1 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, 1999 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) <TABLE> <S> <C> MICHIGAN 38-1999511 (State or other jurisdiction of incorporation or organization) (IRS Employer Identification) 25505 WEST TWELVE MILE ROAD, SUITE 3000 SOUTHFIELD, MICHIGAN 48034-8339 (Address of principal executive offices) (zip code) </TABLE> Registrant's telephone number, including area code: 248-353-2700 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/. No / /. Indicate the number of shares outstanding of each of the issuer's class of common stock, as of the latest practicable date. The number of shares outstanding of Common Stock, par value $.01, on August 12, 1999 was 46,256,754.
2 TABLE OF CONTENTS <TABLE> <CAPTION> PART I. - FINANCIAL INFORMATION <S> <C> <C> ITEM 1. FINANCIAL STATEMENTS Consolidated Balance Sheets - As of December 31, 1998 and June 30, 1999................................................. 1 Consolidated Income Statements - Three and six month periods ended June 30, 1998 and June 30, 1999......................... 2 Consolidated Statements of Cash Flows - Six months ended June 30, 1998 and June 30, 1999.......................................... 3 Consolidated Statement of Shareholders' Equity - Six months ended June 30, 1999............................................................ 4 Notes to Consolidated Financial Statements...................................................... 5 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS....................................................................... 7 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS..................................... 16 PART II. - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS............................................................................... 17 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................. 17 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K................................................................ 18 SIGNATURES ................................................................................................... 19 INDEX OF EXHIBITS............................................................................................. 20 EXHIBITS...................................................................................................... 21 </TABLE>
3 PART I. - FINANCIAL INFORMATION ITEM 1.- FINANCIAL STATEMENTS CREDIT ACCEPTANCE CORPORATION CONSOLIDATED BALANCE SHEETS <TABLE> <CAPTION> As of As of (Dollars in thousands) 12/31/98 6/30/99 --------------- --------------- (Unaudited) <S> <C> <C> ASSETS: Cash and cash equivalents..................................... $ 13,775 $ 14,575 Investments................................................... 10,191 10,807 Installment contracts receivable.............................. 671,768 586,027 Allowance for credit losses................................... (7,075) (5,114) --------------- --------------- Installment contracts receivable, net.................... 664,693 580,913 Retained interest in securitization........................... 13,229 13,735 Floor plan receivables........................................ 14,071 18,666 Notes receivable.............................................. 2,278 2,637 Property and equipment, net................................... 20,627 20,107 Other assets.................................................. 13,065 13,823 --------------- --------------- TOTAL ASSETS........................................................... $ 751,929 $ 675,263 =============== =============== LIABILITIES: Senior notes.................................................. $ 136,165 $ 116,165 Lines of credit............................................... 79,067 43,851 Mortgage loan payable to bank................................. 3,566 8,511 Income taxes payable.......................................... 776 6,899 Accounts payable and accrued liabilities...................... 22,423 24,916 Deferred dealer enrollment fees, net.......................... 296 249 Dealer holdbacks, net......................................... 222,275 171,765 Deferred income taxes, net.................................... 11,098 10,754 --------------- --------------- TOTAL LIABILITIES...................................................... 475,666 383,110 --------------- --------------- SHAREHOLDERS' EQUITY Common stock.................................................. 463 463 Paid-in capital............................................... 129,914 130,332 Retained earnings............................................. 142,989 162,139 Cumulative translation adjustment............................. 2,897 (781) --------------- --------------- TOTAL SHAREHOLDERS' EQUITY............................................. 276,263 292,153 --------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................. $ 751,929 $ 675,263 =============== =============== </TABLE> 1
4 CREDIT ACCEPTANCE CORPORATION CONSOLIDATED INCOME STATEMENTS (UNAUDITED) <TABLE> <CAPTION> Three Months Ended Six Months Ended ----------------------------- ---------------------------- (Dollars in thousands, except per share data) 6/30/98 6/30/99 6/30/98 6/30/99 ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> REVENUE: Finance charges..................... $ 27,894 $ 19,797 $ 55,949 $ 39,202 Premiums earned..................... 2,630 2,331 5,553 4,776 Other income........................ 7,312 6,863 15,644 15,374 ------------ ------------ ------------ ------------ Total revenue.............. $ 37,836 $ 28,991 $ 77,146 $ 59,352 COSTS AND EXPENSES: Operating expenses.................. 14,019 14,461 28,640 29,010 Provision for credit losses......... 4,666 2,084 10,462 4,220 Provision for claims................ 937 894 1,972 1,725 Interest............................ 6,829 4,272 14,175 8,799 ------------ ------------ ------------ ------------ Total costs and expenses... $ 26,451 $ 21,711 $ 55,249 $ 43,754 ------------ ------------ ------------ ------------ Operating income............................. 11,385 7,280 21,897 15,598 ------------ ------------ ------------ ------------ Gain on sale of subsidiary.......... - 14,720 - 14,720 Foreign exchange gain(loss)......... (7) (9) 5 (54) ------------ ------------ ------------ ------------ Income before provision for income taxes..... 11,378 21,991 21,902 30,264 Provision for income taxes.......... 3,935 8,220 7,572 11,114 ------------ ------------ ------------ ------------ Net income................................... $ 7,443 $ 13,771 $ 14,330 $ 19,150 ============ ============ ============ ============ Net income per common share: Basic............................... $ 0.16 $ 0.30 $ 0.31 $ 0.41 ============ ============ ============ ============ Diluted............................. $ 0.16 $ 0.30 $ 0.30 $ 0.41 ============ ============ ============ ============ Weighted average shares outstanding: Basic............................... 46,113,115 46,303,516 46,113,115 46,301,210 ============ ============ ============ ============ Diluted............................. 47,410,190 46,545,290 47,179,931 46,625,575 ============ ============ ============ ============ </TABLE> 2
