UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended 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 000-20202 CREDIT ACCEPTANCE CORPORATION (Exact name of registrant as specified in its charter) MICHIGAN 38-1999511 (State or other jurisdiction of (IRS Employer Identification) incorporation or organization) 25505 WEST TWELVE MILE ROAD, SUITE 3000 SOUTHFIELD, MICHIGAN 48034-8339 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code: 248-353-2700 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date. The number of shares outstanding of Common Stock, par value $.01, On July 1, 2003 was 42,388,148.
TABLE OF CONTENTS <TABLE> <S> <C> <C> PART I. - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Consolidated Income Statements - Three and six months ended June 30, 2003 and June 30, 2002 1 Consolidated Balance Sheets - As of June 30, 2003 and December 31, 2002 2 Consolidated Statements of Cash Flows - Six months ended June 30, 2003 and June 30, 2002 3 Notes to Consolidated Financial Statements 4 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION 13 AND RESULTS OF OPERATIONS ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 31 ITEM 4. CONTROLS AND PROCEDURES 31 PART II. - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS 32 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 32 SIGNATURE 33 INDEX OF EXHIBITS 34 </TABLE>
PART I. - FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS CREDIT ACCEPTANCE CORPORATION CONSOLIDATED INCOME STATEMENTS <TABLE> <CAPTION> (Dollars in thousands, except per share data) THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ------------------------------ ------------------------------ 2003 2002 2003 2002 -------------- -------------- -------------- -------------- (UNAUDITED) (UNAUDITED) <S> <C> <C> <C> <C> Revenue: Finance charges $ 26,431 $ 25,522 $ 50,687 $ 50,407 Lease revenue 1,784 4,428 4,120 9,587 Ancillary product income 4,233 3,794 9,966 7,391 Premiums earned 757 1,054 1,512 2,494 Other income 2,767 3,791 6,616 7,568 ----------- ----------- ----------- ----------- Total revenue 35,972 38,589 72,901 77,447 ----------- ----------- ----------- ----------- Costs and expenses: General and administrative 5,198 6,383 10,961 12,100 Salaries and wages 8,687 7,448 17,204 14,952 Sales and marketing 2,483 1,809 4,660 3,590 Stock-based compensation expense 1,428 565 1,803 1,047 Provision for insurance and warranty claims 209 570 308 1,133 Provision for credit losses 2,863 3,562 6,772 7,077 Depreciation of leased assets 1,167 2,566 2,715 5,507 United Kingdom asset impairment expense 10,493 - 10,493 - Interest 1,401 2,457 2,997 4,762 ----------- ----------- ----------- ----------- Total costs and expenses 33,929 25,360 57,913 50,168 ----------- ----------- ----------- ----------- Operating income 2,043 13,229 14,988 27,279 Foreign exchange gain 14 11 29 27 ----------- ----------- ----------- ----------- Income before provision for income taxes 2,057 13,240 15,017 27,306 Provision for income taxes 1,049 4,774 5,416 12,643 ----------- ----------- ----------- ----------- Net income $ 1,008 $ 8,466 $ 9,601 $ 14,663 =========== =========== =========== =========== Net income per common share: Basic $ 0.02 $ 0.20 $ 0.23 $ 0.35 =========== =========== =========== =========== Diluted $ 0.02 $ 0.19 $ 0.23 $ 0.34 =========== =========== =========== =========== Weighted average shares outstanding: Basic 42,321,170 42,535,312 42,317,443 42,486,667 Diluted 42,868,265 43,821,716 42,629,844 43,684,127 </TABLE> See accompanying notes to consolidated financial statements. 1
CREDIT ACCEPTANCE CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> (Dollars in thousands) AS OF ------------------------------------ JUNE 30, 2003 DECEMBER 31, 2002 --------------- ------------------- ASSETS: (Unaudited) <S> <C> <C> Cash and cash equivalents $ 22,068 $ 13,466 Investments-- held to maturity 456 173 Loans receivable 857,502 778,674 Allowance for credit losses (5,100) (5,497) --------- --------- Loans receivable, net 852,402 773,177 --------- --------- Floorplan receivables 2,964 4,450 Lines of credit 2,817 3,655 Notes receivable (including $1,548 and $1,513 from affiliates as of June 30, 2003 and December 31,2002, respectively) 2,074 3,899 Investment in operating leases 9,328 17,879 Property and equipment, net 18,355 19,951 Other assets 7,077 5,166 --------- --------- Total Assets $ 917,541 $ 841,816 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY: LIABILITIES: Lines of credit $ 8,305 $ 43,555 Secured financing 100,000 58,153 Mortgage note 5,813 6,195 Capital lease obligations 1,538 1,938 Accounts payable and accrued liabilities 33,034 28,341 Dealer holdbacks, net 417,043 362,534 Deferred income taxes, net 4,010 10,058 Income taxes payable 11,700 6,094 --------- --------- Total Liabilities 581,443 516,868 --------- --------- SHAREHOLDERS' EQUITY: Common stock 422 423 Paid-in capital 124,446 124,263 Retained earnings 208,459 198,858 Accumulated other comprehensive income - cumulative translation adjustment 2,771 1,404 --------- --------- Total Shareholders' Equity 336,098 324,948 --------- --------- Total Liabilities and Shareholders' Equity $ 917,541 $ 841,816 ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 2
CREDIT ACCEPTANCE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS <TABLE> <CAPTION> (Dollars In Thousands) SIX MONTHS ENDED JUNE 30, -------------------------------- 2003 2002 ------------- -------------- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 9,601 $ 14,663 Adjustments to reconcile cash provided by operating activities: Provision for credit losses 6,772 7,077 Depreciation 2,231 2,735 Depreciation of leased assets 2,715 5,507 Loss on retirement of property and equipment - 276 Provision (credit) for deferred income taxes (6,048) 9,109 Tax benefit from exercise of stock options 86 1,555 Stock-based compensation 1,566 (692) United Kingdom asset impairment 10,493 -- Change in operating assets and liabilities: Accounts payable and accrued liabilities 4,309 (1,948) Income taxes payable 5,606 683 Lease payment receivable 1,183 535 Unearned insurance premiums, insurance reserves and fees (223) (492) Deferred dealer enrollment fees, net 384 43 Other assets (1,911) 3,088 --------- --------- Net cash provided by operating activities 36,764 42,139 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Principal collected on loans receivable 174,957 170,648 Advances to dealers (200,121) (155,711) Payments of dealer holdbacks (15,394) (16,273) Operating lease acquisitions - (874) Deferred costs from lease acquisitions - (201) Operating lease liquidations 3,446 5,792 Decrease (increase) in floor plan receivables 1,209 (394) Decrease in lines of credit 838 819 Decrease (increase) in notes receivable -- affiliates (35) 28 Decrease in notes receivable -- non-affiliates 1,860 351 Purchases of property and equipment (634) (3,168) --------- --------- Net cash (used in) provided by investing activities 33,874 1,017 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (repayments) under lines of credit (35,250) 18,057 Proceeds from secured financings 100,000 28,552 Repayments of secured financings (58,153) (85,847) Principal payments under capital lease obligations (400) 556 Repayment of senior notes and mortgage note (382) (356) Repurchase of common stock (1,828) (6,325) Proceeds from stock options exercised 358 3,470 --------- --------- Net cash (used in) provided by financing activities 4,345 (41,893) --------- --------- Effect of exchange rate changes on cash 1,367 3,658 --------- --------- Net increase in cash and cash equivalents 8,602 4,921 Cash and cash equivalents, beginning of period 13,466 15,773 --------- --------- Cash and cash equivalents, end of period $ 22,068 $ 20,694 ========= ========= </TABLE> See accompanying notes to consolidated financial statements. 3
CREDIT ACCEPTANCE CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("generally accepted accounting principles" or "GAAP") for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for interim periods are not necessarily indicative of actual results achieved for full fiscal years. The consolidated balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Annual Report on Form 10-K for the year ended December 31, 2002 for Credit Acceptance (the "Company"). Certain amounts have been reclassified to conform to the 2003 presentation, including reclassification due to the Company's change in segment disclosures. See Note 11. Additionally, the results for prior periods were restated related to the Company's adoption of the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS No. 123") under the retroactive restatement method selected by the Company as described in SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure." See Note 10. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 2. ACCOUNTING STANDARDS Pursuant to SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", an impairment analysis is performed on the net asset value of the United Kingdom, Canada, and Automobile Leasing operations on a quarterly basis. This analysis compares the undiscounted forecasted future net cash flows (including servicing expenses and any payments due dealers under servicing agreements) of each operation to the operation's net asset value at the balance sheet date. The impairment analysis for operations which are being liquidated reduces the future cash flows by the amount of servicing expenses (under SFAS No. 144), while the impairment analysis for advances relating to continuing operations does not (under SFAS No. 144). If this analysis indicates that the asset is impaired, the Company is required to write down the value of the asset to the present value of the forecasted net cash flows. United Kingdom -- Effective June 30, 2003, the Company decided to stop originating retail installment contracts (referred to as "Contracts" or "Loans") in the United Kingdom. In analyzing the expected cash flows from this operation, the Company has assumed lower collection rates than were assumed before the decision to liquidate. These lower collection rates reflect uncertainties (such as potentially higher employee turnover or reduced morale) in the servicing environment that may arise as a result of the decision to liquidate. As a result, the assets were deemed to be impaired and the Company recorded an after-tax expense of $6.4 million to reduce the carrying value of the operation's dealer-partner advances to the present value (using a discount rate of 13%) of the forecasted cash flows relating to the dealer-partner advances less estimated future servicing expenses. Canada -- Effective June 30, 2003, the Company decided to stop originating Loans in Canada. Since Loans originated in Canada are serviced in the United States, the Company evaluated cash flows related to the Canadian operation based on the same collection rate assumptions as were used before the decision to liquidate. Based upon management's analysis, no write down of the net asset value of the Canadian operation was necessary at June 30, 2003. Leasing -- Effective January 1, 2002, the Company decided to stop originating automobile leases. Based upon management's analysis, no write down of the net asset value of the leasing operation was necessary at June 30, 2003. 4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 2. ACCOUNTING STANDARDS -- (CONTINUED) In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring)." SFAS No. 146 requires a liability for a cost associated with an exit or disposal activity to be recognized and measured initially at its fair value in the period in which the liability is incurred, rather than at the time of commitment to an exit plan. The Company adopted this standard for exit or disposal activities initiated after December 31, 2002. As a result of the Company's decision to exit the United Kingdom business, the Company recognized: (i) $300,000 after-tax increase in salaries and wages resulting from employee severance expenses and (ii) $100,000 after-tax reduction in other income due to a refund of profit sharing income on ancillary products to an ancillary product provider which was based on volume targets no longer attainable due to the decision to stop Loan originations. As of June 30, 2003, the remaining liability for these expenses was $200,000. The Company may record an additional liability for payment of future lease obligations under a rental agreement through September 2007 once the Company stops using the office space in the United Kingdom. The Company expects to stop using the United Kingdom office space in the fourth quarter of 2005 or first quarter of 2006. 