- -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K
CREDIT ACCEPTANCE CORPORATION YEAR ENDED DECEMBER 31, 2003 INDEX TO FORM 10-K
PART I ITEM 1. BUSINESS GENERAL Since 1972, Credit Acceptance (the "Company" or "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 by selling vehicles to consumers who otherwise could not obtain financing, by 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. Without the Company's product, consumers are often unable to purchase a vehicle or they purchase an unreliable one and are not provided the opportunity to improve their credit standing. As the Company reports to the three national credit reporting agencies, a significant number of its customers improve their lives by improving their credit score and move on to more traditional sources of financing. Credit Acceptance was founded to service and collect retail installment contracts (referred to as "Loans") originated and funded by automobile dealerships owned by the Company's founder, majority shareholder, and current Chairman, Donald Foss. During the 1980's, the Company began to market this service to non-affiliated dealers and, at the same time, began to offer dealer-partners a non-recourse cash payment (an "advance") against anticipated future collections on Loans serviced for that dealer-partner. Today, the Company's program is offered to dealers throughout the United States. The Company refers to participating dealers who share its commitment to changing customers' lives as "dealer-partners". The Company's Internet address is www.creditacceptance.com. The Company makes available, free of charge on the web site, copies of reports it files with or furnishes to the Securities and Exchange Commission as soon as reasonably practicable after the Company electronically files such reports. PRINCIPAL BUSINESS A customer 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 customer; (ii) a cash advance from the Company; and (iii) after the advance has been recovered, the cash from payments made on the Loan, net of certain collection costs and the Company's servicing fee. 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. Customers and dealer-partners benefit as follows: Customers. The Company helps change the lives of customers who do not qualify for conventional automobile financing by helping them obtain quality transportation and, equally important, providing an opportunity to establish or reestablish their credit through the timely repayment of their Loan. Dealer-Partners. The Company's program increases dealer-partners' profits in the following ways: - Enables dealer-partners to sell cars to customers who may not be able to obtain financing without the Company's program. In addition, customers often become repeat customers by financing future vehicle purchases either through the Company's program or, after they have successfully established or reestablished their credit, through conventional financing. - Allows dealer-partners to share in the profits not only from the sale of the vehicle, but also from its financing. - Attracts customers by advertising "guaranteed credit approval". The customers will often use other services of the dealer-partners and refer friends and relatives to them. - Attracts customers who mistakenly assume they do not qualify for conventional financing. 2
Credit Acceptance derives its revenues from the following principal sources: (i) servicing fees (recorded as finance charges) earned as a result of servicing Loans assigned to the Company by dealer-partners; (ii) fees earned from the Company's third party ancillary product offerings, which primarily consist of service contract programs; (iii) lease revenue from investments in operating leases; (iv) premiums earned on service contract and credit life insurance programs; and (v) other income, which primarily consists of: monthly fees from the Company's Internet based Credit Approval Processing System ("CAPS"), interest income and fees from floorplan receivables, secured lines of credit, and notes receivable; net gains resulting from lease terminations; rental income from leasing part of the Company's headquarters to outside parties; and fees charged to dealer-partners at the time they enroll in the Company's program. The following table sets forth the percent relationship to total revenue of each of these sources:
Dealer-partner enrollments in the United States for each of the last five years are presented in the table below.
(iii) a termination fee equal to 15% of the then outstanding amount of the Loans accepted by the Company. Upon receipt in full of such amounts, the Company will reassign the Loan receivable and its security interest in the financed vehicle to the dealer-partner. In the event of a termination by the Company (or any other termination if the Company and the dealer-partner agree), the Company may continue to service Loans accepted prior to termination in the normal course of business without charging a termination fee. Loan Origination. Once a dealer-partner has enrolled in the Company's program, the dealer-partner may begin submitting Loans to the Company for servicing, administration, and collection. A Loan occurs when a customer enters into a contract with a dealer-partner that sets forth the terms of the agreement between the customer and the dealer-partner for the payment of the purchase price of the automobile. The amount of the Loan consists of the total principal and interest that the customer is required to pay over the term of the Loan. During 2003, virtually all of the Company's United States Loan originations were processed through CAPS. CAPS was offered to all dealer-partners located in the United States beginning in January 2001, and allows dealer-partners to input a credit application and view the response from the Company on-line. CAPS, which is patent pending, allows dealer-partners to: (i) receive an approval from the Company much faster than with traditional methods; and (ii) interact with the Company's credit scoring system to improve the structure of each transaction prior to delivery. All responses include the amount of the advance, as well as any stipulations required for funding. The amount of the advance is determined by using a computer model which considers a number of factors including the timing and amount of cash flows expected on the related Loan and the Company's target return on capital at the time the Loan is originated. The estimated future cash flows are determined based upon a proprietary credit scoring system, which considers numerous variables, including the customer's credit bureau report, data contained in the customer's credit application, the structure of the proposed transaction, vehicle information and other factors, to calculate a composite credit score that corresponds to an expected collection rate. The Company's credit scoring system predicts the probability of default based upon the historical performance of Loans in the Company's portfolio that share similar characteristics. The performance of the credit scoring system is evaluated monthly by comparing projected to actual Loan performance. Adjustments are made to the credit scoring system when necessary. While a dealer-partner can assign any Loan to the Company for servicing, administration and collection, the decision whether to pay an advance to the dealer-partner and the amount of any advance, is made solely by the Company. The Company performs all significant functions relating to the processing of the Loan applications and bears certain costs of origination, including the cost of assessing the adequacy of Loan documentation, compliance with underwriting guidelines and the cost of verifying employment, residence and other information submitted by the dealer-partner. CAPS interfaces with the Company's Application and Contract System ("ACS"). Loan information included in CAPS is automatically entered into ACS through a download from CAPS. Additional Loan information is entered into ACS manually. ACS provides credit scoring capability as well as the ability to process Loan packages. ACS compares Loan data against information provided during the approval process and allows the funding analyst to check that all stipulations have been met prior to funding. Loan contracts are written on a contract form provided by the Company and the Loan transaction typically is not completed until the dealer-partner has received approval from the Company. The assignment of the Loan from the dealer-partner to the Company occurs simultaneously with the customer's signing of the Loan contract. Although the dealer-partner is named in the Loan contract, the dealer-partner does not have ownership of the Loan for more than a moment and the Company, not the dealer-partner, is listed as lien holder on the vehicle title. The customer's payment obligation is directly to the Company. Payments are generally made by the customer directly to the Company. For these reasons, the Company views the Loan to be an asset of the Company, not the dealer-partner. The customer's failure to pay amounts due under the Loan will result in collection action by the Company and may result in a charge-off of the Loan. See "Credit Loss Policy" for a description of the Company's charge-off policy. The Company may offer the dealer-partner a non-recourse advance against anticipated future collections on the Loan. Since typically the combination of the advance and the customer's down payment provides the dealer-partner with a cash profit at the time of sale, the dealer-partner's risk in the Loan is limited. The dealer-partner would typically view any future cash flows from dealer holdback payments to be additional profit. The 5
Company cannot demand repayment from the dealer-partner of the advance except in the event the dealer-partner is in default of the servicing agreement. Advances are made only after the Loan is approved, accepted by and assigned to the Company and all other stipulations required for funding have been satisfied. As advances are originated, they are automatically assigned to the originating dealer-partner's open pool of advances. Periodically, pools are closed and subsequent advances are assigned to a new pool. All advances due from a dealer-partner are secured by the future collections on the dealer-partner's portfolio of Loans. Collections on all related Loans within the pool, after payment of the Company's servicing fee and reimbursement of certain collection costs, are applied to reduce the aggregate advance balance owing against those Loans. Once the advance balance has been repaid, the dealer-partner is entitled to receive future collections from Loans within that pool, after payment of the Company's servicing fee and reimbursement of certain collection costs. If the collections on Loans from a dealer-partner's pool are not sufficient to repay the advance balance, the dealer-partner will not receive the dealer holdback. Loans accepted by the Company are secured by liens on the financed vehicles. The Company's acceptance of Loans is generally without recourse to the general assets of the dealer-partner. Dealer-partners have an opportunity to receive a portion of the dealer holdback at the time a pool of 100 or more Loans is capped. The amount paid to the dealer-partner is calculated using a formula that considers the collection rate and the advance balance on the capped pool. The Company records the total payments due under the Loan as a Loan receivable and the amount of its servicing fee as an unearned finance charge, which is netted from the gross amount of the Loan in the balance sheet. The servicing fee represents the portion of the Loan payments above the amount of the advance that the Company is entitled to retain and therefore becomes the interest element on the Loan from the Company's perspective. Amounts contractually due to the dealer-partner, generally 80% of the gross Loan amount, are reflected as a liability (dealer holdback) from which the advance on the Loan is netted. The dealer holdback is a contractual obligation to the dealer-partner from the Company and includes the dealer-partner's profit on the sale of the vehicle as well as the dealer-partner's share of the profits from the financing. Actual payments of dealer holdback will be contingent on collections of the related Loans assigned to the Company. The Company's business model allows it to share the risk and reward of collecting on the Loans with the dealer-partners. Such sharing is intended to motivate the dealer-partner to assign better quality Loans, follow the Company's underwriting guidelines, and provide appropriate service and support to the customer after the sale. The Company believes this arrangement aligns the interests of the Company, the dealer-partner and the customer. The Company measures various criteria for each dealer-partner against other dealer-partners in their area as well as the top performing dealer-partners. Sales representatives are required to present the results to the dealer-partner and to develop an action plan on a quarterly basis with the dealer-partner to improve the dealer-partner's overall success with the Company's program. Information on the Company's Loan originations for each of the last five years is presented in the following table:
Information on the Company's Loan originations in the United States for 2003 and 2002 is presented in the following table:
