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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
---------------------------
(Mark One)
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
( ) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to
-------------------- --------------------
Commission File Number 0-13084
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WARRANTECH CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 13-3178732
- --------------------------------------------------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2220 Highway 121, Suite 100, Bedford, TX 76021
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
-----------------------------
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed since last year)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes __X__ No ______
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act.) Yes [ ] No [ X ]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Class Outstanding at July 31, 2003
- ----------------------------------------- ----------------------------------
Common stock, par value $.007 per share 15,323,165 shares
WARRANTECH CORPORATION AND SUBSIDIARIES
I N D E X
Page No.
--------
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
Condensed Consolidated Statements of Operations -
For the Three Months Ended June 30, 2003 and 2002 (Unaudited).......2
Condensed Consolidated Balance Sheets at June 30, 2003
(Unaudited) and March 31, 2003......................................3
Condensed Consolidated Statements of Cash Flows
For the Three Months Ended June 30, 2003
and 2002 (Unaudited)................................................5
Notes to Condensed Consolidated Financial Statements.......................6
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations .....................10
Item 3. Quantitative and Qualitative Disclosures About Market Risk ..........14
Item 4. Controls and Procedures .............................................14
PART II - OTHER INFORMATION
Item 1: Legal Proceedings....................................................15
Item 2: Changes in Securities................................................15
Item 3: Defaults Upon Senior Securities......................................15
Item 4: Submission of Matters to a Vote of Security Holders..................15
Item 5: Other Information....................................................15
Item 6: Exhibits and Reports on Form 8-K.....................................15
Signature ....................................................................16
1
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended
June 30,
----------------------------------
2003 2002
--------------- ---------------
Earned administrative fee (net of amortization of
deferred costs) $ 8,455,357 $ 9,034,136
Costs and expenses
Service, selling, and general and administrative 7,505,850 7,202,343
Bad debt expense 95,000 -
Depreciation and amortization 928,080 1,023,119
--------------- ---------------
Total costs and expenses 8,528,930 8,225,462
--------------- ---------------
Income (loss) from operations (73,573) 808,674
Other income (expense) 286,868 229,957
--------------- ---------------
Income before provision for income taxes 213,295 1,038,631
Provision (benefit) for income taxes (2,000) 326,272
--------------- ---------------
Net income $ 215,295 $ 712,359
=============== ===============
Earnings per share:
Basic $0.01 $0.05
=============== ===============
Diluted $0.01 $0.05
=============== ===============
Weighted average number of shares outstanding:
Basic 15,284,134 15,307,642
=============== ===============
Diluted 15,672,197 15,386,538
=============== ===============
See accompanying notes to condensed consolidated financial statements.
2
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, March 31,
2003 2003
-------------- --------------
ASSETS
- ------
Current assets:
Cash and cash equivalents $ 4,689,531 $ 5,478,095
Investments in marketable securities 542,413 843,980
Accounts receivable, (net of allowances of
$325,454 and $230,064, respectively) 22,511,199 22,008,608
Loan receivable - Butler Financial
Solutions, Inc. 9,900,767 8,612,678
Other receivables, net 5,745,905 5,299,887
Deferred income taxes 2,098,171 2,098,171
Employee receivables 63,393 73,833
Prepaid expenses and other current assets 1,222,339 1,218,392
-------------- --------------
Total current assets 46,773,718 45,633,644
-------------- --------------
Property and equipment, net 7,517,211 8,296,313
-------------- --------------
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 802,404 800,406
Deferred direct costs 8,419,169 9,972,309
Investments in marketable securities 1,530,433 1,355,263
Restricted cash 825,000 825,000
Split dollar life insurance policies 877,126 877,126
Notes receivable 5,374,772 5,411,653
Other assets 54,184 47,124
-------------- --------------
Total other assets 19,520,378 20,926,171
-------------- --------------
Total Assets $ 73,811,307 $ 74,856,128
============== ==============
See accompanying notes to condensed consolidated financial statements.