3. LOANS RECEIVABLE Loans receivable consisted of the following (in thousands): <TABLE> <CAPTION> AS OF ------------------------------------ JUNE 30, 2003 DECEMBER 31, 2002 ------------- ----------------- <S> <C> <C> Gross Loans receivable $ 1,015,773 $ 919,022 Unearned finance charges (155,100) (136,954) Unearned insurance premiums, insurance reserves and fees (3,171) (3,394) ----------- ----------- Loans receivable $ 857,502 $ 778,674 =========== =========== Non-accrual Loans $ 202,451 $ 220,978 =========== =========== Non-accrual Loans as a percent of gross Loans receivable 19.9% 24.0% =========== =========== </TABLE> A summary of changes in gross Loans receivable is as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------------- ----------------------------------- 2003 2002 2003 2002 --------------- --------------- --------------- --------------- <S> <C> <C> <C> <C> Balance, beginning of period $ 970,703 $ 937,632 $ 919,022 $ 906,808 Gross amount of Loans accepted 206,859 146,869 438,905 338,950 Net cash collections on Loans (112,533) (111,383) (227,563) (226,463) Charge-offs (55,568) (39,634) (120,222) (81,469) Currency translation 6,312 10,686 5,631 6,344 ----------- ----------- ----------- ----------- Balance, end of period $ 1,015,773 $ 944,170 $ 1,015,773 $ 944,170 =========== =========== =========== =========== </TABLE> 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 3. LOANS RECEIVABLE -- (CONCLUDED) A summary of the change in the allowance for credit losses is as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 ------- ------- ------- ------- <S> <C> <C> <C> <C> Balance, beginning of period $ 5,051 $ 4,909 $ 5,497 $ 4,745 Provision for Loan losses 833 491 1,150 951 Charge-offs (830) (461) (1,585) (733) Currency translation 46 87 38 63 ------- ------- ------- ------- Balance, end of period $ 5,100 $ 5,026 $ 5,100 $ 5,026 ======= ======= ======= ======= </TABLE> Loans receivable are collateralized by the related vehicles, with the Company having the right to repossess the vehicle in the event that the consumer defaults on the payment terms of the Loan. Repossessed collateral is valued at the lower of the carrying amount of the receivable or estimated fair value, less estimated costs of disposition, and is classified in Loans receivable on the balance sheets. At June 30, 2003 and December 31, 2002, repossessed assets totaled approximately $6.3 million and $8.6 million, respectively. The Company's policy for non-accrual Loans is 90 days measured on a recency basis (no payments received for 90 days). The Company charges-off delinquent Loans at nine months on a recency basis. 4. FLOORPLAN RECEIVABLES AND LINES OF CREDIT A summary of the change in the allowance for floorplan receivables and lines of credit losses is as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------- ------------------------- 2003 2002 2003 2002 ------- ------- ------- ------- <S> <C> <C> <C> <C> Balance, beginning of period $ 1,323 $ 1,945 $ 1,041 $ 1,827 Provision for credit losses 14 392 277 526 Charge-offs (990) -- (961) -- Currency translation 10 22 -- 6 ------- ------- ------- ------- Balance, end of period $ 357 $ 2,359 $ 357 $ 2,359 ======= ======= ======= ======= </TABLE> 5. INVESTMENT IN OPERATING LEASES The composition of investment in operating leases consisted of the following (in thousands): <TABLE> <CAPTION> AS OF --------------------------------- JUNE 30, 2003 DECEMBER 31, 2002 ------------- ----------------- <S> <C> <C> Gross leased assets $ 17,767 $ 26,821 Accumulated depreciation (9,978) (12,304) Gross deferred costs 2,635 3,956 Accumulated amortization of deferred costs (2,075) (2,706) Lease payments receivable 979 2,112 -------- -------- Investment in operating leases $ 9,328 $ 17,879 ======== ======== </TABLE> 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 5. INVESTMENT IN OPERATING LEASES -- (CONCLUDED) A summary of changes in the investment in operating leases is as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 -------- -------- -------- -------- <S> <C> <C> <C> <C> Balance, beginning of period $ 13,312 $ 35,743 $ 18,355 $ 43,470 Gross operating leases originated - 22 - 1,075 Depreciation of operating leases (1,167) (2,566) (2,715) (5,507) Lease payments due 1,840 4,415 4,189 9,397 Collections on operating leases (2,002) (3,998) (4,589) (8,641) Charge-offs (318) (559) (783) (1,291) Operating lease liquidations (2,589) (4,087) (5,616) (9,517) Currency translation 252 276 487 260 -------- -------- -------- -------- Balance, end of period $ 9,328 $ 29,246 $ 9,328 $ 29,246 ======== ======== ======== ======== </TABLE> 6. DEALER HOLDBACKS AND RESERVE FOR ADVANCE LOSSES Dealer holdbacks consisted of the following (in thousands): <TABLE> <CAPTION> AS OF ---------------------------------- JUNE 30, 2003 DECEMBER 31, 2002 ------------- ----------------- <S> <C> <C> Dealer holdbacks $ 810,741 $ 734,625 Less: advances (net of reserve of $19,361 and $15,494 at June 30, 2003 and December 31, 2002, respectively) (393,698) (372,091) --------- --------- Dealer holdbacks, net $ 417,043 $ 362,534 ========= ========= </TABLE> A summary of the change in the reserve for advance losses (classified with net dealer holdbacks in the accompanying balance sheets) is as follows (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 2003 2002 2003 2002 -------- -------- -------- -------- <S> <C> <C> <C> <C> Balance, beginning of period $ 17,878 $ 10,009 $ 15,494 $ 9,161 Provision for advance losses 1,463 1,368 4,139 2,830 Charge-offs (136) (1,409) (402) (1,974) Currency translation 156 229 130 180 -------- -------- -------- -------- Balance, end of period $ 19,361 $ 10,197 $ 19,361 $ 10,197 ======== ======== ======== ======== </TABLE> 7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 7. NET INCOME PER SHARE Basic net income per share has been computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share has been computed by dividing net income by the total of the weighted average number of common shares and common stock equivalents outstanding. Common stock equivalents included in the computation represent shares issuable upon assumed exercise of stock options that would have a dilutive effect using the treasury stock method. The share effect is as follows: <TABLE> <CAPTION> THREE MONTHS ENDED SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------- ---------------------------- 2003 2002 2003 2002 ------------- ------------- ------------- ------------- <S> <C> <C> <C> <C> Weighted average common shares outstanding 42,321,170 42,535,312 42,317,443 42,486,667 Common stock equivalents 547,095 1,286,404 312,401 1,197,460 ------------- ------------- ------------- ------------- Weighted average common shares and common stock equivalents 42,868,265 43,821,716 42,629,844 43,684,127 ============= ============= ============= ============= </TABLE> The diluted net income per share calculation excludes stock options to purchase approximately 1,041,309 shares and 1,657,430 shares in the three and six months ended June 30, 2003, respectively, and 232,030 shares and 280,193 shares in the same periods in 2002 as inclusion of these options would be anti-dilutive to the net income per share due to the relationship between the exercise prices and the average market price of common stock during these periods. 8. RELATED PARTY TRANSACTIONS In the normal course of its business, the Company regularly accepts assignments of Loans originated by affiliated dealer-partners owned by: (i) the Company's majority shareholder and Chairman; (ii) the Company's President; and (iii) a member of the Chairman's family. Loans accepted from these affiliated dealer-partners were approximately $5.4 million and $11.8 million or 2.6% and 2.7%, respectively, of total Loans accepted for the three and six months ended June 30, 2003, respectively, and $4.3 million and $9.7 million or 2.9%, respectively, of total Loans accepted for the same periods in 2002. Loans receivable from affiliated dealer-partners represented approximately 2.9% and 2.8% of the gross Loans receivable balance as of June 30, 2003 and December 31, 2002, respectively. The Company accepts Loans from affiliated dealer-partners and nonaffiliated dealer-partners on the same terms. Advance balances from affiliated dealer-partners were $10.7 million or 2.7% of total advances and $10.4 million or 2.8% of total advances as of June 30, 2003 and December 31, 2002, respectively. The Company records interest income from unsecured notes receivable from the Company's President with a total balance of $1.5 million as of June 30, 2003 and December 31, 2002. The note bears interest at a rate of 5.22% with interest and principal due on April 19, 2011. Total income earned on the note receivable was $17,000 and $35,000 for the three and six months ended June 30, 2003 and 2002. In the normal course of business, the Company records receivables from dealer-partners for ancillary product charge backs on repossessed leased vehicles. Charge back receivables from affiliated dealer-partners owned by the Company's President were $10,000 as of June 30, 2003 and December 31, 2002. In the normal course of business, the Company analyzes the viability of new products and services by first offering them to a small group of dealer-partners, which includes affiliated dealer-partners, prior to offering them to the entire network of dealer-partners. The Company received fees for direct mail lead generation services provided to affiliated dealer-partners owned by the Company's majority shareholder and Chairman totaling $19,000 and $27,000 for the three and six months ended June 30, 2002, respectively. The Company did not provide these services to affiliated dealer-partners in 2003. 8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 9. INCOME TAXES The Company's effective tax rate was 51.0% and 36.1% for the three and six months ended June 30, 2003 compared to 36.0% and 46.3% for the same periods in 2002. Detail by business unit follows: <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------------- ---------------------------------- 2003 2002 2003 2002 ---------------- ---------------- ---------------- ---------------- <S> <C> <C> <C> <C> Income (loss) before provision (credit) for income taxes: United States $ 13,147 $ 11,704 $ 24,658 $ 24,362 United Kingdom (10,963) 1,792 (9,212) 3,415 Automobile Leasing (252) (519) (766) (1,365) Other 125 263 337 894 ---------------- ---------------- ---------------- ---------------- Total income before provision for income taxes $ 2,057 $ 13,240 $ 15,017 $ 27,306 ================ ================ ================ ================ Provision (credit) for income taxes: United States $ 4,444 $ 4,384 $ 8,477 $ 11,880 United Kingdom (3,369) 496 (2,924) 932 Automobile Leasing (99) (214) (298) (509) Other 73 108 161 340 ---------------- ---------------- ---------------- ---------------- Total provision for income taxes $ 1,049 $ 4,774 $ 5,416 $ 12,643 ================ ================ ================ ================ Effective tax rate: United States 33.8% 37.5% 34.4% 48.8% United Kingdom 30.7% 27.7% 31.7% 27.3% Automobile Leasing 39.3% 41.2% 38.9% 37.3% Other 58.4% 41.1% 47.8% 38.0% ---------------- ---------------- ---------------- ---------------- Total effective tax rate 51.0% 36.0% 36.1% 46.3% ================ ================ ================ ================ </TABLE> The changes in the effective tax rate are attributable to changes in the provision (credit) for income taxes in the United States, United Kingdom, Automobile Leasing, and Other segments, which are discussed for each segment in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. -9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED) 10. CAPITAL TRANSACTIONS At June 30, 2003, the Company has two stock-based compensation plans for employees and directors. Prior to June 30, 2003, the Company accounted for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and related Interpretations. In the second quarter of 2003, the Company adopted the fair value recognition and measurement provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", as amended by SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure" for stock-based employee compensation. Under the retroactive restatement transition method selected by the Company described in SFAS No. 148, the Company restated all prior periods to reflect the stock-based compensation expense that would have been recognized had the recognition provisions of SFAS No. 123 been applied to all awards granted to employees or directors after January 1, 1995. The following table summarizes the reported and restated results: <TABLE> <CAPTION> (Dollars in thousands) 2002 2001 2000 1999 ---------------------- --------------------- --------------------- --------------------- REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- REVENUE: <S> <C> <C> <C> <C> <C> <C> <C> <C> Finance charges $ 97,744 $ 97,744 $ 90,169 $ 90,169 $ 80,580 $ 80,580 $ 76,896 $ 76,896 Lease revenue 16,101 16,101 21,853 21,853 13,019 13,019 1,034 1,034 Ancillary product income 15,620 15,620 11,920 11,920 6,987 6,987 5,720 5,720 Premiums earned 4,512 4,512 6,572 6,572 9,467 9,467 10,389 10,389 Other income 20,357 20,357 16,815 16,815 13,558 13,558 21,789 21,789 ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total revenue 154,334 154,334 147,329 147,329 123,611 123,611 115,828 115,828 COSTS AND EXPENSES: General and administrative 25,274 25,274 21,365 21,365 22,119 22,119 26,205 26,205 Salaries and wages 29,042 29,042 27,170 27,170 21,232 21,232 23,315 23,315 Sales and marketing 7,623 7,623 7,685 7,685 5,790 5,790 5,355 5,355 Stock-based compensation expense 14 2,072 379 1,755 - 1,955 242 3,252 Provision for insurance and warranty claims 1,861 1,861 1,544 1,544 2,984 2,984 3,498 3,498 Provision for credit losses 23,212 23,212 13,594 13,594 12,051 12,051 56,932 56,932 Depreciation of leased assets 9,669 9,669 12,485 12,485 7,004 7,004 569 569 Valuation adjustment on retained interest in securitization - - - - - - 13,517 13,517 Interest 9,058 9,058 14,688 14,688 16,431 16,431 16,576 16,576 ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Total costs and expenses 105,753 107,811 98,910 100,286 87,611 89,566 146,209 149,219 ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Other operating income: Gain on sale of subsidiary - - - - - - 14,720 14,720 ----------------------- --------- ---------- ---------- ---------- ---------- ---------- Operating income (loss) 48,581 46,523 48,419 47,043 36,000 34,045 (15,661) (18,671) Foreign exchange loss - - (42) (42) (11) (11) (66) (66) ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Income (loss) before provision (credit) for income taxes 48,581 46,523 48,377 47,001 35,989 34,034 (15,727) (18,737) Provision (credit) for income taxes 18,880 18,154 19,174 18,586 12,339 11,655 (5,041) (6,091) ----------- ---------- ---------- ---------- ---------- ---------- ---------- ---------- Net income (loss) $ 29,701 $ 28,369 $ 29,203 $ 28,415 $ 23,650 $ 22,379 $(10,686) $ (12,646) =========== ========== ========== ========== ========== ========== ========== ========== </TABLE> 