ITEM 1. BUSINESS
GENERAL
Credit Acceptance Corporation ("CAC" or the "Company"), incorporated in Michigan in 1972, is a specialized financial services company which provides funding, receivables management, collection, sales training and related products and services to automobile dealers located in the United States, the United Kingdom, Canada and Ireland. CAC assists such dealers with the sale of used vehicles by providing an indirect financing source for buyers with limited access to traditional sources of consumer credit ("Non-prime Consumers"). For the year ended December 31, 1998, CAC had total revenues of $142.3 million and net earnings of $25.0 million. At December 31, 1998, aggregate gross installment contracts receivable were $794.8 million and total shareholders' equity was $276.3 million.
CAC also provides additional products and services to dealers which give the Non-prime Consumer the opportunity to purchase a number of ancillary products, including credit life and disability insurance and vehicle service contracts offered by dealers and point-of-sale dual interest collateral protection insurance provided by third party insurance carriers. Through wholly-owned subsidiaries, the Company also reinsures certain of the credit life and disability insurance and point-of-sale dual interest collateral protection insurance policies issued in conjunction with installment contracts originated by dealers. In addition, the Company's credit reporting subsidiary provides credit information and consumer reports to companies serving the Non-prime Consumer market. Furthermore, the Company, through a wholly-owned subsidiary, operates automobile auctions that provide vehicle suppliers with a full range of services to process and sell vehicles to buyers at the auctions.
The Company is organized into four primary business units: North American automotive finance, U.K./Ireland automotive finance, credit reporting services, and auction services. See Note 12 to the consolidated financial statements for information regarding the Company's reportable segments.
PRODUCTS AND SERVICES
CAC derives its revenues from the following principal sources: (i) servicing fees (which are accounted for as finance charges) earned as a result of servicing and collecting installment contracts originated and assigned to the Company by dealers; (ii) fees charged to dealers at the time they enroll in the Company's program; (iii) gains from the securitization of dealer advances; (iv) premiums earned from the Company's reinsurance activities and service contract programs; and (v) other income which primarily consists of fees earned from third party service contract products offered by dealers, the processing and sale of vehicles at auctions, fees from the Company's credit reporting services and interest income from loans made directly to dealers for floor plan financing and working capital purposes. The following table sets forth the percent relationship to total revenue of each of these sources.
PRINCIPAL BUSINESS
CAC's principal business involves: (i) the acceptance of installment contracts originated and assigned by participating dealers; and (ii) the subsequent management and collection of such contracts. For installment contracts meeting the Company's criteria, CAC makes a formula-based cash payment to the dealer (an "Advance"). The Company may Advance up to 90% of the amount financed, but Advances typically range between 50% and 75% of the amount financed. To mitigate its risk, at the time of accepting the assignment of an installment contract, CAC obtains a security interest in the vehicle and establishes a dealer holdback equal to the gross amount of the contract, less the Company's servicing fee, which is recorded as an unearned finance charge. CAC's acceptance of such contracts is generally without recourse to the general assets of the dealer, and accordingly, the dealer usually has no liability to the Company if the consumer defaults on the contract.
CAC offers its dealers several Advance alternatives, which are calculated based upon the dealer's history with the Company, the credit profile of a particular customer and the year, make, model, and mileage of the used vehicle to be financed.
Monthly cash receipts related to the aggregate installment contracts accepted from an individual dealer are remitted to such dealer, but only after:
(i) the Company is reimbursed for certain collection costs relating to all contracts accepted from such dealer;
(ii) the Company receives a servicing fee (typically 20%) of the aggregate net monthly receipts (monthly cash receipts less certain collection costs); and
(iii) the Company has recovered all advances made to such dealer.
OPERATIONS
Dealer Selection and Enrollment Fee. CAC has adopted specific policies relative to establishing the eligibility of prospective dealers for the Company's program. A dealer's participation in the Company's program begins with the execution of a Servicing Agreement, which requires the dealer to disclose information about his dealership and personal finances. The Company undertakes a review of the dealer information to determine whether the dealer should be permitted to participate in the Company's program.
Pursuant to the Servicing Agreement, a dealer represents that it will only submit contracts to CAC which satisfy criteria established by the Company, meet certain conditions with respect to the binding nature and the status of the security interest in the purchased vehicle and comply with applicable state, federal and foreign laws and regulations. Dealers receive a monthly statement from the Company, summarizing all transactions on contracts originated by such dealer. Also, where applicable, the dealer will receive a payment from CAC for any portion of the payments on contracts to which the dealer is entitled under the Servicing Agreement.
The Servicing Agreement may be terminated by the Company or by the dealer (as long as there is no event of default or an event which, with the lapse of time, giving of notice or both, would become an event of default) upon 30 days prior written notice. Events of default include, among other things, (i) the dealer's failure to perform or observe covenants in the Servicing Agreement; (ii) the dealer's breach of a representation in the Servicing Agreement; (iii) a misrepresentation by the dealer relating to an installment contract submitted to the Company or a related vehicle or purchaser; and (iv) the appointment of a receiver for, or the bankruptcy or insolvency of, the dealer. The Company may terminate the servicing agreement immediately in the case of an event of default by the dealer. Upon any termination by the dealer or in the event of a default, the dealer must immediately pay the Company: (i) any unreimbursed collection costs; (ii) any unpaid advances and all amounts owed by the dealer to the Company; and (iii) a termination fee equal to 20% of the then outstanding amount of the installment contracts originated and accepted by the Company. Upon receipt in full of such amounts, the Company will reassign the installment contract receivable and its security interest in the financed vehicle to the dealer. In the event of a termination by the Company (or any other termination
if the Company and the dealer agree), the Company may continue to service installment contracts accepted prior to termination in the normal course of business without charging a termination fee.
New dealers located in North America are generally charged a $4,500 dealer enrollment fee, which affords the dealer access to the Company's training material and programs and helps offset the administrative expenses associated with new dealer enrollment. No dealer enrollment fee is charged to dealers in the United Kingdom and Ireland.
Assignment of Contracts. The dealer assigns title to the installment contract and the security interest in the vehicle to the Company. Thereafter, the rights and obligations of the Company and the dealer are defined by the servicing agreement, which provides that the contract assignment to the Company is for the purposes of administration, servicing and collection of the amounts due under the assigned contract, as well as for security purposes. At the time a contract is submitted, CAC evaluates the contract to determine if it meets the Company's cash Advance criteria. Contracts which do not meet the Company's cash Advance criteria may still be accepted for servicing without an Advance being paid.
Contract Portfolio. The portfolio of installment contracts contains loans of initial duration generally ranging from 24 to 36 months, with an average initial maturity of approximately 31 months. The Company receives a servicing fee generally equal to 20% of the gross amount of the contract, with rate of return varying, based upon the amount of the Advance and the term of the contract.
The following table sets forth, for each of the periods indicated, the average size of installment contracts accepted by the Company, the percent growth in the average size of contracts accepted, the average initial maturity of the contracts accepted, the average advance per installment contract accepted and the average advance as a percent of the average installment contract accepted.
Systems Overview. 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.
ACS -- The ACS, designed and built by an independent consulting firm hired by the Company, was installed in May 1997. This system replaced certain functionality of the Company's previous systems. The system enables the Company to efficiently process a large volume of application and contract data. When a dealer faxes an application to the Company's headquarters in Southfield, Michigan, Company personnel input the application data into the ACS. The system automatically pulls all credit bureau and vehicle guidebook data and includes such data in the application file, which is routed to the analyst team assigned to the dealer's geographic area. An analyst reviews each application file on-line to determine if the transaction is properly structured and meets the Company's guidelines for an advance. The ACS provides the analyst with information regarding the borrower, including information on the borrower's residence, employment, wage level and references, information regarding the vehicle, including the vehicle's age, mileage and guidebook value, and information regarding the transaction, including sale price, down payment, interest rate and term. The system computes the Advance amount according to predefined programs based on dealer and loan variables, provides the analyst with warning flags on out-of-tolerance application variables and allows the
analyst to select from a predefined set of stipulations to include on the Advance approval transmittal, which is automatically faxed to the dealer. After the sale of the vehicle, the installment contract package is sent to the Company by the dealer. The contract information is input into the ACS. The system compares the contract data to the application data and reviews compliance with analyst stipulations. After any variances have been addressed, the system sends an Advance payment to the dealer by check or electronic transaction. The system generally enables the Company to approve application files in under one hour and fund contracts within 24 hours of receipt of all required documents. The system enables management personnel to report on service level by analyst and by region, application and contract volumes by dealer and by program, exceptions granted and various other reports as needed. The ACS automatically loads all new contract data into the LSS system.
LSS -- The LSS, designed and built for the Company by the same consulting firm, was installed and implemented in the third quarter 1997. This system contains all loan transaction data, including payments and charge-offs for loans accepted by the Company since July 1990. The system is the Company's primary information source for management reporting including production of monthly statements sent to dealers summarizing the status of their accounts and the Company's static pool system, which provides the Company with a static pool analysis on a per dealer basis. This system projects future collections for each dealer based on actual prior loss history. These projections are then used to analyze dealer profitability and to estimate and record the Company's reserve on Advances to dealers. The LSS interfaces with both the ACS and CS.
CS -- The CS, which is used by Company collection personnel to service all active accounts was purchased, modified and installed in 1989. The collection system provides data on all of the Company's customer accounts including loan and payment information as well as a log of all account activity including letters sent and summaries of telephone contact. The system generates payment books which are sent on all new accounts, generates all collection letters and notices, allows collectors to record promises to pay and broken promises, interfaces with a predictive dialing system, assigns accounts to collection personnel and tracks results on a per collector basis. Repossession and legal accounts are also processed on this system. The CS interfaces with the phone system, predictive dialer and the LSS.
The Company has developed a comprehensive project plan for achieving year 2000 readiness. The ACS and LSS were developed by the Company in Oracle 7.3 and Oracle Form 4.5 which are year 2000 complaint. The CS has been updated to a version which is year 2000 compliant. See the Company's "Year 2000 Update" included as part of Item 7. of this report.
Servicing and Collections. CAC's staff of professional and experienced collection personnel collects amounts due on installment contracts, assisted by the CS and telephone systems. The customized CS system is integrated with a predictive dialing telephone system, which allows the Company's collection personnel to contact a large number of customers on a daily basis. The integration of the systems allows critical calling information to be seamlessly uploaded to the CS. This integration helps identify customers who are difficult to contact by phone and need additional collections efforts. Customer payments are received through a bank lockbox and at CAC's Southfield, Michigan location. Payment receipt data is electronically transferred from the bank lockbox on a daily basis for posting to the customer's account. The payments are processed in CAC's LSS which provides customer payment information to the CS on a real time basis.
Customer accounts are monitored and serviced by regional collection teams. The team members consist of junior, mid-level, and senior collection personnel. The teams typically take action on accounts within five days of delinquency. If a customer is delinquent, the Company's policy is to attempt to resolve the delinquency by persuading the customer to make payment arrangements until the delinquency is resolved. Since the customer generally has a poor credit history, the Company's program provides the customer with an opportunity to restore their credit rating. The Company believes its interests are best served by permitting the customer to retain the vehicle while making payments, even if the maturity of the loan needs to be extended beyond the original term. Customers, within the first three payments of the contract, are monitored and serviced by a specialized collection team. The first-payment-miss team typically takes action on accounts at one day past due, attempting to resolve the delinquency as soon as possible.