(iii) establish the Company's allowance for credit losses; and (iv) analyze the profitability of the Company's program. SERVICE CONTRACTS AND INSURANCE PRODUCTS The Company maintains relationships with certain insurance carriers which provide dealer-partners the ability to offer customers credit life and disability insurance. Should the customer elect to purchase this insurance, the premium on the insurance policy is added to the amount due under the Loan and to the advance balance. The Company is not involved in the actual sale of the insurance; however, the insurance carrier cedes the premiums, less a fee, to a wholly-owned subsidiary of the Company, which reinsures the coverage under the policy. As a result, the Company, through its subsidiary, bears the risk of loss, and earns revenues from premiums ceded and the investment of such funds. The Company's reserve for insurance claims was $455,000 and $575,000 at December 31, 2003 and 2002, respectively. The Company provides dealer-partners the ability to offer vehicle service contracts to customers. Under this program, the sales price of the service contract is added to the amount due under the Loan. The cost of the service contract, plus a commission earned by the dealer-partner on the sale of the service contract is added to the advance balance. A portion of the amount added to the advance balance is retained by the Company as a fee. Generally, a third party bears all of the risk of loss on claims. Historically, the Company also offered a vehicle service contract program where the Company bore the risk of loss on claims relating to the service contracts. The Company discontinued offering this product effective November 1, 2003, as the product was not competitive with the third-party service contract products offered by the Company. The Company's reserve for service contract claims was $64,000 and $155,000 at December 31, 2003 and 2002, respectively. Revenues derived from the Company's service contract and insurance product businesses during 2003, 2002 and 2001 are as follows:
AUTOMOBILE LEASING In January 2002, the Company decided to exit the automobile leasing business. This decision was based upon the conclusion that the automobile leasing business was unlikely to produce a higher risk-adjusted return on capital than the Company's principal business in the United States over the long-term. Prior to this decision, the Company purchased automobile leases from dealer-partners for an amount based on the value of the vehicle as determined by an industry guidebook, assumed ownership of the related vehicle from the dealer- partner and received title to the vehicle. This program differed from the Company's principal business in that, as leases were purchased outright, the Company assumed no liability to the dealer-partner for dealer holdback payments. Additionally, the customer was required to remit a security deposit to the Company. At lease termination, the Company is responsible for the ultimate disposal of the vehicle, which is sold directly to the dealer-partner, to the customer or at auction. Leases generally have an original term ranging from 24 to 48 months, with an average of 37 months. As of December 31, 2003, the amount of capital invested in this business was $1.9 million. OTHER Canada. Effective June 30, 2003, the Company decided to stop originating automobile Loans in Canada. This decision was based upon the conclusion that the Canadian retail automobile Loan operation was unlikely to produce a higher risk-adjusted return on capital than the Company's principal business in the United States over the long-term. Prior to this decision, the Company originated and serviced Loans in Canada on approximately the same basis as in the United States. As of December 31, 2003, the amount of capital invested in this business was $3.9 million. Floorplan Financing. Floorplan financing is offered on a limited basis to certain dealers, most of which participate in the Company's core program. Under these financing arrangements, loans are provided to finance the dealer's inventory. Dealers are charged documentation fees in connection with each vehicle financed, plus interest on the unpaid balance at rates that generally range from 12% to 18% per annum. Security for these loans generally consists of: (i) a lien on the financed inventory; (ii) a security interest in the dealer's assets, including the dealer-partner's portfolio of Loans serviced by the Company; and (iii) the personal guarantee of the owner. In 2002 and 2003, the Company significantly reduced its investment in the floorplan portfolio after concluding this business was not likely to generate an acceptable return on capital. The Company intends to continue to reduce the amount of capital invested in this business. As of December 31, 2003, the amount of capital invested in this business was $2.7 million. Secured Line of Credit Loans. The Company offered line of credit arrangements to certain dealers who were not participating in the Company's core program. These lines of credit are secured primarily by loans, originated and serviced by the dealer, with additional security provided by the personal guarantee of the dealership's owner. The effective interest rate on these loans varies based upon the amount advanced to the dealer and the percentage of collections on the loan portfolio required to be remitted to the Company. During the third quarter of 2001, the Company discontinued offering this program to new dealers, and is in the process of reducing the amount of capital invested in this business. As of December 31, 2003, the amount of capital invested in this business was $2.3 million. Beginning in 2002, entities owned by the Company's majority shareholder and Chairman began offering secured line of credit loans in a manner similar to the Company's prior program, at his dealerships and at two other dealers, one of whom also does business with the Company. The Company's majority shareholder and Chairman does not intend to expand his line of credit lending activities to additional dealers, except to dealerships which he owns or controls. CREDIT LOSS POLICY For information regarding the Company's accounting policy for the allowance for credit losses, see Note 1 to the consolidated financial statements, which is incorporated herein by reference. 9
COMPETITION The market for customers who do not qualify for conventional automobile financing is large and highly competitive. The Company's largest competition comes from "buy here pay here" dealerships where the dealer finances the customer's purchase and services the loan themselves. The market is also currently served by banks, captive finance affiliates of automobile manufacturers, credit unions and independent finance companies both publicly and privately owned. Many of these companies are much larger and have greater resources than the Company. These companies typically target higher credit tier customers within the Company's market. While the Company is unaware of any other companies offering guaranteed credit approval on a national scale, there is the potential that significant direct competition could emerge and that the Company will be unable to compete successfully. CUSTOMER AND GEOGRAPHIC CONCENTRATIONS No single dealer-partner accounted for more than 10% of total revenues during any of the last three years. The following table provides information regarding the five states that are responsible for the largest dollar amount of Loan originations in the United States during 2003:
revenue and identifiable assets shown may not be indicative of the amounts which would have been reported if the domestic and foreign operations were independent of one another. REGULATION The Company's businesses are subject to various state, federal and foreign laws and regulations, which: (i) require licensing and qualification, (ii) regulate interest rates, fees and other charges, (iii) require specified disclosures to customers, (iv) govern the sale and terms of the ancillary products; and (v) define the Company's rights to collect Loans and repossess and sell collateral. Failure to comply with, or an adverse change in, these laws or regulations could have a material adverse effect on the Company by, among other things, limiting the states or countries in which the Company may operate, restricting the Company's ability to realize the value of the collateral securing the Loans and leases, or resulting in potential liability related to Loans and leases accepted from dealer-partners. In addition, governmental regulations depleting the supply of used vehicles, such as environmental protection regulations governing emissions or fuel consumption, could have a material adverse effect on the Company. The Company is not aware of any such legislation currently pending that could have a material adverse effect on the Company. The sale of insurance products in connection with Loans and leases assigned to the Company by dealer-partners is also subject to state laws and regulations. As the holder of the Loans and leases that contain these products, some of these state laws and regulations may apply to the Company's servicing and collection of the Loans and leases. However, as the Company does not deal directly with customers in the sale of insurance products, it does not believe that such laws and regulations significantly affect its business. Nevertheless, there can be no assurance that insurance regulatory authorities in the jurisdictions in which such products are offered by dealer-partners will not seek to regulate the Company or restrict the operation of the Company's business in such jurisdictions. Any such action could materially adversely affect the income received from such products. The Company's credit life and disability reinsurance and property and casualty insurance subsidiaries are licensed and subject to regulation in the Turks and Caicos Islands. The Company's operations in the United Kingdom and Canada are also subject to various laws and regulations. Generally, these requirements tend to be no more restrictive than those in effect in the United States. The Company believes that it maintains all material licenses and permits required for its current operations and is in substantial compliance with all applicable laws and regulations. The Company's servicing agreement with dealer-partners provides that the dealer-partner shall indemnify the Company with respect to any loss or expense the Company incurs as a result of the dealer-partner's failure to comply with applicable laws and regulations. 11
EMPLOYEES As of January 31, 2004, the Company had 694 employee team members. The Company's team members have no union affiliations and the Company believes its relationship with its team members is good. The table below presents team members by department:
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the shareholders during the fourth quarter. The Company's annual meeting typically occurs during the second quarter of each fiscal year and the results of such matters submitted to a vote of the shareholders at the meeting normally appears in the Quarterly Report on Form 10-Q for that quarter. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is traded on The Nasdaq Stock Market(R) under the symbol CACC. The high and low sale prices for the common stock for each quarter during the two year period ending December 31, 2003 as reported by The Nasdaq Stock Market(R) are set forth in the following table:
For additional information regarding the Company's stock option plans, see Note 11 to the consolidated financial statements, which is incorporated herein by reference. ITEM 6. SELECTED FINANCIAL DATA The selected income statement and balance sheet data presented below are derived from the Company's audited consolidated financial statements and should be read in conjunction with the Company's consolidated audited financial statements and notes thereto and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", included elsewhere in this Annual Report. Certain amounts for prior periods have been reclassified to conform to the current presentation, including the following significant balance sheet reclassifications: (i) the reserve for advance losses, which was previously classified within dealer holdbacks, net, was eliminated and the balance transferred to the allowance for credit losses, which is classified within Loans receivable, net and (ii) repossessed assets were reclassified from Loans receivable, net to other assets. Additionally, as a result of the Company's adoption of the fair value recognition provisions of Statement of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation" under the retroactive restatement method selected by the Company as described in SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure" in the second quarter of 2003, the Company restated all prior periods to reflect the stock-based compensation expense that would have been recognized had the recognition provisions of SFAS No. 123 been applied to all awards granted to employees or directors after January 1, 1995.
structure as well as the required allowance for credit losses. The Company manages its risk by managing the spread between the forecasted collection rate and the advance rate. FORECASTING LOAN PERFORMANCE The following table presents forecasted collection rates, advance rates, the spread (the forecasted collection rate less the advance rate), and the percentage of the forecasted collections that have been realized as of December 31, 2003. The amounts presented are expressed as a percent of the original Loan amount by year of Loan origination.
One method for evaluating the reasonableness of the Company's forecast is to examine the trends in forecasted collection rates over time. The following table compares the Company's forecast as of December 31, 2003 with the forecast as of December 31, 2002.
RESULTS OF OPERATIONS Consolidated The following tables present income statement data on a consolidated basis as well as for the Company's four business segments, United States, United Kingdom, Automobile Leasing, and Other.
