UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______________ to _______________
Commission File Number 000-20202
CREDIT ACCEPTANCE CORPORATION
(Exact name of registrant as specified in its charter)
MICHIGAN 38-1999511
(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification)
25505 WEST TWELVE MILE ROAD, SUITE 3000
SOUTHFIELD, MICHIGAN 48034-8339
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: 248-353-2700
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate the number of shares outstanding of each of the issuer's class of
common stock, as of the latest practicable date.
The number of shares of Common Stock, par value $0.01, outstanding on October
27, 2006 was 30,100,102.
TABLE OF CONTENTS
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Income Statements -
Three and nine months ended September 30, 2006 and 2005 1
Consolidated Balance Sheets -
As of September 30, 2006 and December 31, 2005 2
Consolidated Statements of Cash Flows -
Nine months ended September 30, 2006 and 2005 3
Notes to Consolidated Financial Statements 4
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS 26
ITEM 4. CONTROLS AND PROCEDURES 26
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 27
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS 28
ITEM 6. EXHIBITS 28
SIGNATURES 29
INDEX OF EXHIBITS 30
PART I. - FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED INCOME STATEMENTS
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
(Dollars in thousands, except per share data) 2006 2005 2006 2005
----------- ----------- ----------- -----------
REVENUE:
Finance charges $ 47,474 $ 45,047 $ 141,400 $ 131,380
License fees 3,599 2,658 9,700 6,870
Other income 4,329 3,918 12,409 11,445
----------- ----------- ----------- -----------
Total revenue 55,402 51,623 163,509 149,695
----------- ----------- ----------- -----------
COSTS AND EXPENSES:
Salaries and wages 10,666 9,497 31,279 27,503
General and administrative 6,063 5,440 19,125 16,855
Sales and marketing 3,942 4,160 11,707 10,956
Provision for credit losses 4,404 4,703 7,569 7,373
Interest 5,837 3,655 15,071 11,011
Stock-based compensation 242 491 188 1,756
Other expense 40 489 177 890
----------- ----------- ----------- -----------
Total costs and expenses 31,194 28,435 85,116 76,344
----------- ----------- ----------- -----------
Operating income 24,208 23,188 78,393 73,351
Foreign currency gain (loss) 1 (8) 12 1,019
----------- ----------- ----------- -----------
Income from continuing operations before
provision for income taxes 24,209 23,180 78,405 74,370
Provision for income taxes 8,775 9,231 28,067 28,288
----------- ----------- ----------- -----------
Income from continuing operations 15,434 13,949 50,338 46,082
----------- ----------- ----------- -----------
Discontinued operations
(Loss) gain from discontinued United Kingdom
operations (132) 922 (277) 1,807
(Credit) provision for income taxes (40) 277 (84) 528
----------- ----------- ----------- -----------
(Loss) gain on discontinued operations (92) 645 (193) 1,279
----------- ----------- ----------- -----------
Net income $ 15,342 $ 14,594 $ 50,145 $ 47,361
=========== =========== =========== ===========
Net income per common share:
Basic $ 0.46 $ 0.39 $ 1.47 $ 1.28
=========== =========== =========== ===========
Diluted $ 0.44 $ 0.38 $ 1.38 $ 1.21
=========== =========== =========== ===========
Income from continuing operations per common
share:
Basic $ 0.47 $ 0.38 $ 1.48 $ 1.25
=========== =========== =========== ===========
Diluted $ 0.44 $ 0.36 $ 1.38 $ 1.17
=========== =========== =========== ===========
Weighted average shares outstanding:
Basic 33,093,592 37,020,020 34,062,249 36,962,724
Diluted 35,074,557 38,912,822 36,348,390 39,249,304
See accompanying notes to consolidated financial statements.
1
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
AS OF
----------------------------
SEPTEMBER 30, DECEMBER 31,
(Dollars in thousands, except per share data) 2006 2005
(UNAUDITED)
------------- ------------
ASSETS:
Cash and cash equivalents $ 66,848 $ 7,090
Restricted cash and cash equivalents 42,000 13,473
Restricted securities available for sale 3,641 3,345
Loans receivable (including $21,405 and $22,622
from affiliates as of September 30, 2006
and December 31, 2005, respectively) 730,587 694,939
Allowance for credit losses (130,425) (131,411)
--------- ---------
Loans receivable, net 600,162 563,528
--------- ---------
Property and equipment, net 16,715 17,992
Income taxes receivable 8,989 4,022
Other assets 13,805 9,944
--------- ---------
Total Assets $ 752,160 $ 619,394
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY:
LIABILITIES:
Accounts payable and accrued liabilities $ 177,402 $ 55,705
Line of credit 26,000 36,300
Secured financing 288,500 101,500
Mortgage note and capital lease obligations 8,970 9,105
Deferred income taxes, net 44,419 43,758
--------- ---------
Total Liabilities 545,291 246,368
--------- ---------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 1,000,000 shares
authorized, none issued -- --
Common stock, $.01 par value, 80,000,000 shares
authorized, 30,076,989 and 37,027,286 shares
issued and outstanding as of September 30, 2006
and December 31, 2005, respectively 301 370
Paid-in capital -- 29,746
Unearned stock-based compensation (2,432) (1,566)
Retained earnings 209,036 344,513
Accumulated other comprehensive loss, net of tax
of $18 and $22 at September 30, 2006 and
December 31, 2005, respectively (36) (37)
--------- ---------
Total Shareholders' Equity 206,869 373,026
--------- ---------
Total Liabilities and Shareholders' Equity $ 752,160 $ 619,394
========= =========
See accompanying notes to consolidated financial statements.
2
CREDIT ACCEPTANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
(Dollars in thousands) 2006 2005
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 50,145 $ 47,361
Adjustments to reconcile cash provided by
operating activities:
Provision for credit losses 7,569 6,127
Depreciation 3,538 3,957
(Gain) loss on retirement of property
and equipment (276) 71
Foreign currency gain on forward contracts -- (1,032)
Provision for deferred income taxes 658 2,998
Stock-based compensation 188 1,817
Excess tax benefits from stock-based
compensation plans (8,160) --
Change in operating assets and liabilities:
Accounts payable and accrued liabilities 11,447 6,329
Income taxes receivable/payable 3,193 7,954
Other assets (3,554) 1,900
--------- ---------
Net cash provided by operating activities 64,748 77,482
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Increase in restricted cash and cash equivalents (28,527) (2,878)
Purchases of restricted securities available
for sale (794) (3,089)
Proceeds from sale of restricted securities
available for sale 301 534
Maturities of restricted securities available
for sale 201 --
Principal collected on loans receivable 421,218 349,570
Advances to dealers and accelerated payments
of dealer holdback (406,216) (358,005)
Originations of purchased loans (9,500) (10,392)
Payments of dealer holdbacks (52,796) (38,190)
Net change in floorplan receivables, notes
receivable and lines of credit 2,873 507
Purchases of property and equipment (244) (2,683)
--------- ---------
Net cash used in investing activities (73,484) (64,626)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under line of credit 243,330 202,300
Repayments under line of credit (253,630) (164,000)
Proceeds from secured financing 447,500 111,991
Repayments of secured financing (260,500) (149,244)
Principal payments under mortgage note and
capital lease obligations (1,876) (933)
Repurchase of common stock (123,071) --
Proceeds from stock options exercised 8,670 145
Excess tax benefits from stock-based
compensation plans 8,160 --
--------- ---------
Net cash provided by financing activities 68,583 259
--------- ---------
Effect of exchange rate changes on cash (89) 607
--------- ---------
Net increase in cash and cash equivalents 59,758 13,722
Cash and cash equivalents, beginning of period 7,090 614
--------- ---------
Cash and cash equivalents, end of period $ 66,848 $ 14,336
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 10,929 $ 8,185
Cash paid during the period for income taxes 22,288 17,967
SUPPLEMENTAL DISCLOSURE OF NON-CASH TRANSACTIONS:
Property and equipment acquired through
capital lease obligations $ 1,741 $ 385
Issuance of restricted stock, net of
forfeitures 1,288 1,964
Repurchase of common stock 110,250 --
See accompanying notes to consolidated financial statements.
3
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles" or "GAAP")
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. The results of operations for interim periods
are not necessarily indicative of actual results achieved for full fiscal years.
The consolidated balance sheet at December 31, 2005 has been derived from the
audited financial statements at that date but does not include all the
information and footnotes required by generally accepted accounting principles
for complete financial statements. For further information, refer to the
consolidated financial statements and footnotes thereto included in the Annual
Report on Form 10-K for the year ended December 31, 2005 for Credit Acceptance
Corporation (the "Company" or "Credit Acceptance"). Certain prior period amounts
have been reclassified to conform to the current presentation.
The preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results could differ
from those estimates.
2. SIGNIFICANT ACCOUNTING POLICIES
DESCRIPTION OF BUSINESS
Principal Business. Since 1972, Credit Acceptance has provided auto loans
to consumers, regardless of their credit history. The Company's product is
offered through a nationwide network of automobile dealers who benefit from
sales of vehicles to consumers who otherwise could not obtain financing; from
repeat and referral sales generated by these same customers; and from sales to
customers responding to advertisements for the Company's product, but who
actually end up qualifying for traditional financing.
Credit Acceptance was founded to service and collect retail installment
contracts (referred to as "Consumer Loans") originated and funded by automobile
dealerships owned by the Company's founder, majority shareholder, and current
Chairman, Donald Foss. During the 1980s, the Company began to market this
service to non-affiliated dealers and, at the same time, began to offer dealers
a non-recourse cash payment (referred to as an "advance") against anticipated
future collections on Consumer Loans serviced for that dealer. Today, the
Company's program is offered to dealers throughout the United States. The
Company refers to dealers who participate in its program and who share its
commitment to changing consumers' lives as "dealer-partners".
A consumer who does not qualify for conventional automobile financing can
purchase a used vehicle from a Credit Acceptance dealer-partner and finance the
purchase through the Company. As payment for the vehicle, the dealer-partner
receives the following:
(i) a down payment from the consumer;
(ii) a cash advance from the Company; and
(iii) after the advance has been recovered by the Company, the cash from
payments made on the Consumer Loan, net of certain collection costs
and the Company's servicing fee ("dealer holdback").
The Company's servicing fee is equal to a fixed percentage (typically 20%)
of each payment collected. In addition, the Company receives fees for other
products and services.
If the Company discovers a misrepresentation by the dealer-partner relating
to a Consumer Loan assigned to the Company, the Company can demand that the
Consumer Loan be repurchased for the current balance of the Consumer Loan less
the amount of any unearned finance charge plus the applicable termination fee,
which is generally $500. Upon receipt of such amount in full, the Company will
reassign the Consumer Loan and its security interest in the financed vehicle to
the dealer-partner. The dealer-partner can also opt to repurchase Consumer Loans
at their own discretion. To date, no dealer-partner has repurchased receivables
under these options.