3
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
June 30, March 31,
2003 2003
------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities:
Current maturities of long-term debt and capital lease
obligations $ 737,789 $ 802,070
Insurance premiums payable 37,084,279 36,070,992
Income taxes payable 86,941 81,236
Accounts and commissions payable 7,444,955 8,118,371
Accrued expenses and other current liabilities 3,999,538 3,534,106
------------- --------------
Total current liabilities 49,353,502 48,606,775
------------- --------------
Deferred revenues 13,072,167 15,065,547
Long-term debt and capital lease obligations 1,239,376 1,218,670
Deferred rent payable 391,077 417,720
------------- --------------
Total liabilities 64,056,122 65,308,712
------------- --------------
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.0007 par value authorized - 15,000,000
Shares issued - none at June 30, 2003 and March 31, 2003 - -
Common stock - $.007 par value authorized - 30,000,000 Shares
issued - 16,535,324 shares at June 30, 2003 and
16,525,324 shares at March 31, 2003 115,784 115,714
Additional paid-in capital 23,754,335 23,760,809
Loans to directors and officers (10,533,048) (10,462,094)
Accumulated other comprehensive income (loss), net of taxes (177,380) (196,974)
Retained earnings 819,926 604,631
------------- --------------
13,979,617 13,822,086
Treasury stock - at cost, 1,212,190 shares at June 30, 2003
and 1,249,690 shares at March 31, 2003 (4,224,432) (4,274,670)
------------- --------------
Total Stockholders' Equity 9,755,185 9,547,416
------------- --------------
Total Liabilities and Stockholders' Equity $ 73,811,307 $ 74,856,128
============= ==============
See accompanying notes to condensed consolidated financial statements.
4
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Three Months Ended
June 30,
-----------------------------------
2003 2002
--------------- ------------------
Cash flows from operating activities:
Net income $ 215,295 $ 712,359
--------------- ------------------
Adjustments to reconcile net income to
net cash provided by operating activities: 530,372 (322,841)
--------------- ------------------
Net cash flows provided by (used in) by operating
operating activities 745,667 389,518
--------------- ------------------
Cash flows from investing activities:
Property and equipment purchased (152,192) (241,944)
Purchase of marketable securities (175,000) (445,000)
Proceeds from sales of marketable securities 295,000 450,000
--------------- ------------------
Net cash provided by (used in) by
investing activities (32,192) (236,944)
--------------- ------------------
Cash flows from financing activities:
Issuance of common stock 70 -
Purchase treasury stock - (8,865)
Increase in loans and notes receivable (1,293,878) (230,950)
Repayments, notes and capital leases (208,231) (228,372)
--------------- ------------------
Net cash used in financing activities (1,502,039) (468,187)
--------------- ------------------
Net decrease in cash and cash equivalents (788,564) (315,613)
Cash and cash equivalents at beginning of period 5,478,095 7,033,448
--------------- ------------------
Cash and cash equivalents at end of period $ 4,689,531 $ 6,717,835
============== =================
Supplemental Cash Flow Information:
Cash payments (receipts) for:
Interest $ 43,582 $ 49,903
Income taxes - $ (1,252,774)
============== =================
Non-Cash Investing and financing activities:
Property and equipment financed through capital
leases $ 168,838 54,833
Capital leases refinanced $ - $ -
Increase in loans to officers and directors $ (70,954) $ (81,735)
Issuance of treasury stock $ 50,238 $ -
See accompanying notes to condensed consolidated financial statements.
5
WARRANTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2003
(UNAUDITED)
1. THE COMPANY
Warrantech, through its wholly owned subsidiaries, markets and
administers service contracts, extended warranties and replacement plans.
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. 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 without the costs and responsibilities of operating an
extended warranty program.
The service contracts, extended warranties and replacement contracts
generally have terms ranging from three (3) to one hundred twenty (120)
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 repairs is generally paid for by the insurance companies which have
the ultimate responsibility for the claims or by Butler Financial
Solutions, LLC ("Butler"), if Reliance Insurance Company ("Reliance") or
the Company is the obligor. The insurance policy indemnifies the
dealer/clients against losses resulting from service contract claims and
protects consumers 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 ended June 30, 2003 are not
necessarily indicative of the results that may be expected for the fiscal
year ending March 31, 2004. 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, 2003.