the United Kingdom was partially offset by an increase in net income in the United States to $33.0 million in 2003 from $23.8 million in 2002. The increase in net income in the United States was due primarily to: (i) an increase in finance charges to $91.6 million in 2003 from $78.4 million in 2002 as a result of an increase in the average size of the Loan portfolio due to an increase in Loan originations in 2003, (ii) an increase in ancillary product income to $18.5 million in 2003 from $13.2 million in 2002 due to an increase in the number of third-party service contracts sold, and (iii) a decrease in provision for credit losses to $6.9 million in 2003 from $11.7 million in 2002 due to higher 2002 losses as a result of a difficult conversion to a new collection system. To a lesser extent, the increase in net income was also due to two tax-related adjustments in 2002 related to the anticipated repatriation of earnings from the United Kingdom and a change in estimate of state income tax owed that increased the provision for income taxes and decreased net income by $2.6 million. Partially offsetting these items that positively impacted net income were: (i) a decrease in other income to $10.7 million in 2003 from $14.6 million in 2002 due to interest income of $4.8 million from the Internal Revenue Service received in 2002 in connection with a change in tax accounting methods that affected the characterization and timing of revenue recognition for tax purposes, (ii) an increase in salaries and wages to $28.8 million in 2003 from $23.7 million in 2002 due to increased spending on employee bonuses, servicing salaries, corporate support salaries, and employee benefits, and (iii) an increase of $2.9 million in foreign exchange loss as a result of the Company recognizing the fair value of forward contracts entered into to manage foreign currency risk associated with the cash flows anticipated from the exit of the United Kingdom operation. The results of operations for the Company as a whole are attributable to changes described by segment in the discussion of the results of operations in the United States, United Kingdom, Automobile Leasing, and Other business segments. The following discussion of the results of operations for interest expense is provided on a consolidated basis, as the explanation is not meaningful by business segment. Interest. Consolidated interest expense decreased to $8.1 million in 2003 from $9.1 million in 2002. The decrease in consolidated interest expense was primarily the result of a decrease in average outstanding debt. The decrease was partially offset by an increase in the weighted average interest rate to 7.5% for the year ended December 31, 2003 from 5.7% for the same period in 2002. This increase was primarily the result of an increased impact of borrowing fees and costs on average interest rates due to lower average outstanding borrowings. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Consolidated net income remained relatively consistent at $28.4 million in 2002 and 2001. Net income for the year ended December 31, 2002 included: (i) an increase in net income in the United States business segment to $23.8 million in 2002 from $23.1 million in 2001 and (ii) a reduction in net income in the United Kingdom business segment to $6.3 million in 2002 from $7.2 million in 2001. The increase in net income in the United States was due primarily to: (i) an increase in finance charges to $78.4 million in 2002 from $66.3 million in 2001 as a result of an increase in the average size of the Loan portfolio due to an increase in Loan originations in 2001 and (ii) an increase in other income due to interest income of $4.8 million received from the Internal Revenue Service in 2002 in connection with a change in tax accounting methods that affected the characterization and timing of revenue recognition for tax purposes. Partially offsetting these items that positively impacted net income were: (i) an increase in the provision for credit losses to $11.7 million in 2002 from $2.7 million in 2001 due to higher losses in 2002 as a result of a difficult conversion to a new collection system and (ii) an increase in salaries and wages to $23.7 million in 2002 from $20.0 million in 2001 resulting primarily from increased spending on corporate support functions such as information systems, finance, and a new Six Sigma initiative. The reduction in net income in the United Kingdom was due primarily to a reduction in finance charges to $17.7 million in 2002 from $21.8 million in 2001. The decline in finance charges was due to a reduction in the average size of the Loan portfolio as a result of a reduction in Loan originations in 2002 due to a decline in the amount advanced to dealer-partners as a percent of the gross Loan amount and the Company discontinuing its relationship with certain dealer-partners whose business did not meet the Company's return on capital objectives. This reduction in net income was partially offset by a reduction in salaries and wages to 19
$3.6 million in 2002 from $4.9 million in 2001 primarily as a result of $700,000 in executive severance expense incurred in 2001 and a reduction in staffing levels in 2002. The results of operations for the Company as a whole are attributable to changes described by segment in the discussion of the results of operations in the United States, United Kingdom, Automobile Leasing, and Other business segments. The following discussion of the results of operations for interest expense is provided on a consolidated basis, as the explanation is not meaningful by business segment. Interest. Consolidated interest expense decreased to $9.1 million in 2002 from $14.7 million in 2001. The decrease in consolidated interest expense was primarily the result of: (i) a decrease in average outstanding debt and (ii) a decrease in the weighted average interest rate to 5.7% in 2002 from 7.5% in 2001, which was the result of a decrease in the average interest rate on the Company's variable rate debt, including lines of credit and secured financings, and repayment of the senior note debt. United States
accrual Loans to 17.9% as of December 31, 2003 from 21.9% for the same period in 2002 due primarily to an increase in Loan originations in 2003. Ancillary Product Income. Ancillary product income increased to $18.5 million in 2003 from $13.2 million in 2002 primarily due to an increase in the number of third party service contract products sold, primarily due to the increase in Loan originations in 2003 compared to 2002. Premiums Earned. Premiums earned decreased to $3.0 million in 2003 from $4.5 million in 2002 primarily due to a decrease in the penetration rate on the Company's in-house service contract product in 2003. The decrease in the penetration rate was a result of this product not being competitive with the third-party service contract products offered by the Company. Other Income. Other income decreased to $10.7 million in 2003 from $14.6 million in 2002 primarily due to interest income of $4.8 million received from the Internal Revenue Service in the third quarter of 2002 in connection with a change in tax accounting methods that affected the characterization and timing of revenue recognition for tax purposes. This decrease was partially offset by an increase of $900,000 in monthly fees paid by dealer-partners for the use of CAPS. Salaries and Wages. Salaries and wages increased to $28.8 million in 2003 from $23.7 million in 2002 primarily due to increases of: (i) $1.6 million in employee bonus expense due to improved financial and operational performance, (ii) $1.5 million in servicing salaries due to an increase in servicing personnel as a result of an increase in the number of Loans serviced in the United States, (iii) $800,000 for corporate support salaries, and (iv) $500,000 in employee benefits. The Company expects that servicing salaries will grow at a rate commensurate with the growth in the number of Loans serviced. General and Administrative. General and administrative expenses decreased to $16.8 million in 2003 from $19.2 million in 2002 due to: (i) $1.4 million in losses on the disposal of computer hardware in 2002, (ii) a decrease of $700,000 in legal expenses resulting from a reduction in the frequency and severity of legal proceedings in which the Company is engaged, and (iii) a decrease of $400,000 in Michigan single business tax expense resulting from a reduction in the amount of income apportioned to the state of Michigan. Provision for Credit Losses. The provision for credit losses decreased to $6.9 million in 2003 from $11.7 million in 2002. The provision for credit losses consists of three components: (i) a provision for earned but unpaid revenue on Loans which were transferred to non-accrual status during the period, (ii) a provision to reflect losses inherent in the Company's Loan portfolio, and (iii) a provision for losses on notes receivable. The decrease in the provision for credit losses in 2003 compared to 2002 was primarily due to a decrease in the provision for losses inherent in the Company's Loan portfolio to $3.9 million in 2003 from $8.1 million in 2002 due to higher 2002 losses as a result of a difficult conversion to a new collection system (see "Item 7 -- General"). Sales and Marketing. Sales and marketing expenses increased to $7.5 million in 2003 from $6.5 million in 2002 due primarily to increased sales commissions as a result of an increase in the number of Loans originated. Stock-based Compensation Expense. Stock-based compensation expense increased to $3.3 million in 2003 from $1.7 million in 2002. While the number of stock options outstanding declined in 2003, stock-based compensation expense increased as a result of a change in assumptions that reduced the period over which certain performance based stock options are expected to vest. Provision for Insurance and Service Contract Claims. The provision for insurance and service contract claims, as a percent of premiums earned, decreased to 18.3% in 2003 from 41.2% in 2002 primarily due to a reassessment of the amount of incurred but not reported claims reserves. Foreign exchange loss. The foreign exchange loss increased to $2.9 million in 2003 from zero in 2002. In 2003, the Company entered into forward contracts to ensure that currency fluctuations would not reduce the amount of United States dollars received from the liquidation of the United Kingdom operation. From the date the forward contracts were entered into, the weakening of the United States dollar versus the British pound sterling caused a reduction in the fair value of the contracts and an approximately equal increase in the value of British-pound-sterling-denominated net assets held. These amounts were not equal for the full year ended December 31, 2003 because the change in shareholders' equity reflects the change in exchange rates for 21
the year while the change in the value of the forward contracts reflects the change in exchange rates from the date the contracts were entered into until the end of the year. The reduction in fair value of the forward contracts is recorded as foreign exchange loss while the increase in British-pound-sterling-denominated net assets is recorded as an increase in shareholders' equity. In future periods, the Company expects the amount of the gain or loss recognized by the Company on the forward contracts to be approximately offset by an increase or decrease in shareholders' equity. Provision for Income Taxes. The effective tax rate decreased to 34.9% in 2003 from 41.4% in 2002. The reduction in the effective tax rate in 2003 was primarily due to a decrease of 9.7% resulting from expense recorded in 2002 for estimated taxes due upon repatriation of prior years' earnings in the United Kingdom, partially offset by an increase of 3.2% resulting from a change in estimate of state income tax owed. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Finance Charges. Finance charges increased to $78.4 million in 2002 from $66.3 million in 2001 primarily due to an increase in the average size of the Loan portfolio due to an increase in Loan originations in 2001. This increase was partially offset by a reduction in the average annualized yield on the Company's Loan portfolio to 12.5% in 2002 from 12.8% in 2001. The decrease in the average yield was primarily due to an increase in the percent of non-accrual Loans to 21.9% as of December 31, 2002 from 18.6% for the same period in 2001 due primarily to a reduction in Loan originations in 2002. Ancillary Product Income. Ancillary product income increased to $13.2 million in 2002 from $10.2 million in 2001 primarily due an increase in the number of third party service contracts sold due to increases in penetration rates and the average amount earned per service contract in 2002 compared to 2001. Premiums Earned. Premiums earned decreased to $4.5 million in 2002 from $6.6 million in 2001 primarily due to a decrease in penetration rates on the Company's in-house service contract product in 2002 and 2001. Other Income. Other income increased to $14.6 million in 2002 from $10.0 million in 2001 primarily due to: (i) interest income of $4.8 million from the Internal Revenue Service received in connection with a change in tax accounting methods that affected the characterization and timing of revenue recognition for tax purposes and (ii) an increase of $1.2 million in monthly fees paid by dealer-partners for the use of CAPS. These increases were partially offset by the one-time gain of $1.1 million in 2001 to record the exercise of a clean-up call relating to the July 1998 securitization of advance receivables. Salaries and Wages. Salaries and wages increased to $23.7 million in 2002 from $20.0 million in 2001 primarily due to an increase of $2.9 million resulting primarily from increased spending on corporate support functions such as information systems, finance, and a Six Sigma initiative. General and Administrative. General and administrative expenses increased to $19.2 million in 2002 from $13.5 million in 2001 due to: (i) the reversal in 2001 of Michigan single business taxes of $4.7 million, which were paid from 1993 to 2000, resulting from a re-characterization of the Company's revenue as a result of an Internal Revenue Service examination. This reversal of Michigan single business taxes was partially offset by an increase in state income taxes (see "Provision for Income Taxes" below). The increase was also due to losses of $1.4 million on the disposal of computer hardware in 2002. Provision for Credit Losses. The provision for credit losses increased to $11.7 million in 2002 from $2.7 million in 2001. The increase in the provision for credit losses for the year ended December 31, 2002 compared to the year ended December 31, 2001 was primarily due to increases of: (i) $6.1 million in the provision for losses inherent in the Company's Loan portfolio due to higher losses in 2002 as a result of a difficult conversion to a new collection system (see "Part I, Item 2 -- General"); and (ii) $2.6 million in the provision for earned but unpaid revenue due to an increase in the percent of non-accrual Loans to 21.9% as of December 31, 2002 from 18.6% for the same period in 2001. Sales and Marketing. Sales and marketing expenses increased to $6.5 million in 2002 from $6.2 million in 2001 as a result of expense associated with a direct mail lead generation product provided to dealer-partners and an increase in the average sales commission per Loan originated. 22