The Company is an indirect lender from a legal perspective, meaning the
Consumer Loan is originated by the dealer-partner and immediately assigned to
the Company. The compensation paid to the dealer-partner in exchange for the
Consumer Loan is paid in two parts. A portion of the compensation is paid at the
time of origination, and a portion is paid over time. The amount paid at the
time of origination is called an advance; the portion paid over time is based on
the performance of the loan and is called dealer holdback.
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
For accounting purposes, a majority of the transactions described above are
not considered to be loans to consumers. Instead, the Company's accounting
reflects that of a lender to the dealer-partner. This classification for
accounting purposes is primarily a result of (i) the dealer-partner's financial
interest in the Consumer Loan and (ii) certain elements of the Company's legal
relationship with the dealer-partner. The cash amount advanced to the
dealer-partner is recorded as an asset on the Company's balance sheet. The
aggregate amount of all advances to an individual dealer-partner, plus accrued
income, less repayments comprises the amount recorded in Loans receivable. A
small percentage of Consumer Loans in the United States are purchased without
recourse from the Company's dealer-partners and are considered to be Purchased
Loans ("Purchased Loans") for accounting purposes.
As of September 30, 2006, the Company had approximately 100% of its capital
invested in the United States business segment. In early 2002, the Company
stopped originating automobile leases and effective June 30, 2003 stopped
accepting Consumer Loans originated in the United Kingdom and Canada. The
Company sold the remaining Consumer Loan portfolio of its United Kingdom
subsidiary on December 30, 2005.
The Company's business is seasonal with peak loan originations occurring
during February and March. Seasonality does not have a material impact on the
Company's interim financial results.
ACCOUNTING POLICIES
Finance Charges. The Company recognizes finance charge income in a manner
consistent with the provisions of the American Institute of Certified Public
Accountant's Statement of Position ("SOP") 03-3, "Accounting for Certain Loans
or Debt Securities Acquired in a Transfer." Consistent with SOP 03-3, the
Company recognizes finance charges under the interest method such that revenue
is recognized on a level yield basis based upon forecasted cash flows. As
forecasted cash flows change, the Company adjusts the yield upwards for positive
changes and recognizes impairment for negative changes in the current period.
The Company has relationships with third party vehicle service contract
administrators ("TPAs") whereby the TPAs process claims on vehicle service
contracts underwritten by third party insurers. The Company recognizes the
commission received from the TPAs for contracts financed by the Company as part
of finance charges on a level yield basis based upon forecasted cash flows.
Commissions on contracts not financed by the Company are recognized at the time
the commission is received.
License Fees. The Company recognizes a monthly dealer-partner access fee
for the Company's patented Internet-based proprietary Credit Approval Processing
System ("CAPS") in the month the access is provided.
Loans Receivable and Allowance for Credit Losses. The Company records the
amount advanced to the dealer-partner as a Dealer Loan ("Dealer Loan"), which is
classified within Loans receivable in the Company's consolidated balance sheets.
The Dealer Loan is increased as revenue is recognized and decreased as
collections are received. The Company follows an approach similar to the
provisions of SOP 03-3 in determining its allowance for credit losses.
Consistent with SOP 03-3, an allowance for credit losses is maintained at an
amount that reduces the net asset value (Dealer Loan balance less the allowance)
to the discounted value of forecasted future cash flows at the yield established
at the inception of the Dealer Loan. This allowance is calculated on a
dealer-partner by dealer-partner basis. The discounted value of future cash
flows is comprised of estimated future collections on the Consumer Loans, less
any estimated dealer holdback payments.
In estimating future collections and dealer holdback payments for each
dealer-partner, the Company considers: (i) a dealer-partner's actual collection
and loss data on a static pool basis and (ii) the Company's historical loss and
collection experience. The Company's collection forecast for each dealer-partner
is updated monthly, and considers the most recent static pool data available for
each dealer-partner and the Company's entire portfolio of Consumer Loans.
Cash flows from any individual Dealer Loan are often different than
estimated cash flows at Dealer Loan inception. If such difference is favorable,
the difference is recognized into income over the life of the Dealer Loan
through a yield adjustment. If such difference is unfavorable, a provision for
credit losses is recorded as a current period expense and a corresponding
allowance for credit losses is established. Because differences between
estimated cash flows at inception and actual cash flows occur often, an
allowance is required for a significant portion of the Company's Dealer Loan
portfolio. An allowance for credit losses does not necessarily indicate that a
Dealer Loan is unprofitable, and in recent years, cash flows from a Dealer Loan
portfolio have seldom been insufficient to repay the initial amounts advanced to
the dealer-partners. If a positive revision occurs to the estimated cash flows
for a Dealer Loan that has an allowance for credit losses, the allowance is
reversed up to the lesser of the amount of the positive revision or the amount
of the allowance previously recorded.
5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
2. SIGNIFICANT ACCOUNTING POLICIES - (CONCLUDED)
Stock-based Compensation. On January 1, 2006, the Company adopted revised
Statement of Financial Accounting Standards ("SFAS") No. 123 ("SFAS No. 123R"),
"Share-Based Payment". The Company had previously adopted the fair value
recognition provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation", under the retroactive restatement transition method in 2003.
Adoption of SFAS No. 123R primarily resulted in a change in the Company's
estimated forfeitures for unvested stock based compensation awards, which
resulted in a cumulative reversal of stock-based compensation expense of $0.4
million for the quarter ended March 31, 2006.
Accounting for Uncertainty in Income Taxes. On July 13, 2006, the FASB
issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes-an
interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an entity's financial
statements in accordance with FASB Statement No. 109, "Accounting for Income
Taxes" and prescribes a recognition threshold and measurement attribute for
financial statement disclosure of tax positions taken or expected to be taken on
a tax return. Additionally, FIN 48 provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The Company has not yet determined the impact, if any, of
adopting the provisions of FIN 48 on the Company's financial position, results
of operations or cash flows.
New Accounting Pronouncements. In September 2006, the SEC staff issued
Staff Accounting Bulletin No. 108, "Considering the Effects of Prior Year
Misstatements when Quantifying Misstatements in Current Year Financial
Statements" ("SAB 108"). SAB 108 was issued to provide consistency between how
registrants quantify financial statement misstatements.
Historically, there have been two widely-used methods for quantifying the
effects of financial statement misstatements. These methods are referred to as
the "roll-over" and "iron curtain" method. The roll-over method quantifies the
amount by which the current year income statement is misstated. Exclusive
reliance on an income statement approach can result in the accumulation of
errors on the balance sheet that may not have been material to any individual
income statement, but which may misstate one or more balance sheet accounts. The
iron curtain method quantifies the error as the cumulative amount by which the
current year balance sheet is misstated. Exclusive reliance on a balance sheet
approach can result in disregarding the effects of errors in the current year
income statement that results from the correction of an error existing in
previously issued financial statements.
SAB 108 established an approach that requires quantification of financial
statement misstatements based on the effects of the misstatement on each of the
company's financial statements and the related financial statement disclosures.
This approach is commonly referred to as the "dual approach" because it requires
quantification of errors under both the roll-over and iron curtain methods. SAB
108 allows registrants to initially apply the dual approach either by (1)
retroactively adjusting prior financial statements as if the dual approach had
always been used or by (2) recording the cumulative effect of initially applying
the dual approach as adjustments to the carrying values of assets and
liabilities as of January 1, 2006 with an offsetting adjustment recorded to the
opening balance of retained earnings. Use of this "cumulative effect" transition
method requires detailed disclosure of the nature and amount of each individual
error being corrected through the cumulative adjustment and how and when it
arose.
The Company will initially apply SAB 108 in connection with the preparation
of the Company's annual financial statements for the year ending December 31,
2006. The Company does not believe that the adoption of SAB 108 will have any
impact on the Company's financial statements.
6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
3. LOANS RECEIVABLE
A summary of changes in Loans receivable is as follows (in thousands):
THREE MONTHS ENDED SEPTEMBER 30, 2006
------------------------------------------
DEALER PURCHASED OTHER
LOANS LOANS LOANS TOTAL
--------- --------- ------- --------
Balance, beginning of period $697,730 $15,979 $2,251 $715,960
New loans 134,943 3,721 -- 138,664
Dealer holdback payments 17,161 -- -- 17,161
Net cash collections on loans (134,219) (2,600) -- (136,819)
Write-offs (3,353) (2) -- (3,355)
Net change in floorplan receivables, notes
receivable, and lines of credit -- -- (1,208) (1,208)
Other -- 173 -- 173
Currency translation 11 -- -- 11
-------- ------- ------ --------
Balance, end of period $712,273 $17,271 $1,043 $730,587
======== ======= ====== ========
THREE MONTHS ENDED SEPTEMBER 30, 2005
------------------------------------------
OTHER
DEALER PURCHASED LOANS
LOANS LOANS (1) TOTAL
--------- --------- ------- --------
Balance, beginning of period $665,279 $13,974 $17,188 $696,441
New loans 111,656 3,716 -- 115,372
Dealer holdback payments 13,367 -- -- 13,367
Net cash collections on loans (113,181) (1,950) (1,929) (117,060)
Write-offs (1,786) (21) (2,167) (3,974)
Recoveries -- 30 532 562
Net change in floorplan receivables,
notes receivable, and lines of credit -- -- 79 79
Other -- -- 337 337
Currency translation 52 -- (200) (148)
-------- ------- ------- --------
Balance, end of period $675,387 $15,749 $13,840 $704,976
======== ======= ======= ========
NINE MONTHS ENDED SEPTEMBER 30, 2006
------------------------------------------
DEALER PURCHASED OTHER
LOANS LOANS LOANS TOTAL
--------- --------- ------- --------
Balance, beginning of period $675,692 $15,470 $3,777 $694,939
New loans 406,216 9,500 -- 415,716
Dealer holdback payments 52,796 -- -- 52,796
Net cash collections on loans (413,943) (8,024) -- (421,967)
Write-offs (8,577) (227) -- (8,804)
Recoveries -- 46 -- 46
Net change in floorplan receivables,
notes receivable, and lines of credit -- -- (2,734) (2,734)
Other -- 506 -- 506
Currency translation 89 -- -- 89
-------- ------- ------ --------
Balance, end of period $712,273 $17,271 $1,043 $730,587
======== ======= ====== ========
NINE MONTHS ENDED SEPTEMBER 30, 2005
------------------------------------------
OTHER
DEALER PURCHASED LOANS
LOANS LOANS (1) TOTAL
--------- --------- ------- --------
Balance, beginning of period $626,284 $10,756 $30,354 $667,394
New loans 358,005 10,392 -- 368,397
Dealer holdback payments 37,880 -- -- 37,880
Net cash collections on loans (338,542) (5,109) (7,988) (351,639)
Write-offs (8,100) (370) (8,852) (17,322)
Recoveries -- 80 1,654 1,734
Net change in floorplan receivables,
notes receivable, and lines of credit -- -- (505) (505)
Other -- -- 707 707
Currency translation (140) -- (1,530) (1,670)
-------- ------- ------- --------
Balance, end of period $675,387 $15,749 $13,840 $704,976
======== ======= ======= ========
(1) Other Loans includes the Company's discontinued United Kingdom automobile
financing business.