The repossession process typically begins when a customer becomes approximately 60 days past due. However, when a new customer misses one of their first three payments, or if the customer does not respond to
the collection effort, the repossession process typically begins when the customer becomes approximately 30 days past due. At that time, the Company contracts with a third party to repossess and sell the vehicle at an auction. The costs related to such activities, to the extent permitted by law, are added to the amount due from the customer and the dealer Advance amount. If the proceeds from the sale are not sufficient to cover the total balance due, the Company may seek to recover its "deficiency balance" from the customer through legal means, including wage garnishment to the extent permitted by applicable law. Although the Company continues to pursue collection, the deficiency balance is charged-off after nine months of not receiving any material payments.
ANCILLARY PRODUCTS
The Company continually explores methods by which its business relationships with dealers may be enhanced, including several ancillary products such as insurance and service contracts.
Insurance and Service Contract Programs. CAC has arrangements with insurance carriers to assist dealers in offering credit life and disability insurance to Non-prime Consumers. Pursuant to this program, the Company advances to dealers an amount equal to the credit life and disability insurance premium on contracts accepted by the Company, which include credit life and disability insurance written by the Company's designated insurance carriers. The Company is not involved in the actual sale of insurance; however, as part of the program, the insurance carriers cede insurance coverages and premiums (less a fee) to a wholly-owned subsidiary of the Company, which reinsures such coverages. As a result, the subsidiary bears the risk of loss attendant to claims under the coverages ceded to it, and earns revenues resulting from premiums ceded and the investment of such funds.
Buyers Vehicle Protection Plan, Inc. ("BVPP"), a subsidiary of CAC, operates as an administrator of certain vehicle service contract programs offered by dealers to consumers. Under this program, BVPP charges dealers a premium for the service contracts and in return agrees to reimburse dealers for designated amounts that the dealer is required to pay for covered repairs on the vehicles it sells. CAC advances to dealers an amount equal to the purchase price of the vehicle service contract on contracts accepted by the Company which include vehicle service contracts. CAC has, in turn, subcontracted its obligations to administer these programs to third parties that have experience with such programs. Nevertheless, the risk of loss (reimbursement obligations in excess of the purchase price of the vehicle service contract) remains with BVPP. In addition, BVPP has relationships with third party service contract providers which pay BVPP a fee on service contracts included on installment contracts financed through participating dealers. BVPP does not bear any risk of loss for covered claims on these third party service contracts.
The Company has an arrangement with insurance carriers and a third party administrator to market and provide claims administration for a dual interest collateral protection program. This insurance program, which insures the financed vehicle against physical damage up to the lesser of the cost to repair the vehicle or the unpaid balance owed on the related installment contract, is offered to Non-prime Consumers who finance vehicles through participating dealers. If desired by a Non-prime Consumer, collateral protection insurance coverage is written under a group master policy issued by the unaffiliated insurance carriers to the Company. The Company is not involved in the actual sale of insurance; however, as part of the program, the insurance carriers cede insurance coverages and premiums (less a fee) to CAC Reinsurance, Ltd., a subsidiary of the Company, which acts as a reinsurer of such coverages. As a result, the subsidiary bears the risk of loss attendant to claims under the coverages ceded to it, and earns revenues resulting from premiums ceded and the investment of such funds.
The Company continually considers other programs that will increase its services to dealers. The Company intends that such programs, if undertaken, will be initially marketed selectively in order to establish strong operating systems and assess the potential profitability of these services.
OTHER SERVICES
Credit Reporting Services. Montana Investment Group, Inc. a subsidiary of the Company, supplies risk assessment and fraud alert information and computerized skiptracing services regarding Non-prime
Consumers to companies serving the Non-prime Consumer market. Such information and services are generally not available from traditional consumer information sources.
Auction Services. In June 1998, the Company acquired substantially all of the assets and liabilities of an automobile auction in Pennsylvania and incorporated this business, which currently operates auctions in Pennsylvania and South Carolina, as a wholly-owned subsidiary of the Company. The subsidiary provides vehicle suppliers with a full range of services to process and sell vehicles to buyers at the auctions.
Floor Plan Financing and Secured Working Capital Loans. The Company offers floor plan financing to certain dealers, pursuant to which the Company makes loans to dealers to finance vehicle inventories, in each case secured by the inventory, the related proceeds from the future sale of such inventory and, for dealers participating in the Company's financing program, future collections on installment contracts accepted from such dealers. This financing is provided on a selected basis primarily to dealers participating in the Company's financing program. On a limited basis, the Company provides floor plan financing to dealers not participating in the Company's financing program. The interest rate charged on outstanding floor plan balances generally ranges from 12% to 18% per annum. On a selected basis, the Company also provides dealers with working capital loans. These loans are secured by all assets of the dealer, including any future cash collections owed to the dealer on installment contracts accepted by the Company.
SALES AND MARKETING
The Company's program is marketed directly to used vehicle dealers and to new automobile dealers with used vehicle departments. Marketing efforts are initially concentrated in a particular geographic area through the distribution of marketing brochures and via advertising in trade journals and other industry publications directly to automobile dealers. Follow-up is subsequently conducted through telemarketing, videotapes and monthly newsletters explaining the Company's program. Free training seminars are available to dealers desiring to learn more about the Company's program, as well as to participating dealers. The Company also establishes relationships with dealers through referrals from third party vendors and participating dealers.
CAC employs experienced sales and marketing professionals (sales representatives) both at the Company's headquarters and in the field for purposes of enrolling new dealers and providing services to existing dealers. The sales force also includes non-employee individuals (sales agents) operating on a contract basis. Sales personnel are compensated on a commission basis calculated on the profitability and volume of business submitted by dealers.
CAC provides dealers with training regarding the operation of the Company's program. Seminars are held on a regular basis at the Company's headquarters and periodically at locations throughout the country. Pursuant to the Servicing Agreement, each dealer agrees to attend at least one such seminar each calendar year.
CREDIT LOSS POLICY AND EXPERIENCE
When an installment contract is originated, the Company generally pays a cash Advance to the dealer. These Advance balances represent the Company's primary risk of loss related to the funding activity with the dealers.
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. 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. 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 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 expected 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 servicing fee or finance charge previously recognized on contractually delinquent accounts.
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.
During the third quarter of 1997, the Company changed its non-accrual policy from 120 days on a contractual basis to 90 days on a recency basis and, during the fourth quarter of 1997, changed its charge off policy to nine months on a recency basis from one year on a recency basis. The Company believes these changes allow for earlier recognition of under-performing dealer pools.
COMPETITION
The Non-prime Consumer finance market is very fragmented and highly competitive. The Company believes that there are numerous competitors providing, or are capable of providing, financing programs through dealers to purchasers of used vehicles. The Company also competes, indirectly, with dealers operating dealer-financed programs. Because the Company's program is directed to provide financing to individuals who cannot ordinarily qualify for traditional financing, the Company does not believe that it directly competes with commercial banks, thrifts, automobile finance companies and others that apply more traditional lending criteria to the credit approval process. Historically, these traditional sources of used vehicle financing (some of which are larger, have significantly greater financial resources and have relationships with captive dealer networks) have not served the Company's market segment consistently. The Company's market is primarily served by smaller finance organizations which solicit business when and as their capital resources allow. The Company intends to capitalize on this market segment's lack of a major, consistent financing source. However, if such a competitor were to enter the Company's market segment, the Company's financial position and results of operations could be materially adversely affected. The Company believes that it can compete on the basis of service provided to its participating dealers and superior collection performance.
During the past few years, many of CAC's competitors have disclosed that they have exited the Non-prime Consumer finance market, do not have funding to acquire additional installment contract receivables from dealers or have strengthened credit standards which in turn has reduced the volume of new business. These events suggest that the Non-prime Consumer finance market should become less competitive; however, dealers appear to continue to have many alternatives for financing used vehicles.
CUSTOMER AND GEOGRAPHIC CONCENTRATIONS
Installment contracts receivable attributable to contracts accepted from affiliated dealers owned by the Company's majority shareholder represented approximately 4%, 4% and 2% of gross installment contracts receivable at the end of 1996, 1997 and 1998, respectively. Approximately 3%, 1% and 2% of the value of installment contracts accepted and approximately 3%, 1% and 2% of the number of installment contracts accepted by the Company during 1996, 1997 and 1998, respectively, were originated by affiliated dealers. Affiliated dealers are not obligated to continue doing business with CAC, nor are they precluded from owning or operating businesses which may compete with the Company. As of December 31, 1998, approximately 24.9% of the participating dealers in the United States were located in Michigan, Ohio, and Virginia and these dealers accounted for approximately 29.7% of the number of contracts accepted from United States dealers in 1998. As of December 31, 1998, approximately 11.4% of the Company's total participating dealers were located in the United Kingdom and during 1998 these dealers accounted for approximately 9.8% of the new contracts accepted by the Company. No single dealer accounted for more than 10% of the number of installment contracts accepted by the Company during 1996, 1997 or 1998.
The following table sets forth, for each of the last three years for the Company's domestic and foreign operations, the amount of revenues from customers and long-lived assets (in thousands):
The Company's operations are structured to achieve consolidated objectives. As a result, significant interdependencies and overlaps exist among the Company's domestic and foreign operations. Accordingly, the revenue and identifiable assets shown may not be indicative of the amounts which would have been reported if the domestic and foreign operations were independent of one another.
REGULATION
The Company's businesses are subject to various state, federal and foreign laws and regulations which require licensing and qualification, limit interest rates, fees and other charges associated with the installment contracts assigned to the Company, require specified disclosures by automobile dealers to consumers, govern the sale and terms of the ancillary products and define the Company's rights to repossess and sell collateral. Failure to comply with, or an adverse change in, these laws or regulations could have a material adverse effect on the Company by, among other things, limiting the states or countries in which the Company may operate, restricting the Company's ability to realize the value of the collateral securing the contracts, or resulting in potential liability related to contracts accepted from dealers. In addition, governmental regulations which would deplete the supply of used vehicles, such as environmental protection regulations governing emissions or fuel consumption, could have a material adverse effect on the Company. The Company is not aware of any such legislation currently pending.
The sale of insurance products by dealers is also subject to state laws and regulations. As the Company does not deal directly with consumers in the sale of insurance products, it does not believe that its business is significantly affected by such laws and regulations. Nevertheless, there can be no assurance that insurance regulatory authorities in the jurisdictions in which such products are offered by dealers will not seek to regulate the Company or restrict the operation of the Company's business in such jurisdictions. Any such action could materially adversely affect the income received from such products. CAC's credit life and disability reinsurance subsidiary is licensed, and is subject to regulation, in the state of Arizona, and CAC's property and casualty reinsurance subsidiary is licensed in the Turks and Caicos Islands.
The Company's operations in the United Kingdom, Canada and Ireland are also subject to various laws and regulations. Generally, these requirements tend to be no more restrictive than those in effect in the United States. In addition, the Company's credit reporting subsidiary is subject to various state and federal regulations including the Fair Credit Reporting Act. Furthermore, the Company's auction services subsidiary is subject to various state and federal regulations which require disclosure to consumers regarding licensing, qualification and fees associated with the sale of vehicles.
Management believes that the Company maintains all material licenses and permits required for its current operations and is in substantial compliance with all applicable laws and regulations. The Company's Servicing Agreement with dealers provides that the dealer shall indemnify the Company with respect to any loss or expense the Company incurs as a result of the dealer's failure to comply with applicable laws and regulations.