5 CREDIT ACCEPTANCE CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) <TABLE> <CAPTION> (Dollars in thousands) Six Months Ended ---------------------------- 6/30/98 6/30/99 ------------ ------------ <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net Income.......................................................... $ 14,330 $ 19,150 Adjustments to reconcile net income to net cash provided by operating activities- Gain on sale of subsidiary........................ - (14,720) Credit for deferred income taxes.................. (1,706) (344) Depreciation and amortization..................... 1,911 2,190 Valuation adjustment on retained interest in securitization............................... - 517 Amortization on retained interest in securitization.................................. - (1,023) Provision for credit losses....................... 10,462 4,213 Dealer stock option plan expense.................. 41 66 Change in operating assets and liabilities- Accounts payable and accrued liabilities.......... 5,527 2,856 Income taxes payable.............................. 3,546 6,123 Deferred dealer enrollment fees, net.............. (609) (47) Unearned insurance premiums, insurance reserves and fees............................... 142 369 Other assets...................................... 15,626 (1,597) ------------ ------------ Net cash provided by operating activities............................. 49,270 17,753 ============ ============ CASH FLOWS FROM INVESTING ACTIVITIES: Principal collected on installment contracts receivable............. 203,494 170,353 Advances to dealers and payments of dealer holdback................. (173,413) (141,665) Proceeds from sale of subsidiary.................................... - 16,147 Net purchases of marketable securities.............................. (1,329) (616) Decrease (increase) in floor plan receivables....................... 1,343 (4,595) Increase in notes receivable........................................ (343) (359) Purchase of property and equipment.................................. (1,697) (2,621) ------------ ------------ Net cash provided by investing activities............................. 28,055 36,644 ============ ============ CASH FLOWS FROM FINANCING ACTIVITIES: Net borrowings (repayments) under mortgage loan payable to bank.............................................................. (116) 4,945 Net repayments under line of credit agreement....................... (77,064) (35,216) Repayments of senior notes.......................................... - (20,000) Proceeds from stock options exercised............................... - 352 ------------ ------------ Net cash used in financing activities.... (77,180) (49,919) ------------ ------------ Effect of exchange rate changes on cash.. 934 (3,678) ------------ ------------ NET INCREASE IN CASH......................................................... 1,079 800 Cash and cash equivalents - beginning of period..................... 349 13,775 ------------ ------------ Cash and cash equivalents - end of period........................... $ 1,428 $ 14,575 ============ ============ </TABLE> 3
6 CREDIT ACCEPTANCE CORPORATION CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 1999 (UNAUDITED) <TABLE> <CAPTION> (Dollars in thousands) Accumulated Total Other Shareholders' Comprehensive Common Paid In Retained Comprehensive Equity Income Stock Capital Earnings Income ------------ ------------ ------------ ------------ ------------ ------------ <S> <C> <C> <C> <C> <C> <C> Balance - December 31, 1998........... $ 276,263 $ $ 463 $ 129,914 $ 142,989 $ 2,897 Comprehensive income: Net income....................... 19,150 19,150 19,150 ------------ Other comprehensive income: Foreign currency translation adjustment................... (3,678) (3,678) (3,678) Tax on other comprehensive income..................... 1,287 ------------ Other comprehensive income..... (2,391) ------------ Total comprehensive income.......... $ 16,759 ============ Stock options exercised............. 352 352 Dealer stock option plan expense.... 66 66 ------------ ------------ ------------ ------------ ------------ Balance - June 30, 1999............... $ 292,153 $ 463 $ 130,332 $ 162,139 $ (781) ============ ============ ============ ============ ============ </TABLE> 4
7 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 generally accepted accounting principles 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, 1998 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. Certain amounts in the 1998 financial statements have been reclassified to conform to the 1999 presentation. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 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. NET INCOME PER SHARE Basic net income per share amounts are based on the weighted average number of common shares outstanding. Diluted net income per share amounts are based on 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 which would have a dilutive effect. All per share amounts have been adjusted to reflect all stock splits declared by the Company. 3. NEW ACCOUNTING STANDARDS In the first quarter of 1998, the American Institute of Certified Public Accountants' Accounting Standards Executive Committee issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 provides guidance on the capitalization of software for internal use. The Company adopted SOP 98-1 effective January 1, 1999, as required. The adoption of SOP 98-1 did not have a material effect on the Company's consolidated financial position or results of operations. 5
8 4. BUSINESS SEGMENT INFORMATION The Company operates in two reportable business segments: North American Automotive Finance and U.K./Ireland Automotive Finance. Selected segment information is set forth below: <TABLE> <CAPTION> Three Months Ended Six Months Ended ---------------------------- ----------------------------- 6/30/98 6/30/99 6/30/98 6/30/99 ----------- ----------- ------------ ----------- <S> <C> <C> <C> <C> Total revenue: North American Automotive Finance............. $ 30,572 $ 22,949 $ 62,694 $ 46,315 U.K./Ireland Automotive Finance............... 5,657 4,258 11,771 8,281 All Other..................................... 1,607 1,784 2,681 4,756 ----------- ----------- ------------ ----------- $ 37,836 $ 28,991 $ 77,146 $ 59,352 =========== =========== ============ =========== Earnings before interest and taxes: North American Automotive Finance............. 14,792 24,266 29,120 34,818 U.K./Ireland Automotive Finance............... 3,114 2,134 6,611 4,056 All Other..................................... 301 (137) 346 189 ----------- ----------- ------------ ----------- 18,207 26,263 36,077 39,063 =========== =========== ============ =========== Reconciliation of total earnings before interest and taxes to consolidated income before provision for income taxes: Total earnings before interest and taxes...... 18,207 26,263 36,077 39,063 Interest expense.............................. (6,829) (4,272) (14,175) (8,799) ----------- ----------- ------------ ----------- Consolidated income before provision for income taxes...................................... $ 11,378 $ 21,991 $ 21,902 $ 30,264 =========== =========== ============ =========== </TABLE> 6