7
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
3. LOANS RECEIVABLE - (CONCLUDED)
A summary of changes in the Allowance for credit losses is as follows (in
thousands):
THREE MONTHS ENDED SEPTEMBER 30, 2006
----------------------------------------
DEALER PURCHASED OTHER
LOANS LOANS LOANS TOTAL
--------- --------- ----- --------
Balance, beginning of period $128,111 $ 941 $-- $129,052
Provision for credit losses (1) 4,508 212 -- 4,720
Write-offs (3,353) (2) -- (3,355)
Currency translation 8 -- -- 8
-------- ------ --- --------
Balance, end of period $129,274 $1,151 $-- $130,425
======== ====== === ========
THREE MONTHS ENDED SEPTEMBER 30, 2005
------------------------------------------
OTHER
DEALER PURCHASED LOANS
LOANS LOANS (5) TOTAL
--------- --------- ------- --------
Balance, beginning of period $130,744 $1,272 $4,421 $136,437
Provision for credit losses (2) 4,360 (32) (472) 3,856
Write-offs (1,785) (19) (344) (2,148)
Recoveries -- 30 414 444
Currency translation 69 -- (76) (7)
-------- ------- ------- --------
Balance, end of period $133,388 $1,251 $3,943 $138,582
======== ======= ======= ========
NINE MONTHS ENDED SEPTEMBER 30, 2006
----------------------------------------
DEALER PURCHASED OTHER
LOANS LOANS LOANS TOTAL
--------- --------- ----- --------
Balance, beginning of period $130,722 $689 $-- $131,411
Provision for credit losses (3) 7,061 643 -- 7,704
Write-offs (8,577) (227) -- (8,804)
Recoveries -- 46 -- 46
Currency translation 68 -- -- 68
-------- ------ --- --------
Balance, end of period $129,274 $1,151 $-- $130,425
======== ====== === ========
NINE MONTHS ENDED SEPTEMBER 30, 2005
------------------------------------------
OTHER
DEALER PURCHASED LOANS
LOANS LOANS (5) TOTAL
--------- --------- ------- --------
Balance, beginning of period $134,599 $1,620 $ 5,164 $141,383
Provision for credit losses (4) 6,847 (81) (1,246) 5,520
Write-offs (8,100) (368) (1,204) (9,672)
Recoveries -- 80 1,780 1,860
Other -- -- (10) (10)
Currency translation 42 -- (541) (499)
-------- ------ ------- --------
Balance, end of period $133,388 $1,251 $ 3,943 $138,582
======== ====== ======= ========
(1) Does not include a negative provision for credit losses of $316 on license
fees receivable and other items.
(2) Does not include a provision for credit losses of $375 on license fees
receivable and other items. Includes a negative provision for credit losses
related to discontinued operations of $472.
(3) Does not include a negative provision for credit losses of $135 on license
fees receivable and other items.
(4) Does not include a provision for credit losses of $607 on license fees
receivable and other items. Includes a negative provision for credit losses
related to discontinued operations of $1,246.
(5) Other Loans includes the Company's discontinued United Kingdom automobile
financing business.
8
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT
Line of Credit Facility. At September 30, 2006, the Company had a $135.0
million credit agreement with a commercial bank syndicate. The facility has a
commitment period through June 20, 2008. At September 30, 2006, the agreement
provided that, at the Company's option, interest is payable at either the
Eurodollar rate plus 130 basis points (6.61% at September 30, 2006), or at the
prime rate (8.25% at September 30, 2006). The Eurodollar borrowings may be fixed
for periods of up to six months. Borrowings under the credit agreement are
subject to a borrowing base limitation equal to 75% of the net book value of
Dealer Loans plus 75% of the net book value of Consumer Loans purchased by the
Company (not to exceed a maximum of 25% of the aggregate borrowing base
limitation), less a hedging reserve (not exceeding $1.0 million), the amount of
letters of credit issued under the line of credit, and the amount of other debt
secured by the collateral which secures the line of credit. Currently, the
borrowing base limitation does not inhibit the Company's borrowing ability under
the line of credit. Borrowings under the credit agreement are secured by a lien
on most of the Company's assets. The Company must pay annual and quarterly fees
on the amount of the commitment. As of September 30, 2006 and December 31, 2005,
there was $108.1 million and $93.3 million, respectively, available under the
line of credit. Additional information about the line of credit facility is
included in the following table (in thousands):
THREE MONTHS ENDED
SEPTEMBER 30,
------------------
2006 2005
------- -------
Maximum balance outstanding $43,500 $60,100
Weighted average balance outstanding 31,159 46,422
AS OF
----------------------------
SEPTEMBER 30, DECEMBER 31,
2006 2005
------------- ------------
Balance outstanding $26,000 $36,300
Weighted average interest rate 6.61% 5.75%
Secured Financing. The Company's wholly-owned subsidiary, CAC Warehouse
Funding Corp. II ("Warehouse Funding" or "2003-2"), has a revolving secured
financing facility with institutional investors. In the first quarter of 2006,
Warehouse Funding increased the facility limit and renewed the commitment. Under
the renewed facility, which matures on February 14, 2007, Warehouse Funding may
receive up to $325.0 million in financing when the Company conveys Dealer Loans
to Warehouse Funding for cash and equity in Warehouse Funding. Warehouse Funding
will in turn pledge the Dealer Loans as collateral to the institutional
investors to secure loans that will fund the cash portion of the purchase price
of the Dealer Loans. Warehouse Funding receives 75% of the net book value of the
contributed Dealer Loans up to the $325.0 million facility limit. In addition to
the maturity of the facility, there is a requirement that certain amounts
outstanding under the facility be refinanced within 360 days of the most recent
refinancing occurring after February 15, 2006. On April 18, 2006, $100.0 million
of the amounts outstanding under the facility were refinanced. If the second
refinancing does not occur within 360 days of April 18, 2006 or the requirement
is not waived, or if the facility is not extended, the transaction will cease to
revolve, will amortize as collections are received and, at the option of the
institutional investor, may be subject to acceleration and foreclosure. Although
Warehouse Funding will be liable for any secured financing under the facility,
the financing is non-recourse to the Company, even though Warehouse Funding and
the Company are consolidated for financial reporting purposes. As Warehouse
Funding is organized as a separate special purpose legal entity from the
Company, assets of Warehouse Funding (including the conveyed Dealer Loans) will
not be available to satisfy the general obligations of the Company. All the
assets of Warehouse Funding have been encumbered to secure Warehouse Funding's
obligations to its creditors. Borrowings under the facility bear interest at a
floating rate equal to the commercial paper rate plus 65 basis points (6.01% at
September 30, 2006), which has been limited to a maximum rate of 6.75% through
interest rate cap agreements executed in the third quarter of 2005 and first
quarter of 2006. The Company receives a monthly servicing fee paid out of
collections equal to 6% of the collections received with respect to the conveyed
Dealer Loans. Except for the servicing fee and payments due to dealer-partners,
the Company does not have any rights in any portion of such collections. As of
September 30, 2006 and December 31, 2005, there was $188.5 million and $101.5
million, respectively, outstanding under this facility.
9
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONTINUED)
As noted above, on April 18, 2006, the Company's wholly-owned subsidiary,
Credit Acceptance Funding LLC 2006-1 ("Funding 2006-1"), completed a secured
financing transaction in which Funding 2006-1 received $100.0 million in
financing. In connection with this transaction, the Company conveyed, for cash
and the sole membership interest in Funding 2006-1, Dealer Loans having a net
book value of approximately $133.5 million to Funding 2006-1, which, in turn,
conveyed the Dealer Loans to a trust that issued $100.0 million in notes to
qualified institutional investors. Radian Asset Assurance Inc. issued the
primary financial insurance policy in connection with the transaction, and XL
Capital Assurance, Inc. issued a backup financial insurance policy. The policies
guarantee the timely payment of interest and ultimate repayment of principal on
the final scheduled distribution date. The notes were rated "Aaa" by Moody's
Investor Services and "AAA" by Standard & Poor's Rating Services. The proceeds
of the initial conveyance to Funding 2006-1 were used by the Company to purchase
Dealer Loans, on an arm's-length basis, from Warehouse Funding. Through October
16, 2006, the Company may be required, and is likely, to convey additional
Dealer Loans to Funding 2006-1, which will be conveyed by Funding 2006-1 to the
trust. As of September 30, 2006, additional Dealer Loans having a net book value
of approximately $54.2 million had been conveyed by the Company after the
completion of the initial funding. After October 16, 2006, the debt outstanding
under this facility will begin to amortize. The total expected term of the
facility is 17 months. The secured financing creates loans for which the trust
is liable and which are secured by all the assets of the trust. Such loans are
non-recourse to the Company, even though the trust, Funding 2006-1 and the
Company are consolidated for financial reporting purposes. As Funding 2006-1 is
organized as a separate legal entity from the Company, assets of Funding 2006-1
(including the conveyed Dealer Loans) are not available to satisfy the general
obligations of the Company. The notes bear interest at a fixed rate of 5.36%.
The expected annualized cost of the secured financing, including underwriter's
fees, the insurance premiums and other costs is approximately 7.6%. The Company
receives a monthly servicing fee paid out of collections equal to 6% of the
collections received with respect to the conveyed Dealer Loans. Except for the
servicing fee and payments due to dealer-partners, the Company does not receive,
or have any rights in, any portion of such collections, except for a limited
right in its capacity as Servicer to exercise a "clean-up call" option to
purchase Dealer Loans from Funding 2006-1 under certain specified circumstances.
In exercising its "clean-up call," the Servicer may repurchase the remaining
Dealer Loans from the trust and direct the trust to redeem the indebtedness in
whole, whereby the assets of the trust (including the right to remaining
collections) would be paid over to Funding 2006-1, and distributed to the
Company, resulting in the Company becoming the owner of such remaining
collections; provided that if the trust certificate has been purchased and
financed as described below, such financing of the trust certificate must be
repaid at the same time such "clean-up call" is exercised. Alternatively, when
the trust's underlying indebtedness is paid in full, either through collections
or through a prepayment of the indebtedness, remaining collections would be paid
over to Funding 2006-1 as the sole beneficiary of the trust where they would be
available to be distributed to the Company as the sole member of Funding 2006-1.
As of September 30, 2006 there was $100.0 million outstanding under this secured
financing transaction.