3. RESTATEMENT
The Company's financial statements for the three months ended June 30,
2002, have been restated to reflect a change in accounting treatment in
calculating net earned administrative fees as more fully described in the
Company's Annual Report on Form 10K for the year ended March 31, 2003.
For certain contracts, the Company previously had deferred a portion of
the revenue and would recognize such deferred revenue at the cancellation
or end of the contract's term. The Company is now recognizing this
revenue over the life of the contract's term.
6
The effect of this restatement for the quarter ended June 30, 2002 is as
follows:
JUNE 30, 2002
---------------------------
AS
PREVIOUSLY
REPORTED AS RESTATED
------------- ------------
Statement of operations:
Earned administrative fee (net of $9,030,286 $9,034,136
amortization of deferred costs)
Income from operations 804,824 808,674
Income before provision for income taxes 1,034,781 1,038,631
Provision for income taxes 324,900 326,272
Net income $709,881 $712,359
Earnings per share:
Basic $0.05 $0.05
===== =====
Diluted $0.05 $0.05
===== =====
4. 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.
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, Warrantech Automotive made an initial $1
million loan to Butler and further loans through June 30, 2003 of
$14,392,397.
Funding to Butler is provided by a special surcharge, payable on certain
vehicle service contracts administered by the Company sold after November
19, 2001. The surcharge is payable by agents through whom
Reliance-insured service contracts were sold. Butler will use these funds
to pay the claims previously insured by Reliance and to repay its loans
from Warrantech.
Additionally, in order to assist Butler in addressing its potential
obligations under the service contracts previously insured by Reliance
for which Butler is, or the dealer or Warrantech was, the obligor,
Warrantech Automotive has made loans to Butler, as necessary, for claims
obligations in excess of Butler's fee revenues. Subject to the terms of
the agreement between the Company and Butler, the Company has and will
make further loans to Butler, as necessary, for claims obligations in
excess of Butler's fee revenues. All of Warrantech's loans to Butler 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.
Through June 30, 2003, Warrantech has loaned Butler $15,392,937. RWC,
which is not part of the Reliance liquidation, is obligated to pay Butler
$9,990,767 of that amount. The Company expects Butler to collect the
$9,990,767 from RWC during the third quarter of fiscal 2004 and,
simultaneously, the Company will collect this amount from Butler. The
portion of the Butler receivables for which RWC is legally responsible
for payment is reflected as "Loan Receivables" on the Consolidated
Balance Sheet. The remaining amount representing the loans due from
Butler of $5,402,170 at June 30, 2003, is classified as "Notes
Receivable" on the Consolidated Balance Sheet.
7
The following table sets forth the carrying amounts and fair values of
the Company's notes and other receivables at June 30, 2003.
2004 2005 2006 2007 2008 THEREAFTER TOTAL FAIR VALUE
---- ---- ---- ---- ---- ---------- ----- ----------
Notes Receivable - Butler
Equals 2% above prime - - $2,563,129 $2,839,041 - - $5,402,170 $5,402,170
Loan Receivable - Butler;
0% interest $9,900,767 - - - - - $9,900,767 9,900,767
Other Receivable -
0% interest $5,745,905 - - - - - $5,745,905 $5,745,905
5. COMPREHENSIVE INCOME
The components of comprehensive income are as follows:
For the Three Months Ended
----------------------------------------
June 30,
----------------------------------------
2003 2002
------------------ ------------------
Net income $215,295 $712,359
Other comprehensive income, net of tax
Unrealized gain (loss) on investments (3,442) 18,420
Foreign currency translation adjustments 23,036 (7,106)
------------------ ------------------
Comprehensive income $234,889 $723,673
================== ==================
Comprehensive income per share: $0.02 $0.05
================== ==================
The components of accumulated comprehensive income are as follows:
June 30, March 31,
2003 2003
------------------ ------------------
Unrealized gain/(loss) on investments $14,604 $18,046
Accumulated translation adjustments (191,984) (215,020)
------------------ ------------------
Accumulated other comprehensive income loss ($177,380) ($196,974)
================== ==================
For the Three Months Ended
June 30,
-----------------------------------
2003 2002
---------------- ---------------
Numerator:
Net income applicable to common stock $215,295 $712,359
================ ===============
Denominator:
Average outstanding shares used in the
computation of per
share earnings:
Common Stock issued-Basic shares 15,284,134 15,307,642
---------------- ---------------
-Diluted shares 15,672,197 15,386,538
================ ===============
Earnings Per Common Share:
Basic $0.01 $0.05
================ ===============
Diluted $0.01 $0.05
================ ===============
6. STOCK OPTION PLAN
6. STOCK OPTION PLAN
In December 2002, the FASB issued Statement of Financial Accounting Standards
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment of FASB Statement No. 123" (SFAS No. 148). SFAS No. 148 provides
alternative methods of transition for companies making a voluntary change to
fair value-based accounting for stock-based employee compensation. The Company
continues to account for its stock option plan under the intrinsic value
recognition and measurement principles of APB Opinion No. 25, "Accounting for
Stock Issued to Employees," and related Interpretations. Effective for interim
periods beginning after December 15, 2002, SFAS No. 148 also requires disclosure
of pro-forma results on a quarterly basis as if the Company had applied the fair
value recognition provisions of SFAS No. 123.