EMPLOYEES
As of December 31, 1998, the Company employed 655 persons, 370 of whom were collection personnel, 83 were contract origination and processing personnel, 67 were marketing professionals, 28 were accounting professionals and the remainder were management or support personnel. The Company's employees have no union affiliations and the Company believes its relationship with its employees is good.
ITEM 2.
ITEM 2. PROPERTIES
NORTH AMERICAN AUTOMOTIVE FINANCE
The Company's headquarters are located at 25505 West Twelve Mile Road, Southfield, Michigan 48034. The Company purchased the office building in 1993, which it financed in part by a loan secured by a mortgage on the building. The office building includes approximately 118,000 square feet of space on five floors. The Company occupies approximately 56,000 square feet of the building, with most of the remainder of the building leased to various tenants. The Company plans to continue to lease excess space in the building until such time as the Company's expansion needs require it to occupy additional space.
U.K./IRELAND AUTOMOTIVE FINANCE
The Company leases an office building in Worthing, West Sussex, in the United Kingdom, which is the headquarters for the Company's United Kingdom operations. The Company occupies approximately 10,000 square feet of the building under a lease expiring in September 2007.
OTHER
The Company leases an office building in Norcross, Georgia which houses the Company's credit reporting services subsidiary. The office building includes approximately 13,300 square feet of space on one floor. The lease expires in December 2003.
The Company plans to sell a vacant office building in Norcross, Georgia which previously housed the Company's credit reporting services subsidiary. The office building includes approximately 4,100 square feet of space on two floors.
The Company's auction services subsidiary leases a 13,400 square foot building and 35 acres of land in the Township of East Hanover, Pennsylvania and leases a 17,000 square foot building and five acres of land in North Charleston, South Carolina. The lease on the Pennsylvania property expires in June 1999, and the Company has an option to buy the land and building. The lease on the South Carolina property expires in March 2000.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
In the normal course of business and as a result of the consumer-oriented nature of the industry in which the Company operates, industry participants are frequently subject to various consumer claims and litigation seeking damages and statutory penalties. The claims allege, among other theories of liability, violations of state, federal and foreign truth in lending, credit availability, credit reporting, consumer protection, warranty, debt collection, insurance and other consumer-oriented laws and regulations. The Company, as the assignee of finance contracts originated by dealers, may also be named as a co-defendant in lawsuits filed by consumers principally against dealers. Many of these cases are filed as purported class actions and seek damages in large dollar amounts.
The Company is currently a defendant in a class action proceeding commenced on October 15, 1996 in the United States District Court for the Western District of Missouri seeking money damages resulting for alleged violations of a number of state and federal consumer protection laws (the "Missouri Litigation"). On October 9, 1997, the Court certified two classes on the claims brought against the Company. On August 4, 1998, the Court granted partial summary judgment on liability in favor of the plaintiffs based upon the Court's finding of certain violations but denied summary judgment on certain other claims. The Court also entered a
number of permanent injunctions, which among other things, restrain the Company from collecting the amounts found to be uncollectible. The Court also ruled in favor of the Company on certain claims raised by class plaintiffs. Because the entry of an injunction is immediately appealable as of right, the Company has appealed the summary judgment order to the United States Court of Appeals for the Eighth Circuit and the Company believes that its appeal has substantial merit. Plaintiffs have filed a cross appeal. A trial on the remaining claims, as well as on damages, is not expected to be scheduled until after the appeal has been concluded. Should the Company's appeal be unsuccessful, the potential damages could have a material adverse impact on the Company's financial position, liquidity and results of operations.
During the first quarter of 1998, several putative class action complaints were filed 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 alleges 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 that such results contained material accounting irregularities in that they failed to reflect adequate reserves for credit losses. The Complaint further alleges that the Company issued public statements during the alleged class period which fraudulently created the impression that the Company's accounting practices were proper. The Company intends to vigorously defend this action and, while management believes that meritorious defenses exist and has filed a motion to dismiss the Complaint, the ultimate disposition of this litigation could have a material adverse impact on the Company's financial position, liquidity and results of operations.
The frequency of litigation has increased as the Company's business activities have expanded. The Company believes that the structure of its dealer program and the ancillary products, including the terms and conditions of its Servicing Agreement with dealers, may mitigate its risk of loss in any such litigation. Management believes the Company has taken prudent steps to address the litigation risks associated with its business activities.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
PART II
ITEM 5.
ITEM 5. MARKET PRICE AND DIVIDEND INFORMATION
The Company's Common Stock is traded on The Nasdaq Stock Market(R) under the symbol CACC. The high and low sale prices for the Common Stock for each quarter during the two year period ending December 31, 1998 as reported by the National Association of Securities Dealers, Inc., are set forth in the following table.
As of December 31, 1998, the approximate number of beneficial holders and shareholders of record of the Common Stock was 4,500 based upon securities position listings furnished to the Company.
Other than the dividend paid in connection with the Company's conversion from S corporation status to C corporation status during 1992, the Company has never paid and has no present plans to pay any cash dividends on its Common Stock. The Company intends to retain its earnings to finance the growth and development of its business. The Company's credit agreements contain certain covenants which prohibit the payment of dividends under certain circumstances and other covenants pertaining to the Company's tangible net worth which may indirectly limit the payment of dividends on Common Stock.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected income statement and balance sheet data presented below for and as of each of the five years ended December 31, 1998 are derived from the Company's audited consolidated financial statements. The selected financial data presented below as of December 31, 1997 and 1998 and for the years ended December 31, 1996, 1997 and 1998 should be read in conjunction with the Company's consolidated audited financial statements and notes thereto and "Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The Company is a specialized financial services company providing funding, receivables management, collection, sales training and related products and services to automobile dealers located in the United States, the United Kingdom, Ireland and Canada. The Company assists such dealers by providing them with an indirect source of financing for buyers of used vehicles with limited access to traditional sources of consumer credit. In addition, but to a significantly lesser extent, the Company provides floor plan financing and secured working capital loans to dealers, secured by the related vehicle inventory and any future cash collections owed to the dealer on contracts accepted under the Company's program.
The Company's relationship with a dealer is defined by: (i) the servicing agreement which sets forth the terms and conditions associated with the Company's acceptance of a contract from a dealer; and (ii) the contract, which is a retail installment sales contract between a dealer and a purchaser of a used vehicle, providing for payment over a specified term. The dealer assigns title to the contract and the security interest in the vehicle to the Company. Thereafter, the rights and obligations of the Company and the dealer are defined by the servicing agreement, which provides that a contract is assigned to the Company as nominee for the dealer for purposes of administration, servicing and collection of the amount due under the assigned contract, as well as for security purposes. The Company takes title to the contract as nominee and records the gross amount of the contract as a gross installment contract receivable and the amount of its "servicing fee" (see below) as an unearned finance charge which, for balance sheet purposes, is netted from the gross amount of the contract. The Company records the remaining portion of the contract (the gross amount of the contract less the unearned finance charge) as a "dealer holdback". For balance sheet purposes, dealer holdbacks are shown net of any Advances made by the Company to the dealer in connection with accepting the assignment of a contract.
The Company's program allows dealers to establish the interest rate on contracts, which typically is the maximum rate allowable by the state or country in which the dealer is doing business. As the majority of the Company's revenue is derived from the servicing fee it receives on the gross amount due under the contract (typically 20% of the principal and interest), the Company's revenues from servicing fees are not materially impacted by changes in interest rates. The Company's revenue is principally dependent upon the gross value of contracts accepted, which is determined by the number of contracts accepted and the amount of the average contract. The contracts assigned to the Company are: (i) secured by the related vehicle; and (ii) short-term in duration (generally maturing in 24 to 36 months, with an initial average maturity of approximately 31 months). The interest rates charged on floor plan financing typically range from 12% to 18% per annum and interest rates charged on secured working capital loans are typically prime plus 4%.
The Company's subsidiaries provide additional services to dealers. One such subsidiary is primarily engaged in the business of reinsuring credit life and disability insurance policies issued to borrowers under contracts originated by dealers. Credit life and disability insurance premiums are ceded to the subsidiary on both an earned and written basis and are earned over the life of the contracts using pro rata and sum-of-digits methods. Another subsidiary administers short-term limited extended service contracts offered by dealers. In connection therewith, the subsidiary bears the risk of loss for any repairs covered under the service contract. Revenue is recognized on a straight-line basis over the life of the service contracts. In addition, the subsidiary has relationships with third party service contract providers which pay the subsidiary a fee on service contracts included on installment contracts financed through participating dealers. The subsidiary does not bear the risk of loss for covered claims on these third party service contracts. The income from the non-refundable fee is recognized upon acceptance of the installment contract. A third subsidiary is engaged in the business of reinsuring collateral protection insurance coverage issued to borrowers under contracts originated by dealers. Premiums are ceded to the subsidiary on both an earned and written basis and are earned over the life of the contracts using pro rata and sum-of-digits methods. In addition, the Company's credit reporting subsidiary provides credit information and consumer reports to companies servicing the Non-Prime consumer market. Furthermore, the Company's auction service subsidiary provides vehicle suppliers with a full range of services to process and sell vehicles to buyers at the auctions.
RESULTS OF OPERATIONS
The following table sets forth the percent relationship of certain items to total revenue for the periods indicated.
Year Ended December 31, 1997 Compared To Year Ended December 31, 1998
Total Revenue. Total revenue decreased from $164.2 million in 1997 to $142.3 million in 1998, a decrease of $21.9 million or 13.3%. This decrease was primarily due to the decrease in finance charge revenue resulting from a decrease in the average installment contracts receivable balance. The decrease in gross installment contracts receivable is primarily the result of collections on and charge offs of installment contracts exceeding contract originations for the period. The Company's volume of contract originations decreased in the fourth quarter of 1997 and in 1998 as the Company has implemented more conservative Advance programs and has limited business with marginally profitable and unprofitable dealers. These changes were made primarily as a result of the Company's enhanced analysis made possible by the Company's loan servicing system which became operational in the third quarter of 1997. Based on this review of dealer profitability, the Company has discontinued relationships with certain dealers and continues to monitor its relationships with dealers and make adjustments to these relationships as required. It is expected that the volume of contract originations will continue at lower levels than those experienced prior to the implementation of these changes.
The average yield on the Company's installment contract portfolio, calculated using finance charge revenue divided by average installment contracts receivable, was approximately 10.4% and 11.4% in 1997 and 1998, 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 37.6% and 32.4% as of December 31, 1997 and 1998, respectively.
Premiums earned increased, as a percentage of total revenue, from 6.9% in 1997 to 7.7% in 1998. 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 on the Company's service contract and credit life insurance programs.
Earned dealer enrollment fees decreased, as a percentage of total revenue, from 4.5% to 2.5% for the years ended 1997 and 1998, respectively. The decrease is due to a decline in the number of new dealers enrolling in the Company's financing program. The Company has become more selective with respect to the enrollment of new dealers in an effort to improve the performance of its portfolio of installment contracts receivable.