On September 20, 2006, the Company's wholly-owned subsidiary, Credit
Acceptance Residual Funding LLC ("Residual Funding"), completed a $50.0 million
secured credit facility with an institutional investor. This facility allows
Residual Funding to finance its purchase of trust certificates from special
purpose entities (the "Term SPEs") that purchased loans to dealer-partners under
the Company's term securitization transactions. Historically, the Term SPEs'
residual interests in Dealer Loans, represented by their trust certificates,
have proven to have value that increases as their term securitization
obligations amortize. The new facility enables the Term SPEs to realize and
distribute to the Company up to 65% of that increase in value prior to the time
the related term securitization senior notes are paid in full. Residual
Funding's interests in Dealer Loans, represented by its purchased trust
certificates, are subordinated to the interests of term securitization senior
noteholders but the entire arrangement is non-recourse to the Company. As
Residual Funding is organized as a separate legal entity from the Company,
assets of Residual Funding, including purchased trust certificates, are not
available to satisfy the general obligations of the Company, even though
Residual Funding and the Company are consolidated for financial reporting
purposes. Residual Funding did not make a draw on the facility at closing. The
facility matures September 19, 2007. Borrowings under the facility bear interest
at a floating rate equal to LIBOR or the commercial paper rate plus 145 basis
points (6.81% at September 30, 2006). As of September 30, 2006 there were no
amounts outstanding under this facility.
10
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
4. DEBT - (CONCLUDED)
The Company and its subsidiaries have completed a total of thirteen secured
financing transactions, ten of which have been repaid in full as of September
30, 2006. Information about the outstanding secured financing transactions as of
September 30, 2006 is set forth in the following table (in thousands):
SECURED FINANCING SECURED DEALER
ISSUE BALANCE AT LOAN BALANCE AT
NUMBER CLOSE DATE LIMIT SEPTEMBER 30, 2006 SEPTEMBER 30, 2006
------ -------------- -------- ------------------ ------------------
2003-2 September 2003* $325,000 $188,500 $273,986
2006-1 April 2006 100,000 100,000 133,571
2006-3 September 2006 50,000 -- --
* In February 2006, the 2003-2 Loan and Security Agreement was amended to
increase the facility limit to $325.0 million and extend the commitment
period to February 14, 2007.
Mortgage Loan. The Company has a mortgage loan from a commercial bank that
is secured by a first mortgage lien on the Company's headquarters building and
an assignment of all leases, rents, revenues and profits under all present and
future leases of the building. There was $7.0 million and $7.5 million
outstanding on this loan as of September 30, 2006 and December 31, 2005,
respectively. The loan matures on June 9, 2009, bears interest at a fixed rate
of 5.35%, and requires monthly payments of $92,156 and a balloon payment at
maturity for the balance of the loan.
Capital Lease Obligations. As of September 30, 2006, the Company has
various capital lease obligations outstanding for computer equipment, with
monthly payments totaling $79,000. The total amount of capital lease obligations
outstanding as of September 30, 2006 and December 31, 2005 were $2.0 million and
$1.6 million, respectively. These capital lease obligations bear interest at
rates ranging from 7.87% to 9.31% and have maturity dates between January 2007
and June 2010.
Debt Covenants. As of September 30, 2006, the Company is in compliance with
various restrictive debt covenants that require the maintenance of certain
financial ratios and other financial conditions. The most restrictive covenants
require a minimum ratio of the Company's assets to debt and its earnings before
interest, taxes and non-cash expenses to fixed charges. The covenants also limit
the maximum ratio of the Company's debt to tangible net worth and the Company
must also maintain a specified minimum level of net worth, which may indirectly
limit the payment of dividends on common stock.
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
5. RELATED PARTY TRANSACTIONS
In the normal course of its business, the Company has Dealer Loans with
affiliated dealer-partners owned or controlled by: (i) the Company's majority
shareholder and Chairman; (ii) a member of the Chairman's immediate family; and
(iii) the Company's former President, Keith P. McCluskey. Mr. McCluskey resigned
from his position with the Company effective September 1, 2006. The Company's
Dealer Loans from affiliated dealer-partners and nonaffiliated dealer-partners
are on the same terms. A summary of related party Dealer Loan activity is as
follows (in thousands):
As of September 30, 2006 As of December 31, 2005
-------------------------- --------------------------
Affiliated Affiliated
Dealer Loan % of Dealer Loan % of
balance consolidated balance consolidated
----------- ------------ ----------- ------------
Affiliated Dealer Loan balance $20,800 2.9% $20,900 3.1%
For the Three Months ended For the Three Months ended
September 30, 2006 September 30, 2005
----------------------------- -----------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------------- ------------ -------------- ------------
Advances $4,000 3.0% $4,000 3.6%
Affiliated dealer-partner revenue $1,400 3.1% $1,500 3.4%
For the Nine Months ended For the Nine Months ended
September 30, 2006 September 30, 2005
----------------------------- -----------------------------
Affiliated Affiliated
dealer-partner % of dealer-partner % of
activity consolidated activity consolidated
-------------- ------------ -------------- ------------
Advances $13,900 3.4% $15,800 4.4%
Affiliated dealer-partner revenue $ 4,300 3.2% $ 4,200 3.4%
Pursuant to an employment agreement with the Company's former President,
Mr. McCluskey, dated April 19, 2001, the Company loaned Mr. McCluskey's
dealerships $0.9 million. Obligations under this note, including all principal
and interest, were paid in full on August 16, 2006. In addition, pursuant to the
employment agreement, the Company loaned Mr. McCluskey approximately $0.5
million. The note, including all principal and interest, is due on April 19,
2011, bears interest at 5.22% and is unsecured. The balance of the note
including accrued but unpaid interest was approximately $0.6 million as of
September 30, 2006 and December 31, 2005, respectively.
Total CAPS and dealer enrollment fees earned from affiliated
dealer-partners were $22,000 and $67,000 for the three and nine months ended
September 30, 2006, respectively, and $23,000 and $68,000 for the same periods
in 2005.
The Company paid for air transportation services provided by a company
owned by the Company's majority shareholder and Chairman totaling $56,000 and
$80,000 for the three and nine months ended September 30, 2006, respectively,
and $12,000 and $47,000 for the same periods in 2005.
Beginning in 2002, entities owned by the Company's majority shareholder and
Chairman began offering secured lines of credit to third parties in a manner
similar to a program previously offered by the Company. In December of 2004, the
Company's majority shareholder and Chairman sold his ownership interest in these
entities but he continues to have indirect control over these entities and has
the right or obligation to reacquire the entities under certain circumstances
until December 31, 2014 or the repayment of the related purchase money note.
12
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
6. INCOME TAXES
A reconciliation of the U.S. federal statutory rate to the Company's
effective tax rate, excluding the results of the discontinued United Kingdom
operations, is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
---- ---- ---- ----
U.S. federal statutory rate 35.0% 35.0% 35.0% 35.0%
State income taxes 1.3 3.6 0.8 2.6
U.S. tax impact of foreign earnings 0.1 -- (0.1) --
Other (0.2) 1.2 0.1 0.4
---- ---- ---- ----
Effective tax rate 36.2% 39.8% 35.8% 38.0%
==== ==== ==== ====
The differences between the U.S. federal statutory rate and the Company's
consolidated effective tax rate are primarily related to state income taxes that
are included in the provision for income taxes. A decrease in the effective tax
rate to 36.2% and 35.8% for the three and nine months ended September 30, 2006,
respectively, from 39.8% and 38.0% for the same periods in 2005 is primarily due
to an additional state tax liability recorded in the third quarter of 2005 that
was reversed in the second quarter of 2006 as a result of a favorable
settlement.
7. 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 weighted average
number of common shares and common stock equivalents outstanding. Common stock
equivalents included in the computation represent shares issuable upon assumed
exercise of stock options that would have a dilutive effect using the treasury
stock method. The share effect is as follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
2006 2005 2006 2005
---------- ---------- ---------- ----------
Weighted average common shares outstanding 33,093,592 37,020,020 34,062,249 36,962,724
Common stock equivalents 1,980,965 1,892,802 2,286,141 2,286,580
---------- ---------- ---------- ----------
Weighted average common shares and common stock
equivalents 35,074,557 38,912,822 36,348,390 39,249,304
========== ========== ========== ==========
The diluted net income per share calculation excludes stock options to
purchase 115,000 shares for the three months ended September 30, 2005 as
inclusion of these options would be anti-dilutive to the net income per share
due to the relationship between the exercise prices and the average market price
of common stock during this period. There were no stock options that would be
anti-dilutive for the three months ended September 30, 2006 or the nine months
ended September 30, 2006 and 2005.
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
7. CAPITAL TRANSACTIONS - (CONCLUDED)
RESTRICTED STOCK COMPENSATION
Pursuant to the Company's Incentive Compensation Plan (the "Incentive
Plan"), which was approved by shareholders on May 13, 2004, the Company had
reserved 1.0 million shares of its common stock for the future granting of
restricted stock, restricted stock units, stock options, and performance awards
to employees, officers, and directors at any time prior to April 1, 2014.
During the nine months ended September 30, 2006, the Company granted
115,757 shares of restricted stock to employees and officers under the Incentive
Plan, of which 103,867 shares vest in full or in part based on the Company's
satisfaction of certain performance-related criteria and 11,890 shares vest over
a five year period. The Company recorded $2.8 million of unearned stock-based
compensation representing the grant date fair value of the restricted stock
granted during the nine months ended September 30, 2006. During the nine months
ended September 30, 2006, 68,306 shares of restricted stock were forfeited
resulting in the reversal of $1.2 million in unearned stock-based compensation.
Unearned stock-based compensation is recognized as stock-based compensation
expense over the expected vesting period of the restricted stock.
The Company recognized stock-based compensation expense of $0.1 million and
$0.4 million for the three and nine months ended September 30, 2006,
respectively, and $0.1 million and $0.3 million for the three and nine months
ended September 30, 2005, respectively, for outstanding restricted stock.
At September 30, 2006 and December 31, 2005, the Company had 144,728 and
98,879 shares of restricted stock outstanding, respectively. Shares available
for future grants under the Incentive Plan totaled 855,272 at September 30,
2006.
STOCK REPURCHASE PROGRAM
The Company's board of directors approved a stock repurchase program which
authorizes the Company to purchase common shares in the open market or in
privately negotiated transactions at price levels the Company deems attractive.
At this time, the Company has authorization to repurchase an additional $25.0
million of the Company's common stock. As of September 30, 2006, the Company has
repurchased approximately 7.1 million shares under this program at a cost of
$71.4 million.
DUTCH TENDER OFFER
In addition to the stock repurchase program, the Company has repurchased
12.5 million shares of its common stock at a cost of $304.4 million through four
modified Dutch auction tender offers completed during 2004 and 2006.
COMMENCEMENT EXPIRATION AMOUNT OF AMOUNT OF SHARES PURCHASE PRICE TOTAL COST
DATE DATE SHARES TENDERED REPURCHASED PER SHARE (IN THOUSANDS)
------------------ ------------------ --------------- ---------------- -------------- --------------
November 26, 2003 January 6, 2004 2,201,744 2,201,744 $17.00 $ 37,430
August 11, 2004 September 9, 2004 2,673,073 2,673,073 20.00 53,461
February 10, 2006 March 13, 2006 4,129,735 4,129,735 25.00 103,243
August 28, 2006 September 26, 2006* 20,552,028 3,500,000 31.50 110,250
---------- --------
12,504,552 $304,384
========== ========
* On September 27, 2006, the Company accepted for payment 3.5 million shares.