10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 10. CAPITAL TRANSACTIONS -- (CONCLUDED) In connection with the adoption of the fair value method of accounting for stock-based compensation, the Company recorded stock-based compensation expense of $1,429,000 and $1,803,000 for the three and six months ended June 30, 2003. For the same periods in 2002, the amount of stock-based compensation expense increased to $565,000 and $1,047,000 from $448,000 and $756,000 previously reported. While the number of stock options outstanding declined during the periods, stock-based compensation expense increased as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest. As of June 30, 2003, the cumulative decrease in retained earnings as a result of this restatement was $17.2 million. The decrease in retained earnings was offset by a $19.3 million increase in paid-in capital and a $2.1 million decrease in deferred income taxes, net. The impact on paid-in capital and retained earnings for the interim periods of 2002 and 2003 was as follows: <TABLE> <CAPTION> 2002 2003 ----------------------------------------------------------------------------------------- --------------------- 1ST Q 2ND Q 3RD Q 4TH Q 1ST Q --------------------- -------------------- --------------------- ---------------------- --------------------- REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED ---------- ---------- ---------- --------- ---------- ---------- ---------- ----------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> Paid-in capital $ 113,000 $ 129,102 $ 108,460 $ 124,000 $ 107,571 $ 124,263 $ 107,164 $ 124,263 $ 107,142 $ 124,534 Retained earnings $ 191,471 $ 176,692 $ 200,018 $ 185,156 $ 209,449 $ 193,769 $ 214,856 $ 198,858 $ 223,692 $ 207,451 </TABLE> The impact of this restatement on net income was a decrease of $244,000, $84,000, and $201,000 for the three months ended March 31, 2003 and the three and six months ended June 30, 2002, respectively, as follows. <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS ENDED THREE MONTHS ENDED SIX MONTHS ENDED MARCH 31, 2003 JUNE 30, 2002 JUNE 30, 2002 ------------------------------ ------------------------------ --------------------------- REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED -------------- --------------- --------------- -------------- ------------ -------------- REVENUE: <S> <C> <C> <C> <C> <C> <C> Finance charges $ 24,256 $ 24,256 $ 25,522 $ 25,522 $ 50,407 $ 50,407 Lease revenue 2,336 2,336 4,428 4,428 9,587 9,587 Ancillary product income 5,733 5,733 3,794 3,794 7,391 7,391 Premiums earned 755 755 1,054 1,054 2,494 2,494 Other income 3,849 3,849 3,791 3,791 7,568 7,568 -------------- --------------- --------------- -------------- ------------ -------------- Total revenue 36,929 36,929 38,589 38,589 77,447 77,447 COSTS AND EXPENSES: General and administrative 5,763 5,763 6,383 6,383 12,100 12,100 Salaries and wages 8,517 8,517 7,448 7,448 14,952 14,952 Sales and marketing 2,177 2,177 1,809 1,809 3,590 3,590 Stock-based compensation expense - 375 448 565 756 1,047 Provision for insurance and warranty claims 99 99 570 570 1,133 1,133 Provision for credit losses 3,909 3,909 3,562 3,562 7,077 7,077 Depreciation of leased assets 1,548 1,548 2,566 2,566 5,507 5,507 Interest 1,596 1,596 2,457 2,457 4,762 4,762 -------------- --------------- --------------- -------------- ------------ -------------- Total costs and expenses 23,609 23,984 25,243 25,360 49,877 50,168 -------------- --------------- --------------- -------------- ------------ -------------- Operating income 13,320 12,945 13,346 13,229 27,570 27,279 Foreign exchange gain 15 15 11 11 27 27 -------------- --------------- --------------- -------------- ------------ -------------- Income before provision for income taxes 13,335 12,960 13,357 13,240 27,597 27,306 Provision for income taxes 4,498 4,367 4,807 4,774 12,733 12,643 -------------- --------------- --------------- -------------- ------------ -------------- Net income $ 8,837 $ 8,593 $ 8,550 $ 8,466 $ 14,864 $ 14,663 ============== =============== =============== ============== ============ ============== </TABLE> Stock options outstanding for 1999-2002 and the interim periods of 2002 and 2003 were as follows: <TABLE> <CAPTION> AS OF JUNE 30, AS OF DECEMBER 31, --------------------------- ------------------------------------------------------- 2003 2002 2002 2001 2000 1999 ------------- ---------- ------------- ----------- ---------- --------- <S> <C> <C> <C> <C> <C> <C> Total options outstanding 4,415,491 4,710,598 4,601,754 4,893,411 4,652,611 5,256,463 </TABLE> 11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED) 11. BUSINESS SEGMENT INFORMATION In the second quarter of 2003, the Company re-evaluated its business segments as a result of the decision to stop Loan originations in the United Kingdom and Canada. As a result, the Company has four reportable business segments: United States, United Kingdom, Automobile Leasing, and Other. Selected segment information is set forth below (in thousands): <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ---------------------------------- ----------------------------------- 2003 2002 2003 2002 ---------------- --------------- ---------------- ---------------- Revenue: <S> <C> <C> <C> <C> United States $ 30,544 $ 27,371 $ 59,893 $ 54,023 United Kingdom 2,862 5,125 6,863 10,445 Automobile Leasing 2,077 4,781 4,706 10,271 Other 489 1,312 1,439 2,708 ---------------- --------------- ---------------- ---------------- Total revenue $ 35,972 $ 38,589 $ 72,901 $ 77,447 ================ =============== ================ ================ Income (loss) before provision (credit) for income taxes: United States $ 13,147 $ 11,704 $ 24,658 $ 24,362 United Kingdom (10,963) 1,792 (9,212) 3,415 Automobile Leasing (252) (519) (766) (1,365) Other 125 263 337 894 ---------------- --------------- ---------------- ---------------- Total income before provision for income taxes $ 2,057 $ 13,240 $ 15,017 $ 27,306 ================ =============== ================ ================ </TABLE> 12. SUBSEQUENT EVENT On July 9, 2003, the Company entered into a series of forward contracts with a commercial bank to hedge foreign currency risk associated with the cash flows anticipated from the exit of the United Kingdom operation. In connection with this transaction, the Company will deliver 29.0 million pounds sterling to the commercial bank which will be exchanged into United States dollars at an agreed upon rate on a monthly basis beginning July 31, 2003 through June 30, 2005. The Company believes that this transaction will minimize the currency exchange risk associated with an adverse change in the relationship between the United States dollar and the pound sterling as it repatriates cash from the United Kingdom operation. However, as the Company has not adopted hedge accounting under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities -- an amendment of FASB Statement No. 133", future changes in the fair value of these forward contracts are expected to increase or decrease net income. 12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The Company's business model relies on its ability to forecast Loan performance. The Company's forecasts impact Loan pricing and structure as well as the required reserve for advance losses. The following table presents forecasted collection rates, advance rates, the spread (the forecasted collection rate less the advance rate), and the percentage of the forecasted collections which have been realized through June 30, 2003. The amounts presented are expressed as a percent of total Loan value by year of Loan origination. <TABLE> <CAPTION> As of June 30, 2003 ------------------------------------------------------------------ Year Forecasted % of Forecast Collection% Advance % Spread % Realized - --------- ---------------- --------------- -------------- ---------------- <S> <C> <C> <C> <C> 1992 81% 35% 46% 100% 1993 76% 37% 39% 100% 1994 62% 42% 20% 100% 1995 56% 46% 10% 99% 1996 56% 49% 7% 99% 1997 59% 49% 10% 99% 1998 67% 50% 17% 99% 1999 72% 54% 18% 98% 2000 71% 53% 18% 93% 2001 68% 49% 19% 73% 2002 70% 46% 24% 40% </TABLE> The risk of a forecasting error declines as Loans age. For example, the risk of a material forecasting error for business written in 1995 is very small, with 99% of the total amount forecasted already realized. In contrast, the Company's forecast for recent Loan originations is much less precise. If the Company produces disappointing operating results, it will likely be because the Company overestimated future Loan performance. The spread between the forecasted collection rate and the advance rate reduces the Company's risk of advance losses. Because collections are applied to advances on an individual dealer-partner basis, a wide spread does not eliminate the risk of advance losses, but it does reduce the risk significantly. The Company made no material changes in credit policy or pricing in the second quarter, other than routine changes designed to maintain current profitability levels. One method for evaluating the reasonableness of the Company's forecast is to examine the trends in forecasted collection rates over time. The following table compares the Company's forecast as of June 30, 2003 with the forecast as of March 31, 2003. <TABLE> <CAPTION> March 31, 2003 June 30, 2003 Year Forecasted Collection % Forecasted Collection % Variance - --------- -------------------------- ------------------------- ---------- <S> <C> <C> <C> 1992 81% 81% - 1993 76% 76% - 1994 62% 62% - 1995 56% 56% - 1996 56% 56% - 1997 59% 59% - 1998 67% 67% - 1999 72% 72% - 2000 71% 71% - 2001 67% 68% 1% 2002 68% 70% 2% </TABLE> The Company first began publishing collection forecasts in its 2001 Annual Report. Forecasted collection rates declined in 2002 when a difficult collection system conversion negatively impacted collection results and in the first quarter of 2003 due to post repossession collection results (known as deficiency balance collections) declining from the prior trend line. Forecasted collection rates stabilized in the second quarter of 2003. Accurately predicting future collection rates is critical to the Company's success. The Company's historical results indicate the risk of an unintended adverse change in the profitability of Loan originations is increased during periods of high growth. The 13
growth rate experienced in the second quarter of 2003 is higher than the Company's expected long-term growth rate. However, the Company believes that the investments in infrastructure in 2002, combined with decreases in Loan origination volumes in 2002, have adequately prepared the Company for this growth. The Company intends to make every possible effort to forecast results as accurately as possible. The Company will continue to publish collection forecasts and allow the precision of its estimates to be fully visible to shareholders. RESULTS OF OPERATIONS Three and Six Months Ended June 30, 2003 Compared to Three and Six Months Ended June 30, 2002 The following tables present income statement data on a consolidated basis as well as for the Company's four business segments, United States, United Kingdom, Automobile Leasing and Other. <TABLE> <CAPTION> Consolidated (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE -------------------- ----------- --------------------- ----------- REVENUE: <S> <C> <C> <C> <C> Finance charges $ 26,431 73.5 % $ 25,522 66.1 % Lease revenue 1,784 4.9 4,428 11.5 Ancillary product income 4,233 11.8 3,794 9.8 Premiums earned 757 2.1 1,054 2.8 Other income 2,767 7.7 3,791 9.8 --------------- ----------- ---------------- ----------- Total revenue 35,972 100.0 38,589 100.0 COSTS AND EXPENSES: General and administrative 5,198 14.4 6,383 16.5 Salaries and wages 8,687 24.1 7,448 19.3 Sales and marketing 2,483 6.9 1,809 4.7 Stock-based compensation expense 1,428 4.0 565 1.5 Provision for insurance and warranty claims 209 0.6 570 1.5 Provision for credit losses 2,863 8.0 3,562 9.2 Depreciation of leased assets 1,167 3.2 2,566 6.6 United Kingdom asset impairment expense 10,493 29.2 - - Interest 1,401 3.9 2,457 6.4 --------------- ----------- ---------------- ----------- Total costs and expenses 33,929 94.3 25,360 65.7 --------------- ----------- ---------------- ----------- Operating income 2,043 5.7 13,229 34.3 Foreign exchange gain 14 - 11 - --------------- ----------- ---------------- ----------- Income before provision for income taxes 2,057 5.7 13,240 34.3 Provision for income taxes 1,049 2.9 4,774 12.4 --------------- ----------- ---------------- ----------- Net income $ 1,008 2.8 % $ 8,466 21.9 % =============== =========== ================ =========== </TABLE> 14
<TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE -------------------- ----------- --------------------- ----------- REVENUE: <S> <C> <C> <C> <C> Finance charges $ 50,687 69.4 % $ 50,407 65.1 % Lease revenue 4,120 5.7 9,587 12.4 Ancillary product income 9,966 13.7 7,391 9.5 Premiums earned 1,512 2.1 2,494 3.2 Other income 6,616 9.1 7,568 9.8 --------------- ----------- ---------------- ----------- Total revenue 72,901 100.0 77,447 100.0 COSTS AND EXPENSES: General and administrative 10,961 15.0 12,100 15.6 Salaries and wages 17,204 23.6 14,952 19.3 Sales and marketing 4,660 6.4 3,590 4.6 Stock-based compensation expense 1,803 2.5 1,047 1.4 Provision for insurance and warranty claims 308 0.4 1,133 1.5 Provision for credit losses 6,772 9.3 7,077 9.1 Depreciation of leased assets 2,715 3.7 5,507 7.1 United Kingdom asset impairment expense 10,493 14.4 - - Interest 2,997 4.1 4,762 6.1 --------------- ----------- ---------------- ----------- Total costs and expenses 57,913 79.4 50,168 64.7 --------------- ----------- ---------------- ----------- Operating income 14,988 20.6 27,279 35.3 Foreign exchange gain 29 - 27 - --------------- ----------- ---------------- ----------- Income before provision for income taxes 15,017 20.6 27,306 35.3 Provision for income taxes 5,416 7.4 12,643 16.3 --------------- ----------- ---------------- ----------- Net income $ 9,601 13.2 % $ 14,663 19.0 % =============== =========== ================ =========== </TABLE> For the three months ended June 30, 2003, net income declined to $1.0 million compared to $8.5 million for the same period in 2002. The reduction in net income for the period was primarily due to the $7.6 million loss incurred in the United Kingdom business segment in 2003 compared to net income of $1.3 million in 2002. The loss was primarily the result of $11.1 million in asset impairment and other expenses recorded in connection with the Company's decision to stop Loan originations in the United Kingdom. The impact of the loss in the United Kingdom was partially offset by an increase in net income in the United States to $8.7 million in 2003 from $7.3 million for the same period in 2002. The increase in net income in the United States was due to an increase in total revenue to $30.5 million for the three months ended June 30, 2003 compared to $27.4 million for the same period in 2002 as a result of increases in: (i) finance charges to $23.2 million in 2003 from $20.4 million in 2002 as a result of an increase in the average size of the Loan portfolio due to an increase in Loan originations in 2003, and (ii) ancillary product income to $4.2 million in 2003 from $3.3 million in 2002 due to an increase in commissions on third-party service contracts offered by dealer-partners. Partially offsetting the increase in revenue were increases in the following expenses: (i) salaries and wages to $7.2 million in 2003 from $6.0 million in 2002 due to an increase in corporate infrastructure in the second half of 2002, (ii) stock-based compensation expense to $1.4 million in 2003 from $500,000 in 2002 as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest, and (iii) provision for credit losses to $1.5 million in 2003 from $700,000 in 2002 due to increases in the provision for advance losses and the provision for earned but unpaid revenue. For the six months ended June 30, 2003, net income declined to $9.6 million from $14.7 million for the same period in 2002. The decrease in net income for the period was primarily due to the $6.3 million loss incurred in the United Kingdom business segment in 2003 compared to net income of $2.5 million in 2002. The loss was primarily the result of $11.1 million in asset impairment and other expenses recorded in connection with the Company's decision to stop Loan originations in the United Kingdom. The impact of the loss in the United Kingdom was partially offset by an increase in net income in the United States to $16.2 million in 2003 from $12.5 million in 2002. The increase in net income in the United States in 2003 was primarily due to two tax related adjustments that increased the provision for income taxes and decreased net income in 2002 by $2.6 million. Other factors which impacted net income were an increase in total revenue to $59.9 million in 2003 from $54.0 million in 2002 as a result of increases in: (i) finance charges to $44.0 million in 2003 from $40.0 million in 2002 as a result of an increase in the average size of the Loan portfolio due to an increase in Loan originations in 2003, and (ii) ancillary product income to $9.0 million in 2003 from $6.5 million in 2002 due to an increase in commissions on third-party service contracts offered by dealer-partners. Partially offsetting the increase in revenue were increases in the following expenses: (i) salaries and wages to $14.5 million in 2003 from $11.9 million in 2002 due to an increase in corporate infrastructure in the second half of 2002, (ii) stock-based compensation expense to $1.6 million in 2003 from $800,000 in 2002 as a result of a change in assumptions that reduced the period over which certain performance based stock 15
options are expected to vest, and (iii) provision for credit losses to $4.1 million in 2003 from $1.2 million in 2002 due to increases in the provision for advance losses in the first quarter of 2003 due to a decline in recovery rates versus the prior trend line. The results of operations for the Company as a whole are attributable to changes described by segment in the discussion of the results of operations in the United States, United Kingdom, Automobile Leasing, and Other business segments. The following discussion of the results of operations for interest expense is provided on a consolidated basis, as the explanation is not meaningful by business segment. Interest. Interest expense decreased to $1.4 million and $3.0 million for the three and six months ended June 30, 2003 from $2.5 million and $4.8 million for the same periods in 2002. The decrease in interest expense was primarily the result of the impact of a decrease in average outstanding debt. For the three months ended June 30, 2003, the decrease was also impacted by the decrease in the weighted average interest rate to 4.9% from 5.6% for the same period in 2002, which was the result of a decrease in the average interest rate on the Company's variable rate debt, including the lines of credit and secured financing. For the six months ended June 30, 2003, the decrease in interest expense was partially offset by the increase in the weighted average interest rate to 5.6% from 5.1% for the same period in 2002, which was the result of an increased impact of borrowing fees and costs on average interest rates due to lower average outstanding borrowings. United States The United States segment primarily consists of the Company's United States retail automobile loan operations. <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 23,195 75.9% $ 20,425 74.6% Ancillary product income 4,189 13.7 3,332 12.2 Premiums earned 757 2.5 1,054 3.8 Other income 2,403 7.9 2,560 9.4 -------- ----- -------- ----- Total revenue 30,544 100.0 27,371 100.0 COSTS AND EXPENSES: General and administrative 4,352 14.2 5,043 18.4 Salaries and wages 7,199 23.6 5,982 21.9 Sales and marketing 1,818 6.0 1,577 5.8 Stock-based compensation expense 1,353 4.4 458 1.7 Provision for insurance and warranty claims 209 0.7 570 2.1 Provision for credit losses 1,490 4.9 680 2.5 Interest 958 3.1 1,352 4.9 -------- ----- -------- ----- Total costs and expenses 17,379 56.9 15,662 57.3 -------- ----- -------- ----- Operating income 13,165 43.1 11,709 42.7 Foreign exchange loss (18) (0.1) (5) - -------- ----- -------- ----- Income before provision for income taxes 13,147 43.0 11,704 42.7 Provision for income taxes 4,444 14.5 4,384 16.0 -------- ----- -------- ----- Net income $ 8,703 28.5% $ 7,320 26.7% ======== ===== ======== ===== </TABLE> 16
<TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE --------------- ----------- ---------------- ----------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 43,954 73.4% $ 40,007 74.1% Ancillary product income 9,038 15.1 6,505 12.0 Premiums earned 1,512 2.5 2,494 4.6 Other income 5,389 9.0 5,017 9.3 -------- ----- -------- ----- Total revenue 59,893 100.0 54,023 100.0 COSTS AND EXPENSES: General and administrative 9,128 15.2 9,007 16.7 Salaries and wages 14,489 24.2 11,944 22.1 Sales and marketing 3,656 6.1 3,089 5.7 Stock-based compensation expense 1,649 2.8 848 1.6 Provision for insurance and warranty claims 308 0.5 1,133 2.1 Provision for credit losses 4,072 6.8 1,193 2.2 Interest 1,904 3.2 2,459 4.6 -------- ----- -------- ----- Total costs and expenses 35,206 58.8 29,673 55.0 -------- ----- -------- ----- Operating income 24,687 41.2 24,350 45.0 Foreign exchange gain (loss) (29) - 12 - -------- ----- -------- ----- Income before provision for income taxes 24,658 41.2 24,362 45.0 Provision for income taxes 8,477 14.2 11,880 22.0 -------- ----- -------- ----- Net income $ 16,181 27.0% $ 12,482 23.0% ======== ===== ======== ===== </TABLE> Finance Charges. Finance charges increased to $23.2 million and $44.0 million for the three and six months ended June 30, 2003 from $20.4 million and $40.0 million for the same periods in 2002 primarily due to an increase in the average size of the Loan portfolio resulting from an increase in Loan originations in 2003. This increase was partially offset by a reduction in the average annualized yield on the Company's Loan portfolio to 12.9% and 12.6% for the three and six months ended June 30, 2003 from 13.0% for the same periods in 2002. This decrease was primarily due to an increase in the average initial contract term of the Company's Loan portfolio as of June 30, 2003 compared to the same period in 2002. Selected Loan origination data follows: <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, JUNE 30, JUNE 30, -------------------------------------- ------------------------ -------------------------- 2000 2001 2002 2003 2002 2003 2002 ------------ ------------ ------------ ------------ ----------- ------------ ------------- <S> <C> <C> <C> <C> <C> <C> <C> Loan originations $371,045 $646,572 $571,690 $190,870 $134,829 $411,152 $306,883 Number of Loans originated 45,898 61,277 49,650 14,736 11,678 32,942 27,481 Number of active dealer-partners (1) 1,130 1,120 789 677 571 721 687 Loans per active dealer-partner 40.6 54.7 62.9 21.8 20.5 45.7 40.0 Average Loan size $ 8.1 $ 10.6 $ 11.5 $ 13.0 $ 11.5 $ 12.5 $ 11.2 </TABLE> (1) Active dealer-partners are dealer-partners who submitted at least one Loan during the period. Ancillary Product Income. Ancillary product income increased to $4.2 million and $9.0 million for the three and six months ended June 30, 2003 from $3.3 million and $6.5 million for the same periods in 2002 due to an increase in commissions on third party service contract products offered by dealer-partners, primarily due to the increase in Loan originations compared to the same periods in 2002. Premiums Earned. Premiums earned decreased to $800,000 and $1.5 million for the three and six months ended June 30, 2003 from $1.1 million and $2.5 million for the same periods in 2002 primarily due to a decrease in penetration rates on the Company's in-house service contract and credit life and accident and health products in 2002 and 2003. Other Income. Other income decreased to $2.4 million for the three months ended June 30, 2003 from $2.6 million for the same period in 2002 primarily due to a decrease of $150,000 in income from direct mail lead generation services as a result of the Company discontinuing its in-house direct mail lead generation program and referring dealer-partners to a third party provider of such services. Other income increased to $5.4 million for the six months ended June 30, 2003 from $5.0 million for the same period in 2002. The increase was due to interest income of $600,000 received from the Internal Revenue Service in connection with a change in tax accounting methods that affect the characterization and timing of revenue recognition for tax purposes, offset by a decrease of $100,000 in income from direct mail lead generation services as a result of the Company discontinuing its in-house direct mail 17
lead generation program and referring dealer-partners to a third party provider of such services. General and Administrative. General and administrative expenses decreased to $4.4 million for the three months ended June 30, 2003 from $5.0 million for the same period in 2002 due to: (i) a decrease of $300,000 in depreciation expense due primarily to one of the Company's primary computer systems becoming fully depreciated in June 2002 and (ii) a decrease of $200,000 in losses on the retirement of assets resulting from the write-off of computer software in 2002. General and administrative expenses remained relatively consistent at $9.1 million for the six months ended June 30, 2003 compared to $9.0 million for the same period in 2002. A decrease of $400,000 in depreciation expense due primarily to one of the Company's primary computer systems becoming fully depreciated in June 2002 and a decrease of $200,000 in losses on the retirement of assets resulting from the write-off of computer software in 2002 were partially offset by the 2002 reversal of $300,000 in state tax related expense originally recorded in 2001. Salaries and Wages. Salaries and wages expenses increased to $7.2 million and $14.5 million for the three and six months ended June 30, 2003 from $6.0 million and $11.9 million for the same periods in 2002 resulting primarily from additions to the Company's corporate infrastructure in the second half of 2002. Sales and Marketing. Sales and marketing expenses increased to $1.8 million and $3.7 million for the three and six months ended June 30, 2003 from $1.6 million and $3.1 million for the same periods in 2002 due primarily to increased sales commissions as a result of increased unit volumes. Stock-based Compensation Expense. Stock-based compensation expense increased to $1.4 million and $1.6 million for the three and six months ended June 30, 2003 from $500,000 and $800,000 for the same periods in 2002. While the number of stock options outstanding declined during the periods, stock-based compensation expense increased as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest. Refer to Notes to Consolidated Financial Statements -- Note 10 for further discussion on the adoption of SFAS No. 123, "Accounting for Stock-Based Compensation". Provision for Insurance and Service Contract Claims. The provision for insurance and service contract claims, as a percent of premiums earned, decreased to 27.6% and 20.4% for the three and six months ended June 30, 2003 from 54.1% and 45.4% for the same periods in 2002. The decreases are due to: (i) the reserve for incurred but not reported claims on the Company's in-house service contract product not being reduced proportionally with the reduction in unearned premiums in 2002, thereby increasing claims expense as a percentage of premiums