In July 1998, the Company recognized a net gain on sale of advance receivables of approximately $685,000. The gain resulted from the securitization of dealer Advances having a carrying value of approximately $56 million. See "Liquidity and Capital Resources". The gain represents the difference between the sale proceeds to the Company, net of transaction costs, and the Company's carrying amount of the dealers Advances, plus the present value of the estimated cash flows to be received by the Company. In determining the gain on sale of receivables, the Company assumed an excess cash flow discount rate of 15%, cumulative credit losses of 14% and an interest rate on the underlying debt of 7.5%. The present value of such estimated excess cash flows has been recorded by the Company as a retained interest in securitization of $13.2 million as of December 31, 1998. The installment contracts supporting the dealer Advances include contracts with origination dates ranging from July 1990 to June 1998, with a weighted average age of 15 months. The amount of such contracts included on the Company's balance sheet as of June 30, 1998 was $98.6 million, of which $43.8 million was in non-accrual status. In addition, the Advances are supported by installment contracts which had been previously written off for financial statement purposes. The excess cash flows result from the amount by which projected collections on the installment contracts exceeds i) the principal and interest to be paid on the commercial paper and ii) the amount of dealer holdback due to dealers.
In the securitization, the Company retained servicing responsibilities and subordinated interests. The Company receives monthly servicing fees of 4% of the collections on the installment contracts receivable, and rights to future cash flows arising after the investors in the commercial paper received the return for which they are contracted. The investors have no recourse to the Company's other assets for failure of debtors to pay when due. The Company's retained interests are generally restricted until investors have been fully paid and are subordinate to investors' interests. Their value is subject to substantial credit and interest rate risk and the timing of projected collections on the transferred financial assets.
Other income increased, as a percent of total revenue, from 17.4% in 1997 to 20.4% in 1998. The increase is primarily due to i) revenues from the Company's auction services business which the Company began operating in June 1998; ii) an increase in revenues from the Company's credit reporting subsidiary and iii) servicing fees and interest earned on the retained interest in securitization resulting from the Company's securitization of advance receivables in July 1998. The increase is offset by 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 decline in contract originations.
Operating Expenses. Operating expenses, as a percent of total revenue, increased from 28.0% in 1997 to 41.5% in 1998. Operating expenses consist primarily of salaries and wages, general and administrative, and sales and marketing expenses.
The increase for the period is due in part to an increase in salaries and wages. Salaries and wages increased due to i) increases in the Company's average wage rates necessary to attract and retain quality personnel; ii) the Company's purchase of the auction services business in June 1998; iii) information technology personnel added to maintain the Company's new computer systems and applications and; iv) severance compensation paid to or accrued for an executive who terminated employment in 1998.
A portion of management personnel compensation paid by the Company is charged to a company controlled by the Company's Chairman (the "Affiliated Company"), based upon the percentage of time spent working for the Affiliated Company. The Company charged the Affiliated Company approximately $208,000 and $226,000 in 1997 and 1998, respectively. Shared employees devote between 30% and 90% of their time to
the Company, depending on their responsibilities. The Company believes that the amounts charged by the Company are representative of the respective employees' activities.
In addition, the increase in operating expenses is due to an increase in general and administrative expenses. These expenses were higher in 1998 primarily due to increases in i) legal fees and settlement provisions resulting from an increase in the frequency and magnitude of litigation against the Company (See Item 3. "Legal Proceedings"); ii) depreciation and amortization primarily resulting from the addition of new computer systems in 1997 and; iii) audit fees charged by the Company's independent auditors. Also, the increase results from general and administrative expenses at the Company's auction services subsidiary.
Provision for Credit Losses. The amount provided for credit losses, as a percent of total revenue, decreased from 52.0% in 1997 to 11.5% in 1998. The provision for the year ended December 31, 1997 included a charge recorded to reflect the enhancements in the Company's methodology for estimating its reserve for Advances made possible by a new loan servicing system implemented by the Company. Utilizing the new information made available upon the successful implementation of this new system, the Company undertook an extensive review of its exposure related to dealer Advances using a static pool analysis on a per dealer basis. In order to reflect the impact of this analysis on the Company's Advance reserve, additional provisions were recorded in 1997.
The provision for credit losses consists of two components: i) a provision for loan losses for the earned but unpaid servicing fees or finance charges recognized on contractually delinquent installment contracts 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 decreases were primarily due to lower provisions needed for Advance losses, based on the Company's static pool analysis. Advance balances are continually 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 decreases were also due to lower provisions needed for loan losses primarily resulting from a decrease in the percent of non-accrual installment contracts receivable, which were 37.6% and 32.4% of gross receivables as of December 31, 1997 and 1998, respectively.
Provision for Claims. The amount provided for insurance and service contract claims, as a percent of total revenue, was 2.4% and 2.6% in 1997 and 1998, respectively. The increase corresponds with the increase, as a percent of total revenue, in premiums earned from 6.9% in 1997 to 7.7% in 1998.
The Company has established claims reserves on accumulated estimates of claims reported but unpaid plus estimates of incurred but unreported claims. The Company believes the reserves are adequate to cover future claims associated with the programs.
Interest Expense. Interest expense, as a percent of total revenue, increased from 16.8% in 1997 to 18.0% in 1998. Total interest expense decreased from $27.6 million in 1997 to $25.6 million in 1998. The $2.0 million decrease in interest expense for 1998 is primarily the result of a decrease in the amount of average outstanding borrowings, which resulted 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 for 1998 was partially offset by higher average interest rates during the year. The increase in the average interest rate is primarily the result of increases in the Company's Eurocurrency-based borrowing and facility fee margins under its credit agreement with a commercial bank syndicate, due to the downgrade of the Company's credit rating with Moody's Investor Service from Baa3 to Ba2, and with Standard and Poor's from BBB- to BB effective October 22, 1997, and a further downgrade by Moody's Investor Service on June 24, 1998 from Ba2 to Ba3. Additionally, the increase in the average interest rate is due to increases in the interest rate on outstanding borrowings under the Company's note purchase agreements resulting from amendments due to the Company's securitization of advance receivables.
Operating Income. As a result of the aforementioned factors, operating income increased from $1.3 million in 1997 to $37.6 million in 1998, a increase of $36.3 million.
Foreign Exchange Loss. The Company incurred a foreign exchange loss of $41,000 and $116,000 in 1997 and 1998, respectively. The losses were the result of exchange rate fluctuations between the U.S. dollar and foreign currency on unhedged intercompany balances between the Company and subsidiaries which operate outside the United States.
Provision (Credit) for Income Taxes. The provision (credit) for income taxes increased from ($0.2) million in 1997 to $12.6 million in 1998. The increase is due to higher pretax profits in 1998. For 1998, the effective tax rate was 33.5%. The Company provides income taxes on its foreign earnings at the statutory rate in effect for the applicable country where such earnings arise. The principal foreign earnings of the Company arise from its operations in the United Kingdom, where the statutory rate is lower than the U.S. statutory tax rate.
Year Ended December 31, 1996 Compared To Year Ended December 31, 1997
Total Revenue. Total revenue increased from $123.9 million in 1996 to $164.2 million in 1997, an increase of $40.3 million or 32.5%. This increase was primarily due to the increase in finance charge revenue resulting from an increase in the average installment contracts receivable balance. The increase in gross installment contracts receivable was primarily the result of contract originations for the period exceeding the sum of collections on installment contracts and charge offs of installment contracts for the period.
The average yield on the Company's portfolio, calculated using finance charge revenue divided by average net installment contracts receivable, was approximately 10.9% and 11.2% in 1996 and 1997, respectively. The increase in the average yield principally resulted from the Company changing its accounting policy relating to the write-off of installment contracts receivable. The revised policy requires write-off of delinquent installment contracts receivable at nine months on a recency basis compared to one year under the old policy. This change was partially offset by an increase in the percent of non-accrual installment contracts (which were 34.1% and 37.6% of contracts as of December 31, 1996 and 1997, respectively). The increase in the percent of non-accrual contracts was principally due to a change in the Company's non-accrual policy in 1997 to 90 days measured on a recency basis from 120 days measured on a contractual basis, as well as a maturing of the installment contract receivable portfolio due to lower origination growth. The Company implemented the change in the non-accrual policy in an effort to more quickly identify unprofitable dealer relationships.
Also contributing to the increase in total revenue was vehicle service contract fees and other income which increased as a percent of total revenue from 13.2% in 1996 to 17.4% in 1997. This increase was primarily due to fees earned from the sale of third party service contract and credit life products offered by dealers, which increased from $6.5 million in 1996 to $15.8 million in 1997, and an increase in interest earned on floor plan financing which resulted from increased floor plan balances in 1997. Earned dealer enrollment fees increased, as a percent of total revenue, from 4.1% in 1996 to 4.5% in 1997. This increase was due to the continued increase in the number of new dealers enrolling in the Company's financing program, particularly during 1996, as these fees are deferred and amortized over the estimated repayment term of the outstanding dealer Advance. Premiums earned decreased, as a percent of total revenue, from 7.7% in 1996 to 6.9% in 1997. This decrease was primarily the result of decreases, as a percent of total revenue, in premiums reinsured under the Company's service contract and credit life insurance programs.
Operating Expenses. Operating Expenses, as a percentage of total revenue, increased from 24.6% in 1996 to 28.0% in 1997. Operating expenses consist primarily of salaries and wages, general and administrative, and sales and marketing.
The increase for the period was due in part to an increase in salaries and wages expense. Salaries and wages increased due to increases in employee headcount, particularly collection personnel added to service the Company's larger installment contract portfolio. To a lesser extent, the increase is due to increases in the Company's average wage rates.
A portion of management personnel compensation paid by the Company is charged to a company controlled by the Company's Chairman (the "Affiliated Company"), based upon the percentage of time spent working for the Affiliated Company. The Company charged the Affiliated Company approximately $311,000
and $208,000 in 1996 and 1997, respectively. Shared employees devote between 30% and 90% of their time to the Company, depending on their responsibilities. The Company believes that the amounts charged by the Company are representative of the respective employees' activities.
In addition, the increase in operating expenses was due to an increase in general and administrative expenses. These expenses were higher in 1997 primarily due to: (i) an increase in depreciation and amortization resulting from the addition of new computer systems which became operational in 1997 and (ii) an increase in legal expenses resulting from the increase in the frequency and severity of litigation in 1997. In addition, this increase was due to the $500,000 write-off of computer software in 1997 no longer used in the Company's operations.
To a lesser extent, the increase in the operating expense was due to an increase in the sales and marketing expenses. The increase corresponds with the increase in earned dealer enrollment fees, as the sales commissions paid for dealer enrollments are deferred and amortized to expense over the estimated repayment term of the outstanding dealer Advance. In addition, the increase was also the result of increases in advertising and other promotions in 1997.
Provision for Credit Losses. The amount provided for credit losses, as a percent of total revenue, increased from 10.5% in 1996 to 52.0% in 1997. This increase was primarily the result of a charge recorded to reflect the enhancements in the Company's methodology for estimating its reserve for Advances made possible by a new loan servicing system implemented by the Company. Utilizing the new information made available upon the successful implementation of this new system, the Company undertook an extensive review of its exposure related to dealer Advances using a static pool analysis on a per dealer basis. In order to reflect the impact of this analysis on the Company's Advance reserve additional provisions were recorded in 1997.
Provision for Claims. The amount provided for insurance and service contract claims, as a percent of total revenue, decreased from 2.5% in 1996 to 2.4% in 1997. This decrease corresponds with decreases, as a percent of total revenue, in premiums earned from 7.7% in 1996 to 6.9% in 1997.
The Company has established claims reserves based on accumulated estimates of claims reported but unpaid, plus estimates of incurred but unreported claims. The Company believes the reserves are adequate to cover future claims associated with the programs.