On October 3, 2006, the Company made payment for these shares.
14
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONCLUDED)
(UNAUDITED)
8. BUSINESS SEGMENT INFORMATION
During the first quarter of 2006, the Company combined the United Kingdom
business segment into its Other business segment as the Company sold the
remaining Consumer Loan portfolio of its United Kingdom subsidiary on December
30, 2005 and the United Kingdom segment no longer met the quantitative
thresholds of a reportable segment. As a result, the Company now has two
reportable business segments: United States and Other. Prior year's disclosures
have been reclassified to conform to the current year presentation. The United
States segment primarily consists of the Company's United States automobile
financing business. The Other segment consists of the Company's discontinued
United Kingdom automobile financing business, automobile leasing business,
Canadian automobile financing business and secured lines of credit and floorplan
financing products. The Company is currently liquidating its operations in the
Other segment.
Selected segment information is set forth below (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -------------------
2006 2005 2006 2005
------- ------- -------- --------
Revenue:
United States $55,375 $51,302 $163,284 $148,521
Other 27 321 225 1,174
------- ------- -------- --------
Total revenue $55,402 $51,623 $163,509 $149,695
======= ======= ======== ========
Income from continuing operations before provision
for income taxes:
United States $24,171 $23,557 $ 78,234 $ 74,714
Other 38 (377) 171 (344)
------- ------- -------- --------
Total income from continuing operations
before provision for income taxes $24,209 $23,180 $ 78,405 $ 74,370
======= ======= ======== ========
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ -----------------
Segment Assets
United States $751,008 $614,149
Other 1,152 5,245
-------- --------
Total Assets $752,160 $619,394
======== ========
9. DEBT ISSUANCE COSTS
As of September 30, 2006 and December 31, 2005, deferred debt issuance
costs were $3.1 million (net of amortization expense of $2.7 million) and $1.6
million (net of amortization expense of $3.8 million), respectively. Expenses
associated with the issuance of debt instruments are capitalized and amortized
over the term of the debt instrument on a level-yield basis for term secured
financings and on a straight-line basis for lines of credit and revolving
secured financings.
10. COMPREHENSIVE INCOME
The Company's comprehensive income for the three and nine months ended
September 30, 2006 and 2005 is set forth below (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ -----------------
2006 2005 2006 2005
------- ------- ------- -------
Net Income $15,342 $14,594 $50,145 $47,361
Other comprehensive gain (loss), net of tax 29 (427) 1 (1,063)
------- ------- ------- -------
Comprehensive income $15,371 $14,167 $50,146 $46,298
======= ======= ======= =======
15
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
EXECUTIVE SUMMARY
Since 1972, Credit Acceptance has provided auto loans to consumers,
regardless of their credit history. The Company's product is offered through a
nationwide network of automobile dealers who benefit from sales of vehicles to
consumers who otherwise could not obtain financing; from repeat and referral
sales generated by these same customers; and from sales to customers responding
to advertisements for the Company's product, but who actually end up qualifying
for traditional financing.
The Company is an indirect lender from a legal perspective, meaning the
Consumer Loan is originated by the dealer-partner and immediately assigned to
the Company. The compensation paid to the dealer-partner in exchange for the
Consumer Loan is paid in two parts. A portion of the compensation is paid at the
time of origination, and a portion is paid over time. The amount paid at the
time of origination is called an advance; the portion paid over time is based on
the performance of the loan and is called dealer holdback. For accounting
purposes, a majority of the transactions described above are not considered to
be loans to consumers. Instead the Company's accounting reflects that of a
lender to the dealer-partner. This classification for accounting purposes is
primarily a result of (i) the dealer-partner's financial interest in the
Consumer Loan and (ii) certain elements of the Company's legal relationship with
the dealer-partner. The cash amount advanced to the dealer-partner is recorded
as an asset on the Company's balance sheet. The aggregate amount of all advances
to an individual dealer-partner, plus accrued income, less repayments comprises
the amount recorded in Loans receivable. A small percentage of transactions in
the United States are considered to be Consumer Loans for accounting purposes.
For additional information regarding the Company's accounting for Loans
receivable, see Note 2 to the consolidated financial statements, which is
incorporated herein by reference.
The Company believes it has been successful in improving the profitability
of its Dealer Loans in recent years primarily as a result of increasing the
spread between the forecasted collection rate and the advance rate, and
increasing revenue from ancillary products. For the three months ended September
30, 2006, Dealer Loan dollar volume increased 20.9% compared to the same period
in 2005 due to an increase in the number of active dealer-partners which
resulted in an increase in the number of Consumer Loans accepted and a 13.1%
increase in the average loan size. Since the Company believes it is one of only
a few financial services companies serving the Company's target market, the
Company believes that it has an opportunity to grow its business profitably in
the future.
Critical success factors for the Company include access to capital and the
ability to accurately forecast Consumer Loan performance. The Company's strategy
for accessing the capital required to grow its business is to: (i) maintain
consistent financial performance, (ii) maintain modest financial leverage, and
(iii) maintain multiple funding sources. The Company's funded debt to equity
ratio is 1.6 to 1.0 at September 30, 2006. The Company currently funds its
business through a bank line of credit facility, privately placed secured
financings and commercial bank conduit-financed secured financings.
16
CONSUMER LOAN PERFORMANCE
Although the majority of loan originations are recorded in the Company's
financial statements as Dealer Loans, each transaction starts with a loan from
the dealer-partner to the individual purchasing the vehicle. Since the cash
flows available to repay the Dealer Loans are generated, in most cases, from the
underlying Consumer Loan, the performance of the Consumer Loans is critical to
the Company's financial results. The following table presents forecasted
Consumer Loan collection rates, advance rates, the spread (the forecasted
collection rate less the advance rate), and the percentage of the forecasted
collections that have been realized as of September 30, 2006 for the United
States business segment. Payments of dealer holdback and accelerated payments of
dealer holdback are not included in the analysis of the initial advance paid to
the dealer-partner. All amounts are presented as a percentage of the initial
balance of the Consumer Loan (principal + interest).
As of September 30, 2006
---------------------------------------------------
Year of Forecasted % of Forecast
Origination Collection % Advance % Spread % Realized
----------- ------------ --------- -------- -------------
1996 55.1% 46.9% 8.2% 100.0%
1997 58.4% 47.8% 10.6% 99.6%
1998 67.6% 46.0% 21.6% 99.0%
1999 72.5% 48.7% 23.8% 98.2%
2000 73.0% 47.9% 25.1% 97.3%
2001 67.6% 46.0% 21.6% 97.0%
2002 70.6% 42.2% 28.4% 96.7%
2003 74.4% 43.5% 30.9% 93.0%
2004 73.9% 44.0% 29.9% 79.2%
2005 74.3% 46.9% 27.4% 54.6%
2006 71.7% 46.5% 25.2% 17.0%
The following table compares the Company's forecast of Consumer Loan
collection rates as of September 30, 2006 with the forecast as of December 31,
2005:
September 30, 2006 December 31, 2005
Loan Origination Year Forecasted Collection % Forecasted Collection % Variance
--------------------- ----------------------- ----------------------- --------
1996 55.1% 55.0% 0.1%
1997 58.4% 58.3% 0.1%
1998 67.6% 67.7% (0.1)%
1999 72.5% 72.7% (0.2)%
2000 73.0% 73.2% (0.2)%
2001 67.6% 67.2% 0.4%
2002 70.6% 70.3% 0.3%
2003 74.4% 74.0% 0.4%
2004 73.9% 72.9% 1.0%
2005 74.3% 73.6% 0.7%
Accurately forecasting future collection rates is critical to the Company's
success. The risk of a forecasting error declines as Consumer Loans age. For
example, the risk of a material forecasting error for business written in 1999
is very small since 98.2% of the total amount forecasted has already been
realized. In contrast, the Company's forecast for recent Consumer Loans is less
certain. If the Company produces disappointing operating results, it will likely
be because the Company overestimated future Consumer Loan performance. Although
the Company makes every effort to estimate collection rates as accurately as
possible, there can be no assurance that the Company's estimates will be
accurate or that Consumer Loan performance will be as expected.
A wider spread between the forecasted collection rate and the advance rate
reduces the Company's risk of credit losses. Because collections are applied to
advances on an individual dealer-partner basis, a wide spread does not eliminate
the risk of losses, but it does reduce the risk significantly. While the spread
has decreased from 2003 to 2006, the Company believes it is still at a
sufficient level to minimize the Company's risk of being able to recover the
cash advance.
The Company modified its loan pricing model during the third quarter of
2006. As a result, the composition of new loan originations changed during the
three months ended September 30, 2006 compared to the same period in 2005 as
follows: (1) the average loan size was larger by 13.1%, (2) the average loan
term increased from 35 to 41 months, (3) the projected return on capital has
decreased by approximately 100 basis points, and (4) the average spread between
the advance rate and the expected collection rate has decreased by approximately
200 basis points.
There were no other material changes in credit policy or pricing in the
third quarter of 2006, other than routine changes designed to maintain current
profitability levels.
17
RESULTS OF OPERATIONS
---------------------
Three and Nine Months Ended September 30, 2006 Compared to
----------------------------------------------------------
Three and Nine Months Ended September 30, 2005
----------------------------------------------
The following is a discussion of the results of operations and income
statement data for the Company on a consolidated basis.