Provision for Insurance and Service Contract Claims. The provision for insurance and service contract claims, as a percent of premiums earned, increased to 41.2% in 2002 from 23.5% in 2001 as the amount of incurred but not reported claims reserves increased relative to the number of insurance and service contract policies outstanding. Provision for Income Taxes. The effective tax rate remained relatively consistent at 41.4% in 2002 compared to 41.8% in 2001. The provision for income taxes in 2002 includes a provision of $3.6 million for estimated taxes due upon repatriation of prior years' earnings in the United Kingdom, which were previously considered permanently invested. Partially offsetting this was a 2.6% decrease in the provision related to a change in the estimate of state income tax owed versus what was originally estimated in 2001. The provision for income taxes in 2001 includes a $4.1 million increase in the estimate of state income tax owed partially offset by a related federal income tax benefit of $1.4 million. United Kingdom
United Kingdom Asset Impairment Expense. As a result of the decision to stop originating Loans in the United Kingdom, the Company recorded an expense in the second quarter of 2003 consisting of: (i) $9.8 million to reduce the carrying value of the operation's net asset value of the Loan portfolio to the present value (using a discount rate of 13%) of the forecasted cash flows relating to the Loan portfolio less estimated future servicing expenses and (ii) a write-off of $700,000 of fixed assets that would no longer be used in the operation. In determining the impairment of the Loan portfolio, the Company analyzed the expected cash flows from this operation assuming lower collection rates than were assumed before the decision to liquidate. These lower collection rates reflect uncertainties (such as potentially higher employee turnover or reduced morale) in the servicing environment that may arise as a result of the decision to liquidate. The Company does not expect to record additional impairment expense unless the actual results are less than the forecast used by management in the impairment analysis, resulting in a decrease in the present value of forecasted cash flows relative to the United Kingdom's net asset value. For further discussion on the impairment analysis performed in accordance with SFAS No. 144, "Accounting for Impairment or Disposal of Long-Lived Assets", see Note 1 to the consolidated financial statements, which is incorporated herein by reference. As of June 30, 2003, the effective date of the Company's decision to stop Loan originations in the United Kingdom, the Company estimated future cash flows from the United Kingdom of approximately $50.9 million. Since June 30, 2003, approximately $21.0 million in cash flows from the United Kingdom Loan portfolio have been reinvested in the United States. The Company expects that approximately 70% of the remaining estimated cash flows will be reinvested in the United States within one year, 90% within two years, and the remainder within three years. In order to manage the foreign currency risk associated with the expected cash flows, the Company entered into a series of forward contracts to deliver British pounds sterling, representing approximately 90% of the total expected cash to be repatriated, to a commercial bank in exchange for United States dollars at an agreed upon rate through June 30, 2005. Sales and Marketing. Sales and marketing expenses increased to $900,000 in 2003 from $800,000 in 2002 primarily due to employee severance costs of $250,000 associated with the Company's decision to stop Loan originations in the United Kingdom. This increase was partially offset by the elimination of sales and marketing activities after the decision to stop Loan originations. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 Finance Charges. Finance charges decreased to $17.7 million in 2002 from $21.8 million in 2001 primarily as the result of decreases in: (i) the average size of the Loan portfolio due to a decrease in Loan originations in 2002 and (ii) the average annualized yield on the Company's Loan portfolio to 12.7% in 2002 from 13.6% in 2001. The decrease in the average yield was primarily due to an increase in the percent of non-accrual Loans to 31.3% as of December 31, 2002 from 22.4% for the same period in 2001 due to a reduction in Loan originations in 2002. Loan originations decreased in 2002 to $43.3 million from $122.8 million in 2001 as the result of the Company decreasing the amount advanced to dealer-partners and discontinuing its relationship with certain dealer-partners whose business did not meet the Company's return on capital objectives. Ancillary Product Income. Ancillary product income increased to $3.3 million in 2002 from $2.7 million in 2001 primarily due to a change in revenue recognition policy, which increased revenue by $1.5 million. This change was the result of a complete review of the Company's revenue recognition policies, which determined that, while conservative, the policies relative to ancillary product revenue recognition in the United Kingdom were inconsistent with those employed in the United States. Therefore, the Company adopted the accounting treatment that was appropriate and consistent with the policies employed in the United States. This increase in income resulting from the change in revenue recognition was partially offset by a $300,000 decrease in revenue under a profit sharing agreement with an insurance provider. Salaries and Wages. Salaries and wages decreased to $3.6 million in 2002 from $4.9 million in 2001 primarily due to executive severance agreement expenses of $700,000 incurred in 2001 and a reduction in staffing levels in 2002. General and Administrative. General and administrative expenses decreased to $2.5 million in 2002 from $2.8 million in 2001 as a result of accounting and legal expenses incurred in 2001 related to the restructuring of legal entities within this business segment. 24
Provision for Credit Losses. Provision for credit losses increased to $4.5 million in 2002 from $3.4 million in 2001. The provision for credit losses consists of two components: (i) a provision for earned but unpaid revenue on Loans that were transferred to non-accrual status during the period; and (ii) a provision to reflect losses inherent in the Company's Loan portfolio. The increase was primarily due to an increase of $1.4 million in the provision for losses inherent in the Company's Loan portfolio due to a decline in credit quality of Loans originated in 2001, partially offset by a decrease of $300,000 in the provision for earned but unpaid revenue. As a result of the decline in credit quality of Loans originated in 2001, the Company stopped originating Loans in Ireland and decreased the amount advanced to dealer-partners in the United Kingdom. Stock-based Compensation Expense. Stock-based compensation expense increased to $400,000 in 2002 from $100,000 in 2001 due to an increase in the number of stock options outstanding as a result of stock options granted during the second half of 2001 and in 2002. Provision for Income Taxes. The effective tax rate decreased to 27.2% in 2002 from 29.5% in 2001. The reduction in the effective rate in 2002 was attributable to a restructuring of the legal entities within this business segment. Automobile Leasing
Other
General and Administrative. General and administrative expenses decreased to $800,000 in 2002 from $1.4 million in 2001 due to a general reduction in the amount of resources necessary to support the Canadian operations. Provision for Credit Losses. The provision for credit losses increased to $2.6 million in 2002 from $1.8 million in 2001. The provision for credit losses consists of four components: (i) a provision for earned but unpaid revenue on Loans which were transferred to non-accrual status during the period, (ii) a provision to reflect losses inherent in the Company's Loan portfolio, (iii) a provision for losses on secured line of credit loans, and (iv) a provision for floorplan loan losses. The increase in the provision for credit losses in 2002 was primarily due to an increase of $800,000 in the provision for floorplan and secured line of credit loan losses in 2002. Provision for Income Taxes. The effective tax rate increased to 46.5% in 2002 from 36.5% in 2001. The increase in the effective rate was due to losses reported in the floorplan business in 2002. This business is based in the United States, and has a lower effective tax rate than the Canadian automobile Loan business. As a result, the tax benefit from losses incurred in these businesses does not fully offset taxes relating to profits earned in the Canadian operation, thereby increasing the effective tax rate for the business segment. AVERAGE CAPITAL ANALYSIS The following presentation of financial results and subsequent analysis is based on analyzing the income statement as a percent of capital invested. This information provides an additional perspective on the financial performance of the Company in addition to the presentation of the Company's results as a percent of revenue. The Company believes this information provides a useful measurement of how effectively the Company is utilizing its capital. Consolidated
(ii) a decrease in the provision for credit losses as a percent of average capital due to higher 2002 losses as a result of a difficult conversion to a new collection system, (iii) an increase in ancillary product income as a percent of average capital due to Loan originations increasing at a faster rate than average capital, and (iv) a decrease in the provision for income taxes as a percent of average capital due to two tax-related adjustments in 2002. Partially offsetting these items that positively impacted return of capital were: (i) a decrease in other income as a percent of average capital due to interest income received from the Internal Revenue Service in 2002 in connection with a change in tax accounting methods that affected the characterization and timing of revenue recognition for tax purposes, (ii) an increase in salaries and wages as a percent of average capital due to increased spending on employee bonuses, servicing salaries, corporate support functions, and employee benefits, and (iii) an increase in foreign exchange loss as a percent of average capital due to the Company recognizing the fair value of forward contracts entered into to manage foreign currency risk associated with the cash flows anticipated from the exit of the United Kingdom business. The decrease in the return on capital in the United Kingdom was primarily a result of the $7,238,000 after-tax adjustment for asset impairment and accrued expenses related to the Company's decision to stop originating Loans in the United Kingdom effective June 30, 2003. This adjustment decreased the Company's reported return on capital by 1.6% for the year ended December 31, 2003. YEAR ENDED DECEMBER 31, 2002 COMPARED TO YEAR ENDED DECEMBER 31, 2001 The Company's return on capital decreased to 7.3% for the year ended December 31, 2002 from 8.2% for the same period in 2001. The decrease in return on capital was primarily due to a reduction in the return on capital in the United States, partially offset by an increase in the percent of total capital invested in the United States to 74.6% in 2002 from 69.2% in 2001. The decrease in the return on capital in the United States was primarily a result of an increase in the provision for credit losses. This increase was due to higher 2002 losses as a result of a difficult conversion to a new collection system. ECONOMIC PROFIT The Company defines economic profit as net operating profit after-tax less an imputed cost of equity. Economic profit measures how efficiently the Company utilizes its total capital, both debt and equity. To consider the cost of both debt and equity, the Company's calculation of economic profit deducts from net income as determined under GAAP 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 investing capital in its core business with the return they could expect if the Company returned capital to shareholders and they invested in other securities. The Company generated an economic loss of ($5,757,000), or ($0.13) per diluted share, for the year ended December 31, 2003 compared to an economic loss of ($2,425,000), or ($0.06) per diluted share for the same period in 2002 and an economic profit of $1,144,000, or $0.03 per diluted share, for the same period in 2001. The following table presents the calculation of the Company's economic profit (loss) for the periods indicated (dollars in thousands, except per share data):
(2) Cost of equity is equal to 10% (on an annual basis) of total average shareholders' equity, which was $339,378,000, $307,895,000 and $272,707,000 for years ended December 31, 2003, 2002, and 2001, respectively, calculated as described in the Average Capital Analysis. (3) Economic profit (loss) per share equals the economic profit (loss) divided by the weighted average number of shares outstanding. CRITICAL ACCOUNTING POLICIES AND LOSS EXPERIENCE The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for credit losses, finance charge revenue, stock-based compensation expense, impairment of various assets, contingencies, and taxes. The Company believes the following critical accounting policies involve a high degree of judgment and complexity, and the use of different estimates or assumptions could produce different financial results. Allowance for Credit Losses Balance Sheet Caption: Allowance for credit losses Income Statement Caption: Provision for credit losses Nature of Estimates Required: Estimating losses inherent in the Company's Loan portfolio. Assumptions and Approaches Used: The Company maintains an allowance for credit losses at a level it considers to be adequate to absorb probable losses inherent in the Company's Loan portfolio. The Company compares the present value of estimated future collections for each dealer-partner's Loan portfolio to the Company's net investment in that portfolio to record losses. The estimate of future collections uses various assumptions based on a dealer-partner's actual loss data on a static pool basis and the Company's historical loss and collection experience. Forecasted collections are discounted to present value using a rate equal to the rate of return expected at the origination of the Loan. The allowance also includes estimates of the amount of earned but unpaid finance charge revenue on non-accrual Loans. The Company estimates the amount of finance charge revenue earned not paid at the time the Loan moves to non-accrual status based on the Loan's month of origination. For additional information, see Note 1 to the consolidated financial statements, which is incorporated herein by reference. Key Factors: Variances in the amount and timing of future collections from current estimates and the amount of earned but unpaid revenue on non-accrual Loans would impact earnings in future periods. Finance Charge Revenue Balance Sheet Caption: Loans receivable, net Income Statement Caption: Finance charges Nature of Estimates Required: Estimating revenue recognition using the interest rate method of accounting. Assumptions and Approaches Used: The Company calculates finance charge income based on a pooling methodology that converts cash basis collections to accrual basis earned finance charge income. The Company does not apply the 30