Interest Expense. Interest expense, as a percent of total revenue, increased from 10.9% in 1996 to 16.8% in 1997. This increase was a result of an increase in the amount of average outstanding borrowings. To a lesser extent, interest expense increased due to a higher average interest rate. The increase in the average interest rate is primarily the result of the sale of $71.75 million in senior notes, at a fixed rate of interest, in March 1997. The increase was also attributable to the downgrade of the Company's credit rating with Moody's Investor Service from Baa3 to Ba2 and with Standard and Poor's from BBB- to BB effective October 22, 1997. As a result of these downgrades, the Company's Eurocurrency-based borrowing margins under the $250 million credit agreement were increased from 82.5 basis points to 120 basis points in accordance with the terms of the credit agreement.
Operating Income. As a result of the aforementioned factors, operating income decreased from $63.6 million in 1996 to $1.3 million in 1997, a decrease of $62.3 million or 97.9%.
Foreign Exchange Gain (Loss). The Company incurred a foreign exchange gain of $27,000 in 1996 and a foreign exchange loss of $41,000 in 1997. The gain and loss were the result of exchange rate fluctuations between the U.S. dollar and foreign currency on unhedged intercompany balances between the Company and subsidiaries which operate outside the United States.
Provision (Credit) for Income Taxes. The provision (credit) for income taxes decreased from $22.1 million in 1996 to ($0.2) million in 1997. The decrease was due to lower pretax profits in 1997.
CREDIT LOSS POLICY AND EXPERIENCE
When an installment contract is originated, the Company generally pays a cash Advance to the dealer. These Advance balances represent the Company's primary risk of loss related to the funding activity with the dealers.
The Company maintains a reserve against Advances to dealers that are not expected to be recovered through collections on the related 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. During 1997, the Company implemented a new loan servicing system which allows the Company to better estimate future collections for each dealer pool using historical loss experience and a dealer by dealer static pool analysis. The Company took a non-cash charge during 1997 to reflect the impact of this enhancement in the Company's methodology for estimating the Advance reserve. 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. 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 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 expected future 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 servicing fee or finance charge recognized on contractually delinquent accounts.
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.
During the third quarter of 1997, the Company changed its non-accrual policy from 120 days on a contractual basis to 90 days on a recency basis and, during the fourth quarter of 1997, changed its charge off policy to nine months on a recency basis from one year. The Company believes these changes will allow for earlier identification of underperforming dealer pools.
The following table sets forth information relating to charge offs, the allowance for credit losses, the reserve on Advances, and dealer holdbacks. 1998 and 1997 charge offs are based on nine month recency method; 1996 charge offs are based on one year recency method.
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 $520.6 million in 1997 to $290.6 million in 1998. 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. During 1998, the Company paid down approximately $133.7 million on its credit agreements and repaid $39.0 million on its outstanding senior notes. The positive cash flow during 1998 is primarily a result of collections on installment contracts receivable exceeding cash Advances to dealers and payments of dealer holdbacks. In addition, the Company raised approximately $49.3 million through the securitization of dealer Advances during the third quarter of 1998. To a lesser extent, the positive cash flow is a result of refunds received from the overpayment of 1997 U.S. federal income taxes. During the fourth quarter of 1997 and in 1998, the Company implemented more conservative Advance programs and reduced business with marginally profitable and unprofitable dealers in order to improve the performance of its portfolio of installment contracts. These changes have resulted in reduced levels of originations and cash Advances to dealers in the fourth quarter of 1997 and in 1998, a trend which is expected to continue in future periods. To the extent that this trend continues, the Company could continue to experience a decrease in its need for capital in future periods.
The Company has a $125 million credit agreement with a commercial bank syndicate. The facility has a commitment period through June 15, 1999 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 gross 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 December 31, 1998, there was approximately $79.0 million outstanding under this facility.
In July, 1998, the Company completed a $50 million securitization of advance receivables. Pursuant to this transaction, the Company contributed dealer Advances having a carrying amount of approximately $56 million and received approximately $49.3 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 1% with a maximum of 7.5% and is anticipated to fully amortize within thirty months. The Company receives a monthly servicing fee equal to 4% of the collections of the contributed installment contracts receivable. Except for the servicing fee, 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 agreement.
When borrowing to fund the operations of its foreign subsidiaries, the Company's policy is to borrow funds denominated in the currency of the country in which the subsidiary operates, thus mitigating the Company's exposure to foreign exchange fluctuations.
The Company maintains a significant dealer holdback on installment contracts accepted which assists the Company in funding its long-term cash flow requirements.
As the Company's $125 million credit facility expires on June 15, 1999, the Company will be required to renew the facility or refinance any amounts outstanding under this facility on or before such date. As of March 24, 1999, there was approximately $48.0 million outstanding under this facility. In addition, in 1999, the Company will have $42.2 million of principal maturing on its senior notes and $3.5 million maturing on a mortgage loan. The Company believes that the $125 million credit facility will be renewed with similar terms and a similar commitment amount and that the mortgage loan will be refinanced.
Pending the appeal of the Missouri 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. Failure to complete the refinancing or failure to obtain other financing alternatives may have a material adverse effect on the Company's operations.
MARKET RISK
The market risk discussion and the estimated amounts generated from the analysis that follows are forward-looking statements of market risk assuming certain adverse market conditions occur. Actual results in the future may differ materially due to changes in the Company's product and debt mix and developments in the financial markets.
The Company is exposed primarily to market risks associated with movements in interest rates and foreign currency exchange rates. The Company believes that it takes the necessary steps to appropriately reduce the potential impact of interest rate and foreign exchange exposures on the Company's financial position and operating performance.
Interest Rate Risk. The Company requires substantial amounts of cash to fund cash Advances to dealers in connection with the acceptance of installment contracts. The Company relies on various sources of financing to assist in funding its operations, some of which is at floating rates of interest and exposes the Company to risks associated with increases in interest rates. The Company manages such risk by converting portions of its floating rate debt to long-term fixed rates on a periodic basis, as deemed necessary.
As of December 31, 1998, the Company had $ 79.1 million of floating rate debt outstanding. For every 1% increase in interest rates, annual after-tax earnings would decrease by approximately $500,000, assuming the Company maintains a level amount of floating rate debt and assuming an immediate increase in rates.
Foreign Currency Risk. The Company is exposed to foreign currency risk from the possibility of changes in foreign exchange rates that could have a negative impact on earnings or asset and liability values from operations in foreign countries. The Company's most significant foreign currency exposure relates to the United Kingdom. It is the Company's policy to borrow and lend in local currencies to mitigate such risks. For an immediate, hypothetical 10% decrease in quoted foreign currency exchange rates, annual after tax earnings would have declined by approximately $700,000 at December 31, 1998. The potential loss in net asset values from such a decrease would be approximately $6 million as of December 31, 1998. Immediate changes in interest rates and foreign currency exchange rates discussed in the proceeding paragraphs are hypothetical rate scenarios, used to calibrate risk, and do not currently represent management's view of future market developments.
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 by the Company 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 software package. The vendor has certified to the Company that the system is year 2000 compliant. The Company has finished testing on this system as well as all other mission critical systems to ensure year 2000 compliance. All non-mission critical systems are anticipated to be year 2000 compliant by June 30, 1999.
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. While modifications and testing of all mission critical and non-mission critical systems is substantially complete, these systems will undergo additional testing in 1999.
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 $25,000 has been spent to date. 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 expects that the systems within its control will be year 2000 compliant before the end of 1999, 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. The Company has and is continuing to develop contingency plans, which document the processes necessary to maintain critical business functions should a significant third party system or mission critical internal system fail. These contingency plans generally include the repair of existing systems and, in some instances, the use of alternative systems or procedures.
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 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information called for by Item 7A is incorporated by reference from the information in Item 7 under the caption "Market Risk" in this Form 10-K.
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders Credit Acceptance Corporation:
We have audited the accompanying consolidated balance sheet of Credit Acceptance Corporation and subsidiaries (the "Company") as of December 31, 1998, and the related consolidated statements of income, shareholders' equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such 1998 consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 1998, and the results of its operations and its cash flows for the year then ended in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
Detroit, Michigan January 27, 1999
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
The Board of Directors and Shareholders Credit Acceptance Corporation:
We have audited the accompanying consolidated balance sheet of Credit Acceptance Corporation (a Michigan corporation) and subsidiaries as of December 31, 1997, and the related consolidated statements of income, shareholders' equity and cash flows for each of the two years in the period ended December 31, 1997. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Credit Acceptance Corporation and subsidiaries as of December 31, 1997, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1997 in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Detroit, Michigan February 2, 1998
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
CONSOLIDATED BALANCE SHEETS
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
See accompanying notes to consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Principal Business. Credit Acceptance Corporation and its subsidiaries ("CAC" or the "Company") is a specialized financial services company which provides funding, receivables management, collection, sales training and related products and services to automobile dealers located in the United States, the United Kingdom, Canada and Ireland. The Company assists such dealers by providing an indirect source of financing for buyers with limited access to traditional sources of consumer credit due to past credit history. Installment contracts originated and assigned to the Company by automobile dealers are generally considered to have a high risk of default. To a significantly lesser extent, CAC provides inventory floor plan financing and working capital loans for dealers secured by inventory and the related cash collections owed to the dealer by CAC.
Credit Acceptance Corporation UK, Ltd., CAC of Canada, Ltd., and Credit Acceptance Corporation of Ireland Ltd. are all wholly-owned subsidiaries of the Company which operate in their respective countries. These subsidiary companies offer essentially the same dealer programs as are offered in the United States.
The dealer assigns title to the installment contract and the security interest in the vehicle to the Company. At the time it accepts the assignment of a contract, CAC records the gross amount of the contract as a gross installment contract receivable. The Company records the amount of its servicing fee as an unearned finance charge with the remaining portion recorded as a dealer holdback. At the time of acceptance, contracts which meet certain criteria are eligible for a cash advance, which is computed on a formula basis. Advances are non-interest bearing and are secured by the cash collections on all of the installment contracts receivable assigned from an individual dealer. Dealer advances are netted against dealer holdbacks in the accompanying consolidated financial statements, as dealer holdbacks are not paid until such time as all advances related to such dealer have been recovered.
CAC collects the scheduled monthly payments based on contractual arrangements with the consumer. Monthly cash collections are remitted to the dealer subject to the Company first: (i) being reimbursed for certain collection costs associated with all installment contracts originated by such dealer; (ii) reducing the collections by the Company's servicing fee; and (iii) recovering the aggregate advances made to such dealer.
Upon enrollment into the Company's financing program, the dealer enters into a servicing agreement with CAC which defines the rights and obligations of CAC and the dealer. The servicing agreement may be terminated by the Company or by the dealer (so long as there is no event of default or an event which with the lapse of time, giving of notice or both, would become an event of default) upon 30 days prior written notice. The Company may also terminate the servicing agreement immediately in the case of an event of default by the dealer. Upon any termination by the dealer or in the event of a default, the dealer must immediately pay the Company: (i) any unreimbursed collection costs; (ii) any unpaid advances and all amounts owed by the dealer to the Company; and (iii) a termination fee equal to the unearned finance charge of the then outstanding amount of the installment contracts originated by such dealer and accepted by the Company.
Ancillary Products and Services. Credit Acceptance Corporation Life Insurance Company ("CAC Life"), Buyers Vehicle Protection Plan, Inc. ("BVPP") and Credit Acceptance Reinsurance, LTD. ("CAC Reinsurance"), all wholly-owned subsidiaries of the Company, provide additional services to participating dealers.