THREE MONTHS THREE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
(Dollars in thousands) 2006 REVENUE 2005 REVENUE
------------- ------- ------------- -------
REVENUE:
Finance charges $47,474 85.7% $45,047 87.3%
License fees 3,599 6.5 2,658 5.1
Other income 4,329 7.8 3,918 7.6
------- ----- ------- -----
Total revenue 55,402 100.0 51,623 100.0
COSTS AND EXPENSES:
Salaries and wages 10,666 19.4 9,497 18.4
General and administrative 6,063 10.9 5,440 10.5
Sales and marketing 3,942 7.1 4,160 8.1
Provision for credit losses 4,404 7.9 4,703 9.1
Interest 5,837 10.5 3,655 7.1
Stock-based compensation 242 0.4 491 1.0
Other expense 40 0.1 489 0.9
------- ----- ------- -----
Total costs and expenses 31,194 56.3 28,435 55.1
------- ----- ------- -----
Operating income 24,208 43.7 23,188 44.9
Foreign currency gain (loss) 1 -- (8) --
------- ----- ------- -----
Income from continuing operations before provision
for income taxes 24,209 43.7 23,180 44.9
Provision for income taxes 8,775 15.8 9,231 17.9
------- ----- ------- -----
Income from continuing operations 15,434 27.9 13,949 27.0
------- ----- ------- -----
Discontinued operations
(Loss) gain from discontinued United Kingdom
operations (132) (0.2) 922 1.8
(Credit) provision for income taxes (40) (0.1) 277 0.5
------- ----- ------- -----
(Loss) gain on discontinued operations (92) (0.1) 645 1.3
------- ----- ------- -----
Net income $15,342 27.8% $14,594 28.3%
======= ===== ======= =====
NINE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, % OF SEPTEMBER 30, % OF
(Dollars in thousands) 2006 REVENUE 2005 REVENUE
------------- ------- ------------- -------
REVENUE:
Finance charges $141,400 86.5% $131,380 87.8%
License fees 9,700 5.9 6,870 4.6
Other income 12,409 7.6 11,445 7.6
-------- ----- -------- -----
Total revenue 163,509 100.0 149,695 100.0
COSTS AND EXPENSES:
Salaries and wages 31,279 19.2 27,503 18.4
General and administrative 19,125 11.7 16,855 11.3
Sales and marketing 11,707 7.2 10,956 7.3
Provision for credit losses 7,569 4.6 7,373 4.9
Interest 15,071 9.2 11,011 7.4
Stock-based compensation 188 0.1 1,756 1.2
Other expense 177 0.1 890 0.6
-------- ----- -------- -----
Total costs and expenses 85,116 52.1 76,344 51.1
-------- ----- -------- -----
Operating income 78,393 47.9 73,351 48.9
Foreign currency gain 12 -- 1,019 0.7
-------- ----- -------- -----
Income from continuing operations before provision
for income taxes 78,405 47.9 74,370 49.6
Provision for income taxes 28,067 17.2 28,288 18.9
-------- ----- -------- -----
Income from continuing operations 50,338 30.7 46,082 30.7
-------- ----- -------- -----
Discontinued operations
(Loss) gain from discontinued United Kingdom
operations (277) (0.2) 1,807 1.2
(Credit) provision for income taxes (84) (0.1) 528 0.4
-------- ----- -------- -----
(Loss) gain on discontinued operations (193) (0.3) 1,279 0.8
-------- ----- -------- -----
Net income $ 50,145 30.4% $ 47,361 31.5%
======== ===== ======== =====
18
For the three months ended September 30, 2006, net income increased to
$15.3 million, or $0.44 per diluted share, compared to $14.6 million, or $0.38
per diluted share, for the same period in 2005. The increase in net income
primarily reflects the following:
- Finance charge revenue increased $2.4 million (5.4%) primarily due to
a 5.4% increase in the average size of the loan portfolio.
- License fees increased $0.9 million primarily due to an increase in
the number of dealer-partners.
- The Company's effective tax rate decreased from 39.8% to 36.2%
primarily due to an additional state tax liability recorded in the
third quarter of 2005 that was reversed in the second quarter of 2006
as a result of a favorable settlement.
Partially offsetting these improvements:
- Interest expense increased $2.2 million primarily due to a 33.9%
increase in the amount of average outstanding debt as a result of
borrowings used to fund stock repurchases and new Dealer Loan
originations. Interest expense also increased as a result of a 140
basis point increase in interest rates.
For the nine months ended September 30, 2006, net income increased to $50.1
million, or $1.38 per diluted share, compared to $47.4 million, or $1.21 per
diluted share, for the same period in 2005. The increase in net income primarily
reflects the following:
- Finance charge revenue increased $10.0 million (7.6%) primarily due to
a 6.5% increase in the average size of the loan portfolio.
- License fees increased $2.8 million primarily due to an increase in
the number of dealer-partners.
- Stock-based compensation expense decreased $1.6 million primarily due
to a decline in the number of unvested stock options and the Company's
adoption of SFAS No. 123R.
- The Company's effective tax rate decreased from 38.0% to 35.8%
primarily due to an additional state tax liability recorded in the
third quarter of 2005 that was reversed in the second quarter of 2006
as a result of a favorable settlement.
Partially offsetting these improvements:
- Interest expense increased $4.1 million primarily due to a 230 basis
point increase in interest rates and a 13.7% increase in the amount of
average outstanding debt as a result of borrowings used to fund stock
repurchases in the first nine months of 2006.
Finance Charges. Finance charges increased to $47.5 million and $141.4
million for the three and nine months ended September 30, 2006 from $45.0
million and $131.4 million for the same periods in 2005 primarily due to
increases in the size of the Dealer Loan portfolio.
19
The following table summarizes the changes in active dealer-partners and
corresponding Consumer Loan unit volume for the three months ended September 30,
2006 and 2005:
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------
2006 2005 % CHANGE
------ ------ --------
Consumer Loan unit volume 22,648 20,037 13.0
Active dealer-partners (1) 1,590 1,318 20.6
------ ------
Average volume per dealer-partner 14.2 15.2 (6.6)
Consumer loan unit volume from dealer-partners
active both periods 15,417 15,964 (3.4)
Dealer-partners active both periods 866 866 --
------ ------
Average volume per dealer-partner active both
periods 17.8 18.4 (3.4)
Consumer loan unit volume from new dealer-partners 1,322 1,442 (8.3)
New active dealer-partners (2) 218 198 10.1
------ ------
Average volume per new active dealer-partner 6.1 7.3 (16.4)
Attrition (3) -20.3% -15.0%
(1) Active dealer-partners are dealer-partners who submit at least one Consumer
Loan during the period.
(2) New active dealer-partners are dealer-partners that have enrolled in the
Company's program and have submitted their first Consumer Loan to the
Company during the period.
(3) Attrition is measured according to the following formula: decrease in
Consumer Loan unit volume from dealer-partners who submitted at least one
Consumer Loan during the comparable period of the prior year but who
submitted no Consumer Loans during the current period divided by prior year
comparable period Consumer Loan unit volume.
In March 2005, the Company implemented a change in policy that allows
prospective dealer-partners to enroll in the Company's program without paying
the $9,850 enrollment fee. Prospective dealer-partners choosing this option
instead agree to allow the Company to keep 50% of the first accelerated dealer
holdback payment. This payment, called Portfolio Profit Express, is paid to
qualifying dealer-partners after 100 Consumer Loans have been originated and
assigned to the Company. While the Company will lose enrollment fee revenue on
those dealer-partners choosing this option and not reaching 100 Consumer Loans
or otherwise qualifying for a Portfolio Profit Express payment, the Company
estimates that it will realize higher per dealer-partner enrollment fee revenue
from those dealer-partners choosing this option and qualifying for a Portfolio
Profit Express payment. Based on the historical average of Portfolio Profit
Express payments, the Company expects average enrollment fee revenue per
dealer-partner for those dealer-partners electing the new option and reaching
100 Consumer Loans will be approximately $15,000 - $20,000. Approximately 75% of
the dealer-partners that enrolled during the third quarter of 2006 took
advantage of this new enrollment option.
License Fees. License fees increased to $3.6 million and $9.7 million for
the three and nine months ended September 30, 2006 from $2.7 million and $6.9
million for the same periods in 2005. License fees represent CAPS fees charged
to dealer-partners on a monthly basis. The increases were primarily due to an
increase in the number of dealer-partners. The average number of dealer-partners
billed for CAPS fees for the nine months ended September 30, 2006 was 1,872
compared to 1,270 for the same period in the prior year.
Salaries and Wages. Salaries and wages, as a percentage of revenue,
increased to 19.4% and 19.2% for the three and nine months ended September 30,
2006 from 18.4% for the same periods in 2005. The increases in salaries and
wages, as a percentage of revenue, were primarily due to increased costs of
information systems personnel and an increase in payroll taxes primarily due to
employee and director stock option exercises.
Sales and Marketing. Sales and marketing expenses, as a percentage of
revenue, decreased to 7.1% for the three months ended September 30, 2006
compared to 8.1% for the same period in 2005 while these expenses, as a
percentage of revenue, remained consistent at 7.2% for the nine months ended
September 30, 2006, compared to 7.3% for the same period in 2005. The decrease,
as a percentage of revenue, for the three months was primarily due to $0.5
million related to the Company's annual dealer-partner convention in the third
quarter of 2005. The Company's 2006 dealer-partner convention was held in
October of 2006.
20
Provision for Credit Losses. The provision for credit losses decreased to
$4.4 million for the three months ended September 30, 2006 compared to $4.7
million for the same period in 2005. The provision for credit losses increased
to $7.6 million for the nine months ended September 30, 2006 compared to $7.4
million for the same period in 2005. The provision for credit losses consists
primarily of a provision to reduce the carrying value of Dealer Loans to
maintain the initial yield established at the inception of the Dealer Loan.
Additionally, the provision for credit losses includes a provision for losses on
Purchased Loans and a provision for losses on notes receivable. The decrease in
the provision for the three months ended September 30, 2006 was primarily due to
a one-time pre-tax charge of $2.9 million related to a reduction in forecasted
collection rates resulting from Hurricanes Katrina and Rita in the third quarter
of 2005 partially offset by an increase in the provision for credit losses
required to maintain the initial yield established at the inception of the
Dealer Loan due to a decrease in the Company's forecast of future collections.
The increase in the provision for the nine months ended September 30, 2006 was
primarily due to increases in the provision for credit losses for Purchased
Loans and in the provision for credit losses required to maintain the initial
yield established at the inception of the Dealer Loan. This increase was
partially offset by a one-time pre-tax charge of $2.9 million related to a
reduction in forecasted collection rates resulting from Hurricanes Katrina and
Rita in the third quarter of 2005.
Interest. Interest expense increased to $5.8 million and $15.1 million for
the three and nine months ended September 30, 2006 from $3.7 million and $11.0
million for the same periods in 2005. The increase in interest expense during
the three months ended September 30, 2006 was primarily due to a 33.9% increase
in the amount of average outstanding debt as a result of borrowings used to fund
stock repurchases and new Dealer Loan originations and a 140 basis point
increase in interest rates. The increase in interest expense during the nine
months ended September 30, 2006 was primarily due to a 230 basis point increase
in interest rates and a 13.7% increase in the amount of average outstanding debt
as a result of borrowings used to fund stock repurchases.
Stock-based Compensation. Stock-based compensation expense decreased to
$0.2 million for the three and nine months ended September 30, 2006 from $0.5
million and $1.8 million for the same periods in 2005. The decrease for the
three months ended September 30, 2006 was primarily due to a decline in the
number of unvested stock options outstanding. The decrease for the nine months
ended September 30, 2006 was primarily due to: (i) a decline in the number of
unvested stock options outstanding, (ii) the Company's adoption of SFAS No. 123R
which resulted in revised turnover assumptions for the stock options granted
during 2002-2004. The change in compensation expense was accounted for as a
change in estimate and its cumulative effect was recognized in the first quarter
of 2006, and (iii) an adjustment recognized in the second quarter of 2005 as a
result of a decrease in the period over which certain performance based stock
options and restricted stock are expected to vest.
Foreign Exchange Gain. The foreign exchange gain of $1.0 million for the
nine months ended September 30, 2005 was primarily the result of changes in the
fair value of forward contracts entered into during the third quarter of 2003.
There were no forward contracts outstanding during 2006.