9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS THREE AND SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE AND SIX MONTHS ENDED JUNE 30, 1999 TOTAL REVENUE. Total revenue decreased from $37.8 million and $77.1 million for the three and six months ended June 30, 1998 to $29.0 million and $59.4 million for the same periods in 1999, representing decreases of 23.4% and 23.1%. These decreases are primarily due to decreases in finance charge revenue resulting from lower average installment contract receivable balances. The decline in the average installment contract receivable balance is primarily the result of collections on and charge offs of installment contracts exceeding contract originations for the period. The volume of contract originations for the Company's North American Automotive Finance Operations decreased from $138.5 million and $328.1 million for the three and six months ended June 30, 1998 to $105.8 million and $220.1 million for the same periods in 1999. The volume of contract originations for the Company's U.K./Ireland Automotive Finance Operations increased from $14.4 million and $27.7 million for the three and six months ended June 30, 1998 to $29.3 million and $42.9 million for the same periods in 1999. Based upon reviews of dealer profitability and improvements in credit quality, the Company has introduced new advance programs, both in the United States and United Kingdom, which have increased the Company's overall advance rates. The Company's advances to dealers and payment of dealer holdback, as a percent of gross installment contracts accepted, increased from 50.9% and 48.6% for the three and six months ended June 30, 1998 to 55.6% and 53.7% for the same periods in 1999. There can be no assurance that higher advance rates will lead to increased origination volumes in future periods, or that advance rates will not need to be lowered in future periods based on continued review of dealer profitability and credit quality or that higher advance rates will not lead to higher losses on dealer advances in future periods. The average annualized yield on the Company's installment contract portfolio, calculated using finance charge revenue divided by average installment contracts receivable, was approximately 11.6% and 12.6% for the six months ended June 30, 1998 and 1999, respectively. The increase in the average yield is due to a decrease in the percentage of installment contracts which were in non-accrual status as well as improvements in collection levels on non-accrual installment contracts. The percentage of installment contracts which were in non-accrual status was 32.3% and 25.9% as of June 30, 1998 and 1999, respectively. Premiums earned increased, as a percent of total revenue, from 7.0% and 7.2% for the three and six months ended June 30, 1998 to 8.0% for the same periods in 1999. Premiums on the Company's service contract program are earned on a straight-line basis over the life of the service contracts. Premiums reinsured under the Company's credit life and collateral protection insurance programs are earned over the life of the contracts using the pro rata and sum-of-digits methods. As a result of these revenue recognition methods, premiums earned decreased at a slower rate than the decrease in finance charges. In addition, the increase is due to an increase in the penetration rate of the Company's service contract and credit life insurance programs. Other income increased, as a percent of total revenue, from 19.3% and 20.3% for the three and six months ended June 7
10 30, 1998 to 23.7% and 25.9% for the same periods in 1999. The increases are primarily due to i) revenues from the Company's auction services business which the Company began operating in June 1998 and ii) servicing fees and interest earned on the retained interest in securitization resulting from the Company's securitization of advance receivables in July 1998. The increases are partially offset by i) decreases in earned dealer enrollment fees due to a decline in the number of dealers enrolling in the Company's financing program and ii) a decrease in fees earned on third party service contract products offered by dealers on installment contracts, as the volume of this business has declined proportionately with the decrease in installment contract originations. For the three month period ended June 30, 1999, the decrease is also due to a decrease in revenues from the Company's credit reporting subsidiary which was sold on May 7, 1999. The increases in other income, as a percent of total revenue, are also partially offset by a valuation adjustment recorded by the Company during the three months ended June 30, 1999, on its retained interest in securitization. The $517,000 adjustment resulted from the write-down of the retained interest in securitization generated from the Company's securitization completed in July 1998. The retained interest in securitization represents an accounting estimate based on several variables including the amount and timing of collections on the underlying installment contracts receivable, the amount and timing of projected dealer holdback payments and interest costs. The Company regularly reviews the actual performance of these variables against the assumptions used to record the retained interest. This evaluation has resulted in a reassessment of the timing and amount of collections on the installment contracts underlying the securitized advances. The Company will continue to assess the performance of its securitization and make adjustments when necessary. OPERATING EXPENSES. Operating expenses, as a percent of total revenue, increased from 37.1% for the three and six months ended June 30, 1998 to 49.9% and 48.9% for the same periods in 1999. Operating expenses consist of salaries and wages, general and administrative, and sales and marketing expenses. The increase, as a percent of revenue, is primarily due to an increase in salaries and wages. Salaries and wages increased principally due to increases in the Company's average wage rates necessary to attract and retain quality personnel. In addition, salaries and wages increased, as a percent of revenue, as the Company's