CAC Life is engaged primarily in the business of reinsuring credit life and disability insurance policies issued to borrowers under installment contracts originated by participating dealers. CAC advances to dealers an amount equal to the credit life and disability insurance premium on contracts accepted by the Company which include credit life and disability insurance written by the Company's designated insurance carriers. The policies insure the holder of the installment contract for the outstanding balance payable in the event of death or disability of the debtor. Premiums are ceded to CAC Life on both an earned and written basis and are earned over the life of the contracts using pro rata and sum-of-digits methods. CAC Life bears the risk of loss attendant to claims under the coverages ceded to it. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) BVPP administers short-term limited extended service contracts offered by participating dealers. In connection therewith, BVPP bears the risk of loss for any repairs covered under the service contract. Income is recognized on a straight-line basis over the life of the service contracts. In addition, BVPP has relationships with third party service contract providers which pay BVPP a fee on service contracts included on installment contracts financed through participating dealers. BVPP does not bear any risk of loss for covered claims on these third party service contracts. The income from the non-refundable fee is recognized upon acceptance of the installment contract. The Company advances to dealers an amount equal to the purchase price of the vehicle service contract on contracts accepted by the Company which include vehicle service contracts.
CAC has arrangements with insurance carriers and a third party administrator to market and provide claims administration for a dual interest collateral protection program. This insurance program, which insures the financed vehicle against physical damage up to the lesser of the cost to repair the vehicle or the unpaid balance owed on the related installment contract, is made available to borrowers who finance vehicles through participating dealers. If desired by a borrower, collateral protection insurance coverage is written under group master policies issued by unaffiliated insurance carriers to the Company. As part of the program, the insurance carriers cede insurance coverages and premiums (less a fee) to CAC Reinsurance, which acts as a reinsurer of such coverages. As a result, CAC Reinsurance bears the risk of loss attendant to claims under the coverages ceded to it, and earns revenues resulting from premiums ceded and the investment of such funds.
Other Services. Montana Investment Group, Inc. ("Montana") and Arlington Investment Company ("Arlington"), wholly-owned subsidiaries of the Company, provide additional sources of revenue to the Company. Montana supplies risk assessment and fraud alert information and computerized skiptracing services regarding borrowers to companies serving the Non-prime Consumer market. Arlington provides a full range of auction services to vehicle suppliers to process and sell vehicles to buyers at auctions.
Significant accounting policies are described in the following paragraphs.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated.
REPORTABLE BUSINESS SEGMENTS
The Company is organized into four primary business units: North American automotive finance, U.K./ Ireland automotive finance, credit reporting services, and auction services. See Note 12 for information regarding the Company's reportable segments.
USE OF ESTIMATES
The accounting and reporting policies of the Company require management to make estimates and assumptions 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. The accounts which are subject to such estimation techniques include the reserve against advances and the allowances for credit losses. Actual results could differ from those estimates.
FOREIGN CURRENCY TRANSLATION
The financial position and results of operations of the Company's foreign operations are measured using the local currency as the functional currency. Revenues and expenses are translated at average exchange rates during the year and assets and liabilities are translated at current exchange rates at the balance sheet date. Translation adjustments are accumulated as a separate component of shareholders' equity.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) On January 1, 1999, 11 of 15 member countries of the European Monetary Union established fixed conversion rates between their existing currencies and adopted the euro as their new common currency. The euro trades on currency exchanges and the legacy currencies remain legal tender in the participating countries for a transition period until January 1, 2002. Beginning on January 1, 2002, euro denominated bills and coins will be issued and legacy currencies will be withdrawn from circulation.
The Company will assess and address the potential impact to CAC that may result from the euro conversion, as the Company has operations in both the United Kingdom and Ireland. These issues include, but are not limited to: 1) the technical challenges to adapt information systems to accommodate euro transactions; 2) the impact on currency exchange rate risks; 3) the impact on existing contracts; and 4) tax and accounting implications. The Company expects that the euro conversion will not have a material adverse impact on its consolidated financial condition or results of operations.
CASH AND CASH EQUIVALENTS
Cash equivalents consist of readily marketable securities with original maturities of three months or less.
INVESTMENTS
Investments consist principally of short-term money market funds and U.S. Treasury Securities which the Company has both the intent and the ability to hold to maturity.
INSTALLMENT CONTRACTS RECEIVABLE
Installment contracts receivable are collateralized by vehicle titles, and the Company has the right to repossess the vehicle in the event that the consumer defaults on the payment terms of the contract. 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 installment contracts receivable on the balance sheets. At December 31, 1998 and 1997, repossessed assets totaled approximately $10.2 million and $13.8 million, respectively.
The Company changed its policy relating to non-accrual loans in the third quarter of 1997 to 90 days measured on a recency basis from 120 days measured on a contractual basis. The Company believes this change allows for earlier identification of underperforming dealer pools.
During the fourth quarter of 1997, the Company changed its accounting policies relating to the write-off of installment contracts receivable based on data available from the Company's new loan servicing system. The revised policy requires write-off of delinquent installment contracts at nine months on a recency basis compared to one year under the old policy.
ALLOWANCE FOR CREDIT LOSSES
The Company maintains an allowance for credit losses which, in the opinion of management, adequately reserves against credit losses on installment contracts that are considered to be impaired. The risk of loss to the Company related to the installment contracts receivable balances relates primarily to the earned but unpaid servicing fee or finance charge recognized on contractually delinquent accounts. To the extent that the Company does not collect the gross amount of the contract balance, the remaining gross installment contract receivable balance is charged off against dealer holdbacks, unearned finance charges and the allowance for credit losses. Ultimate losses may vary from current estimates and the amount of the provision, which is current expense, may be either greater or less than actual charge-offs.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) RESERVE ON ADVANCES
When an installment contract is accepted, the Company generally pays a cash advance to the dealer. These advance balances represent the Company's primary risk of loss related to the funding activity with the dealers. The Company maintains a reserve on advances to dealers which reflects advance balances that are not expected to be recovered through collections on the related installment contract receivable portfolio. To serve as a basis for evaluating the reserve requirement, management reviews delinquencies, charge-off experience factors, the payment performance of loan pools, changes in collateral value, economic conditions and trends and other information. For purposes of establishing the reserve, future collections (including the anticipated proceeds from repossessed collateral) 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.
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. Estimating cash collections from the installment contracts receivable is complicated by the unusual payment patterns of the borrowers who generally cannot obtain traditional financing. The evaluation of the reserve against advances considers such factors as current delinquencies, the characteristics of the accounts, the value of the underlying collateral, the location of the borrower, general economic conditions and trends among other information. Although the Company uses many resources to assess the adequacy of the reserve against advances, actual losses may vary significantly from current estimates and the amount of provision, which is a current expense, may be either greater or less than actual charge offs.
FLOOR PLAN RECEIVABLES
CAC finances used vehicle inventories for both affiliated dealers and nonaffiliated dealers. Amounts loaned are secured by the related inventories and any future cash collections owed to the dealer on outstanding contracts.
NOTES RECEIVABLE
Notes receivable are primarily working capital loans to dealers and are due on demand. These notes receivable are secured by all assets of the dealer including any future cash collections owed to the dealer on outstanding contracts.
ADVANCE RECEIVABLE SALES
When the Company sells advance receivables in securitizations, it retains interest-only strips and servicing rights all of which are retained interests in the securitized assets. Gain or loss on sale of the advance receivables depends in part on the previous carrying amount of retained interests in advances, allocated in proportion to their fair value. To obtain fair values, quoted market prices are used if available. However, quotes are generally not available for retained interests, so the Company generally estimates fair value based on the present value of future cash flows expected under management's best estimates of the key assumptions -- credit losses, timing of projected collections, and discount rates commensurate with the risks involved.
The Company evaluates the fair value and potential impairment of its retained interest in securitization on a quarterly basis utilizing the methodology described above.
PROPERTY AND EQUIPMENT
Additions to property and equipment are recorded at cost. Depreciation is generally provided on a straight-line basis over the estimated useful lives (primarily five to forty years) of the assets. The cost of assets sold or retired and the related accumulated depreciation are removed from the accounts at the time of
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED) disposition and any resulting gain or loss is included in operations. Maintenance, repairs and minor replacements are charged to operations as incurred; major replacements and betterments are capitalized.
GOODWILL
The Company's goodwill represents the excess of cost over the fair value of assets acquired and is amortized using the straight-line method over ten years. Based on management's review of the goodwill, the Company believes that no material impairment of the asset exists. Goodwill, net of amortization of $181,000, is recorded in other assets at $2,919,000 at December 31, 1998. Prior to 1998, no goodwill was recorded in the financial statements.
DEALER HOLDBACKS
As part of the dealer servicing agreement, the Company establishes a dealer holdback to protect the Company from potential losses associated with installment contracts. This dealer holdback is not paid until such time as all advances related to such dealer have been recovered.
INCOME TAXES
Deferred income taxes are provided for all temporary differences between the book and tax basis of assets and liabilities. Deferred income taxes are adjusted to reflect new tax rates when they are enacted into law.
REVENUE RECOGNITION
Finance Charges. The Company computes its servicing fee based upon the gross amount due under the installment contract. Income is 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.
Premiums Earned. Credit life and disability premiums are ceded to CAC Life and collision premiums are ceded to CAC Reinsurance on both an earned and written basis and are earned over the life of the contracts using the pro rata and sum-of-digits methods. Premiums on BVPP warranties are earned on a straight-line basis over the life of the service contracts.
Dealer Enrollment Fees. Enrollment fees are paid by each dealer in the United States and Canada signing a servicing agreement and are nonrefundable. These fees and the related direct incremental costs of originating these fees are deferred and amortized on a straight-line basis over the estimated repayment term of the outstanding dealer advance.
Other Income. Dealers are charged an initial fee to floor plan a vehicle. Interest is charged based on the number of days a vehicle remains on the floor plan. Interest rates typically range from 12% to 18% per annum.
Interest on notes receivable is charged based on the outstanding monthly balance and is typically 4% above prime per annum, generally with a minimum rate of 12% per annum.
Fees received by the Company for the sale of third party vehicle service contracts are recognized upon acceptance of the related installment contract receivable as the Company bears no further obligation.
NEW ACCOUNTING STANDARDS
Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS 130"). SFAS 130 establishes standards for reporting and displaying comprehensive income and its components in annual financial statements. The Company's other comprehensive income consists of foreign currency transaction adjustments.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONCLUDED) Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 supersedes SFAS 14, "Financial Reporting for Segments of a Business Enterprise," replacing the "industry segment" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. SFAS 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of SFAS 131 did not affect results of consolidated operations or financial position of the Company, but did affect the disclosure of segment information as illustrated in Note 12.
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. The new standard requires that all derivatives be recognized as either assets or liabilities on the consolidated balance sheets and that those instruments be measured fair value. If certain conditions are met, a derivative may be specifically designated as a hedging instrument. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company does not believe that adoption of SFAS 133 will have a material effect on the Company's consolidated financial position or results of operations.
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. CAC adopted SOP 98-1 effective January 1, 1999, as required. Management is currently assessing the impact of this SOP on the consolidated financial statements of the Company.
RECLASSIFICATION
Certain amounts for the prior periods have been reclassified to conform to the current presentation.
(2) FINANCIAL INSTRUMENTS
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate their value.
Cash and Cash Equivalents. The carrying amount of cash and cash equivalents approximate the fair values due to the short maturity of these instruments.
Investments. The fair values of U.S. Treasury securities are based on quoted market prices. The carrying amount of money market funds approximates the fair value due to the short maturity.