Provision for Income Taxes. The effective tax rates decreased to 36.2% and
35.8% for the three and nine months ended September 30, 2006 from 39.8% and
38.0% for the same period in 2005 primarily due to an additional state tax
liability recorded in the third quarter of 2005 that was reversed in the second
quarter of 2006 as a result of a favorable settlement.
RETURN ON CAPITAL
The return on capital analysis provides an additional perspective on the
financial performance of the Company. The Company believes this information
provides a useful measurement of how effectively the Company is utilizing its
capital. Return on capital is equal to annualized net operating profit after-tax
(net income plus interest expense after-tax) divided by average capital
as follows:
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
(Dollars in thousands) 2006 2005 2006 2005
-------- -------- -------- --------
Net income $ 15,342 $ 14,594 $ 50,145 $ 47,361
Interest expense after-tax (1) 3,677 2,303 9,495 6,937
-------- -------- -------- --------
Net operating profit after-tax $ 19,019 $ 16,897 $ 59,640 $ 54,298
======== ======== ======== ========
Average debt $260,439 $194,571 $223,807 $196,904
Average shareholders' equity 281,631 342,017 313,996 324,764
-------- -------- -------- --------
Average capital $542,070 $536,588 $537,803 $521,668
======== ======== ======== ========
Return on capital 14.0% 12.6% 14.8% 13.9%
(1) Interest expense after-tax calculated using a 37% tax rate which
approximates the Company's long term effective tax rate.
21
ECONOMIC PROFIT
The Company defines economic profit as net income less an imputed cost of
equity. Economic profit measures how efficiently the Company utilizes its
capital. To consider the cost of both debt and equity, the Company's calculation
of economic profit deducts from net income a cost of equity equal to 10% of
average equity, which approximates the S&P 500's rate of return since 1965.
Management uses economic profit to assess the Company's performance as well as
to make capital allocation decisions. Management believes this information is
important to shareholders because it allows shareholders to compare the returns
earned by the Company with the return they could expect if the Company returned
capital to shareholders and they invested in other securities.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------- -------------------------
(Dollars in thousands, except per share data) 2006 2005 2006 2005
----------- ----------- ----------- -----------
Net income $ 15,342 $ 14,594 $ 50,145 $ 47,361
Imputed cost of equity at 10% (1) (7,041) (8,551) (23,550) (24,357)
----------- ----------- ----------- -----------
Total economic profit $ 8,301 $ 6,043 $ 26,595 $ 23,004
=========== =========== =========== ===========
Diluted weighted average shares outstanding 35,074,557 38,912,822 36,348,390 39,249,304
Economic profit per diluted share (2) $ 0.24 $ 0.16 $ 0.73 $ 0.59
(1) Cost of equity is equal to 10% (on an annual basis) of average
shareholders' equity, as disclosed in the Return on Capital calculation.
(2) Economic profit per diluted share equals the economic profit divided by the
diluted weighted average number of shares outstanding.
FLOATING YIELD FINANCIAL RESULTS
The Company's GAAP finance charge revenue is based on estimates of future
cash flows and is recognized on a level yield basis. Under the level yield
basis, the amount of finance charge revenue recognized in a given period,
divided by the loan asset, is a constant percentage. Under GAAP, favorable
changes in expected cash flows are treated as increases to the level yield and
are recognized over time, while unfavorable changes are recorded as a current
period expense. The non-GAAP measure ("Floating Yield") is identical to the
Company's GAAP results except that, under the Floating Yield method, all changes
in expected cash flows are treated as yield adjustments and therefore impact
earnings over time. The GAAP treatment always results in a lower carrying value
of the loan receivable asset, but may result in either higher or lower earnings
for any given period depending on the timing and amount of expected cash flow
changes.
The Company believes Floating Yield earnings are a more accurate reflection
of the economics of the business since both favorable and unfavorable changes in
estimated cash flows are treated consistently. The Company uses Floating Yield
earnings to measure performance internally including financial performance
measures utilized in incentive compensation plans.
The following table presents selected non-GAAP Floating Yield financial
data.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------------ ------------------------------
(Dollars in thousands, except per share data) 2006 2005 % CHANGE 2006 2005 % CHANGE
-------- -------- -------- -------- -------- --------
Net income $ 16,615 $ 15,743 5.5 $ 49,587 $ 47,383 4.7
Income from continuing operations 16,707 15,098 10.7 49,780 46,104 8.0
Income from continuing operations per diluted
share 0.48 0.39 23.1 1.37 1.17 17.1
Net operating profit after tax 20,292 18,046 12.4 59,082 54,320 8.8
Average capital $547,365 $544,112 0.6 $542,982 $529,426 2.6
Return on capital 14.8% 13.3% 11.3 14.5% 13.7% 5.8
22
The following table reconciles selected financial data from the Company's
GAAP financial results to the Floating Yield financial results.
FOR THE THREE MONTHS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------- -------------------
(Dollars in thousands) 2006 2005 2006 2005
-------- -------- -------- --------
GAAP net operating profit after tax $ 19,019 $ 16,897 $ 59,640 $ 54,298
Floating Yield adjustment 1,273 1,149 (558) 22
-------- -------- -------- --------
Floating Yield net operating profit after tax $ 20,292 $ 18,046 $ 59,082 $ 54,320
GAAP average capital $542,070 $536,588 $537,803 $521,668
Floating Yield adjustment 5,295 7,524 5,179 7,758
-------- -------- -------- --------
Floating Yield average capital $547,365 $544,112 $542,982 $529,426
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary sources of capital are cash flows from operating
activities, collections of Consumer Loans and borrowings under the Company's
line of credit and secured financings. The Company's principal needs for capital
are to fund Dealer Loan originations, for the payment of dealer holdback, and to
fund stock repurchases.
The Company's cash and cash equivalents increased to $66.8 million as of
September 30, 2006 from $7.1 million at December 31, 2005. This increase was
primarily a result of the borrowings used to fund the Company's modified Dutch
auction tender offer. The Company's total balance sheet indebtedness increased
to $323.5 million at September 30, 2006 from $146.9 million at December 31,
2005. This increase was primarily a result of borrowings used to fund stock
repurchases in the first, second and third quarters of 2006.
Restricted Cash and Cash Equivalents increased to $42.0 million as of
September 30, 2006 from $13.5 million at December 31, 2005. The balance consists
primarily of cash collections and required reserves related to secured funding
and future warranty claims.
Restricted Securities. The Company determines the appropriate
classification of its investments in debt and equity securities at the time of
purchase and reevaluates such determinations at each balance sheet date. Debt
securities for which the Company does not have the intent or ability to hold to
maturity are classified as available for sale, and stated at fair value with
unrealized gains and losses, net of income taxes included in the determination
of comprehensive income and reported as a component of shareholders' equity.
Restricted securities available for sale consisted of the following:
AS OF SEPTEMBER 30, 2006
--------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
(in thousands) COST GAINS LOSSES VALUE
------ ---------- ---------- ---------
US Government and agency securities $1,578 $-- $ (9) $1,569
Corporate bonds 2,117 -- (45) 2,072
------ --- ---- ------
Total restricted securities available for sale $3,695 $-- $(54) $3,641
====== === ==== ======
AS OF DECEMBER 31, 2005
--------------------------------------------
GROSS GROSS ESTIMATED
UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
------ ---------- ---------- ---------
US Government and agency securities $1,336 $-- $(14) $1,322
Corporate bonds 2,068 -- (45) 2,023
------ --- ---- ------
Total restricted securities available for sale $3,404 $-- $(59) $3,345
====== === ==== ======
23
The cost and estimated fair values of securities available for sale by
contractual maturity as of the dates shown are set forth in the table below
(securities with multiple maturity dates are classified in the period of final
maturity). Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.
AS OF AS OF
SEPTEMBER 30, 2006 DECEMBER 31, 2005
------------------ ------------------
ESTIMATED ESTIMATED
FAIR FAIR
(in thousands) COST VALUE COST VALUE
------ --------- ------ ---------
Contractual Maturity
Within one year $ 728 $ 720 $ -- $ --
Over one year to five years 2,967 2,921 3,028 2,971
Over five years to ten years -- -- 376 374
Over ten years -- -- -- --
------ ------ ------ ------
Total restricted securities available for
sale $3,695 $3,641 $3,404 $3,345
====== ====== ====== ======
Stock Repurchases. In the first quarter of 2006, the Board of Directors
authorized the repurchase of up to 5.0 million common shares through a modified
Dutch auction tender offer. Upon expiration of the tender offer in March 2006,
the Company repurchased 4.1 million common shares at a cost of $103.2 million.
Additionally, during the third quarter of 2006, the Board of Directors
authorized the repurchase of up to 3.5 million common shares through a modified
Dutch auction tender offer. Upon expiration of the tender offer in September
2006, the Company accepted for payment 3.5 million common shares at a price of
$31.50 per share. On October 3, 2006, the Company made payment for the 3.5
million common shares at a total cost of approximately $110.3 million.
On August 1, 2006, the Company's Board of Directors authorized the
repurchase of up to $25.0 million of the Company's common stock in addition to
the Board's prior authorizations.
For additional information regarding the Company's stock repurchase
program, see "Part II, Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds", which is incorporated herein by reference.
Contractual Obligations. In addition to the balance sheet indebtedness as
of September 30, 2006, the Company also has contractual obligations resulting in
future minimum payments under operating leases. A summary of the total future
contractual obligations requiring repayments is as follows (in thousands):
PAYMENTS DUE BY PERIOD
-------------------------------------------------------
CONTRACTUAL OBLIGATIONS TOTAL < 1 YEAR 1-3 YEARS 3-5 YEARS > 5 YEARS
----------------------- -------- -------- --------- --------- ---------
Long-term debt obligations $321,507 $289,245 $32,262 $-- $--
Capital lease obligations 1,963 686 1,277 -- --
Operating lease obligations 1,528 672 856 -- --
-------- -------- ------- --- ---
Total contractual obligations $324,998 $290,603 $34,395 $-- $--
======== ======== ======= === ===
CRITICAL ACCOUNTING ESTIMATES
The Company's consolidated financial statements are prepared in accordance
with GAAP. The preparation of these financial statements requires the Company to
make estimates and judgments that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. On an ongoing basis, the Company evaluates its
estimates, including those related to the recognition of finance charge revenue
and the allowance for credit losses. Item 7 of the Company's Annual Report on
Form 10-K for the year ended December 31, 2005 discusses several critical
accounting policies, which the Company believes involve a high degree of
judgment and complexity. There have been no material changes to the estimates
and assumptions associated with these accounting policies, other than related to
stock-based compensation expense as discussed in Note 2 to the consolidated
financial statements, incorporated herein by reference, from those discussed in
the Company's Annual Report on Form 10-K for the year ended December 31, 2005.
24
FORWARD-LOOKING STATEMENTS
The Company makes forward-looking statements in this report and may make
such statements in future filings with the Securities and Exchange Commission.