As the exercise price of all options granted under the plan was equal to or
above the market price of the underlying common stock on the grant date, no
stock-based employee compensation is recognized in net income. The following
table illustrates the effect on net income and earnings per share if the company
had applied the fair value recognition provisions of SFAS No. 123, as amended,
to options granted under the stock option plans and rights to acquire stock
granted under the company's Stock Participation Plan, collectively called
"options." For purposes of this pro-forma disclosure, the value of the options
is estimated using a Black-Scholes option pricing model and amortized ratably to
expense over the options' vesting periods. Because the estimated value is
determined as of the date of grant, the actual value ultimately realized by the
employee may be significantly different.
For the Three Months
Ended June 30,
--------------------------
2003 2002
------------ -------------
Net income as reported $215,295 $712,359
Net income pro forma $195,611 $695,531
Shares - Basic 15,284,134 15,307,642
Basic earnings per share as reported $0.01 $0.05
Basic earnings per share pro forma $0.01 $0.05
The fair value of Warrantech stock options used to compute pro forma net income
and earnings per share disclosures is the estimated value at grant date using
the Black-Scholes option-pricing model with the following weighted average
assumptions for the three months ended June 30, 2003 and 2002, respectively:
expected dividend yield of 0%; expected volatility of 30% - 50%; a risk free
interest rate of 4.0% - 5.0%; and expected option life of 3 to 10 years.
Presented below is a summary of the status of the stock options in the plan and
the related transactions for the three months ended June 30, 2003 and 2002.
2003 2002
--------------------------------------------
Weighted Weighted
Average Average
Exercise Exercise
Shares Price Shares Price
--------------------------------------------
Options outstanding at beginning of 1,306, 380 $1.10 1,416,283 $1.54
the period
Granted 180,000 2.18 215,238 0.42
Canceled/Surrendered - - (5,000) (0.42)
Exercised - - - -
Forfeited - - - -
--------------------------------------------
Options outstanding at end of period 1,486,380 $1.16 1,581,521 $1.31
============================================
--------------------------------------------
Options exercisable at end of period 708,660 $1.36 610,111 $1.21
============================================
The weighted average fair value of stock options at date of grant, calculated
using the Black-Scholes option-pricing model, granted during the three months
ended June 30, 2003 and 2002 was $0.54 and $0.48, respectively.
The Company may issue options to purchase its common stock to officers,
non-employees, non-employee directors or others as part of settlements in
disputes and/or incentives to perform services for the Company. The Company
accounts for stock options issued to vendors and non-employees of the Company
under SFAS No. 123 "Accounting for Stock-based Compensation." The fair value of
each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model is charged to operations utilizing weighted average
assumptions identical to those used for options granted to employees.
The following table summarizes the status of all Warrantech's stock options
outstanding and exercisable at June 30, 2003.