interest rate method of accounting at the individual installment contract level. Key Factors: Applying the interest rate method of accounting at the individual contract level may impact earnings in future periods. Stock-Based Compensation Expense Balance Sheet Caption: Paid-in capital Income Statement Caption: Stock-based compensation expense Nature of Estimates Required: Compensation expense for stock options is based on this fair value of the options on the date of grant, which is estimated by the Company, and is recognized over the vesting period of the options. Assumptions and Approaches Used: The Company uses the Black-Scholes option pricing model to estimate the fair value of stock option grants. This model calculates the fair value using various assumptions, including the expected life of the option, the expected volatility of the underlying stock, and the expected dividend yield on the underlying stock. In recognizing stock-based compensation expense, the Company makes assumptions regarding the expected forfeiture rate of stock options and the expected vesting date of performance-based options. For additional information, see Notes 1 and 11 to the consolidated financial statements, which are incorporated herein by reference. Key Factors: Factors impacting future stock-based compensation expense would be a change in forfeiture rate and a change in the expected vesting date of performance-based stock options versus assumptions currently employed. Impairment of Assets Balance Sheet Caption: Various assets Income Statement Caption: Impairment expense Nature of Estimates Required: Estimating impairment for businesses in liquidation on a quarterly basis. Assumptions and Approaches Used: The Company estimates impairment for each business in liquidation by comparing its future forecasted net cash flows to its net asset value. In estimating the future net cash flows of the business, the Company makes assumptions regarding the amount and timing of cash flows. For additional information, see Note 1 to the consolidated financial statements, which is incorporated herein by reference. Key Factors: Negative variances in future forecasted net cash flows from current estimates may result in the recognition of impairment expenses in future periods. Litigation and Contingent Liabilities Balance Sheet Caption: Accrued liabilities Income Statement Caption: General and administrative expense Nature of Estimates Required: Estimating the likelihood of adverse legal judgments and any resulting damages owed. Assumptions and Approaches Used: The Company, with assistance from its legal counsel, determines if the likelihood of an adverse judgment for various claims and 31
litigation is remote, reasonably possible, or probable. To the extent the Company believes an adverse judgment is probable and the amount of the judgment is estimable, the Company recognizes a liability. For information regarding the potential various customer claims against the Company, see Note 13 to the consolidated financial statements, which is incorporated herein by reference. Key Factors: Negative variances in the ultimate disposition of claims and litigation outstanding from current estimates could result in additional expense in future periods. Taxes Balance Sheet Caption: Deferred income taxes, net Income Statement Caption: Provision for income taxes Nature of Estimates Required: Estimating the recoverability of deferred tax assets. Assumptions and Approaches Used: The Company, based on historical and projected future financial results by tax jurisdiction, determines if it is more likely than not a deferred tax asset will be realized. To the extent the Company believes the recovery of all or a portion of a deferred tax asset is not likely, a valuation allowance is established. For additional information, see Note 10 to the consolidated financial statements, which is incorporated herein by reference. Key Factors: Changes in tax laws and variances in projected future results from current estimates that impact judgments made on valuation allowances could impact the Company's provision for income taxes in future periods. Loss Experience The following sets forth the components of the provision for credit losses, charge-offs related to the Company's Loan portfolio, and the allowance for credit losses as a percentage of gross Loans receivable:
Effective July 1, 2003, the Company prospectively eliminated its charge-off policy related to dealer advances and modified its Loans receivable charge-off policy to require charge-off of Loans receivable after 270 days of no payment against dealer holdbacks, net and, if such holdback is insufficient, against the allowance for credit losses. For the first six months of 2003, advances were charged-off when the Company's analysis forecasted no future collections on Loans relating to the dealer-partner advance pool. Prior to January 1, 2003, advances were charged-off or partially charged-off when the Company's analysis determined that the expected discounted cash flows associated with the related Loans were insufficient to recover the outstanding advance balance in the pool. As a result, the charge-offs for the year ended December 31, 2003 are presented on a different basis than the other years presented and, as a result, are not comparable. LIQUIDITY AND CAPITAL RESOURCES The Company's primary sources of capital are cash flows from operating activities, collections on Loans receivable and borrowings under the Company's lines of credit and secured financings. The Company's principal need for capital is to fund cash advances made to dealer-partners in connection with the acceptance of Loans and for the payment of dealer holdbacks to dealer-partners who have repaid their advance balances. The Company's cash flow requirements are dependent on levels of Loan originations. In 2003, the Company experienced an increase in Loan originations over 2002 primarily due to: (i) an increase in the number of active dealer-partners due to increased dealer-partner enrollments and reduced levels of dealer-partner attrition, (ii) a continued increase in the number of Loans per active dealer-partner, and (iii) an increase in the average Loan size. The Company currently finances its operations through: (i) a bank line of credit facility; (ii) term secured financings; (iii) revolving secured financings; (iv) a mortgage loan; and (v) capital lease obligations. For information regarding these financings and the covenants included in the related documents, see Note 7 to the consolidated financial statements, which is incorporated herein by reference. The Company is currently in compliance with these covenants. The Company's total balance sheet indebtedness decreased to $106.5 million at December 31, 2003 from $109.8 million at December 31, 2002. In addition to the balance sheet indebtedness as of December 31, 2003, the Company also has contractual obligations resulting in future minimum payments under operating leases. A summary of the total future contractual obligations requiring repayments is as follows (in thousands):
the Company expects to receive approximately $37.9 million from the liquidation of its United Kingdom, Canadian, and Automobile Leasing businesses. The expected liquidation proceeds have been determined based on the Company's forecast of cash inflows and outflows during the estimated remaining years of operation for each business. Detail of expected future net liquidation proceeds follows:
designated these contracts as hedges as defined under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 138 and SFAS No. 149, changes in the fair value of these forward contracts will increase or decrease net income. As of December 31, 2003, the fair value of the forward contracts was $2,817,000 less than the notional amount of the contracts due to the weakening of the United States dollar versus the British pound sterling since the date the contracts were entered into. As a result, during 2003, the Company recognized a foreign currency loss of $2,817,000 related to the change in the fair value of the forward contracts. At December 31, 2003, an immediate 10% weakening of the United States dollar would have increased shareholders' equity by approximately $400 thousand and decreased net income by approximately $1.9 million. NEW ACCOUNTING PRONOUNCEMENTS For information regarding new accounting pronouncements and the related impact of adoption to the Company, see Note 1 to the consolidated financial statements, which is incorporated herein by reference. FORWARD-LOOKING STATEMENTS The Company makes forward-looking statements in this report and may make such statements in future filings with the Securities and Exchange Commission. It may also make forward-looking statements in its press releases or other public or shareholder communications. The Company's forward-looking statements are subject to risks and uncertainties and include information about its expectations and possible or assumed future results of operations. When the Company uses any of the words "believes," "expects," "anticipates," "estimates" or similar expressions, it is making forward-looking statements. The Company claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all of its forward-looking statements. These forward-looking statements represent the Company's outlook only as of the date of this report. While the Company believes that its forward-looking statements are reasonable, actual results could differ materially since the statements are based on our current expectations, which are subject to risks and uncertainties. Factors that might cause such a difference include, but are not limited to, the following: - the Company's potential inability to accurately forecast and estimate future collections and historical collection rates, - increased competition from traditional financing sources and from non-traditional lenders, - the unavailability of funding at competitive rates of interest, - the Company's potential inability to continue to obtain third party financing on favorable terms, - the Company's potential inability to generate sufficient cash flow to service its debt and fund its future operations, - adverse changes in applicable laws and regulations, - adverse changes in economic conditions, - adverse changes in the automobile or finance industries or in the non-prime consumer finance market, - the Company's potential inability to maintain or increase the volume of Loans, - the Company's potential inability to accurately estimate the residual values of the lease vehicles, - an increase in the amount or severity of litigation against the Company, 35
- the loss of key management personnel, and - the effect of terrorist attacks and potential attacks. Other factors not currently anticipated by management may also materially and adversely affect the Company's results of operations. The Company does not undertake, and expressly disclaims any obligation, to update or alter its forward-looking statements whether as a result of new information, future events or otherwise, except as required by applicable law. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The information called for by Item 7A is incorporated by reference from the information in Item 7 under the caption "Market Risk" in this Form 10-K. 36
INDEPENDENT AUDITORS' REPORT To the Board of Directors and Shareholders Credit Acceptance Corporation We have audited the accompanying consolidated balance sheets of Credit Acceptance Corporation and subsidiaries (the "Company") as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America. As discussed in Note 1, during 2003 the Company changed its method of accounting for stock-based compensation by adopting the fair value method prescribed by Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, with retroactive restatement of all prior periods. DELOITTE & TOUCHE LLP Detroit, Michigan February 26, 2004 37
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF BUSINESS Principal Business. Since 1972, Credit Acceptance (the "Company" or "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 by selling vehicles to consumers who otherwise could not obtain financing, by 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. Without the Company's product, consumers are often unable to purchase a vehicle or they purchase an unreliable one and are not provided the opportunity to improve their credit standing. As the Company reports to the three national credit reporting agencies, a significant number of its customers improve their lives by improving their credit score and move on to more traditional sources of financing. The Company refers to participating dealers who share its commitment to changing customers' lives as "dealer-partners". Upon enrollment in the Company's financing program, the dealer-partner enters into a servicing agreement with Credit Acceptance that defines the legal relationship between Credit Acceptance and the dealer-partner. The servicing agreement assigns the responsibilities for administering, servicing, and collecting the amounts due on retail installment contracts (referred to as "Loans") from the dealer-partners to the Company. Upon acceptance of an assigned Loan, the Company records the total payments due under the Loan as a Loan receivable and the amount of its servicing fee as an unearned finance charge which, for balance sheet purposes, is netted from the gross amount of the Loan and represents the interest element on the Loan from the Company's perspective. The Company records the remaining portion of the Loan (the gross amount of the Loan less the unearned finance charge) as a dealer holdback. At the time of acceptance, Loans that meet certain criteria are eligible for a cash advance, which is computed on a formula basis. As advances are originated, they are automatically assigned to the originating dealer-partner's open pool of advances. Periodically, pools are closed and subsequent advances are assigned to a new pool. All advances due from a dealer-partner are secured by the future collections on the dealer-partner's portfolio of Loans. Collections on all related Loans within the pool, after payment of the Company's servicing fee and reimbursement of certain collection costs, are applied to reduce the aggregate advance balance owing against those Loans. Once the advance balance has been repaid, the dealer-partner is entitled to receive future collections from Loans within that pool, after payment of the Company's servicing fee and reimbursement of certain collection costs. If the collections on Loans from a dealer-partner's pool are not sufficient to repay the advance balance, the dealer-partner will not receive the dealer holdback. Loans accepted by the Company are secured by liens on the financed vehicles. The Company's acceptance of Loans is generally without recourse to the general assets of the dealer-partner. Dealer-partner advances are netted against dealer holdbacks in the accompanying consolidated financial statements. Businesses in Liquidation. Pursuant to Statement of Financial Accounting Standards ("SFAS") No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", an impairment analysis is performed on the net asset value of the United Kingdom, Canadian, and Automobile Leasing operations on a quarterly basis. This analysis compares the undiscounted forecasted future net