Installment Contracts Receivable and Net Dealer Holdbacks. As the majority of the Company's revenue is derived from the servicing fee it receives on the gross amount due under the installment contract (typically 20% of the principal and interest), the Company's revenues from servicing fees are not materially impacted by changes in interest rates. As such, the carrying amounts recorded on a historical cost basis for installment contracts receivable and net dealer holdbacks in the financial statements related to the financing and service program which the Company provides to dealers approximates fair value.
Floor Plan and Notes Receivable. The fair values of floor plan and note receivables are estimated by discounting the future cash flows using applicable current interest rates. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) FINANCIAL INSTRUMENTS -- (CONCLUDED) Retained Interest in Securitization. The fair value of the retained interest in securitization is estimated by discounting expected future excess cash flows utilizing current assumptions as described in Note 4.
Debt. The fair value of debt is determined using quoted market prices, if available, or calculating the estimated value of each debt instrument based on current rates offered to the Company for debt with similar maturities.
A comparison of the carrying value and fair value of these financial instruments is as follows (in thousands):
CERTAIN DEBT AND MARKETABLE SECURITIES
The Company's portfolio of investment securities includes short-term money market instruments and U.S. Treasury securities. All investments are categorized as held-to-maturity and are stated at amortized cost. Pursuant to reinsurance agreements, the Company is required to hold investment securities in a trust account. The restricted investment securities totaled approximately $9.4 million and $8.9 million at December 31, 1997 and 1998, respectively.
A summary of investments held by the Company consist of the following (in thousands):
(3) INSTALLMENT CONTRACTS RECEIVABLE
Installment contracts generally have initial terms ranging from 24 to 36 months and are collateralized by the related vehicles. Contractual maturities of contracts by year have not been presented as this information is not meaningful due to the uneven payment patterns of non-prime consumers. The initial average term of an installment contract was approximately 30 months in 1996 and 31 months in 1997 and in 1998. As of December 31, 1997 and 1998, the accrual of finance charge revenue has been suspended, and fully reserved
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(3) INSTALLMENT CONTRACTS RECEIVABLE -- (CONCLUDED) for, on approximately $471.8 million and $257.5 million of delinquent installment contracts, respectively. Installment contracts receivable consisted of the following (in thousands):
A summary of changes in gross installment contracts receivable is as follows (in thousands):
A summary of the allowance for credit losses is as follows (in thousands):
Recoveries related to charged off contracts are primarily the result of the recovery of earned but unpaid finance charges and are netted against charge-offs.
The Company's financing and service program allows dealers to establish the interest rate on contracts, which typically is the maximum rate allowable by the state or country in which the dealer is doing business.
(4) ADVANCE RECEIVABLE SALES
On July 8, 1998, the Company completed a $50 million securitization of advance receivables. Pursuant to this transaction, the Company contributed dealer advances having a carrying value of approximately $56 million and received approximately $49.3 million in financing from an institutional investor. The debt is
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) ADVANCE RECEIVABLE SALES -- (CONCLUDED) non-recourse to the Company, bears interest at the thirty day commercial paper rate with a maximum of 7.5% and is anticipated to fully amortize within 30 months. The Company recognized a gain on the transaction of approximately $685,000 which represents the difference between the sale proceeds to the Company, net of transaction costs, and the Company's carrying amount of the dealer advances, plus the present value of the estimated cash flows to be received by the Company. In determining the gain on the sale of receivables and the estimated fair value of the Company's retained interest in securitization, the Company assumed an excess cash flow discount rate of 15%, cumulative credit losses of 14% and an interest rate of 7.5% on the underlying debt. The excess cash flows result from the amount by which projected collections on the installment contracts exceeds i) the principal and interest to be paid on the commercial paper and ii) the amount of dealer holdback due to dealers.
In the securitization, the Company retained servicing responsibilities and subordinated interests. The Company receives monthly servicing fees of 4% of the collections on the installment contracts receivable, and rights to future cash flows arising after the investors in the commercial paper received the return for which they are contracted. The present value of such estimated cash flows has been recorded by the Company as a retained interest in securitization of $13.2 million as of December 31, 1998. The investors have no recourse to the Company's other assets for failure of debtors to pay when due. The Company's retained interests are generally restricted until investors have been fully paid and are subordinate to investors' interests. Their value is subject to substantial credit and interest rate risk and the timing of projected collections on the transferred financial assets.
The installment contracts supporting the dealer advances that were sold include contracts with origination dates ranging from July 1990 to June 1998, with a weighted average age of 15 months. The amount of such contracts included on the Company's balance sheet as of June 30, 1998 was $98.6 million, of which $43.8 million was in non-accrual status.
(5) PROPERTY AND EQUIPMENT
Property and equipment consists of the following at December 31 (in thousands):
The depreciation expense on the property and equipment was $1,369,000, $2,550,000 and $3,793,000 in 1996, 1997 and 1998, respectively.
(6) LEASED PROPERTIES
PROPERTY LEASED TO OTHERS
The Company leases part of its headquarters to outside parties as non-cancelable operating leases, which is not a significant part of its business activities. Rental income, which is included in other income, is recognized on a straight-line basis over the related lease term. Rental income on leased property was $1,255,000, $991,000 and $997,000 for 1996, 1997 and 1998, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) LEASED PROPERTIES -- (CONCLUDED) PROPERTY LEASED FROM OTHERS
The Company utilizes leases in its day to day operations for administrative offices, auction facilities and office equipment. Management expects that in the normal course of business, leases will be renewed or replaced by other leases. One of the auction facility leases expires in June 1999 and the Company has an option to purchase the property.
Total rental expense on all operating leases was $175,000, $242,000 and $388,000 for 1996, 1997 and 1998, respectively. Contingent rentals under the operating leases were insignificant. Minimum future lease commitments under operating leases are as follows:
(7) DEBT
SENIOR NOTES
On November 7, 1994, the Company completed the sale of its $60 million 8.87% Senior Notes due November 1, 2001 to various insurance companies. On July 1, 1998, the interest rate on these notes was increased to 9.12%. The Notes are secured and require semi-annual interest payments and annual payments of principal.
On August 29, 1996, the Company completed the sale of its $70 million 7.99% Senior Notes due July 1, 2001 to various insurance companies. On July 1, 1998, the interest rate on these notes was increased to 8.24%. The Notes are secured and require semi-annual interest payments and annual payments of principal.
On March 25, 1997, the Company completed the sale of its $71.75 million 7.77% Senior Notes due October 1, 2001 to various insurance companies. On July 1, 1998, the interest rate on these notes was increased to 8.02%. The Notes are secured and require semi-annual payments of interest and annual payments of principal commencing on October 1, 1998.
MORTGAGE LOAN PAYABLE
The Company has a loan from its principal commercial bank secured by a mortgage on the Company's headquarters building. The loan bears interest at 6.5% and is secured by a first mortgage lien on the building and an assignment of all leases, rents, revenues and profits under all present and future leases. There was $3,799,000 and $3,566,000 outstanding on this loan as of December 31, 1997 and 1998, respectively. The loan matures on May 1, 1999.
LINES OF CREDIT
The Company has a $125 million credit agreement with a commercial bank syndicate with a commitment period through June 15, 1999 subject to annual extensions for additional one year periods at the request of the Company and with the consent of each of the banks in the facility. The borrowings are secured by a lien on most of the Company's assets, including a pledge of the stock in its United Kingdom subsidiary, with interest payable at the Eurocurrency rate plus 1.4% or at the prime rate (7.75% as of December 31, 1998). The Eurocurrency borrowings may be fixed for periods of up to six months. The Company must pay an agent's fee
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) DEBT -- (CONCLUDED) of $48,000 annually and a commitment fee of .60% quarterly on the amount of the commitment. As of December 31, 1998, there was approximately $79.0 million outstanding under this facility. The maximum amount outstanding was approximately $213.4 million and $210.2 million in 1997 and 1998, respectively. The weighted average balance outstanding was $172.5 million and $143.4 million in 1997 and 1998, respectively.
The Company also has a $1,000,000 Canadian dollar line of credit with a commercial bank in Canada, which is used to fund the day to day cash flow requirements of the Company's Canadian subsidiary. The borrowings are unsecured, guaranteed by the Company, with interest payable at the Libor rate plus 1.4% or at the Canadian bank's prime rate (6.75% at December 31, 1998). As of December 31, 1998, there was approximately $125,000 Canadian dollars ($80,000 U.S. dollars) outstanding under the facility.
The Company also has a $1,200,000 line of credit with a commitment period through May 16, 1999 with a commercial bank which is used to fund the day to day operations of its auction services subsidiary. The borrowings are secured by the assets of the Company's auction services subsidiary and by a $500,000 letter of credit issued by the Company's principal commercial bank, with interest payable at the bank's prime rate. As of December 31, 1998, there was approximately $1,000,000 outstanding under the facility.
The weighted average interest rate on line of credit borrowings outstanding was 7.34% and 6.89% as of December 31, 1997 and 1998, respectively.
PRINCIPAL DEBT MATURITIES
The principal maturities of the Company's total debt at December 31, 1998 are as follows (in thousands):
DEBT COVENANTS
The Company must comply with various restrictive debt covenants which require the maintenance of certain financial ratios and other financial conditions. The most restrictive covenants limit the ratio of the Company's debt-to-equity, limit the ratio of the Company's fixed charges to net income, limit the Company's investment in its foreign subsidiaries, limit the ratio of debt to advances, limit the ratio of debt to gross installment contracts receivable, limit the ratio of advances to installment contracts receivable, and require that the Company maintain specified minimum levels of net worth.
(8) DEALER HOLDBACKS AND RESERVE ON ADVANCES
Dealer holdbacks consisted of the following (in thousands):
During 1997, the Company implemented a new loan servicing system which allows the Company to better estimate future collections for each dealer pool using historical loss experience and a dealer by dealer
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) DEALER HOLDBACKS AND RESERVE ON ADVANCES -- (CONCLUDED) static pool analysis. The Company took a charge during 1997 to reflect the impact of this enhancement in the Company's methodology for estimating the reserve. During the fourth quarter of 1997, the Company reevaluated the timing of the charge off of advances to dealers and concluded that it was appropriate to accelerate the recognition of charge offs since the static pool analysis demonstrated that the advances were uncollectible.
A summary of the change in the reserve against advances (classified with dealer holdbacks, net in the accompanying balance sheets) is as follows (in thousands):
(9) RELATED PARTY TRANSACTIONS
In the normal course of its business, the Company regularly accepts assignments of installment contracts originated by affiliated dealers owned by the Company's majority shareholder. Installment contracts accepted from affiliated dealers were approximately $25.6 million, $13.4 million and $10.0 million in 1996, 1997 and 1998, respectively. Remaining installment contracts receivable from affiliated dealers represented approximately 3.9% and 1.6% of the gross installment contracts receivable balance as of December 31, 1997 and 1998, respectively. The Company accepted installment contracts from affiliated dealers and nonaffiliated dealers on the same terms. Dealer holdbacks from contracts accepted from affiliated dealers were approximately $20.5 million, $10.7 million and $8.0 million in 1996, 1997 and 1998, respectively.
The Company receives interest income and fees from affiliated dealers on floor plan receivables and notes receivable. Total income earned was $1,409,000, $1,564,000 and $1,187,000 for the years ended December 31, 1996, 1997 and 1998, respectively.