Stock Options Stock Options
Outstanding Exercisable
--------------------------------- --------------------------
Weighted Weighted
Average Average
Exercise
Exercise
Range Of Exercise Prices Shares Price Shares Price
- --------------------------- ------------- ------------ ------------ -----------
$0.67 to $0.87 909,082 $0.74 366,666 $0.71
$1.3125 to $1.595 616,008 $1.33 380,713 $1.33
$2.00 4,650,000 $2.00 3,000,000 $2.00
$3.25 to $3.375 101,290 $3.35 101,290 $3.27
------------- ------------ ------------ -----------
Total at June 30, 2003 6,276,380 $1.97 3,848,669 $1.83
============= ============ ============ ===========
7. SEGMENTS
The Company operates in three major business segments: Automotive,
Consumer Products and International. The Automotive segment markets and
administers extended warranties on automobiles, light trucks,
motorcycles, recreational vehicles and automotive components, which are
sold principally by franchised and independent automobile and motorcycle
dealers, leasing companies, repair facilities, retail stores, financial
institutions and other specialty marketers. The Consumer Products segment
develops, markets and administers extended
8
warranties and product replacement plans on household appliances,
consumer electronics, televisions, computers, home office equipment,
jewelry, musical instruments and homes and which are sold principally
through retailers, distributors, manufacturers, utility companies,
financial institutions and other specialty marketers. Warrantech also
markets these warranties and plans directly to the ultimate consumer on
behalf of the retailer/dealer and/or the manufacturer through
telemarketing and direct mail campaigns. The International segment
markets and administers predominately the same products and services as
the other business segments. The International segment is currently
operating in Central and South America, Puerto Rico and the Caribbean.
"Other" includes intersegment eliminations of revenues and receivables
and net unallocated Corporate expenses.
Consumer Reportable
QUARTER ENDED Automotive Products International Segments Other Total
---------- -------- ------------- -------- ----- -----
JUNE 30, 2003
- -------------
Earned administrative fee $3,311,467 $3,883,855 $1,080,427 $8,275,749 $179,608 $8,455,357
Income (loss) from operations 1,074,576 466,793 260,433 1,801,802 (1,875,375) (73,573)
Pretax income (loss) (259,178) 6,375 263,832 11,029 202,266 213,295
Net interest income (expense) (60,691) (7,031) 1,906 (65,816) 183,002 117,186
Depreciation/amortization 95,706 404,834 21,441 521,981 406,099 928,080
Total assets 40,304,814 20,052,523 3,868,190 64,225,527 9,585,780 73,811,307
JUNE 30, 2002
- -------------
Earned administrative fee $5,009,132 $3,361,845 $716,273 $9,087,250 ($53,114) $9,034,136
Income (loss) from 3,079,140 (41,645) 46,705 3,084,200 (2,275,526) 808,674
operations
Pretax income (loss) 1,431,739 (594,437) 47,283 884,585 154,046 1,038,631
Net interest income 19,498 (4,452) 3,551 18,597 107,329 125,926
Depreciation/amortization 99,508 436,567 21,237 557,312 465,807 1,023,119
Total assets 40,183,577 26,637,731 3,591,600 70,412,908 4,306,156 74,719,064
9
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 report on Form 10-Q may contain forward-looking
statements that involve risks and uncertainties that could cause actual results
to differ materially from those contemplated by the forward-looking statements.
The Company makes such forward-looking statements under the provisions of the
"safe harbor" section of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements reflect the Company's views and assumptions, based on
information currently available to management. 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. When used in this Quarterly Report on Form 10-Q, the words
"believes," "estimates," "plans," "expects," and "anticipates" and similar
expressions as they relate to the Company or its management are intended to
identify forward-looking statements.
Although the Company believes that the expectations reflected in the
forward-looking statements are reasonable, it can give no assurance that its
expectations will prove to be correct. These statements are subject to certain
risks, uncertainties and assumptions, including, but not limited to, (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, (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) the adverse
outcomes of litigation,(i) the non-payment of notes due from an officer and two
directors of the Company due in 2007, (j) the inability of any of the insurance
companies which insure the service contracts marketed and administered by the
Company to pay the claims under the service contracts, (k) the inability of
Butler to pay the claims previously insured by Reliance, (l) the termination of
extended credit terms being provided by the Company's current insurance company,
(m) the inability of the Company to collect the "Other Receivables" in the
amount of $9,900,767 by the end of the Company's fiscal year, and (n) the
outcome of the review currently being conducted by the staff of the Securities
and Exchange Commission ("SEC") of the Company's financial statements and
related disclosures. 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 and there could be a materially
adverse effect on the Company's business.
