRANTECH
CORPORATION, WARRANTECH CONSUMER PRODUCT SERVICES, INC. AND WARRANTECH HELP
DESK, INC., DISTRICT COURT OF TARRANT COUNTY, TEXAS, 17TH JUDICIAL DISTRICT.
During the period that Houston General was the underwriter of certain of
Warrantech's programs, it reinsured certain of the underwritten risks with one
or more Lloyd's insurance syndicates. At some point thereafter, Houston General
commenced an arbitration against the Lloyd's syndicates seeking to recover
approximately $46,000,000 under the reinsurance treaties with respect to claims
previously paid by Houston General on warranty claims submitted by customers
under the Warrantech programs. The Warrantech entities were not parties in the
arbitration but were the subject of extensive discovery by each of Houston
General and the Lloyd's syndicates. The arbitration concluded in August 2002
with an award of approximately $39,000,000 in favor of Houston General.
The award supports the assertions of Houston General with respect to the
validity of the claims that it paid. Warrantech was not involved in the
selection of these re-insurers, has no contractual relationship with them, and
has had no reporting or other obligation to them. Despite these facts, the
Lloyd's syndicates now seek to recover some portion of the arbitration award
from the Warrantech entities on two theories of liability. The first is that, at
the time certain claims were presented to Houston General for payment, the
Warrantech entities either fraudulently or negligently represented to Houston
General that such claims were valid. The second is that the Warrantech entities
intentionally failed to comply with their legal obligations to cooperate with
the parties during the discovery process for the arbitration. No specific demand
for damages is contained in the complaint. The parties are presently engaged in
extensive document discovery and, in particular, the review of electronic files
and databases.
19
The Company believes that the ongoing actions described above are without merit
and it intends to defend them vigorously. Since it is not able to estimate
accurately its potential liability in either of them, no reserves for potential
liabilities have been provided for these actions.
ITEM 2. CHANGES IN SECURITIES
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6(a). EXHIBITS
99 (a) - CEO Certification Pursuant to 18 U.S.C. Section 1350
99 (b) - CFO Certification Pursuant to 18 U.S.C. Section 1350
ITEM 6(b). REPORTS ON 8-K
None
20
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PER
SECTION 302 OF THE SARBANES-OXLEY ACT
I, Joel San Antonio, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Warrantech
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 This registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and p oced s (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 q arte 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 te 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 o r
ev ation 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.
Date: February 11, 2003 /s/ Joel San Antonio
----------------------------------------------
Joel San Antonio
Chairman, Chief Executive Officer and Director
21
CERTIFICATION OF CHIEF FINANCIAL OFFICER PER
SECTION 302 OF THE SARBANES-OXLEY ACT
I, Richard F. Gavino, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Warrantech
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. Ths registrants's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and p s (a 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.
Date: February 11, 2003 /s/ Richard F. Gavino
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Richard F. Gavino
Executive Vice President, Chief Financial
Officer and Accounting Officer and Treasurer
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SIGNATURE
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Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WARRANTECH CORPORATION
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(Registrant)
/s/ Richard F. Gavino
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Richard F. Gavino - Executive Vice President, Chief
Financial Officer, Chief Accounting Officer and Treasurer
(Chief Financial Officer and Duly Authorized Officer)
Dated: February 11, 2003
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