The Company shares certain expenses including payroll and related benefits, occupancy costs and insurance with its affiliated company owned by the Company's majority shareholder. For the years ended December 31, 1996, 1997 and 1998, the Company charged its affiliated company approximately $311,000, $247,000 and $248,000, and was charged $97,000, $45,000 and $80,000 by the affiliated company for such shared expenses incurred in its operations. This arrangement is covered under a services agreement. The agreement has an indefinite term, but may be terminated upon 30 days written notice by either party.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) INCOME TAXES
The income tax provision (credit) consists of the following (in thousands):
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities consist of the following (in thousands):
No valuation allowances were considered necessary in the calculation of deferred tax assets as of December 31, 1997 and 1998.
The Company's effective income tax rate was approximately equal to the domestic and foreign statutory rates in 1996, 1997 and 1998.
Deferred U.S. federal income taxes and withholding taxes have not been provided on the undistributed earnings of the Company's foreign subsidiaries as such amounts are considered to be permanently reinvested. The cumulative undistributed earnings at December 31, 1998 on which the Company had not provided additional national income taxes and withholding taxes were approximately $21.1 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) CAPITAL TRANSACTIONS
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 which would have a dilutive effect.
The share effect is as follows:
CAPITAL STOCK TRANSACTIONS
On December 11, 1996, the Company acquired all of the outstanding shares of Montana Investment Group, Inc. in exchange for a total of 200,000 shares of the Company's common stock which were issued to two shareholders of Montana. The acquisition has been accounted for under the pooling of interests method. The impact of this acquisition was not significant to the Company's financial statements. The issuance of such shares was exempt from registration under Section 4(2) of the Securities Act of 1933. On May 19, 1997, CAC's Board of Directors and shareholders approved an amendment to the Articles of Incorporation of the Company increasing the number of authorized Common shares to 80,000,000.
STOCK OPTION PLANS
Pursuant to the Company's 1992 Stock Option Plan (the "1992 Plan"), the Company has reserved 5,000,000 shares of its common stock for the future granting of options to officers and other employees. The exercise price of the options is equal to the fair market value on the date of the grant. Options under the 1992 Plan become exercisable over a three to five year period, or immediately upon a change of control. Nonvested options are forfeited upon termination of employment and otherwise expire ten years from the date of grant. Shares available for future grants totaled 1,179,559, 967,066 and 115,559 as of December 31, 1996, 1997 and 1998, respectively.
Pursuant to the Company's Stock Option Plan for dealers (the "Dealer Plan") the Company has reserved 1,000,000 shares of its common stock for the future granting of options to participating dealers. Options are generally granted to participating dealers based on the Company accepting a minimum of 100 retail installment contracts from the dealer in a calendar year. Upon the Company's acceptance of 100 contracts from a dealer, the dealer receives an option to purchase 1,000 shares of the Company's Common Stock. The dealer receives an option to purchase an additional 200 shares for each additional 100 contracts accepted by the Company. The exercise price of the options is equal to the fair market value on the date of grant. The options become exercisable over a three year period. Nonvested options are forfeited upon the termination of the dealer's servicing agreement by the Company or the dealer and otherwise expire five years from the date of grant. Shares available for future grants totaled 235,600, 185,600 and 478,385 as of December 31, 1996, 1997 and 1998, respectively. Effective January 1, 1999, the Company suspended the granting of future options under the Dealer Plan.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) CAPITAL TRANSACTIONS -- (CONTINUED) The Company accounts for the 1992 Plan under APB Opinion No. 25, under which no compensation cost has been recognized Had compensation cost for the 1992 Plan been recognized, the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
The Company accounts for the compensation costs related to its grants under the Dealer Plan in accordance with Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS 123). The sales and marketing cost that has been charged against income for the non-employee Dealer Plan was $67,000 and $150,000 in 1997 and 1998, respectively. No costs were charged against income for 1996. Because the SFAS 123 method of accounting has not been applied to options granted prior to January 1, 1995 (December 15, 1995 for the Dealer Plan), the resulting cost is not necessarily indicative of costs which may be recognized in future years.
The fair value of each option granted included in the above calculations is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) CAPITAL TRANSACTIONS -- (CONTINUED) Additional information relating to the Stock Option Plans are as follows:
Options granted and options forfeited under the 1992 Plan for 1997 include 1,713,577 options which were repriced on November 3, 1997. The options which were repriced were originally granted between September 30, 1995 and September 2, 1997 with original exercise prices between $12.75 and $27.50. These options were cancelled on November 3, 1997 and reissued at an exercise price of $6.00 per share with a new three year vesting period.
The weighted average fair value of options granted during 1996, 1997 and 1998 was $10.92, $4.68 and $5.09 respectively, for the 1992 Plan and $8.88, $4.06 and $3.98, respectively, for the Dealer Plan.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) CAPITAL TRANSACTIONS -- (CONCLUDED) The following tables summarize information about options outstanding at December 31, 1998:
(12) BUSINESS SEGMENT INFORMATION
As described in Note 1, the Company adopted SFAS 131 effective January 1, 1998. Prior year segment information has been restated on a basis consistent with the 1998 presentation. The Company has two reportable business segments: North American automotive finance and U.K./Ireland automotive finance.
REPORTABLE SEGMENT OVERVIEW
The North American automotive finance operations consist of the Company's U.S. and Canadian automotive finance and services businesses, including the Company's reinsurance activities and automotive service contract programs. These businesses have been aggregated into one reportable segment because they have similar operating and economic characteristics. The North American automotive finance segment provided funding, receivables management, collection, sales training and related products and services to automobile dealers located in the United States and Canada. The U.K./Ireland automotive finance operations provide substantially the same products and services as the Company's North American automotive finance operations to dealers located in the United Kingdom and Ireland. The Company's credit reporting and auction services businesses do not constitute reportable operating segments as they do not meet the quantitative thresholds prescribed by SFAS 131, and have therefore been disclosed in the "all other" category in the following table.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) BUSINESS SEGMENT INFORMATION -- (CONCLUDED) MEASUREMENT
The Company allocates resources to and evaluates the performance of its segments primarily based on finance charges, other revenue, segment earnings before interest and taxes (EBIT), and segment assets. The table below presents this information for each reportable segment (in thousands):
INFORMATION ABOUT PRODUCTS AND SERVICES
The Company manages its product and service offerings primarily through those reportable segments. Therefore, pursuant with the provisions of SFAS 131, no enterprise-wide disclosures of information about products and services are necessary.
MAJOR CUSTOMERS
The Company did not have any customer which provided 10% or more of any segment's revenue during 1996, 1997, or 1998.
(13) LITIGATION AND CONTINGENT LIABILITIES
In the normal course of business and as a result of the consumer-oriented nature of the industry in which the Company operates, industry participants are frequently subject to various consumer claims and litigation seeking damages and statutory penalties. The claims allege, among other theories of liability, violations of state, federal and foreign truth in lending, credit availability, credit reporting, consumer protection, warranty, debt collection, insurance and other consumer-oriented laws and regulations. The Company, as the assignee of finance contracts originated by dealers, may also be named as a co-defendant in lawsuits filed by consumers principally against dealers. Many of these cases are filed as purported class actions and seek damages in large dollar amounts.
The Company is currently a defendant in a class action proceeding commenced on October 15, 1996 in the United States District Court for the Western District of Missouri seeking money damages resulting for alleged violations of a number of state and federal consumer protection laws (the "Missouri Litigation"). On October 9, 1997, the Court certified two classes on the claims brought against the Company. On August 4, 1998, the Court granted partial summary judgment on liability in favor of the plaintiffs based upon the Court's
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) LITIGATION AND CONTINGENT LIABILITIES -- (CONCLUDED) finding of certain violations but denied summary judgment on certain other claims. The Court also entered a number of permanent injunctions, which among other things, restrain the Company from collecting the amounts found to be uncollectible. The Court also ruled in favor of the Company on certain claims raised by class plaintiffs. Because the entry of an injunction is immediately appealable as of right, the Company has appealed the summary judgment order to the United States Court of Appeals for the Eighth Circuit and the Company believes that its appeal has substantial merit. Plaintiffs have filed a cross appeal. A trial on the remaining claims, as well as on damages, is not expected to be scheduled until after the appeal has been concluded. Should the Company's appeal be unsuccessful, the potential damages could have a material adverse impact on the Company's financial position, liquidity and results of operations.
During the first quarter of 1998, several putative class action complaints were filed 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 alleges 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 that such results contained material accounting irregularities in that they failed to reflect adequate reserves for credit losses. The Complaint further alleges that the Company issued public statements during the alleged class period which fraudulently created the impression that the Company's accounting practices were proper. The Company intends to vigorously defend this action and, while management believes that meritorious defenses exist and has filed a motion to dismiss the Complaint, the ultimate disposition of this litigation could have a material adverse impact on the Company's financial position, liquidity and results of operations.
The Company is currently being examined by the Internal Revenue Service. While the outcome of the examination is undeterminable at this time, management does not believe that the ultimate outcome will have a material adverse impact on the Company's financial position, liquidity or results of operations.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a summary of quarterly financial position and results of operations for the years ended December 31, 1997 and 1998.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(14) QUARTERLY FINANCIAL DATA (UNAUDITED) -- (CONCLUDED)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not Applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information is contained under the captions "Matters to Come Before the Meeting -- Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
Information is contained under the caption "Compensation of Executive Officers" (excluding the Report of the Executive Compensation Committee and the stock performance graph) in the Company's Proxy Statement and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information is contained under the caption "Common Stock Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information is contained under the caption "Certain Relationships and Transactions" in the Company's Proxy Statement and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
The following documents are filed as part of this report. Those exhibits previously filed and incorporated herein by reference are identified below. Exhibits not required for this report have been omitted.
1 Reference to the Company's Registration Statement on Form S-1, File No. 33-46772.
2 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1994, and incorporated herein by reference.
3 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1994, and incorporated herein by reference.
4 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1995, and incorporated herein by reference.
5 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1996, and incorporated herein by reference.
6 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1996 and incorporated herein by reference.
7 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1996, and incorporated herein by reference.
8 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1997 and incorporated herein by reference.
9 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended June 30, 1997, and incorporated herein by reference.
10 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1997, and incorporated herein by reference.
11 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1998 and incorporated herein by reference.
12 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended June 30, 1998, and incorporated herein by reference.
13 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1998, and incorporated herein by reference.
14 Filed herewith
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 24, 1999.
CREDIT ACCEPTANCE CORPORATION
By: /s/ DONALD A. FOSS ------------------------------------ Donald A. Foss Chairman of the Board, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on March 24, 1999 on behalf of the registrant and in the capacities indicated.
EXHIBIT INDEX
1 Reference to the Company's Registration Statement on Form S-1, File No. 33-46772.
2 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1994, and incorporated herein by reference.
3 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1994, and incorporated herein by reference.
4 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1995, and incorporated herein by reference.
5 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1996, and incorporated herein by reference.
6 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1996 and incorporated herein by reference.
7 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1996, and incorporated herein by reference.
8 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1997 and incorporated herein by reference.
9 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended June 30, 1997, and incorporated herein by reference.
10 Previously filed as an exhibit to the Company's Form 10-K Annual Report for the year ended December 31, 1997, and incorporated herein by reference.
11 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended March 31, 1998 and incorporated herein by reference.
12 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended June 30, 1998, and incorporated herein by reference.
13 Previously filed as an exhibit to the Company's Form 10-Q for the quarterly period ended September 30, 1998, and incorporated herein by reference.
14 Filed herewith