SEC REVIEW OF THE COMPANY'S FILINGS
The Staff of the Division of Corporation Finance of the SEC selected certain of
the Company's periodic reports for review, including the Annual Report on Form
10-K for the fiscal year ended March 31, 2002 and the Quarterly Reports on Form
10-Q for the periods ended June 30, 2002, September 30, 2002 and December 31,
2002. The staff informed the Company that the purpose of the review is to assist
the Company in its compliance with applicable disclosure requirements and to
enhance the overall disclosure in the Company's reports.
In the course of its review, the staff requested clarification of some of the
Company's disclosures and items in its financial statements and the Company
agreed to amend certain of them on a going-forward basis. These disclosures are
included in the Annual Report on Form 10-K for the period ended March 31, 2003
and this Quarterly Report on Form 10-Q.
The most recent letter from the staff contains four remaining comments. These
comments primarily pertain to the Company's accounting treatment of the loans to
Butler to pay Reliance claims. The Company is reviewing the staff's latest
comments and will be preparing a response. The Company does not know what
changes, if any, may be required as a result of these comments.
10
RESULTS OF OPERATIONS
GROSS REVENUES
FOR THE YEARS ENDED JUNE 30,
------------------------------------
2003 2002
-------------- ---------------
Gross revenues $40,083,441 $33,650,184
============== ===============
Gross revenues for the period ended June 30, 2003 increased $6,433,257, or 19%,
over the same period in 2002. The Automotive and International segments reported
increased gross revenues of 18% and 60% respectively, in the period ended June
30, 2003 over 2002. The Automotive segment increase in gross revenues was due to
new business from direct marketing and reinsurance programs. The International
segment also experienced higher sales volumes in both Puerto Rico and in South
America. The Consumer Products segment reported a 17% increase in gross revenues
during the period ended June 30, 2003 compared to the same period in 2002, as
sales increased from its top five customers and the Consumer Products segment
added new business.
NET EARNED ADMINISTRATIVE FEES
FOR THE YEARS ENDED JUNE 30,
-----------------------------
2003 2002
------------- -------------
Automotive segment $3,311,467 $5,009,132
Consumer Products segment 3,883,855 3,361,845
International segment 1,080,427 716,273
Other 179,608 (53,114)
------------- -------------
Total net earned administrative fee $8,455,357 $9,034,136
============= =============
Net earned administrative fees are gross revenues less directs costs, the
combined sum of net premiums, commissions and sales allowances plus or minus
deferred revenue. Net earned administrative fees for the quarter ended June 30,
2003 decreased $578,779 over the same period in 2002 as a result of lower
margins and lower deferred revenue of $383,362 recognized in the first quarter
of fiscal 2004 compared to deferred revenue of $616,314 recognized in the first
quarter of fiscal 2003. As the Company's older obligor contracts, which make up
the majority of its deferred revenue, continue to decline, there is less
deferred revenue to record in the current period.
The Automotive segment net earned administrative fees decreased $828,748 or 4%
during the fiscal period ended June 30, 2003 compared to 2002. Although gross
revenues increased 18% during the first quarter ended June 30, 2003, its earned
administrative fees decreased due to lower margins and lower net deferred
revenues from prior periods recognized in the period ended June 30, 2003
compared to the same period in 2002.
The Consumer Products segment net earned administrative fees increased $522,010
or 15% during the fiscal period ended June 30, 2003 compared to the same period
in 2002. The change was primarily attributed to higher sales from new business
and increased volume from existing clients. Additionally, higher net deferred
revenues from prior periods recognized in the period ended June 30, 2003
compared to the same period in 2002 contributed to the Consumer Products
segment's higher net earned administrative fees.
The International segment net earned administrative fees increased $364,154, or
51%, during period ended June 30, 2003 compared to the same period in 2002. The
increase resulted from greater market penetration by its existing dealers in
Puerto Rico and in South America.