employee head count was not reduced proportionately with the decrease in revenues, as the Company has retained collection personnel in order to continue to improve collection levels. The increase is also due to an increase, as a percent of revenue, in general and administrative expenses which, due to the fixed nature of certain of these expenses, did not decline proportionately with the decline in revenue. To a lesser extent, the increase in operating expenses results from the Company's purchase of the auction services business in June 1998, which requires proportionately higher operating expenses than the Company's other businesses. The increases in salaries and wages and general and administrative expenses are partially offset by a decrease in sales and marketing expenses. These expenses decreased primarily due to reductions in sales commissions as a result of lower contract origination volumes and reductions in the Company's total sales force. The decrease in sales and marketing expenses is also the result of decreases in advertising due to the termination of the Company's customer lead generating program. PROVISION FOR CREDIT LOSSES. The amount provided for credit losses, as a percent of total revenue, decreased from 12.3% and 13.6% for the three and six months ended June 30, 1998 to 7.2% and 7.1% for the same periods in 1999. The provision for credit losses consists of two components: (i) a provision for earned but unpaid revenue on installment contracts which were transferred to non-accrual status during the period and (ii) a provision for losses on advances to dealers that are not expected to be recovered through collections on the related installment contract receivable portfolio. The decrease is primarily due to lower provisions needed for advance losses, based on improvements in the Company's loan performance as measured by the static pool analysis. Advance balances are regularly reviewed by management utilizing the Company's loan servicing system which allows management to estimate future collections for each dealer pool using historical loss experience and a dealer by dealer static pool analysis. In addition, the decrease is also due to lower provisions needed for earned but unpaid revenue primarily resulting from the decrease in the percent of non-accrual installment contracts receivable which were 32.3% and 25.9% of gross receivables as of June 30, 1998 and 1999, respectively. PROVISION FOR CLAIMS. The amount provided for insurance and service contract claims, as a percent of total revenue, increased from 2.5% and 2.6% during the three and six months ended June 30, 1998 to 3.1% and 2.9% during the same periods in 1999. These increases correspond with increases, as a percent of total revenue, in premiums earned from 7.0% and 7.2% for the three and six months ended June 30, 1998 to 8.0% for the same periods in 1999. The Company has established claims reserves based on accumulated estimates of claims reported but unpaid plus estimates of incurred but unreported claims. 8
11 INTEREST EXPENSE. Interest expense, as a percent of total revenue, decreased from 18.0% and 18.4% for the three and six months ended June 30, 1998 to 14.7% and 14.8% for the same periods in 1999. The decrease in interest expense is primarily the result of a decrease in the amount of average outstanding borrowings, which results from i) the positive cash flow generated primarily from collections on installment contracts receivable exceeding cash advances to dealers and payments of dealer holdbacks and ii) $49.3 million raised in July 1998 from the securitization of advance receivables. The decrease was partially offset by higher average interest rates during the 1999 periods. The weighted average interest rates increased from 8.25% and 8.19% for the three and six months ended June 30, 1998 to 9.80% and 9.41% for the same periods in 1999. The increase in the average interest rates is the result of i) the impact of fixed borrowing costs, such as facility fees, up front legal fees and other costs on average interest rates when average outstanding borrowings are decreasing ii) a 25 basis point increase in the interest rate on outstanding borrowings under the Company's senior notes resulting from amendments to the note purchase agreements due to the Company's securitization of advance receivables in July 1998; and iii) a decrease in line of credit balances, which carry lower interest rates, as a percentage of total average balance sheet debt. OPERATING INCOME. As a result of the aforementioned factors, operating income decreased from $11.4 million and $21.9 million for the three and six months ended June 30, 1998 to $7.3 million and $15.6 million for the same periods in 1999, representing decreases of 36.1% and 28.8%, respectively. GAIN ON SALE OF SUBSIDIARY. The Company recorded a pre-tax gain of $14.7 million during the three months ended June 30, 1999 from the sale of the Company's credit reporting services subsidiary. The net proceeds from the sale were used to reduce outstanding indebtedness under the Company's $125 million credit facility. FOREIGN EXCHANGE GAIN (LOSS). The Company incurred foreign exchange gains (losses) of ($7,000) and $5,000 for the three and six months ended June 30, 1998 and foreign exchange losses of ($9,000) and ($54,000) for the same periods in 1999. The gains and losses result from the effect of exchange rate fluctuations between the U.S. dollar and foreign currencies on unhedged intercompany balances between the Company and its subsidiaries which operate outside the United States. PROVISION FOR INCOME TAXES. The provision for income taxes increased from $3.9 million and $7.6 million during the three and six months ended June 30, 1998 to $8.2 million and $11.1 million during the same periods in 1999. The increases are due to a higher level of pretax income in 1999, primarily resulting from the gain on the sale of the Company's credit reporting subsidiary. For the six months ended June 30, the effective tax rate was 34.6% in 1998 and 36.7% in 1999. The increase in the effective tax rate is primarily due to approximately $900,000 of state income taxes incurred on the sale of the Company's credit reporting subsidiary. The increase in the effective tax rate is also due to a lower percentage of the Company's consolidated pretax income being earned by the Company's United Kingdom subsidiary in 1999, where the statutory rate is lower than the U.S. statutory federal tax rate. INSTALLMENT CONTRACTS RECEIVABLE The following table summarizes the composition of installment contracts receivable at the dates indicated: <TABLE> <CAPTION> As of As of (Dollars in thousands) 12/31/98 6/30/99 - ---------------------- ---------------- --------------- <S> <C> <C> (Unaudited) Gross installment contracts receivable.................................... $ 794,831 $ 695,074 Unearned finance charges.................................................. (114,617) (100,232) Unearned insurance premiums, insurance reserves, and fees................. (8,446) (8,825) ---------------- --------------- Installment contracts receivable.......................................... $ 671,768 $ 586,027 ================ =============== </TABLE> 9