cash flows (including future servicing expenses and any payments due to dealer-partners under servicing agreements) of each operation to the operation's net asset value at the balance sheet date. If this analysis indicates impairment (i.e. the net asset value exceeds the undiscounted forecasted future net cash flows), the Company is required to write down the value of the asset to the present value of the forecasted net cash flows. While the impairment analysis for operations that are being liquidated reduces the future cash flows by the amount of servicing expenses (under SFAS No. 144), the impairment analysis for Loan portfolios relating to continuing operations does not (under SFAS No. 114). Effective June 30, 2003, the Company decided to stop originating Loans in the United Kingdom. In analyzing the expected cash flows from this operation, the Company assumed lower collection rates than 42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) assumed before the decision to liquidate. These lower collection rates reflect uncertainties (such as potentially higher employee turnover or reduced morale) in the servicing environment that may arise as a result of the decision to liquidate. As a result of this analysis, in the second quarter of 2003, the net asset value of the operation's Loan portfolio was deemed to be impaired and the Company recorded an after-tax expense of $6.4 million to reduce the carrying value of its Loan portfolio to the present value (using a discount rate of 13%) of the forecasted cash flows relating to the Loan portfolio less estimated future servicing expenses. Based upon management's analysis as of December 31, 2003, no additional reduction of the carrying value of the United Kingdom Loan portfolio is required. Effective June 30, 2003, the Company decided to stop originating Loans in Canada. Since Loans originated in Canada are serviced in the United States, the Company evaluated cash flows related to the Canadian operation based on the same collection rate assumptions as were used before the decision to liquidate. Based upon management's analysis as of December 31, 2003, no reduction of the carrying value of the Canadian Loan portfolio is required. In January 2002, the Company decided to stop originating automobile leases. Based upon management's analysis as of December 31, 2003, no reduction of the carrying value of the Automobile Leasing's net assets is required. In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," which nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in Restructuring)." SFAS No. 146 requires a liability for a cost associated with an exit or disposal activity to be recognized and measured initially at its fair value in the period in which the liability is incurred, rather than at the time of commitment to an exit plan. The Company adopted this standard for exit or disposal activities initiated after December 31, 2002. As a result of the Company's decision to exit the United Kingdom business in the second quarter of 2003, the Company recognized: (i) $300,000 after-tax increase in salaries and wages resulting from employee severance expenses and (ii) $100,000 after-tax reduction in other income due to a refund of profit sharing income on ancillary products to an ancillary product provider which was based on volume targets no longer attainable due to the decision to stop Loan originations. As of December 31, 2003, the remaining liability for these expenses was $156,000, which the Company expects to pay by December 2005. The Company may record an additional liability of up to $400,000 for payment of future lease obligations under a rental agreement through September 2007 once the Company stops using the office space in the United Kingdom. The Company expects to stop using the United Kingdom office space in the fourth quarter of 2005 or first quarter of 2006. Ancillary Products and Services. Buyers Vehicle Protection Plan, Inc. ("BVPP") and CAC Reinsurance, Ltd. ("Credit Acceptance Reinsurance"), both wholly-owned subsidiaries of the Company, provide additional services to participating dealer-partners. BVPP has a relationship with third party service contract providers that pay BVPP a fee on service contracts included on Loans financed through participating dealer-partners. BVPP does not bear any risk of loss for claims covered on these third party service contracts. The income from the non-refundable fee is recognized upon sale of the service contract. The Company advances to dealer-partners an amount equal to the purchase price of the vehicle service contract on Loans accepted by the Company that include vehicle service contracts. In addition, BVPP had its own short-term limited extended service contract product offered by participating dealer-partners. In connection therewith, BVPP bears the risk of loss for any repairs covered under the service contract. The Company recognizes income and related expense for this service contract program on an accelerated basis over the life of the service contract. The Company stopped offering this product effective November 1, 2003. Credit Acceptance Reinsurance is engaged primarily in the business of reinsuring credit life and disability insurance policies issued to borrowers under Loans originated by participating dealer-partners. The Company advances to dealer-partners an amount equal to the credit life and disability insurance premium on Loans accepted by the Company which include credit life and disability insurance written by the Company's designated insurance carriers. The policies insure the holder of the Loan for the outstanding balance payable 43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) in the event of death or disability of the customer. Premiums are ceded to Credit Acceptance Reinsurance on both an earned and written basis and are earned over the life of the Loans using pro rata and sum-of-digits methods. Credit Acceptance Reinsurance bears the risk of loss attendant to claims under the coverage ceded to it. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions have been eliminated. REPORTABLE BUSINESS SEGMENTS The Company is organized into four primary business segments: United States, United Kingdom, Automobile Leasing, and Other. See Note 12 - Business Segment Information for information regarding the Company's reportable segments. USE OF ESTIMATES The accounting and reporting policies of the Company require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The accounts which are subject to significant estimation include the allowance for credit losses, finance charge revenue, stock-based compensation expense, impairment of various assets, contingencies, and taxes. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS Cash equivalents consist of readily marketable securities with original maturities at the date of acquisition of three months or less. Cash and cash equivalents totaling $16.0 million and $9.7 million at December 31, 2003 and 2002, respectively, are restricted pursuant to: (i) the secured financings and (ii) reinsurance agreements. LOANS RECEIVABLE AND ALLOWANCE FOR CREDIT LOSSES The Company maintains an allowance for credit losses to cover losses inherent in the Company's Loan portfolio. Such losses consist of Loans receivable determined to be uncollectible or with expected future collections less than the full contractual amount, less any losses absorbed by dealer holdbacks. By definition, these losses equal the amount by which the advances to dealer-partners plus accrued income (the "net investment") exceed the net present value of the related Loans receivable. To record losses, as required under SFAS No. 114, "Accounting by Creditors for Impairment of a Loan -- an amendment of FASB Statements No. 5 and 15", as amended by SFAS No. 118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures", the Company utilizes a present value methodology and compares the present value of estimated future collections for each dealer-partner's Loan portfolio to the Company's net investment in that portfolio. The Company maintains historical loss experience for each dealer-partner on a static pool basis and uses this information to forecast the timing and amount of the future collections on each dealer-partner's Loan portfolio. In estimating future collections for each dealer-partner, the Company considers: (i) a dealer-partner's actual 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 Loans. Forecasted collections are discounted to present value using a rate equal to the rate of return expected at the origination of the Loan. To the extent that the present value of future collections is less than the Company's net investment in the portfolio, the Company records an allowance equal to the difference between the net investment and the present value of the estimated future collections. Proceeds from one dealer-partner's portfolio cannot be used to offset losses relating to another dealer-partner. 44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Effective July 1, 2003, the Company retroactively eliminated the reserve for advance losses balance, which was previously classified within dealer holdbacks, net and transferred the balance into the allowance for credit losses which is classified within Loans receivable, net. In addition, the Company prospectively eliminated its charge-off policy related to dealer advances and modified its Loans receivable charge-off policy to require charge-off of Loans receivable after 270 days of no payment against dealer holdbacks, net and, if such holdback is insufficient, against the allowance for credit losses. In effect, the Company combined its advance and Loans receivable charge-off policies into a single policy whereby the Loan and related advance are charged-off at the same time. For the first six months of 2003, advances were charged-off when the Company's analysis forecasted no future collections on Loans relating to the dealer-partner advance pool. Prior to January 1, 2003, advances were charged-off or partially charged-off when the Company's analysis determined that the expected discounted cash flows associated with the related Loans were insufficient to recover the outstanding advance balance in the pool. In addition, effective July 1, 2003, the Company implemented a revised policy related to collections of previously charged-off Loans ("recoveries"). Under the new policy, recoveries of Loans charged-off are credited to the allowance for credit losses to the extent that any prior losses were charged against the allowance, with the remainder credited to dealer holdbacks. Under the Company's prior policy, generally 80% of recoveries were credited to dealer holdbacks and 20% to finance charges. A significant percentage of charged-off Loans are absorbed by dealer holdbacks and, as a result, do not result in losses to the Company. The Company's primary protection against losses relates to appropriately managing the spread between the collection rate and the amount advanced to dealer-partners at Loan inception. The Company's allowance for credit losses also covers earned but unpaid servicing fees on Loans receivable in non-accrual status. Servicing fees, which are recorded as finance charges, are recognized under the interest method of accounting until the earlier of the underlying obligation becoming 90 days past due on a recency basis (no payments received for 90 days) or the repossession and sale of the vehicle securing the Loan. At such time, the Company suspends the recognition of revenue and records a provision for credit losses equal to the earned but unpaid revenue. Once a Loan is classified in non-accrual status, it remains in non-accrual status for the remaining life of the Loan. Revenue on non-accrual Loans is recognized on a cash basis. INVESTMENT IN OPERATING LEASES Leased assets are depreciated to their residual values on a straight-line basis over the scheduled lease term. The Company established its residual values based upon an industry guidebook and data from repossessed vehicles sold at auction. Realization of the residual values is dependent on the Company's future ability to market the vehicles under then prevailing market conditions. FLOORPLAN RECEIVABLES Floorplan receivables represent loans to dealer-partners to finance used vehicle inventories and are secured primarily by the related inventories and any future cash collections owed to the dealer-partner on outstanding Loans, with additional security provided by the personal guarantee of the dealership's owner. Floorplan receivables are reported net of the related allowance for credit losses of $87,000 and $831,000 at December 31, 2003 and 2002, respectively. NOTES RECEIVABLE Notes receivable are primarily working capital loans that are generally due on demand and are secured primarily by any future cash collections owed to the dealer-partner on outstanding Loans. Notes receivable are reported net of the related allowance for credit losses of $7,000 and $220,000 at December 31, 2003 and 2002, respectively. 45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) LINES OF CREDIT Secured lines of credit represent loans to dealers not participating in the Company's core program and are secured primarily by loans originated and serviced by the dealer with additional security provided by the personal guarantee of the dealership's owner. Secured lines of credit are reported net of the related allowance for credit losses of $12,000 and $210,000 at December 31, 2003 and 2002, respectively. PROPERTY AND EQUIPMENT Additions to property and equipment are recorded at cost. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets. Estimated useful lives are generally as follows: buildings and building improvements -- 10 years, data processing equipment and software -- 5 years, office furniture and equipment -- 7 years, and leasehold improvements -- the lesser of the lease term or 7 years. The cost of assets sold or retired and the related accumulated depreciation are removed from the accounts at the time of disposition and any resulting gain or loss is included in operations. Maintenance, repairs and minor replacements are charged to operations as incurred; major replacements and betterments are capitalized. Software development costs are capitalized and generally amortized on a straight-line basis. The Company evaluates long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. OTHER ASSETS Repossessed collateral, which is included in other assets on the balance sheets, is valued at the lower of the carrying amount of the receivable or estimated fair value, less estimated costs of disposition. As of December 31, 2003 and 2002, repossessed assets totaled approximately $8.4 million and $8.6 million, respectively. DEALER HOLDBACKS As part of the dealer-partner servicing agreement, the Company records the gross amount of the Loan less the unearned finance charges as dealer holdbacks. Loans originated by and advances to each dealer-partner are automatically assigned to that dealer-partner's open pool of Loans. Periodically, pools are closed and subsequent Loans and advances are assigned to a new pool. Collections on the Loans within each pool, after payment of the Company's servicing fee and reimbursement of certain collection costs, are applied to reduce the aggregate advance balance owing against those Loans. Once the advance balance has been repaid, the dealer-partner is entitled to receive collections from the Loans within that pool. All advances from a dealer-partner are secured by all of the future collections on Loans originated by that dealer-partner. For balance sheet purposes, dealer holdbacks are shown net of the current advance balance. INCOME TAXES Deferred income taxes are provided for all temporary differences between the book and tax basis of assets and liabilities. Deferred income taxes are adjusted to reflect new tax rates when they are enacted into law. DERIVATIVE INSTRUMENTS Interest Rate Caps. The Company purchases interest rate cap agreements to manage its interest rate risk on its secured financings. As the Company has not designated these agreements as hedges as defined under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS No. 138 and SFAS No. 149, changes in the fair value of these agreements will increase or decrease net income. 