earned and (ii) an increase in the percent of total claims paid relating to the Company's credit life and accident and health products, which have a lower ratio of claims paid to premiums earned than the Company's service contract product. Provision for Credit Losses. The provision for credit losses increased to $1.5 million and $4.1 million for the three and six months ended June 30, 2003 from $700,000 and $1.2 million for the same periods in 2002. The provision for credit losses consists of two components: (i) a provision for losses on advances to dealer-partners that are not expected to be recovered through collections on the related Loan portfolio and (ii) a provision for earned but unpaid revenue on Loans which were transferred to non-accrual status during the period. The increase in the provision for credit losses for the three months ended June 30, 2003 was due to: (i) an increase in the provision for losses on advances to $800,000 from $300,000 in 2002 and (ii) an increase in the provision for earned but unpaid revenue on Loans to $700,000 from $400,000 in 2002 which was due to the increase in the size of the Loan portfolio. The Company's current period provision for advance losses is comprised of: (i) estimated losses incurred during the current period on advances originated in the current period, (ii) estimated losses incurred during the current period on advances originated in prior periods due to changes in forecasted collection rates and (iii) revisions of prior period loss estimates for reasons not attributable to current period events. The Company estimates losses created on advances originated during the period, for which there is very little Loan performance data, using loss estimates on business originated in prior periods, adjusted for other variables, such as the spread between the advance rate and the forecasted collection rate, the volume of advances originated, and improvements in risk management and pricing compared to prior periods. The increase in the provision for losses on advances for the three months ended June 30, 2003 was due primarily to an increase in the estimate of losses on advances originated in this period. This was caused by the reduction in forecasted collection rates reported in the third and fourth quarters of 2002 and first quarter of 2003 which increased the estimate of losses on prior period advances. In addition, the increased provision for losses reflected higher levels of originations during the quarter ended June 30, 2003. For the six months ended June 30, 2003, the increase in the provision for credit losses was due primarily to a $2.5 million increase in the provision for advance losses as a result of a reduction in the Company's forecast of future collections on its portfolio of Loans in the first quarter of 2003. 18
Provision for Income Taxes. The effective tax rate decreased to 33.8% and 34.4% for the three and six months ended June 30, 2003 from 37.5% and 48.8% for the same periods in 2002. The reduction in the effective tax rate for the three months ended June 30, 2003 was due to a change in estimate of taxes due on repatriation of United Kingdom earnings. This change in estimate was due to an increase in the United Kingdom pound sterling exchange rate versus the United States dollar which enabled the Company to utilize foreign tax credits that it had previously assumed would not be utilizable. The reduction in the effective tax rate for the six months ended June 30, 2003, was primarily due to a decrease of 16.3% resulting from an expense recorded in 2002 for estimated taxes due upon repatriation of prior years' earnings in the United Kingdom. The reduction in the effective tax rate for the six months ended June 30, 2003 was partially offset by an increase of 2.7% resulting from the reversal of expense in 2002 due to a change in estimate of state income tax owed. United Kingdom The United Kingdom segment consists of the Company's United Kingdom retail automobile loan operations. This segment is being liquidated as the Company decided to stop originating Loans in the United Kingdom effective June 30, 2003. <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 2,812 98.3 % $ 4,646 90.7 % Ancillary product income 44 1.5 462 9.0 Other income 6 0.2 17 0.3 -------- -------- -------- -------- Total revenue 2,862 100.0 5,125 100.0 COSTS AND EXPENSES: General and administrative 632 22.1 621 12.1 Salaries and wages 1,176 41.1 1,055 20.6 Sales and marketing 638 22.3 158 3.1 Stock-based compensation expense 75 2.6 107 2.1 Provision for credit losses 811 28.4 1,160 22.6 United Kingdom asset impairment expense 10,493 366.6 - - Interest - - 235 4.6 -------- -------- -------- -------- Total costs and expenses 13,825 483.1 3,336 65.1 -------- -------- -------- -------- Operating income (loss) (10,963) (383.1) 1,789 34.9 Foreign exchange gain - - 3 - -------- -------- -------- -------- Income (loss) before provision for income taxes (10,963) (383.1) 1,792 34.9 Provision (credit) for income taxes (3,369) (117.7) 496 9.7 -------- -------- -------- -------- Net income (loss) $ (7,594) (265.4) % $ 1,296 25.2 % ======== ======== ======== ======== </TABLE> 19
<TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 5,914 86.2% $ 9,509 91.0% Ancillary product income 928 13.5 886 8.5 Other income 21 0.3 50 0.5 -------- ----- -------- ----- Total revenue 6,863 100.0 10,445 100.0 COSTS AND EXPENSES: General and administrative 1,192 17.4 1,353 12.9 Salaries and wages 2,047 29.8 2,086 20.0 Sales and marketing 944 13.8 331 3.2 Stock-based compensation expense 154 2.2 199 1.9 Provision for credit losses 1,245 18.1 2,506 24.0 United Kingdom asset impairment expense 10,493 152.9 - - Interest - - 558 5.3 -------- ----- -------- ----- Total costs and expenses 16,075 234.2 7,033 67.3 -------- ----- -------- ----- Operating income (loss) (9,212) (134.2) 3,412 32.7 Foreign exchange gain - - 3 - -------- ----- -------- ----- Income (loss) before provision for income taxes (9,212) (134.2) 3,415 32.7 Provision (credit) for income taxes (2,924) (42.6) 932 8.9 -------- ----- -------- ----- Net income (loss) $ (6,288) (91.6)% $ 2,483 23.8% ======== ===== ======== ===== </TABLE> Finance Charges. Finance charges decreased to $2.8 million and $5.9 million for the three and six months ended June 30, 2003 from $4.6 million and $9.5 million for the same periods in 2002 primarily as the result of a decrease in the average size of the Loan portfolio due to a decrease in Loan originations in 2002 and the first quarter of 2003. To a lesser extent, the decrease in finance charges was due to a reduction in the average annualized yield on the Company's Loan portfolio to 11.4% and 12.1% for the three and six months ended June 30, 2003 from 12.9% and 12.8% for the same periods in 2002. The decreases in the average annual yield were primarily due to increases in the: (i) average initial term of the Company's Loan portfolio as of June 30, 2003 compared to the same period in 2002 and (ii) non-accrual percentage to 28.8% as of June 30, 2003 from 27.1% as of the same period in 2002. Selected Loan origination data follows: <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, JUNE 30, JUNE 30, ------------------------------ ------------------- ------------------- 2000 2001 2002 2003 2002 2003 2002 -------- -------- -------- -------- -------- -------- -------- <S> <C> <C> <C> <C> <C> <C> <C> Loan originations $142,228 $122,817 $ 43,325 $ 13,358 $ 9,365 $ 22,784 $ 26,903 Number of Loans originated 10,664 9,121 3,062 758 651 1,363 1,955 Number of active dealer-partners(1) 205 215 147 65 45 86 151 Loans per active dealer-partner 52.0 42.4 20.8 11.7 14.5 15.8 12.9 Average Loan size $ 13.3 $ 13.5 $ 14.1 $ 17.6 $ 14.4 $ 16.7 $ 13.8 </TABLE> (1) Active dealer-partners are dealer-partners who submitted at least one Loan during the period. Ancillary product income. Ancillary product income decreased to $50,000 for the three months ended June 30, 2003 from $500,000 for the same period in 2002 primarily due to: (i) a refund of $150,000 of profit sharing income on ancillary products to an ancillary product provider which was based on volume targets no longer attainable due to the decision to stop Loan originations and (ii) a change in the Company's revenue recognition policy for ancillary products in the third quarter of 2002. Prior to the change in revenue recognition policy, the Company recognized ancillary product revenue over the life of the Loan or ancillary product, depending upon the product. The Company's current policy is to recognize this revenue at the time the ancillary product is sold. The change in the Company's revenue recognition policy, combined with a decline in Loan originations in 2002 and the first quarter of 2003, resulted in a decrease in ancillary product commissions. Ancillary product income remained consistent at $900,000 for the six months ended June 30, 2003 and 2002 due to the receipt of $500,000 in revenue under an ancillary products profit sharing agreement with an insurance provider, offset by a decrease of $500,000 resulting from the change in the revenue recognition policy and decline in Loan originations in 2002 and the first quarter of 2003. Other Income. Other income remained relatively consistent for the three and six months ended June 30, 2003 and 2002. 20
General and Administrative. General and administrative expenses remained consistent at $600,000 for the three months ended June 30, 2003 and 2002. General and administrative expenses remained relatively consistent at $1.2 million for the six months ended June 30, 2003 compared to $1.4 million for the same period in 2002. Salaries and Wages. Salaries and wages expenses remained relatively consistent at $1.2 million and $2.0 million for the three and six months ended June 30, 2003 compared to $1.1 million and $2.1 million for the same periods in 2002. Employee severance costs of $250,000 associated with the Company's decision to stop Loan originations in the United Kingdom were offset by a decrease in salaries and wages of $100,000 and $400,000 for the three and six months ended June 30, 2003, respectively, as a result of a reduction in staffing levels. Sales and Marketing. Sales and marketing expenses increased to $600,000 and $900,000 for the three and six months ended June 30, 2003 from $200,000 and $300,000 for the same periods in 2002 primarily due to: (i) employee severance costs of $250,000 associated with the Company's decision to stop Loan originations in the United Kingdom and (ii) increased salaries and wages of $200,000 and $400,000, respectively, as a result of an increase in sales and marketing personnel in an effort to increase Loan originations. Stock-based Compensation Expense. Stock-based compensation expense remained consistent at $100,000 and $200,000 for the three and six months ended June 30, 2003 and 2002. Refer to Notes to Consolidated Financial Statements -- Note 10 for further discussion on the adoption of SFAS No. 123, "Accounting for Stock-Based Compensation". Provision for Credit Losses. The provision for credit losses decreased to $800,000 and $1.2 million for the three and six months ended June 30, 2003 from $1.2 million and $2.5 million for the same periods in 2002. The provision for credit losses consists of two components: (i) a provision for losses on advances to dealer-partners that are not expected to be recovered through collections on the related Loan portfolio; and (ii) a provision for earned but unpaid revenue on Loans which were transferred to non-accrual status during the period. The decreases in the provision for credit losses were primarily due to decreases in the provision for losses on advances to dealer-partners to $700,000 and $1.1 million in the three and six months ended June 30, 2003, respectively, from $1.1 million and $2.2 million for the same periods in 2002, respectively, due to an increase in the spread between the advance rate and the forecasted collection rate. United Kingdom Asset Impairment Expense. Effective June 30, 2003, the Company elected to stop originating Loans in the United Kingdom. As a result of this decision, the Company recorded an expense consisting of: (i) $9.8 million to reduce the carrying value of the operation's dealer-partner advances to the present value (using a discount rate of 13%) of the forecasted cash flows relating to the dealer-partner advances less estimated future servicing expenses and (ii) a write-off of $700,000 of fixed assets which will no longer be used in the operation. In determining the impairment of dealer-partner advances, the Company analyzed the expected cash flows from this operation assuming lower collection rates than were assumed before the decision to liquidate. These lower collection rates reflect uncertainties (such as potentially higher employee turnover or reduced morale) in the servicing environment that may arise as a result of the decision to liquidate. Refer to Notes to Consolidated Financial Statements -- Note 2 for further discussion on the impairment analysis in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". Provision (Credit) for Income Taxes. The effective tax rate increased to 30.7% and 31.7% for the three and six months ended June 30, 2003 from 27.7% and 27.3% for the same periods in 2002. The changes in the effective rate for the three and six months ended June 30, 2003 were attributable to a restructuring of the legal entities within this business segment. This restructuring provides the United Kingdom business segment with a fixed dollar amount of tax benefit. The impact of this fixed benefit on the effective tax rates varies based upon (i) whether the business segment reports income or loss, and (ii) the amount of the income or loss. For the three and six months ended June 30, 2002, the restructuring tax benefit reduced the effective tax rate on the business segments earnings. For the three and six months ended June 30, 2003, since the business segment reported a pre-tax loss, the restructuring tax benefit increased the amount of the credit for income taxes, thereby increasing the effective tax rate. This increase in the effective tax rate was partially offset by a reduction in the impact of the restructuring benefit on the effective tax rate due to the magnitude of the loss in 2003. 21