SG&A
FOR THE YEARS ENDED JUNE 30,
--------------------------------
2003 2002
------------- ----------------
Service, selling and general $7,505,850 $7,202,343
administrative
Service, selling and general and administrative ("SG&A") for the quarter ended
June 30, 2003 increased $303,507, or 4%, compared to the same quarter in the
11
prior year. Legal expenses decreased $220,465 for the period ended June 30, 2003
compared to the 2002 period, primarily because of the decrease in litigation
expenses related to several lawsuits that were settled during fiscal period
2003. Employee costs were higher at $4,654,879 during the period ended June 30,
2003, compared to $4,380,283 in the period ended June 30, 2002, primarily due to
an increase in salary costs. Telephone expenses were reduced 36%, or $157,397,
to $279,773 as compared to $437,170 in the period ended June 30, 2002, due to
lower negotiated telephone usage rates and the elimination of data transmission
lines after the Company consolidated operations into one building. Rent expense
increased from $427,012 for the period ended June 30, 2002 to $603,522 for the
period ended June 30, 2003, reflecting the Company's move to its new corporate
headquarters in Bedford, Texas.
DEPRECIATION AND AMORTIZATION
FOR THE YEARS ENDED JUNE 30,
--------------------------------------
2003 2002
----------------- ------------------
Depreciation and amortization $928,080 $1,023,119
================= ==================
Depreciation and amortization expenses were reduced by $95,039, or 9%, during
period ended June 30, 2003 compared to the same period for 2002. This decrease
is the result of the Company's assets maturing and the continued reduction of
capital expenditures for the past few years.
OTHER INCOME
FOR THE YEARS ENDED JUNE 30,
---------------------------------
2003 2002
-------------- ----------------
Interest and dividend income $249,383 $175,829
Interest expense (132,197) (49,903)
Gain (loss) on sale of assets 23 (47,854)
Credit card usage rebate 129,177 146,894
Miscellaneous income 40,482 4,991
-------------- ----------------
Total other income $286,868 $229,957
============== ================
Other income for quarter ended June 30, 2003 increased slightly compared to the
quarter ended June 30, 2002 due to a loss on the sale of assets in 2002. Higher
interest income during the quarter ended June 30, 2003 was offset by higher
interest expense.
INCOME TAX EXPENSE
FOR THE YEARS ENDED JUNE 30,
----------------------------------
2003 2002
--------------- ----------------
Income taxes expense (benefit) ($2,000) $326,272
=============== ================
Income taxes expense decreased $328,272 for the period ended June 30, 2003
compared to the period ended June 30, 2002. Although the Company reported
$213,295 of income before taxes, the use of Puerto Rico's net operating loss and
a lower effective tax rate on the Company's income from its International
segment was offset by the Company's tax benefit from its U.S. operations.
LIQUIDITY AND FINANCIAL RESOURCES
During the three months ended June 30, 2003, the Company had a net decrease in
cash and cash equivalents of $788,564, which was primarily used in operating
activities to fund working capital. Working capital was a negative $2.6 million
at June 30, 2003 compared to a negative $0.6 million at June 30, 2002, primarily
due to an increase in the loan to Butler. The Company believes that internally
generated funds, reimbursement of claims paid for RWC obligations and the $3
million line of credit from Great American Insurance Company, 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.
12
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 three months ended June 30, 2003 amounted to $168,838
compared to $54,833 during the three months ended June 30, 2002.
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 Company's Consolidated Financial Statements
set forth in the "Item 8. - Financial Statements and Supplementary Data," in the
Company's Annual Report on Form 10-K for the year ended March 31, 2003,
describes the significant accounting policies and methods used in the
preparation of the Consolidated Financial Statements. The following lists some
of the Company's critical accounting policies affected by judgments, assumptions
and estimates.
REVENUE RECOGNITION
Under SAB 101, the Company recognizes revenue when the revenue is realizable and
earned. The Company considers revenue realized and earned when a definitively
discrete earnings event has occurred. The Company has two discrete earnings
events (1) for marketing and administration of service contracts and (2) for
servicing fees. The marketing and administrative fee is paid by the retailer of
the service contract. This revenue is recognized at the time of the sale to the
retailer as the Company will have substantially completed the services it has
agreed to provide in connection with the sale of the service contract to the
consumer.