46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) As of December 31, 2003, the following interest rate cap agreements were outstanding (in thousands of dollars):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) recognized had the recognition provisions of SFAS No. 123 been applied to all awards granted to employees or directors after January 1, 1995. The following tables summarize the reported and restated results:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Other Income Other income consists of the following (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) requires that items such as mandatorily redeemable financial instruments, obligations to repurchase equity shares by transferring assets, and certain obligations to issue a variable number of shares be classified as liabilities. The adoption of this statement on July 1, 2003 did not have a material impact on the Company. In December 2003, the FASB issued Interpretation No. 46 (Revised), "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R requires that subsidiaries defined as variable interest entities be consolidated by the enterprise that will absorb the majority of the entities' expected gains or losses. The Company, through fully consolidated wholly owned subsidiaries, sponsors debt issuances. The Company determined that these subsidiaries meet the definition of variable interest entities and that the Company is the primary beneficiary of these subsidiaries' activities. The adoption of this interpretation on December 31, 2003 did not have a material impact on the Company. RECLASSIFICATION Certain amounts for prior periods have been reclassified to conform to the current presentation, including the following significant balance sheet reclassifications: (i) the reserve for advance losses, which was previously classified within dealer holdbacks, net, was eliminated and the balance transferred to the allowance for credit losses, which is classified within Loans receivable, net and (ii) repossessed assets were reclassified from Loans receivable, net to other assets. Additionally, as a result of the Company's adoption of the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" under the retroactive restatement method selected by the Company as described in SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure" in the second quarter of 2003, the Company restated all prior periods to reflect the stock-based compensation expense that would have been recognized had the recognition provisions of SFAS No. 123 been applied to all awards granted to employees or directors after January 1, 1995. (2) FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate their value. Cash and Cash Equivalents and Investments. The carrying amount of cash and cash equivalents and investments approximate their fair value due to the short maturity of these instruments. Net Investment in Loans. Loans receivable, net less dealer holdbacks, net represents the Company's net investment in Loans. The Company received an independent valuation of its Unites States automobile Loan portfolio as of December 31, 2002. As the United States automobile Loan portfolio represents 94% and 84% of the Company's total Loan portfolio as of December 31, 2003 and 2002, respectively, the Company has used the relationship between the fair value as determined in this valuation and the related carrying value as the basis for calculating the fair value of the total Loan portfolio for both years. Floorplan, Lines of Credit, and Notes Receivable. The carrying values of floorplan, lines of credit, and notes receivable approximate their fair values as the interest rates on these instruments approximate the interest rates the Company would charge on similar instruments as of December 31, 2003 and 2002. Debt. The fair value of debt is determined using quoted market prices, if available, or calculated using the estimated value of each debt instrument based on current rates offered to the Company for debt with similar maturities. Derivative Instruments. The fair value of interest rate caps and foreign currency forward contracts are based on quoted market values. 50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A comparison of the carrying value and estimated fair value of these financial instruments is as follows (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) A summary of changes in gross Loans receivable is as follows (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (5) INVESTMENTS IN OPERATING LEASES The composition of net investment in operating leases consists of the following (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (7) DEBT LINES OF CREDIT At December 31, 2003, the Company had a $135.0 million credit agreement with a commercial bank syndicate. The facility has a commitment period through June 9, 2005. The agreement provides that, at the Company's discretion, interest is payable at either the eurodollar rate plus 140 basis points (2.44% at December 31, 2003), or at the prime rate (4.0% at December 31, 2003). The eurodollar borrowings may be fixed for periods of up to six months. Borrowings under the credit agreement are subject to a borrowing base limitation equal to 65% of advances to dealer-partners and leased vehicles (as reflected in the consolidated financial statements and related notes), less a hedging reserve (not exceeding $1.0 million), the amount of letters of credit issued under the line of credit, and the amount of other debt secured by the collateral which secures the line of credit. Currently, the borrowing base limitation does not inhibit the Company's borrowing ability under the line of credit. The credit agreement has certain restrictive covenants, including a minimum required ratio of the Company's assets to debt, its liabilities to tangible net worth, and its earnings before interest, taxes and non-cash expenses to fixed charges. Additionally, the agreement requires that the Company maintain a specified minimum level of net worth. Borrowings under the credit agreement are secured by a lien on most of the Company's assets. The Company must pay annual and quarterly fees on the amount of the commitment. As of December 31, 2003 and 2002, there was zero and $43.4 million outstanding under this facility, respectively. The maximum amount outstanding was approximately $82.9 million and $105.5 million in 2003 and 2002, respectively. The weighted average balance outstanding was $59.0 million and $77.2 million in 2003 and 2002, respectively. The Company also had a 1.0 million Canadian dollar line of credit with a commercial bank in Canada, which expired on June 5, 2003. The borrowings were used to fund the day-to-day cash flow requirements of the Company's Canadian subsidiary, and were secured by a letter of credit issued by the Company's principal commercial bank, with interest payable at the LIBOR rate plus 1.4% or at the Canadian bank's prime rate. Additionally, the Company had to pay a quarterly commitment fee of 0.6% on the amount of the commitment. As of December 31, 2002, there was 183,000 Canadian dollars ($116,000) outstanding under the facility. The weighted average interest rate on line of credit borrowings outstanding as of December 31, 2002 was 3.3%. SECURED FINANCING In the second quarter of 2003, the Company's wholly-owned subsidiary, Credit Acceptance Funding LLC 2003-1 ("Funding 2003-1"), completed a secured financing transaction, in which Funding 2003-1 received $100.0 million in financing. In connection with this transaction, the Company conveyed, for cash and the sole membership interest in Funding 2003-1, dealer-partner advances having a carrying amount of approximately $134.0 million to Funding 2003-1, which, in turn, conveyed the advances to a trust, which issued $100 million in notes to qualified institutional investors. A financial insurance policy was issued in connection with the transaction. The policy guarantees the timely payment of interest and ultimate repayment of principal on the final scheduled distribution date. The notes are rated "AA" by Standard & Poor's Rating Services. The proceeds of the conveyance to Funding 2003-1 were used by the Company to reduce outstanding borrowings under the Company's line of credit. Until December 15, 2003, the Company and Funding 2003-1 received additional proceeds from the transaction by having the Company convey additional dealer-partner advances to Funding 2003-1 that were then conveyed by Funding 2003-1 to the trust and used by the trust as collateral to support additional borrowings. Additional dealer-partner advances having a carrying amount of approximately $35.0 million have been conveyed by the Company after the completion of the initial funding. After December 15, 2003, the debt outstanding under the facility began to amortize. The total expected term of the facility is 16 months. The secured financing creates loans for which the trust is liable and which are secured by all the assets of the trust and of Funding 2003-1. Such loans are non-recourse to the Company, even though the trust, Funding 2003-1 and the Company are consolidated for financial reporting purposes. The notes bear interest at a fixed rate of 2.77%. The expected annualized cost of the secured financing, including underwriters fees, the insurance premium and other costs is approximately 6.8%. As Funding 2003-1 is organized as a 54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) separate legal entity from the Company, assets of Funding 2003-1 (including the conveyed dealer-partner advances) will not be available to satisfy the general obligations of the Company. All the assets of Funding 2003-1 have been encumbered to secure Funding 2003-1's obligations to its creditors. The Company receives a monthly servicing fee paid out of collections equal to 6% of the collections received with respect to the conveyed dealer-partner advances and related Loans. Except for the servicing fee and payments due to dealer- partners, the Company does not receive, or have any rights in, any portion of such collections until the trust's underlying indebtedness is paid in full, either through collections or through a prepayment of the indebtedness. Thereafter, remaining collections would be paid over to Funding 2003-1 as the sole beneficiary of the trust where they would be available to be distributed to the Company as the sole member of Funding 2003-1, or the Company may choose to cause Funding 2003-1 to repurchase the remaining dealer-partner advances from the trust and then dissolve, whereby the Company would become the owner of such remaining collections. In the third quarter of 2003, the Company's wholly-owned subsidiary, CAC Warehouse Funding Corp. II ("Warehouse Funding" or "2003-2"), completed a revolving secured financing transaction with an institutional investor, in which Warehouse Funding may receive up to $100.0 million in financing when the Company conveys dealer-partner advances to Warehouse Funding for equity in Warehouse Funding. Warehouse Funding will in turn pledge the dealer-partner advances as collateral to the institutional investor to secure loans that will fund the cash portion of the purchase price of the dealer-partner advances. No dealer-partner advances were contributed and no financing proceeds were received at the time of closing or through December 31, 2003. This revolving facility allows conveyances of dealer-partner advances by the Company and related borrowing by Warehouse Funding in which Warehouse Funding will receive 70% of the net book value of the contributed dealer-partner advances up to the $100.0 million facility limit. The facility has a commitment period through September 28, 2004. Provided that the commitment is renewed, there is a requirement that any amounts outstanding under the facility be refinanced, and the facility paid to zero, by December 23, 2004. If this does not occur, the transaction will cease to revolve, will amortize as collections are received and, at the option of the institutional investor, may be the subject of acceleration and foreclosure. Upon completion of the refinancing and pay down, the full facility will again be available to Warehouse Funding. Although Warehouse Funding will be liable for any secured financing under the facility, the loans will be non-recourse to the Company, even though Warehouse Funding and the Company are consolidated for financial reporting purposes. Such loans will bear interest at a floating rate equal to the commercial paper rate plus 65 basis points, which has been limited to a maximum rate of 6.25% through an interest rate cap agreement executed in the fourth quarter of 2003. As Warehouse Funding is organized as a separate special purpose legal entity from the Company, assets of Warehouse Funding (including the conveyed dealer-partner advances) 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. The Company will receive a monthly servicing fee paid out of collections equal to 6% of the collections received with respect to the conveyed dealer-partner advances and related Loans. Except for the servicing fee and payments due to dealer-partners, the Company will not receive, or have any rights in, any portion of such collections until Warehouse Funding's underlying indebtedness is paid in full either through collections or through a prepayment of the indebtedness. The Company has completed a total of ten secured financing transactions, eight of which have been repaid in full. Information about the currently outstanding secured financing transactions is as follows (dollars in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) MORTGAGE LOAN PAYABLE 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 $5,418,000 and $6,195,000 outstanding on this loan as of December 31, 2003 and 2002, respectively. The loan matures on May 1, 2004, bearing interest at a fixed rate of 7.07%, and requires monthly payments of $99,582 and a balloon payment at maturity for the balance of the loan. CAPITAL LEASE OBLIGATIONS As of December 31, 2003, the Company has various capital lease obligations outstanding for computer equipment, with monthly payments totaling $83,000. These capital lease obligations bear interest at rates ranging from 4.45% to 9.31% and have maturity dates between June 2004 and October 2006. LETTERS OF CREDIT Letters of credit are issued by a commercial bank and reduce amounts available under the Company's line of credit. As of December 31, 2003, the Company has three letters of credit relating to reinsurance agreements totaling $5.4 million. Such letters of credit will expire on May 26, 2004, at which time they will be automatically extended