Automobile Leasing The Automobile Leasing segment consists of the Company's automobile leasing operations. This segment is being liquidated as the Company decided to stop originating leases in early 2002. <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Lease revenue $ 1,784 85.9% $ 4,428 92.6% Other income 293 14.1 353 7.4 ------- ------ ------- ----- Total revenue 2,077 100.0 4,781 100.0 COSTS AND EXPENSES: General and administrative 139 6.7 485 10.1 Salaries and wages 247 11.9 348 7.3 Provision for credit losses 555 26.7 1,330 27.8 Depreciation of leased assets 1,167 56.2 2,566 53.7 Interest 253 12.2 584 12.2 ------- ------ ------- ----- Total costs and expenses 2,361 113.7 5,313 111.1 ------- ------ ------- ----- Operating loss (284) (13.7) (532) (11.1) Foreign exchange gain 32 1.5 13 0.3 ------- ------ ------- ----- Loss before credit for income taxes (252) (12.2) (519) (10.8) Credit for income taxes (99) (4.8) (214) (4.5) ------- ------ ------- ----- Net loss $ (153) (7.4)% $ (305) (6.3)% ======= ====== ======= ===== </TABLE> <TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Lease revenue $ 4,120 87.5 % $ 9,587 93.3 % Other income 586 12.5 684 6.7 -------- ----- -------- ----- Total revenue 4,706 100.0 10,271 100.0 COSTS AND EXPENSES: General and administrative 437 9.3 1,279 12.5 Salaries and wages 520 11.0 792 7.7 Sales and marketing - - 21 0.2 Provision for credit losses 1,193 25.4 2,849 27.7 Depreciation of leased assets 2,715 57.7 5,507 53.6 Interest 665 14.1 1,200 11.7 -------- ----- -------- ----- Total costs and expenses 5,530 117.5 11,648 113.4 -------- ----- -------- ----- Operating loss (824) (17.5) (1,377) (13.4) Foreign exchange gain 58 1.2 12 - -------- ----- -------- ----- Loss before credit for income taxes (766) (16.3) (1,365) (13.4) Credit for income taxes (298) (6.3) (509) (5.0) -------- ----- -------- ----- Net loss $ (468) (10.0)% $ (856) (8.4) % ======== ===== ======== ===== </TABLE> Lease Revenue. Lease revenue decreased to $1.8 million and $4.1 million for the three and six months ended June 30, 2003 from $4.4 million and $9.6 million for the same periods in 2002 primarily due to the decrease in the dollar value of the Company's lease portfolio. The decrease was the result of the Company's decision to stop originating automobile leases in the first quarter of 2002. Other Income. Other income, as a percent of revenue, increased to 14.1% and 12.5% for the three and six months ended June 30, 2003 from 7.4% and 6.7% for the same periods in 2002 due to revenue from gains recognized on leases terminated before their maturity date remaining consistent as lease revenue declined. General and Administrative. General and administrative expenses decreased to $100,000 and $400,000 for the three and six months ended June 30, 2003 from $500,000 and $1.3 million for the same periods in 2002 primarily due to a decreases of: (i) $200,000 and $400,000, respectively, in the provision for uncollectible receivables from dealer-partners for ancillary product charge backs on repossessed leased vehicles and (ii) $100,000 in third party lease servicing costs due to a reduction in the number of leases being serviced. For the six months ended June 30, 2003, the decrease was also due to an expense of $100,000 recorded in 2002 for the impairment of certain assets. 22
Salaries and Wages. Salaries and wages expenses, as a percent of revenue, increased to 11.9% and 11.0% for the three and six months ended June 30, 2003 from 7.3% and 7.7% for the same periods in 2002 primarily due to servicing salaries and wages expenses declining at a slower rate than the decline in revenue producing leases. Sales and Marketing. There were no sales and marketing expenses for the three and six months ended June 30, 2003 due to discontinuing automobile lease originations in January 2002. Provision for Credit Losses. The provision for credit losses, as a percent of revenue, decreased to 26.7% and 25.4% for the three and six months ended June 30, 2003 from 27.8% and 27.7% for the same periods in 2002 primarily due to the decline in the frequency of lease repossessions. Depreciation of Leased Assets. Depreciation of leased assets, including the amortization of initial direct lease costs, is recorded on a straight-line basis to the residual value of leased vehicles over their scheduled lease terms. Depreciation expense, as a percent of revenue, increased to 56.2% and 57.7% for the three and six months ended June 30, 2003 from 53.7% and 53.6% for the same periods in 2002 primarily due to a reduction in the average residual value, as a percent of original lease value, in the lease portfolio. Credit for Income Taxes. The effective tax rate decreased to 39.3% for the three months ended June 30, 2003 from 41.2% for the same period in 2002. The effective tax rate increased to 38.9% for the six months ended June 30, 2003 from 37.3% for the same period in 2002. The changes in the effective tax rates did not have material impact on financial results. Other The Other segment consists of the Company's Canadian retail automobile loan operations and secured lines of credit and floorplan financing products offered to certain dealer-partners. In June 2003, the Company decided to stop originating Loans in Canada. The Company is also reducing its investment in secured lines of credit and floorplan financing offered to certain dealer-partners. <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 424 86.7% $ 451 34.4% Other income 65 13.3 861 65.6 ------ ----- ------ ----- Total revenue 489 100.0 1,312 100.0 COSTS AND EXPENSES: General and administrative 75 15.3 234 17.8 Salaries and wages 65 13.3 63 4.8 Sales and marketing 27 5.5 74 5.6 Provision for credit losses 7 1.4 392 29.9 Interest 190 38.9 286 21.8 ------ ----- ------ ----- Total costs and expenses 364 74.4 1,049 79.9 ------ ----- ------ ----- Income before provision for income taxes 125 25.6 263 20.1 Provision for income taxes 73 14.9 108 8.2 ------ ----- ------ ----- Net income $ 52 10.7% $ 155 11.9% ====== ===== ====== ===== </TABLE> 23
<TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF ENDED % OF JUNE 30, 2003 REVENUE JUNE 30, 2002 REVENUE ------------- ------- ------------- ------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 819 56.9% $ 891 32.9% Other income 620 43.1 1,817 67.1 ------ ----- ------ ----- Total revenue 1,439 100.0 2,708 100.0 COSTS AND EXPENSES: General and administrative 204 14.2 461 17.0 Salaries and wages 148 10.3 130 4.8 Sales and marketing 60 4.2 149 5.5 Provision for credit losses 262 18.2 529 19.5 Interest 428 29.7 545 20.1 ------ ----- ------ ----- Total costs and expenses 1,102 76.6 1,814 66.9 ------ ----- ------ ----- Income before provision for income taxes 337 23.4 894 33.1 Provision for income taxes 161 11.2 340 12.6 ------ ----- ------ ----- Net income $ 176 12.2% $ 554 20.5% ====== ===== ====== ===== </TABLE> Finance charges. Finance charges decreased to $400,000 and $800,000 for the three and six months ended June 30, 2003 from $500,000 and $900,000 for the same periods in 2002. Finance charges decreased for the three and six months ended June 30, 2003 primarily due to a reduction in the average annualized yield on the Company's Loan portfolio to 12.5% and 12.2% for the three and six months ended June 30, 2003 from 13.0% and 12.8% for the same periods in 2002. This decrease was primarily due to an increase in the percent of non-accrual Loans to 20.0% as of June 30, 2003 from 17.4% as of the same period in 2002. Other Income. Other income decreased to $100,000 and $600,000 for the three and six months ended June 30, 2003 from $900,000 and $1.8 million for the same periods in 2002. The decreases for the three and six months ended June 30, 2003 are primarily due to the decreases in revenue from secured lines of credit and floorplan financing offered to certain dealer-partners of $800,000 and $1.2 million, respectively, as the Company continues to reduce its investment in these products. General and Administrative. General and administrative expenses decreased to $100,000 and $200,000 for the three and six months ended June 30, 2003 from $200,000 and $500,000 for the same periods in 2002 as a result of a general reduction in the amount of resources dedicated to the Canadian operations. Salaries and Wages. Salaries and wages expenses, as a percent of revenue, increased to 13.3% and 10.3% for the three and six months ended June 30, 2003 from 4.8% for the same periods in 2002 primarily due to salaries and wages relating to the Company's floorplan and line of credit loan products remaining relatively constant as the income from these products declined as a result of the Company's decision to decrease its investment in these products. Sales and Marketing. Sales and marketing expenses decreased to $50,000 for the three and six months ended June 30, 2003 from $100,000 for the same periods in 2002 due primarily to decreased sales commissions in the Canadian automobile loan operations as a result of decreased unit volumes. Provision for Credit Losses. The provision for credit losses decreased by $400,000 and $300,000, respectively, for the three and six months ended June 30, 2003 compared to the same periods in 2002 primarily due to the decreases in the provision for floorplan loan losses as the Company continues to reduce its investment in this product. Provision for Income Taxes. The effective tax rate increased to 58.4% and 47.8% for the three and six months ended June 30, 2003 from 41.1% and 38.0% for the same periods in 2002. The increases in the effective rate for the three and six months ended June 30, 2003 compared to the same periods in 2002 were due to losses reported in the floorplan and line of credit businesses in 2003. These businesses are based in the United States, and have a lower effective tax rate than the Canadian automobile loan business. As a result, the tax benefit from losses incurred in these businesses does not fully offset taxes relating to profits earned in the Canadian automobile loan operation, thereby increasing the effective tax rate for the business segment. 24
AVERAGE CAPITAL ANALYSIS The following presentation of financial results and subsequent analysis is based on analyzing the income statement as a percent of capital invested. This information provides an additional perspective on the financial performance of the Company in addition to the presentation of the Company's results as a percent of revenue. The Company believes this information provides a useful measurement of how effectively the Company is utilizing its capital. Consolidated <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS THREE MONTHS ENDED % OF AVERAGE ENDED % OF AVERAGE JUNE 30, 2003 CAPITAL (1) JUNE 30, 2002 CAPITAL (1) --------------- --------------- ---------------- --------------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 26,431 24.1 % $ 25,522 21.5 % Lease revenue 1,784 1.6 4,428 3.7 Ancillary product income 4,233 3.9 3,794 3.2 Premiums earned 757 0.7 1,054 0.9 Other income 2,767 2.5 3,791 3.2 --------------- --------------- ---------------- --------------- Total revenue 35,972 32.8 38,589 32.5 COSTS AND EXPENSES: General and administrative 5,198 4.7 6,383 5.4 Salaries and wages 8,687 7.9 7,448 6.3 Sales and marketing 2,483 2.2 1,809 1.5 Stock-based compensation expense 1,428 1.3 565 0.5 Provision for insurance and warranty claims 209 0.2 570 0.5 Provision for credit losses 2,863 2.6 3,562 3.0 Depreciation of leased assets 1,167 1.1 2,566 2.1 United Kingdom asset impairment expense 10,493 9.6 - - Interest 1,401 1.3 2,457 2.1 --------------- --------------- ---------------- --------------- Total costs and expenses 33,929 30.9 25,360 21.4 --------------- --------------- ---------------- --------------- Operating income 2,043 1.9 13,229 11.1 Foreign exchange gain 14 - 11 - --------------- --------------- ---------------- --------------- Income before provision for income taxes 2,057 1.9 13,240 11.1 Provision for income taxes 1,049 1.0 4,774 4.0 --------------- --------------- ---------------- --------------- Net income $ 1,008 0.9 % $ 8,466 7.1 % =============== =============== ================ =============== Average capital (1) $ 438,684 $ 474,285 </TABLE> 25