It may also make forward-looking statements in its press releases or other
public or shareholder communications. The Company's forward-looking statements
are subject to risks and uncertainties and include information about its
expectations and possible or assumed future results of operations. When the
Company uses any of the words "may," "will," "should," "believes," "expects,"
"anticipates," "assumes," "forecasts," "estimates," "intends," "plans" or
similar expressions, it is making forward-looking statements.
The Company claims the protection of the safe harbor for forward-looking
statements contained in the Private Securities Litigation Reform Act of 1995 for
all of its forward-looking statements. These forward-looking statements
represent the Company's outlook only as of the date of this report. While the
Company believes that its forward-looking statements are reasonable, actual
results could differ materially since the statements are based on our current
expectations, which are subject to risks and uncertainties. Factors that might
cause such a difference include, but are not limited to, the factors set forth
in Item 1A of the Company's Form 10-K for the year ended December 31, 2005,
other risk factors discussed herein or listed from time to time in the Company's
reports filed with the Securities and Exchange Commission and the following:
- The Company's inability to accurately forecast the amount and
timing of future collections could have a material adverse effect
on results of operations.
- Due to increased competition from traditional financing sources
and non-traditional lenders, the Company may not be able to
compete successfully.
- The Company's ability to maintain and grow the business is
dependent on the ability to continue to access funding sources
and obtain capital on favorable terms.
- The Company may not be able to generate sufficient cash flow to
service its outstanding debt and fund operations.
- The substantial regulation to which the Company is subject limits
the business, and such regulation or changes in such regulation
could result in potential liability.
- Adverse changes in economic conditions, or in the automobile or
finance industries or the non-prime consumer finance market,
could adversely affect the Company's financial position,
liquidity and results of operations and its ability to enter into
future financing transactions.
- Litigation the Company is involved in from time to time may
adversely affect its financial condition, results of operations
and cash flows.
- The Company is dependent on its senior management and the loss of
any of these individuals or an inability to hire additional
personnel could adversely affect its ability to operate
profitably.
- Natural disasters, acts of war, terrorist attacks and threats or
the escalation of military activity in response to such attacks
or otherwise may negatively affect the business, financial
condition and results of operations.
Other factors not currently anticipated by management may also materially
and adversely affect the Company's results of operations. The Company does not
undertake, and expressly disclaims any obligation, to update or alter its
statements whether as a result of new information, future events or otherwise,
except as required by applicable law.
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS.
Refer to the Company's Annual Report on Form 10-K for the year ended
December 31, 2005 for a complete discussion of the Company's market risk. There
have been no material changes to the market risk information included in the
Company's 2005 Annual Report on Form 10-K.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures.
The Company maintains disclosure controls and procedures that are designed
to ensure material information required to be disclosed in the Company's reports
that it files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to the Company's management, including its Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
financial disclosure. In designing and evaluating the disclosure controls and
procedures, management recognized that a control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the objectives of the control system are met. Because of the inherent
limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, with
a company have been detected.
As of the end of the period covered by this report, the Company carried out
an evaluation, under the supervision and with the participation of the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act
of 1934. Based upon that evaluation, the Company's Chief Executive Officer and
Chief Financial Officer concluded that the Company's disclosure controls and
procedures were effective, at the reasonable assurance level, as of the end of
the period covered by this report to cause the material information required to
be disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934 to be recorded, processed, summarized and
reported within the time periods specified in the Commission's rules and forms.
Changes in Internal Controls Over Financial Reporting. There have been no
changes in the Company's internal controls over financial reporting during the
quarter ended September 30, 2006 that have materially affected, or are
reasonably likely to materially affect, the Company's internal controls over
financial reporting.
26
PART II. - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In the normal course of business and as a result of the customer-oriented
nature of the industry in which the Company operates, industry participants are
frequently subject to various customer 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, customer protection, warranty, debt collection, insurance and
other customer-oriented laws and regulations, including claims seeking damages
for physical and mental damages relating to the Company's repossession and sale
of the customer's vehicle and other debt collection activities. The Company, as
the assignee of Consumer Loans originated by dealer-partners, may also be named
as a co-defendant in lawsuits filed by customers principally against
dealer-partners. Many of these cases are filed as purported class actions and
seek damages in large dollar amounts. An adverse ultimate disposition in any
such action could have a material adverse impact on the Company's financial
position, liquidity and results of operations.
The Company is currently a defendant in a class action proceeding commenced
on October 15, 1996 in the Circuit Court of Jackson County, Missouri and removed
to the United States District Court for the Western District of Missouri. The
complaint seeks unspecified money damages for alleged violations of a number of
state and federal consumer protection laws. On October 9, 1997, the District
Court certified two classes on the claims brought against the Company, one
relating to alleged overcharges of official fees, the other relating to alleged
overcharges of post-maturity interest and a subclass relating to allegedly
inadequate repossession notices. On August 4, 1998, the District Court granted
partial summary judgment on liability in favor of the plaintiffs on the interest
overcharge claims based upon the District Court's finding of certain violations
but denied summary judgment on certain other claims. The District Court also
entered a number of permanent injunctions, which among other things, restrained
the Company from collecting on certain class accounts. 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, the Company appealed the
summary judgment order to the United States Court of Appeals for the Eighth
Circuit. Oral argument on the appeals was heard on April 19, 1999. On September
1, 1999, the United States Court of Appeals for the Eighth Circuit overturned
the August 4, 1998 partial summary judgment order and injunctions against the
Company. The Court of Appeals held that the District Court lacked jurisdiction
over the interest overcharge claims and directed the District Court to sever
those claims and remand them to state court. On February 18, 2000, the District
Court entered an order remanding the post-maturity interest class to the Circuit
Court of Jackson County, Missouri while retaining jurisdiction on the official
fee class. The Company then filed a motion requesting that the District Court
reconsider that portion of its order of August 4, 1998, in which the District
Court had denied the Company's motion for summary judgment on the federal
Truth-In-Lending Act ("TILA") claim. On May 26, 2000, the District Court entered
summary judgment in favor of the Company on the TILA claim and directed the
Clerk of the Court to remand the remaining state law official fee claims to the
appropriate state court.
On July 18, 2002, the Circuit Court of Jackson County, Missouri granted
plaintiffs leave to file a fourth amended petition which was filed on October
28, 2002. Instead of a subclass of Class 2, that petition alleges a new,
expanded Class 3 relating to allegedly inadequate repossession notices. The
Company filed a motion to dismiss the plaintiff's fourth amended complaint on
November 4, 2002. On November 18, 2002, the Company filed a memorandum urging
the decertification of the classes. On February 21, 2003, the plaintiffs filed a
brief opposing the Company's November 4, 2002 motion to dismiss the case. On May
19, 2004, the Circuit Court released an order, dated January 9, 2004, that
denied the Company's motion to dismiss. On November 16, 2005 the Circuit Court
issued an order that, among other things, adopted the District Court's order
certifying classes. By adopting the District Court's order, the Circuit Court's
order certified only the two original classes and did not certify the new,
expanded Class 3. On January 13, 2006, plaintiffs filed a motion entitled
Plaintiffs' Motion To Adjust Class 2 Definition To Correspond With Allegations
Of Their Fourth Amended Complaint which requested that the "repossession
subclass" be deleted from Class 2 and a new Class 3 be adopted. The Company
filed a response arguing that the new, expanded Class 3 is inappropriate for a
number of reasons including the expiration of the statute of limitations. On May
23, 2006, the Circuit Court issued several orders, including an order granting
plaintiffs' motion and adding the new Class 3. On June 2, 2006 the Company filed
for leave to appeal the Circuit Court's decision to allow the expanded
repossession class as well as its November 16, 2005 certification order. The
Court of Appeals denied the Company's request for leave to appeal the Circuit
Court's decision on August 31, 2006.
The Company will continue its vigorous defense of all remaining claims.
However, an adverse ultimate disposition of this litigation could have a
material negative impact on the Company's financial position, liquidity and
results of operations.
27
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table summarizes the Company's stock repurchases for the
three months ended September 30, 2006:
TOTAL NUMBER OF MAXIMUM NUMBER
SHARES PURCHASED OF SHARES THAT MAXIMUM DOLLAR VALUE
AS PART OF MAY YET BE THAT MAY YET BE USED
TOTAL NUMBER PUBLICLY PURCHASED UNDER TO PURCHASE SHARES
OF SHARES AVERAGE PRICE ANNOUNCED PLANS THE PLANS OR UNDER THE PLANS
PERIOD PURCHASED PAID PER SHARE OR PROGRAMS PROGRAMS (A)(B) OR PROGRAMS (A)
------ ------------ -------------- ---------------- ---------------- --------------------
July 1 through July 31, 2006 -- $ -- -- 224,014 $ --
August 1 through August 31, 2006 314,383 27.39 314,383 3,500,000 22,529,186
September 1 through September 30, 2006 3,500,000 31.50 3,500,000 -- 22,529,186
--------- ------ ---------
3,814,383 $31.16 3,814,383
========= ====== =========
(A) The Company's board of directors approved a stock repurchase program which
authorizes the Company to purchase common shares in the open market or in
privately negotiated transactions at price levels the Company deems
attractive. At this time, the Company has authorization to repurchase an
additional $25.0 million of the Company's common stock. As of September 30,
2006, the Company has repurchased approximately 7.1 million shares under
this program at a cost of $71.4 million.
(B) On August 28, 2006, the Company announced a modified Dutch auction tender
offer to purchase up to 3.5 million shares of its common stock at a
purchase price of not less than $28.00 per share and not greater than
$31.50 per share. Upon expiration of the tender offer on September 26,
2006, the company accepted for payment 3.5 million shares of its common
stock at a price of $31.50 per share. The Company made payment for these
shares on October 3, 2006.
ITEM 6. EXHIBITS
See Index of Exhibits following the signature page, which is incorporated
herein by reference.
28
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CREDIT ACCEPTANCE CORPORATION
(Registrant)
By: /s/ Kenneth S. Booth
------------------------------------
Kenneth S. Booth
Chief Financial Officer
October 30, 2006
(Principal Financial Officer, Principal
Accounting Officer and Duly Authorized
Officer)
29
INDEX OF EXHIBITS
EXHIBIT
NO. NOTE DESCRIPTION
-------- ---- -----------
4(f)(77) 1 Certificate Funding Agreement, dated September 20, 2006,
between the Company, Credit Acceptance Residual Funding LLC,
Wachovia Bank, National Association, Variable Funding Capital
Company LLC, and Wachovia Capital Markets, LLC, and agreements
related thereto.
31(a) 2 Certification of Chief Executive Officer, pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
31(b) 2 Certification of Chief Financial Officer, pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
32(a) 2 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350 and Rule 13a-14(b) of the Securities
Exchange Act of 1934.
32(b) 2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350 and Rule 13a-14(b) of the Securities
Exchange Act of 1934.
1 Previously filed as an exhibit to the Company's Current Report on Form 8-K,
as amended, dated September 20, 2006, and incorporated herein by reference.
2 Filed herewith.
30