12 A summary of changes in gross installment contracts receivable is as follows: <TABLE> <CAPTION> Three Months Ended Six Months Ended ----------------------------- ----------------------------- (Dollars in thousands) 6/30/98 6/30/99 6/30/98 6/30/99 - ---------------------- ------------- ------------ ------------- ------------ (Unaudited) (Unaudited) <S> <C> <C> <C> <C> Balance - beginning of period.................... $ 1,143,469 $ 724,946 $ 1,254,858 $ 794,831 Gross amount of installment contracts accepted...................................... 153,515 135,996 356,480 263,976 Cash collections on installment contracts receivable.................................... (137,139) (104,481) (276,243) (215,984) Charge offs...................................... (121,789) (56,738) (296,678) (139,281) Currency translation............................. 2,614 (4,649) 2,253 (8,468) ------------- ------------ ------------ ------------ Balance - end of period.......................... $ 1,040,670 $ 695,074 $ 1,040,670 $ 695,074 ============= ============ ============ ============ </TABLE> DEALER HOLDBACKS The following table summarizes the composition of dealer holdbacks at the dates indicated: <TABLE> <CAPTION> As of As of (Dollars in thousands) 12/31/98 6/30/99 - ---------------------- ------------ -------------- (Unaudited) <S> <C> <C> Dealer holdbacks........................................................... $ 634,102 $ 554,183 Less: Advances (net of reserves of $19,954 and $16,090 at December 31, 1998 and June 30, 1999, respectively).................. (411,827) (382,418) ------------ -------------- Dealer holdbacks, net...................................................... $ 222,275 $ 171,765 ============ ============== </TABLE> CREDIT POLICY AND EXPERIENCE When an installment contract is assigned to the Company by a participating dealer, the Company generally pays a cash advance to the dealer. The Company maintains a reserve against advances to dealers that are not expected to be recovered through collections on the related installment contract portfolio. For purposes of establishing the reserve, future collections are reduced to present-value in order to achieve a level yield over the remaining term of the advance equal to the expected yield at the origination of the impaired advance. The Company's loan servicing system allows the Company to estimate future collections for each dealer pool using historical loss experience and a dealer by dealer static pool analysis. Future reserve requirements will depend in part on the magnitude of the variance between management's prediction of future collections and the actual collections that are realized. The Company charges off dealer advances against the reserve at such time and to the extent that the Company's static pool analysis determines that the advance is completely or partially impaired. The Company also maintains an allowance for credit losses which, in the opinion of management, adequately reserves against losses in the portfolio of receivables. The risk of loss to the Company related to the installment contracts receivable balances relates primarily to the earned but unpaid revenue on installment contracts which were transferred to non-accrual status during the period. Servicing fees, which are booked as finance charges, are recognized under the interest method of accounting until the underlying obligation is 90 days past due on a recency basis. At such time, the Company suspends the accrual of revenue and makes a provision for credit losses equal to the earned but unpaid revenue. In all cases, contracts on which no material payment has been received for nine months are charged off against dealer holdbacks, unearned finance charges and the allowance for credit losses. 10
13 Ultimate losses may vary from current estimates and the amount of provision, which is a current expense, may be either greater or less than actual charge offs. The following tables set forth information relating to charge offs, the allowance for credit losses, and the reserve on advances. <TABLE> <CAPTION> Three Months Ended Six Months Ended ----------------------------- ----------------------------- (Dollars in thousands) 6/30/98 6/30/99 6/30/98 6/30/99 - ---------------------- ------------- ------------ ------------- ------------ (Unaudited) (Unaudited) <S> <C> <C> <C> <C> CHARGES OFFS Charged against dealer holdbacks.................. $ 97,459 $ 45,480 $ 237,328 $ 111,533 Charged against unearned finance charges.......... 22,133 10,365 53,481 25,472 Charged against allowance for credit losses....... 2,197 893 5,869 2,276 ------------- ------------ ------------- ------------ Total contracts charged off....................... $ 121,789 $ 56,738 $ 296,678 $ 139,281 ============= ============ ============ ============ Net charge offs against the reserve on advances... $ - $ 2,626 $ - $ 7,508 ============= ============ ============ ============ </TABLE> <TABLE> <CAPTION> Three Months Ended Six Months Ended ----------------------------- ----------------------------- (Dollars in thousands) 6/30/98 6/30/99 6/30/98 6/30/99 - ---------------------- ------------- ------------ ------------- ------------ (Unaudited) (Unaudited) <S> <C> <C> <C> <C> ALLOWANCE FOR CREDIT LOSSES Balance - beginning of period.................... $ 10,473 $ 5,849 $ 13,119 $ 7,075 Provision for loan losses........................ 875 183 1,905 375 Charge offs...................................... (2,197) (893) (5,869) (2,276) Currency translation............................. 23 (25) 19 (60) ------------- ------------ ------------- ------------ Balance - end of period.......................... $ 9,174 $ 5,144 $ 9,174 $ 5,114 ============= ============ ============= ============ </TABLE> <TABLE> <CAPTION> Three Months Ended Six Months Ended ----------------------------- ----------------------------- (Dollars in thousands) 6/30/98 6/30/99 6/30/98 6/30/99 - ---------------------- ------------- ------------ ------------- ------------ (Unaudited) (Unaudited) <S> <C> <C> <C> <C> RESERVE ON ADVANCES Balance - beginning of period.................... $ 21,262 $ 16,884 $ 16,369 $ 19,954 Provision for advance losses..................... 3,791 1,894 8,557 3,838 Advance reserve fees............................. 15 4 167 8 Charge offs...................................... - (2,626) - (7,508) Currency translation............................. 206 (66) 181 (202) ------------- ------------ ------------- ------------ Balance - end of period.......................... $ 25,274 $ 16,090 $ 25,274 $ 16,090 ============= ============ ============= ============ </TABLE> 11