The second discrete earnings event occurs over the life of the contract. As
such, Warrantech recognizes and realizes the revenue over the contract life.
IMPAIRMENT OF LONG-LIVED ASSETS
The Company assesses potential impairment of its long-lived assets, which
include its property and equipment and its identifiable intangibles such as
software development costs, goodwill and deferred charges under the guidance of
SFAS 144 "Accounting for the Impairment or Disposal of Long-Lived Assets." Once
annually or as events or circumstances indicate that an asset may be impaired,
the Company assesses potential impairment of its long-lived assets. The Company
determines impairment by measuring the undiscounted future cash flow generated
by the assets, comparing the result to the assets' carrying value and adjusting
the assets to the lower of its carrying value or fair value and charging current
operations for any measured impairment. At June 30, 2003 and 2002, the Company
found no impairment to its property and equipment or its other identifiable
intangibles.
INCOME TAXES
Deferred tax assets and liabilities are determined using enacted tax rates for
the effects of net operating losses and temporary differences between the book
and tax bases of assets and liabilities. The Company records a valuation
allowance on deferred tax assets when appropriate to reflect the expected future
tax benefits to be realized. In determining the appropriate valuation allowance,
certain judgments are made relating to recoverability of deferred tax assets,
use of tax loss carryforwards, level of expected future taxable income and
available tax planning strategies. These judgments are routinely reviewed by
management. At June 30, 2003, the Company had deferred tax assets of $2,900,575,
net of a valuation allowance of $256,434. For further discussion, see Note 12 to
the Consolidated Financial Statements in the Company's Annual Report on Form
10-K for the year ended March 31, 2003.
13
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As of June 30, 2003, the Company did not have any derivatives, debt or hedges
outstanding. Therefore, the Company was not subject to interest rate risk. In
addition, the risk of foreign currency fluctuation was and is not material to
the Company's financial position or results of operations.
Short-term marketable securities and long-term investments are comprised of
municipal bonds which bear interest at fixed rates. Interest income from these
securities is generally affected by changes in the U.S. interest rates. The
following tables provide information about the Company's financial instruments
that are sensitive to changes in interest rates. The tables present principal
cash flows and weighted-average interest rates by expected maturity dates. All
of the investments are considered "available for sale." The resultant
differences between amortized cost and fair value, net of taxes, have been
reflected as a separate component of accumulated other comprehensive income.
Principal amounts by expected maturity as of June 30, 2003 of marketable
securities are as follows:
Expected Maturity Date as of June 30,
----------------------------------------------------------
2004 2005 2006 2007 2008 Thereafter Total Cost Fair Value
---- ---- ---- ---- ---- ---------- ---------- ----------
Available for sale
securities $542,413 $1,016,477 $476,620 - - $37,336 $2,072,846 $2,072,846
Interest rate 4.36% 4.82% 4.87% - - 5.50%
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
The Company's Chief Executive Officer (CEO) and Chief Financial Officer (CFO)
are primarily responsible for the accuracy of the financial information that is
presented in this Quarterly Report on Form 10-Q. Each of them has, within 90
days of the filing date of this Quarterly 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 Company's 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.
14
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Not applicable.
Item 2. Changes in Securities and Use of Proceeds
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant
to Section 302 of Sarbanes-Oxley Act.
31.2 Certification of Chief Financial Officer pursuant
to Section 302 of Sarbanes-Oxley Act.
32.1 Certification of Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of Sarbanes-Oxley Act.
32.2 Certification of Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of Sarbanes-Oxley Act.
(b) Reports on Form 8-K
Current Report on Form 8-K, dated June 26, 2003,
reporting, under Item 9, the Company's financial results
for the fiscal year ended March 31, 2003.
15
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WARRANTECH CORPORATION
----------------------------------
(Registrant)
/s/ Richard F. Gavino
----------------------------------
Richard F. Gavino - Executive Vice President, Chief
Financial Officer, Chief Accounting Officer and Treasurer
(Chief Financial Officer and Duly Authorized Officer)
Dated: August 14, 2003
16