<TABLE> <CAPTION> (Dollars in thousands) SIX MONTHS SIX MONTHS ENDED % OF AVERAGE ENDED % OF AVERAGE JUNE 30, 2003 CAPITAL (1) JUNE 30, 2002 CAPITAL (1) --------------- --------------- --------------- --------------- <S> <C> <C> <C> <C> REVENUE: Finance charges $ 50,687 23.4 % $ 50,407 21.0 % Lease revenue 4,120 1.9 9,587 4.0 Ancillary product income 9,966 4.6 7,391 3.1 Premiums earned 1,512 0.7 2,494 1.0 Other income 6,616 3.0 7,568 3.1 --------------- --------------- --------------- --------------- Total revenue 72,901 33.6 77,447 32.2 COSTS AND EXPENSES: General and administrative 10,961 5.1 12,100 5.0 Salaries and wages 17,204 7.9 14,952 6.2 Sales and marketing 4,660 2.1 3,590 1.5 Stock-based compensation expense 1,803 0.8 1,047 0.4 Provision for insurance and warranty claims 308 0.1 1,133 0.5 Provision for credit losses 6,772 3.1 7,077 3.0 Depreciation of leased assets 2,715 1.3 5,507 2.3 United Kingdom asset impairment expense 10,493 4.9 - - Interest 2,997 1.4 4,762 2.0 --------------- --------------- --------------- --------------- Total costs and expenses 57,913 26.7 50,168 20.9 --------------- --------------- --------------- --------------- Operating income 14,988 6.9 27,279 11.3 Foreign exchange gain 29 - 27 - --------------- --------------- --------------- --------------- Income before provision for income taxes 15,017 6.9 27,306 11.3 Provision for income taxes 5,416 2.5 12,643 5.2 --------------- --------------- --------------- --------------- Net income $ 9,601 4.4 % $ 14,663 6.1 % =============== =============== =============== =============== Average capital (1) $ 434,022 $ 480,620 </TABLE> (1) Average capital is equal to the average amount of debt and equity during the period in accordance with generally accepted accounting principles in the United States of America ("GAAP"). The calculation of average capital follows: <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------------- ----------------------------- 2003 2002 2003 2002 ---------------- ---------------- ------------- ------------- <S> <C> <C> <C> <C> Average debt $ 101,821 $ 172,077 $101,147 $182,381 Average shareholders' equity 336,863 302,208 332,875 298,239 ---------------- ---------------- ------------- ------------- Average capital $ 438,684 $ 474,285 $434,022 $480,620 ================ ================ ============= ============= </TABLE> RETURN ON CAPITAL ANALYSIS Return on capital is equal to net operating profit after-tax (net income plus interest expense after-tax) divided by average capital as follows: <TABLE> <CAPTION> (Dollars in thousands) THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, ----------------------------------- ---------------------------- 2003 2002 2003 2002 ---------------- ---------------- ------------ ------------ <S> <C> <C> <C> <C> Net income $ 1,008 $ 8,466 $ 9,601 $ 14,663 Interest expense $ 1,401 $ 2,457 $ 2,997 $ 4,762 Tax rate 65.0% 65.5% 65.0% 65.6% ---------------- ---------------- ------------ ------------ Interest expense after-tax $ 911 $ 1,609 $ 1,948 $ 3,124 ---------------- ---------------- ------------ ------------ Net operating profit after-tax $ 1,919 $ 10,075 $ 11,549 $ 17,787 ================ ================ ============ ============ Average capital $ 438,684 $ 474,285 $434,022 $480,620 ================ ================ ============ ============ Return on capital 1.7% 8.5% 5.3% 7.4% </TABLE> The Company's return on capital decreased to 1.7% and 5.3% for the three and six months ended June 30, 2003 from 8.5% and 7.4% for the same periods in 2002. The decreases in return on capital were primarily due to a reduction in the return on capital in the United Kingdom business segment as a result of the $7,238,000 after-tax adjustment for asset impairment and accrued expenses related to the Company's decision to stop originating Loans in the United Kingdom. This adjustment decreased the Company's reported return on capital by 6.6% and 3.4% for the three and six months ended June 30, 2003, respectively. Refer to Notes to Consolidated Financial Statements -- Note 2 for further discussion on the impairment analysis in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets". 26
For the three months ended June 30, 2003, the reduction in the return on capital was also due to decreases in the return on capital in the Automobile Leasing and Other business segments. Partially offsetting the decreases in the return on capital in the United Kingdom, Automobile Leasing and Other segments was an increase in the return on capital in the United States to 10.2% in 2003 from 9.4% in 2002 and an increase in the percent of total capital invested in the United States to 83.6% in 2003 from 73.6% in 2002. The increase in the return on capital in the United States was due to increases in: (i) finance charges as a percent of average capital due to a reduction in the amount advanced to dealer-partners as a percent of the gross Loan amount, and (ii) ancillary product income, which is recognized upon the sale of the ancillary product. Ancillary product income, as a percent of average capital, increased as a result of Loan originations increasing at a faster rate than average capital in the United States. Partially offsetting these increases in revenue were increases in the following expenses as a percent of average capital: (i) salaries and wages due to the increase in corporate infrastructure in the second half of 2002, (ii) stock-based compensation expense as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest, and (iii) provision for credit losses due to increases in the provision for advance losses and the provision for earned but unpaid revenue. For the six months ended June 30, 2003, the reduction in the return on capital was also due to decreases in the return on capital in the Automobile Leasing and Other business segments. Partially offsetting the decreases in the return on capital in the United Kingdom, Automobile Leasing and Other segments was an increase in the return on capital in the United States to 9.8% in 2003 from 8.1% in 2002 and an increase in the percent of total capital invested in the United States to 82.1% in 2003 from 72.6% in 2002. The increase in the return on capital in the United States was due to increases in: (i) finance charges as a percent of average capital due to a reduction in the amount advanced to dealer-partners as a percent of the gross Loan amount, and (ii) ancillary product income, which is recognized upon the sale of the ancillary product. Ancillary product income, as a percent of average capital, increased as a result of Loan originations increasing at a faster rate than average capital in the United States. Partially offsetting these increases in revenue were increases in the following expenses as a percent of average capital: (i) salaries and wages due to the increase in corporate infrastructure in the second half of 2002, (ii) stock-based compensation expense as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest, (iii) provision for credit losses due to increases in the provision for advance losses in the first quarter of 2003 due to a decline in recovery rates versus the prior trend line, and (iv) provision for income taxes for two tax related adjustments in 2002. ECONOMIC PROFIT Economic profit or loss represents net operating profit after-tax less an imputed cost of equity. By considering an imputed cost of equity, the Company's economic profit or loss calculation differs from net income or loss under GAAP, which does not assign a cost of equity. Management assumes a cost of equity equal to 10% of average shareholders' equity in its economic profit or loss calculations, which approximates the long-term rate of return on publicly traded equity investments. Economic profit or loss is a measurement of how efficiently the Company utilizes its capital. The Company has used economic profit internally since January 1, 2000 to evaluate its performance. The Company's goal is to maximize the amount of economic profit per share generated. The Company generated an economic loss of ($7,414,000), or ($0.18) per adjusted share, for the three months ended June 30, 2003 compared to an economic profit of $911,000, or $0.02 per adjusted share, for the same period in 2003. The economic loss increased to ($7,043,000), or ($0.17) per adjusted share, for the six months ended June 30, 2003 from ($249,000), or ($0.01) per adjusted share, for the same period in 2002. The following presents the calculation of the Company's economic loss for the periods indicated (dollars in thousands, except per share data): <TABLE> <CAPTION> FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED JUNE 30, JUNE 30, ---------------------------------- ---------------------------------- 2003 2002 2003 2002 ---------------- --------------- --------------- ---------------- <S> <C> <C> <C> <C> Economic profit (loss) Net income (1) $ 1,008 $ 8,466 $ 9,601 $ 14,663 Imputed cost of equity at 10% (2) (8,422) (7,555) (16,644) (14,912) ---------------- --------------- --------------- ---------------- Total economic profit (loss) $ (7,414) $ 911 $ (7,043) $ (249) Weighted average shares outstanding 42,321,170 42,535,312 42,317,443 42,486,667 Economic profit (loss) per share (3) $ (0.18) $ 0.02 $ (0.17) $ (0.01) </TABLE> (1) Consolidated net income from the Consolidated Statement of Income. See "Item 1. Consolidated Financial Statements." (2) Cost of equity is equal to 10% (on an annual basis) of total average shareholders' equity, which was $336,863,000 and $332,875,000 for the three and six months ended June 30, 2003, respectively, and $302,208,000 and $298,239,000 for the three and six months ended June 30, 2002, respectively, calculated as described in the Average Capital Analysis. (3) Economic profit (loss) per share equals the economic profit (loss) divided by the weighted average shares outstanding. 27
CRITICAL ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to the reserve for advance losses, the allowance for credit losses, and the allowance for lease vehicle losses. Item 7 of the Company's Annual Report on Form 10-K discusses several critical accounting policies, which the Company believes involve a high degree of judgment and complexity. There have been no material changes to that information during the three and six months ended June 30, 2003. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of capital are cash flows from operating activities, collections on Loans receivable, borrowings under the Company's credit agreements and secured financings. The Company's principal need for capital has been to fund cash advances made to dealer-partners in connection with the acceptance of Loans and for the payment of dealer holdbacks to dealer-partners who have repaid their advance balances. The Company's cash flow requirements are dependent on future levels of Loan originations. In the three and six months ended June 30, 2003, the Company experienced increases in Loan originations compared to the same periods in 2002 primarily due to increases in the number of active dealer-partners and Loans per active dealer-partner. The Company expects Loan originations to increase in future periods and, to the extent this trend does continue, the Company will experience an increase in its need for capital. The Company currently finances its operation through: (i) a bank line of credit facility; (ii) secured financings; (iii) a mortgage loan; and (iv) capital lease obligations. Line of Credit Facility -- At June 30, 2003, the Company had a $135.0 million credit agreement with a commercial bank syndicate. The facility has a commitment period through June 9, 2005. The agreement provides that, at the Company's discretion, interest is payable at either the eurodollar rate plus 140 basis points, or at the prime rate (4.0% as of June 30, 2003). The eurodollar borrowings may be fixed for periods of up to six months. Borrowings under the credit agreement are subject to a borrowing base limitation equal to 65% of advances to dealer-partners and leased vehicles (as reflected in the consolidated financial statements and related notes), less a hedging reserve (not exceeding $1.0 million), the amount of letters of credit issued under the line of credit, and the amount of other debt secured by the collateral which secures the line of credit. Currently, the borrowing base limitation does not inhibit the Company's borrowing ability under the line of credit. The credit agreement has certain restrictive covenants, including a minimum required ratio of the Company's assets to debt, its liabilities to tangible net worth, and its earnings before interest, taxes and non-cash expenses to fixed charges. Additionally, the agreement requires that the Company maintain a specified minimum level of net worth. Borrowings under the credit agreement are secured by a lien on most of the Company's assets. The Company must pay annual and quarterly fees on the amount of the commitment. As of June 30, 2003, there was approximately $8.3 million outstanding under this facility. Secured Financing -- On June 27, 2003, the Company's wholly-owned subsidiary, Credit Acceptance Funding 2003-1 LLC ("Funding 2003-1"), completed a secured financing transaction, in which Funding 2003-1 received $100.0 million in financing. In connection with this transaction, the Company conveyed, for cash and the sole membership interest in Funding 2003-1, dealer-partner advances having a carrying amount of approximately $134.0 million to Funding 2003-1, which, in turn, conveyed the advances to a trust, which issued $100 million in notes to qualified institutional investors. A financial insurance policy was issued in connection with the transaction by Radian Asset Assurance. The policy guarantees the timely payment of interest and ultimate repayment of principal on the final scheduled distribution date. The notes are rated "AA" by Standard & Poor's Rating Services. The proceeds of the secured financing were used by the Company to reduce outstanding borrowings under the Company's credit facility. Until December 15, 2003, the Company and Funding 2003-1 may receive additional proceeds from the transaction by having the Company convey additional dealer-partner advances to Funding 2003-1 which could then be conveyed by Funding 2003-1 to the trust and used by the trust as collateral to support additional borrowings. The secured financing creates loans for which the trust is liable and which are secured by security interests in all assets of the trust and of Funding 2003-1. Such loans are non-recourse to the Company, even though the trust, Funding 2003-1 and the Company are consolidated for financial reporting purposes. The notes bear interest at a fixed rate of 2.77%. The expected annualized cost of the secured financing, including underwriters fees, the insurance premium and other costs is approximately 6.8%. As Funding 2003-1 is organized as a separate legal entity from the Company, assets of Funding 2003-1 (including the conveyed dealer-partner advances) will not be available to satisfy the general obligations of the Company until the secured financing is repaid. The Company receives a monthly servicing fee paid out of collections equal to 6% of the collections received with respect to the conveyed dealer-partner 28