14 <TABLE> <CAPTION> As of ----------------------- (Dollars in thousands) 6/30/98 6/30/99 - ---------------------- ------- ------- <S> <C> <C> CREDIT RATIOS (Unaudited) Allowance for credit losses as a percent of gross installment contracts receivable......................... 0.9% 0.7% Reserve on advances as a percent of advances................ 4.6% 4.0% Gross dealer holdbacks as a percent of gross installment contracts receivable......................... 79.8% 79.7% </TABLE> LIQUIDITY AND CAPITAL RESOURCES The Company's principal need for capital is to fund cash advances made to dealers in connection with the acceptance of installment contracts and for the payment of dealer holdbacks to dealers who have repaid their advance balances. These cash outflows to dealers decreased from $173.4 million during the six months ended June 30, 1998 to $141.7 million during the same period in 1999. These amounts have historically been funded from cash collections on installment contracts, cash provided by operating activities and draws under the Company's credit agreements. The Company maintains a significant dealer holdback on installment contracts accepted which assists the Company in funding its long- term cash flow requirements. During the first six months of 1999, the Company reduced the amount of indebtedness outstanding under its $125 million credit agreement by approximately $35.2 million and prepaid $20.0 million of senior notes. The positive cash flow during the period is primarily a result of collections on installment contracts receivable exceeding cash advances to dealers and payments of dealer holdbacks. The Company has a $125 million credit agreement with a commercial bank syndicate. The facility has a commitment period through June 13, 2000 and is subject to annual extensions for additional one year periods at the request of the Company with the consent of each of the banks in the facility. The agreement provides that interest is payable at the Eurocurrency rate plus 140 basis points, or at the prime rate. The Eurocurrency borrowings may be fixed for periods up to six months. The credit agreement has certain restrictive covenants, including limits on the ratio of the Company's debt to equity, debt to advances, debt to installment contracts receivable, advances to installment contracts receivable, fixed charges to net income, limits on the Company's investment in its foreign subsidiaries and requirements that the Company maintain a specified minimum level of net worth. Borrowings under the credit agreement are secured through a lien on most of the Company's assets on an equal and ratable basis with the Company's senior notes. As of June 30, 1999, there was approximately $43.9 million outstanding under this facility. When borrowing to fund the operations of its foreign subsidiaries, the Company's policy is to borrow funds denominated in the currency of the country in which the subsidiary operates, thus mitigating the Company's exposure to foreign exchange fluctuations. On April 26, 1999, the Company refinanced a mortgage loan on its headquarters which resulted in net proceeds to the Company of approximately $5.0 million. These proceeds were used to reduce amounts outstanding under the Company's $125 million credit facility. On May 7, 1999, the Company sold its credit reporting services subsidiary for $20.5 million in cash. The Company received $16.1 million of net proceeds from the sale, after the buyout of an employment agreement and other costs of sale, which were used to reduce the outstanding indebtedness under the Company's $125 million credit facility. In connection with this transaction, the Company recorded a pre-tax gain of approximately $14.7 million during the quarter ended June 30, 1999. On July 21, 1999, the Company completed a securitization of advance receivables. Pursuant to this transaction, the Company contributed dealer advances having a carrying amount of approximately $62.4 million and received approximately $49.5 million in financing from an institutional investor. The financing, which is nonrecourse to the Company, bears interest at a floating rate equal to the thirty day commercial paper rate plus 70 basis points with a 12
15 maximum rate of 7.5% and is anticipated to fully amortize within thirty months. The financing is secured by the contributed dealer advances, the rights to collections on the related installment contracts receivable and certain related assets up to the sum of the contributed dealer advance and the Company's servicing fee. The Company will receive a monthly servicing fee equal to 4% of the collections of the contributed installment contracts receivable. Except for the servicing fee and payments due to dealers, the Company will not receive any portion of collections on the installment contracts receivable until the underlying indebtedness has been repaid in full. The proceeds of the securitization were used to reduce indebtedness under the Company's credit facility. On August 5, 1999, the Company's Board of Directors authorized a common stock repurchase program of up to 1,000,000 shares of the Company's common stock. The shares, which can be repurchased through the open market or in privately negotiated transactions, represent approximately 2.2% of the outstanding common shares. The Company expects to fund the repurchases from cash generated from operations and amounts available under its $125 million credit agreement. The Company has $23.9 million of principal maturing on its senior notes in the fourth quarter of 1999 which the Company expects to repay from cash generated from operations and amounts available under its $125 million credit agreement. As previously disclosed in the Company's 1998 Annual Report on Form 10-K and the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, the Company is currently a defendant in a class action proceeding seeking money damages resulting for alleged violations of a number of Missouri state and federal consumer protection laws. Pending the appeal of this litigation, the Company may be required to post a bond or letter of credit, which would reduce availability under the Company's credit agreement. Based upon anticipated cash flows, management believes that amounts available under its credit agreement, cash flow from operations and various financing alternatives available will provide sufficient financing for current debt maturities and for future operations. If the various financing alternatives were to become limited or unavailable to the Company, the Company's operations would be materially adversely affected. YEAR 2000 UPDATE The year 2000 issue is the result of computer programs and microprocessors using two digits rather than four to define the applicable year (the "Year 2000 Issue"). Such programs or microprocessors may recognize a date using "00" as the year 1900 rather than the year 2000. This could result in system failures or miscalculations leading to disruptions in the Company's activities and operations. If the Company or third parties with which it has a significant relationship fail to make necessary modifications, conversions and contingency plans on a timely basis, the Year 2000 Issue could have a material adverse effect on the Company's business, financial condition and results of operations. However, the effect cannot be quantified at this time because the Company cannot accurately estimate the magnitude, duration or ultimate impact of noncompliance by its systems or those of vendors and other third parties. The Company believes that its competitors face a similar risk. Although the risk is not presently quantifiable, the following disclosure is intended to summarize the Company's actions to minimize its risk from the Year 2000 Issue. Programs that will operate in the year 2000 unaffected by the change in year from 1999 to 2000 are referred to herein as "year 2000 compliant." State of Readiness. The Company employs three major computer systems in its U.S. Operations: (i) the Application and Contract System (ACS) which is used from the time a dealer faxes an application to the Company until the contract is received and funded, (ii) the Loan Servicing System (LSS) which contains all loan and payment information and is the primary source for management information reporting, and (iii) the Collection System (CS) which is used by the Company's collections personnel to track and service all active customer accounts. The ACS and LSS went into production in 1997 and were developed in Oracle 7.3 and Oracle Forms 4.5 which are year 2000 compliant. The CS is a third party software package which has been upgraded to be year 2000 compliant. The Company employs one major computer system in its United Kingdom operations which is a third party 13
16 software package. The vendor has certified to the Company that the system is year 2000 compliant. The Company or its third party suppliers have substantially completed testing all of the Company's mission critical and non-mission critical computer systems and other non-information technology systems material to the Company's operations and the Company believes that such systems are year 2000 compliant. The Company has completed a comprehensive inventory of all other computer hardware, software, third party vendors and other non-information technology systems. All items identified were prioritized and assigned to a responsible party to investigate and ensure that the item becomes year 2000 compliant by the end of 1999. The Company initiated communication with its significant suppliers to determine the extent to which its operations are vulnerable to those third parties' failure to remediate their own year 2000 issues. Suppliers of hardware, software or products that might contain embedded processors were asked to provide information regarding the year 2000 compliance status of their products. The Company will continue to seek information from non-responsive suppliers in the third quarter of 1999. The Company cannot give any assurance that the systems of other companies on which its systems rely will be year 2000 compliant and that any failure of such a company to be year 2000 compliant will not have an adverse effect on the Company's operations. The Company expects verification activities will continue through the end of the year. The Company also expects some aspects of the year 2000 plan to continue beyond January 1, 2000 with respect to resolution of non-critical issues. Costs. The Company expects that all software installations or other modifications will be expensed as incurred, while the cost for new software will be capitalized and amortized over the software's useful life. At this time, the Company anticipates spending no more than $50,000 in its efforts to become year 2000 compliant, of which approximately $42,000 has been spent to date from available working capital. Estimates of time, cost and risks are based on currently available information. Developments that could affect estimates include, without limitation, the availability of trained personnel, the ability to locate and correct all non-compliant systems, cooperation and remediation success of third parties material to the Company, and the ability to correctly anticipate risks and implement suitable contingency plans in the event of system failures at the Company or third parties. Risks. Because the Company believes that the mission critical systems within its control are year 2000 compliant, the Company believes that the most reasonably likely worst case scenario is a compliance failure by a third party upon which the Company relies. Such a failure would likely have an effect on the Company's business, financial condition and results of operations. The magnitude of that effect however, cannot be quantified at this time because of variables such as the type and importance of the third party, the possible effect on the Company's operations and the Company's ability to respond. Thus, there can be no assurance that there will not be a material adverse effect on the Company if such third parties do not remediate their systems in a timely manner. In addition, it is possible that the Company could experience a failure of a non-mission critical system for a period of time, which could result in a minor disruption in some internal operations. Contingency Plans. Contingency planning is an integral part of the Company's year 2000 readiness project. While substantial contingency planning has occurred, the Company has not yet completed a comprehensive contingency plan to address situations that may result should a significant third party system or mission critical internal system fail. Development of contingency plans is in progress and will develop and expand during the remainder of 1999. The Company cannot give any assurance that it will be able to develop a contingency plan that will adequately address all issues that may arise in the year 2000. The Company's failure to develop and implement, if necessary, an appropriate contingency plan could have a material adverse impact on its operations. Finally, the Company is also vulnerable to external forces that might generally affect industry and commerce, such as utility or transportation company year 2000 compliance failures and related service interruptions. The disclosure in this section contains information regarding Year 2000 readiness which constitutes "Year 2000 Readiness Disclosure" as defined in the Year 2000 Readiness Disclosure Act. Readers are cautioned that forward-looking statements contained in the Year 2000 Update should be read in conjunction with the Company's disclosures 14