advances and related Loans. Except for the servicing fee and payments due to dealer-partners, the Company does not receive, or have any rights in, any portion of such collections until the trust's underlying indebtedness is paid in full, either through such collections or through a prepayment of the indebtedness. Thereafter, remaining collections would be paid over to Funding 2003-1 as the sole beneficiary of the trust where they would be available to be distributed to the Company as the sole member of Funding 2003-1, or the Company may choose to cause Funding 2003-1 to repurchase the remaining dealer-partner advances from the trust and then dissolve, whereby the Company would become the owner of such remaining collections. The secured financing transaction that had been outstanding as of March 31, 2003 between the Company's wholly-owned subsidiary, CAC Warehouse Funding Corp. ("Warehouse Funding"), and an institutional investor, in which Warehouse Funding had received $75.0 million in financing, was repaid in the second quarter of 2003. The Company has completed a total of nine secured financing transactions, eight of which have been repaid in full. Information about the currently outstanding secured financing transaction is as follows (dollars in thousands): <TABLE> <CAPTION> Secured Financing Secured Dealer Balance as Issue Original Balance at Advance Balance Percent of Number Close Date Balance June 30, 2003 at June 30, 2003 Original Balance - ------ ---------- -------- ------------------ ---------------- ---------------- <S> <C> <C> <C> <C> <C> 2003-1 June 2003 $100,000 $100,000 * $134,892 100% </TABLE> * Bears a fixed interest rate of 2.77% and is anticipated to fully amortize within 16 months. Mortgage Loan -- The Company has a mortgage loan from a commercial bank that is secured by a first mortgage lien on the Company's headquarters building and an assignment of all leases, rents, revenues and profits under all present and future leases of the building. The loan matures on May 1, 2004, bearing interest at a fixed rate of 7.07%, and requires monthly payments of $99,582 and a balloon payment at maturity for the balance of the loan. The Company believes that the monthly payments under the mortgage loan can be made from cash resources available to the Company and that the balloon payment will be refinanced at the time it is due. Capital Lease Obligations -- As of June 30, 2003, the Company has twelve capital lease obligations outstanding related to various computer equipment, with monthly payments totaling $82,598. These capital lease obligations bear interest at rates ranging from 4.45% to 9.22% and have maturity dates between June 2004 and March 2006. The Company believes that capital lease obligation payments can be made from cash resources available to the Company at the time such payments are due. The Company's total balance sheet indebtedness increased to $115.7 million at June 30, 2003 from $109.8 million at December 31, 2002. In addition to the balance sheet indebtedness as of June 30, 2003, the Company also has contractual obligations resulting in future minimum payments under operating leases. A summary of the total future contractual obligations requiring repayments is as follows (in thousands): <TABLE> <CAPTION> PERIOD OF REPAYMENT --------------------------------------------- CONTRACTUAL OBLIGATIONS < 1 YEAR 1-3 YEARS > 3 YEARS TOTAL ------------- --------------- ------------- -------------- <S> <C> <C> <C> <C> Secured financing $ 75,000 $ 25,000 $ - $ 100,000 Lines of credit 4,275 4,030 - 8,305 Mortgage loan 5,813 - - 5,813 Capital lease obligations 909 629 - 1,538 Non-cancelable operating lease obligations 336 446 278 1,060 ------------- --------------- ------------- -------------- Total contractual cash obligations $ 86,333 $ 30,105 $ 278 $ 116,716 ============= =============== ============= ============== </TABLE> United Kingdom Repatriation -- As a result of the Company's decision to stop Loan originations in the United Kingdom, the capital invested in the United Kingdom operation will be reinvested in the United States operation. Based on management's analysis of estimated future cash flows, the Company expects that approximately $50.9 million will be recovered and reinvested in the United States. It is expected that approximately 70% of this amount will be recovered within one year, 90% within two years, and the remainder within three years. In order to manage the foreign currency risk associated with the expected cash flows, the Company entered into forward contracts to deliver 29.0 million pounds sterling to the commercial bank which will be exchanged into United States dollars at an agreed upon rate with a commercial bank beginning July 31, 2003 through June 30, 2005. Repurchase and Retirement of Common Stock -- In 1999, the Company began acquiring shares of its common stock in connection with a stock repurchase program announced in August 1999. That program authorized the Company to purchase up to 1.0 million common shares on the open market or pursuant to negotiated transactions at price levels the Company deems 29
attractive. On each of February 7, 2000, June 7, 2000, July 13, 2000, November 10, 2000, and May 20, 2002, the Company's Board of Directors authorized increases in the Company's stock repurchase program of an additional 1.0 million shares. As of June 30, 2003, the Company has repurchased approximately 5.2 million shares of the 6.0 million shares authorized to be repurchased under this program at a cost of $32.5 million. The 6.0 million shares, which can be repurchased through the open market or in privately negotiated transactions, represent approximately 13.0% of the shares outstanding at the beginning of the program. Based upon anticipated cash flows, management believes that cash flows from operations, various financing alternatives available to the Company, and amounts available under its credit agreement will provide sufficient financing for debt maturities and for future operations. The Company's ability to borrow funds may be impacted by many economic and financial market conditions. If the various financing alternatives were to become limited or unavailable to the Company, the Company's operations could be materially and adversely affected. FORWARD-LOOKING STATEMENTS The Company makes forward-looking statements in this report and may make such statements in future filings with the Securities and Exchange Commission. It may also make forward-looking statements in its press releases or other public or shareholder communications. The Company's forward-looking statements are subject to risks and uncertainties and include information about its expectations and possible or assumed future results of operations. When the Company uses any of the words "believes," "expects," "anticipates," "estimates" or similar expressions, it is making forward-looking statements. The Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all of its forward-looking statements. These forward-looking statements represent the Company's outlook only as of the date of this report. While the Company believes that its forward-looking statements are reasonable, actual results could differ materially since the statements are based on our current expectations, which are subject to risks and uncertainties. Factors that might cause such a difference, without limitation, include the following: - increased competition from traditional financing sources and from non-traditional lenders, - the unavailability of funding at competitive rates of interest, - the Company's potential inability to continue to obtain third party financing on favorable terms, - the Company's potential inability to generate sufficient cash flow to service its debt and fund its future operations, - adverse changes in applicable laws and regulations, - adverse changes in economic conditions, - adverse changes in the automobile or finance industries or in the non-prime consumer finance market, - the Company's potential inability to maintain or increase the volume of Loans, - the Company's potential inability to accurately forecast and estimate future collections and historical collection rates, - the Company's potential inability to accurately estimate the residual values of the lease vehicles, - an increase in the amount or severity of litigation against the Company, - the loss of key management personnel, and - the effect of terrorist attacks and potential attacks. Other factors not currently anticipated by management may also materially and adversely affect the Company's results of operations. The Company does not undertake, and expressly disclaims any obligation, to update or alter its forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable law. 30
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS. Refer to the Company's Annual Report on Form 10-K for the year ended December 31, 2002 for a complete discussion of the Company's market risk. There have been no material changes to the market risk information included in the Company's 2002 Annual Report on Form 10-K. ITEM 4. CONTROLS AND PROCEDURES. As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to cause the material information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. There have been no significant changes in the Company's internal controls or in other factors which could significantly affect internal controls subsequent to the date the Company carried out its evaluation. 31
PART II. - OTHER INFORMATION ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On June 6, 2003, the Board of Directors approved amendments to the Company's Bylaws modifying the provisions relating to indemnification included in Article XI. The Amended and Restated Bylaws are attached to this Form 10-Q as an exhibit. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Shareholders on May 15, 2003 at which the shareholders considered the election of six directors. The following table sets forth the number of votes for and withheld with respect to each nominee. <TABLE> <CAPTION> Nominee Votes For Votes Withheld ------- --------- -------------- <S> <C> <C> Brett A. Roberts 40,412,425 921,067 Donald A. Foss 41,272,421 61,071 Harry E. Craig 41,272,421 61,071 Sam M. LaFata 41,272,421 61,071 Daniel P. Leff 40,415,425 918,067 Thomas N. Tryforos 41,272,421 61,071 </TABLE> ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits See Index of Exhibits following the signature page. (b) Reports on Form 8-K The Company filed a current report on Form 8-K pursuant to Items 7, 9 and 12, dated April 24, 2003, reporting that the Company issued a press release announcing its financial results for the three months ended March 31, 2003, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated June 2, 2003, reporting that the Company issued a press release on June 2, 2003 announcing the decision to stop Loan originations in Canada and the United Kingdom effective June 30, 2003 and that the Company issued a press release dated June 3, 2003 announcing that it was preparing to engage in a $100 million asset-backed bond transaction in June 2003, copies of which were filed as Exhibit 99.1 and 99.2, respectively. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated June 9, 2003, reporting that the Company issued a press release announcing the renewal of its $135 million credit agreement with a group of commercial banks for two years, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated June 27, 2003, reporting that the Company issued a press release announcing the completion of a $100 million asset-backed non-recourse secured financing, a copy of which was filed as Exhibit 99.1. 32
SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. CREDIT ACCEPTANCE CORPORATION (Registrant) By: /s/ Douglas W. Busk ------------------------------ Douglas W. Busk Chief Financial Officer and Treasurer August 5, 2003 (Principal Financial Officer, Accounting Officer and Duly Authorized Officer) 33
INDEX OF EXHIBITS EXHIBIT NO. DESCRIPTION - ---------- ---------------------------------------------------------------- 3(b) Bylaws of the Company, as amended June 6, 2003 4(c)12 Second Amended and Restated Credit Agreement, dated as of June 9, 2003, among the Company, certain of the Company's subsidiaries, Comerica Bank, as Administrative Agent and Collateral Agent, and the banks signatory thereto. 4(f)(47) Contribution Agreement dated June 27, 2003 between the Company and Credit Acceptance Funding LLC 2003-1 4(f)(48) Back-Up Servicing Agreement dated June 27, 2003 among the Company, Credit Acceptance Funding 2003-1, Credit Acceptance Auto Dealer Loan Trust 2003-1, Systems & Services Technologies, Inc., Radian Asset Assurance Inc. 4(f)(49) Intercreditor Agreement, dated June 27, 2003, among the Company, CAC Warehouse Funding Corp., Credit Acceptance Funding LLC 2003-1, Credit Acceptance Auto Dealer Loan Trust 2003-1, Wachovia Securities, Inc., as agent, JPMorgan Chase Bank, as trustee, and Comerica Bank, as agent. 4(f)(50) Sale and Servicing Agreement dated June 27, 2003 among the Company, Credit Acceptance Auto Dealer Loan Trust 2003-1, Credit Acceptance Funding LLC 2003-1, JPMorgan Chase Bank, and Systems & Services Technologies, Inc. 4(f)(51) Indenture, dated June 27, 2003, between Credit Acceptance Auto Dealer Loan Trust 2003-1 and JPMorgan Chase Bank 4(f)(52) Amended and Restated Trust Agreement dated June 27, 2003 between Credit Acceptance Funding LLC 2003-1 and Wachovia Bank of Delaware, National Association 10(d)(9) Form of Servicing Agreement as of April 2003 31(a) Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. 31(b) Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act. 32 Certification of Chief Executive Officer and Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the Securities Exchange Act. 34