17 under the heading "Forward-Looking Statements". FORWARD-LOOKING STATEMENTS The foregoing discussion and analysis contains a number of forward looking statements within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, both as amended, with respect to expectations for future periods which are subject to various risks and uncertainties. The risks and uncertainties are detailed from time to time in reports filed by the Company with the Securities and Exchange Commission, including forms 8-K, 10-Q, and 10-K, and include, among others, competition from traditional financing sources and from non-traditional lenders, availability of funding at competitive rates of interest, adverse changes in applicable laws and regulations, adverse changes in economic conditions, year 2000 compliance by the Company or third parties to the Company, adverse changes in the automobile or finance industries or in the non-prime consumer finance market, the Company's ability to maintain or increase the volume of installment contracts accepted and historical collection rates and the Company's ability to complete various financing alternatives. 15
18 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Refer to the Company's Annual Report on Form 10-K for the year ended December 31, 1998 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 1998 Annual Report on Form 10-K. 16
19 PART II.--OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS As previously disclosed in the Company's 1998 Annual Report on Form 10-K and the Company's Quarterly Report on Form 10-Q for the quarterly period ended March 31, 1999, during the first quarter of 1998, several putative class action complaints were filed by shareholders against the Company and certain officers and directors of the Company in the United States District Court for the Eastern District of Michigan seeking money damages for alleged violations of the federal securities laws. On August 14, 1998, a Consolidated Class Action Complaint, consolidating the claims asserted in those cases, was filed. The Complaint generally alleged that the Company's financial statements issued during the period August 14, 1995 through October 22, 1997 did not accurately reflect the Company's true financial condition and results of operations because such reported results failed to be in accordance with generally accepted accounting principles and such results contained material accounting irregularities in that they failed to reflect adequate reserves for credit losses. The Complaint further alleged that the Company issued public statements during the alleged class period which fraudulently created the impression that the Company's accounting practices were proper. On April 23, 1999, the Court granted the Company's motion to dismiss the Complaint and entered a final judgment dismissing the action with prejudice. On May 6, 1999, plaintiffs filed a motion for reconsideration of the order dismissing the Complaint or, in the alternative, for leave to file an amended complaint. On July 13, 1999, the Court granted the plaintiffs' motion for reconsideration and granted the plaintiffs leave to file an amended complaint. Plaintiffs filed their First Amended Consolidated Class Action Complaint on August 2, 1999. The Company intends to move to dismiss the amended complaint and intends to continue to vigorously defend this action. While management believes it has meritorious legal and factual defenses, an adverse ultimate disposition of this litigation could have a material adverse impact on the Company's financial position, liquidity and results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company held its Annual Meeting of Shareholders on May 24, 1999 at which the shareholders considered the following. 1. The election of five directors. Each of the nominees for director at the meeting was an incumbent and all nominees were elected. The following table sets forth the number of votes for and withheld with respect to each nominee. Nominee Votes For Votes Withheld ------- --------- -------------- Donald A. Foss 41,463,335 1,101,492 Harry E. Craig 41,461,635 1,103,192 Thomas A. FitzSimmons 41,464,735 1,100,092 David T. Harrison 41,463,835 1,100,992 Sam M. LaFata 41,461,740 1,103,087 2. The approval of a proposal to amend the 1992 Stock Option Plan to increase the number of shares subject to the plan from 5,000,000 to 8,000,000 and to increase the number of options that may be granted to any individual salaried employee in any three-year period from 500,000 to 1,000,000. Votes For Votes Against Abstain Broker Non-Votes --------- ------------- ------- ---------------- 32,535,004 5,151,075 42,743 4,836,005 17
20 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits See Index of Exhibits following the signature page. (b) Reports on Form 8-K The Company was not required to file a current report on Form 8-K during the quarter ended June 30, 1999 and none were filed during that period. 18
21 SIGNATURES 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) /S/ BRETT A. ROBERTS ------------------------------------------------------- BRETT A. ROBERTS Executive Vice President and Chief Financial Officer August 13, 1999 (Principal Financial Officer and Duly Authorized Officer) /S/ JOHN P. CAVANAUGH -------------------------------------------------------- JOHN P. CAVANAUGH Corporate Controller and Assistant Secretary August 13, 1999 (Principal Accounting Officer) 19
22 INDEX OF EXHIBITS EXHIBIT DESCRIPTION 4(a)(6) 1 Fifth Amendment dated April 13, 1999 to Note Purchase Agreement dated October 1, 1994 between various insurance companies and the Company 4(b)(4) 1 Third Amendment dated April 13, 1999 to Note Purchase Agreement dated August 1, 1996 between various insurance companies and the Company 4(c)(5) Third Amended and Restated Credit Agreement dated as of June 15, 1999 between the Company, Comerica Bank as Administrative Agent and Collateral Agent, NationsBank, N.A., as Syndications Agent and Banc of America Securities, LLC as Sole Lead Arranger and Sole Book Manager. 4(e)(4) 1 Third Amendment dated April 13, 1999 to Note Purchase Agreement dated March 25, 1997 between various insurance companies and the Company 4(f)(4) Amendment No. 1 dated June 30, 1999 to Note Purchase Agreement dated July 7, 1998 among Kitty Hawk Funding Corporation, CAC Funding Corp. and NationsBank, N.A. 4(f)(5) Amendment No. 1 dated June 30, 1999 to Security Agreement dated July 7, 1998 among Kitty Hawk Funding Corporation, CAC Funding Corp., the Company and NationsBank, N.A. 4(f)(6) Amendment No. 1 dated June 30, 1999 to Contribution Agreement dated July 7, 1998 between the Company and CAC Funding Corp. 10(f)(4) Credit Acceptance Corporation 1992 Stock Option Plan, as amended and restated May 1999. 27 Financial Data Schedule - ---------------- 1 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1999, and incorporated herein by reference. 20