for the period of one year unless the Company is notified otherwise by the commercial bank syndicate. PRINCIPAL DEBT MATURITIES The scheduled principal maturities of the Company's debt at December 31, 2003 are as follows (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) (8) DEALER HOLDBACKS Dealer holdbacks consists of the following (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) dealer-partner owned by the Company's President for a test program which offered increased CAPS functionality to dealer-partners. The Company did not provide these products and services to affiliated dealer-partners in 2003. Beginning in 2000, the Company offered a line of credit arrangement to certain dealers who were not participating in the Company's core business. These lines of credit are secured primarily by loans originated and serviced by the dealer, with additional security provided by the personal guarantee of the dealership's owner. The Company ceased offering this program to new dealers in the third quarter of 2001 and has been reducing the amount of capital invested in this program since that time. Beginning in 2002, entities owned by the Company's majority shareholder and Chairman began offering secured line of credit loans in a manner similar to the Company's prior program, at his dealerships and at two other dealers, one of whom also does business with the Company. The Company's majority shareholder and Chairman does not intend to expand his line of credit lending activities to additional dealers, except to dealerships which he owns or controls. (10) INCOME TAXES The income tax provision consists of the following (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The tax effects of timing differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities consist of the following (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) In 2001, there was an increase in state income taxes due to the re-characterization of revenue resulting from the Internal Revenue Service examination. The 2001 state income tax expense is an estimated cumulative amount of taxes owed to various states for the years 1993 to 2001. The decrease in state income taxes in 2002 was primarily due to a change in the estimate of the cumulative amounts owed from 1993 to 2001. During 2002, management determined that the undistributed earnings of the Company's foreign subsidiaries should no longer be considered to be permanently reinvested. As a result of that determination, the Company recorded the amount of U.S. federal income taxes and withholding taxes that would be due upon repatriation of these earnings. (11) CAPITAL TRANSACTIONS NET INCOME PER SHARE Basic net income per share has been computed by dividing net income by the weighted average number of common shares outstanding. Diluted net income per share has been computed by dividing net income by the total of the weighted average number of common shares and common stock equivalents outstanding. Common stock equivalents included in the computation represent shares issuable upon assumed exercise of stock options that would have a dilutive effect using the treasury stock method. The share effect is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) performance targets are met. In addition, the Company issued 234,810 and 890,838 options in 2002 and 2001, respectively, that will vest over a three to five year period. Nonvested options are forfeited upon termination of employment and otherwise expire ten years from the date of grant. Shares available for future grants totaled 1,647,225, 1,607,615, and 2,155,028 as of December 31, 2003, 2002, and 2001, respectively. Pursuant to the Company's Director Stock Option Plan (the "Director Plan"), the Company has reserved 200,000 shares of its common stock for future granting of options to members of its Board of Directors. The exercise price of the options is equal to the fair market value on the date of grant. In 2001, the Company granted 100,000 options that will vest only if the Company meets certain performance targets. Nonvested options are forfeited if the participant should cease to be a director and otherwise expire ten years from the date of grant. Shares available for future grants totaled 100,000 as of December 31, 2003, 2002 and 2001. Pursuant to the Company's Stock Option Plan for Dealers (the "Dealer Plan"), the Company had reserved 1.0 million shares of its common stock for the future granting of options to participating dealer-partners. Effective January 1, 1999, the Company suspended the granting of future options under the Dealer Plan. As of December 31, 2003, the Dealer Plan has been cancelled and all previously outstanding options under the Dealer Plan have been exercised or forfeited. The Company accounts for the compensation costs related to its grants under the stock option plans in accordance with SFAS No. 123. The Company recognized stock-based compensation expense of $3,583,000, $2,072,000, and $1,755,000 for 2003, 2002, and 2001, respectively, for the 1992 Plan and Director Plan. The fair value of each option granted used in determining the above stock-based compensation expense is estimated on the date of grant using the Black-Scholes option-pricing model. The weighted-average assumptions used in the option-pricing model as well as the resulting weighted-average fair value of options granted are as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) Additional information relating to the stock option plans is as follows:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) REPORTABLE SEGMENT OVERVIEW In the second quarter of 2003, the Company re-evaluated its business segments as a result of the decision to stop Loan originations in the United Kingdom and Canada. Business decisions, including resources to be allocated, are based on the financial performance of the operations that will continue to originate new business, separate from those that do not. The chief operating decision maker reviews financial information combined into six components: United States, United Kingdom, Automobile Leasing, Canada, Floor Plan and Lines of Credit. Each component is an operating segment, however, Canada, Floor Plan and Lines of Credit are combined in an "all other" category as none meet the quantitative thresholds of a reportable segment. As a result, the Company has four reportable business segments: United States, United Kingdom, Automobile Leasing, 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 United Kingdom segment primarily consists of the Company's United Kingdom retail automobile Loan operation. The Automobile Leasing segment consists of the Company's automobile leasing operation. The Other segment consists of the Company's Canadian retail automobile Loan operation and secured lines of credit and floorplan financing programs. The Company is currently liquidating its operations in all segments other than the United States. 63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) MEASUREMENT The table below presents finance charge revenue, lease revenue, other revenue, segment net income (loss) and segment assets information for each reportable segment (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) The Company operates primarily in the United States and the United Kingdom (excluding Ireland). The table below presents the key financial information by geographic location (in thousands):
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED) 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 United States District Court for the Western District of Missouri seeking 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. 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 Missouri state court 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") portion of the 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 September 18, 2001, the Circuit Court of Jackson County, Missouri mailed an order assigning this matter to a judge. On October 28, 2002, the plaintiffs filed a fourth amended complaint. 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 January 15, 2003, the case was assigned to a new judge. On February 21, 2003 the plaintiffs filed a brief opposing the Company's November 4, 2002 motion to dismiss the case. 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. (14) QUARTERLY FINANCIAL DATA (UNAUDITED) The following is a summary of quarterly financial position and results of operations for the years ended December 31, 2003 and 2002, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Certain amounts for prior periods have been reclassified to conform to the current presentation, including the following significant balance sheet reclassifications: (i) the reserve for advance losses, which was previously classified within dealer holdbacks, net, was eliminated and the balance transferred to the allowance for credit losses, which is classified within Loans receivable, net and (ii) repossessed assets were reclassified from Loans receivable, net to other assets. Additionally, as a result of the Company's adoption of the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation" under the retroactive restatement method selected by the Company as described in SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure" in the second quarter of 2003, the Company restated all prior periods to reflect the stock-based compensation expense that would have been recognized had the recognition provisions of SFAS No. 123 been applied to all awards granted to employees or directors after January 1, 1995. 66
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not Applicable. ITEM 9A. CONTROLS AND PROCEDURES As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures are effective to cause the material information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms. There were no changes in the Company's internal controls over financial reporting during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information is contained under the captions "Matters to Come Before the Meeting -- Election of Directors" (excluding the Report of the Audit Committee) and "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's Proxy Statement and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION Information is contained under the caption "Compensation of Executive Officers" (excluding the Report of the Executive Compensation Committee and the stock performance graph) in the Company's Proxy Statement and is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS Information is contained under the caption "Common Stock Ownership of Certain Beneficial Owners and Management" in the Company's Proxy Statement and is incorporated herein by reference. In addition, the information contained in the "Equity Compensation Plans" subheading under Item 5 of this Report is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information is contained under the caption "Certain Relationships and Transactions" in the Company's Proxy Statement and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES Information is contained under the caption "Independent Accountants" in the Company's Proxy Statement and is incorporated herein by reference. 69
PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) The following consolidated financial statements of the Company and Report of Independent Public Accountants are contained in "Item 8 -- Financial Statements and Supplementary Data." Report of Independent Public Accountants Consolidated Financial Statements: -- Consolidated Balance Sheets as of December 31, 2003 and 2002 -- Consolidated Income Statements for the years ended December 31, 2003, 2002 and 2001 -- Consolidated Statements of Shareholders' Equity for the years ended December 31, 2003, 2002 and 2001 -- Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 Notes to Consolidated Financial Statements (2) Financial Statement Schedules have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto. (3) The Exhibits filed in response to Item 601 of Regulation S-K are listed in the Exhibit Index, which is incorporated herein by reference. (b) Reports on Form 8-K The Company filed a current report on Form 8-K pursuant to Items 9 and 12, dated September 24, 2003, furnishing institutional investor presentation materials, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated October 6, 2003, reporting that the Company issued a press release announcing the completion of a $100 million revolving warehouse facility, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated November 4, 2003, reporting that the Company issued a press release announcing the delay of its third quarter earnings, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 7 and 12, dated November 17, 2003, reporting that the Company issued a press release announcing financial results for the three and nine months ended September 30, 2003, a copy of which was filed as Exhibit 99.1. The Company filed a current report on Form 8-K pursuant to Items 5 and 7, dated November 26, 2003, reporting that the Company issued a press release announcing that it commenced a modified Dutch auction tender offer, a copy of which was filed as Exhibit 99.1. 70
SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CREDIT ACCEPTANCE CORPORATION By: /s/ BRETT A. ROBERTS ------------------------------------ Brett A. Roberts Chief Executive Officer Date: March 15, 2004 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on March 15, 2004 on behalf of the registrant and in the capacities indicated.
EXHIBIT INDEX The following documents are filed as part of this report. Those exhibits previously filed and incorporated herein by reference are identified below. Exhibits not required for this report have been omitted. The Company's commission file number is 000-20202.
Exhibit 21 (l) (CREDIT ACCEPTANCE LOGO) CREDIT ACCEPTANCE CORPORATION SCHEDULE OF CREDIT ACCEPTANCE CORPORATION SUBSIDIARIES The following is a list of subsidiaries as of the date of this filing of Credit Acceptance Corporation, other than subsidiaries which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary, as defined by the Securities and Exchange Commission Regulation S-X. Arlington Investment Company Buyers Vehicle Protection Plan, Inc. AutoNet Finance Company.com, Inc CAC Funding Corp. Credit Acceptance Funding LLC 2003-1 Credit Acceptance Auto Dealer Loan Trust 2003-1 CAC Warehouse Funding Corp. CAC Warehouse Funding Corporation II CAC Leasing, Inc. CAC Reinsurance, Ltd. CAC of Nevada, Inc. Credit Acceptance Corporation of South Dakota, Inc. CAC International Holdings LLC Vehicle Remarketing Services, Inc. Credit Acceptance Corporation UK Limited CAC of Canada Company Credit Acceptance Corporation Ireland Limited Auto Funding America, Inc. Auto Funding America of Nevada, Inc. Auto Lease Services, LLC Credit Acceptance Wholesale Buyers Club, Inc. CAC Scotland CAC Luxembourg, S.a.r.l CAC UK Funding, Ltd. CAC (TCI) Ltd.
EXHIBIT 23 (1) INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in this Registration Statement of Credit Acceptance Corporation on Form S-3 (File Nos. 33-75246 (as amended) and 333-18301) and Forms S-8 (File Nos. 33-64876, 33-80339, 333-67348, 333-91734, and 333-11831) of our report dated February 26, 2004, appearing in this Annual Report on Form 10-K of Credit Acceptance Corporation for the year ended December 31, 2003. Detroit, Michigan March 15, 2004
EXHIBIT 31 (A) I, Brett A. Roberts, certify that: 1. I have reviewed this annual report on Form 10-K of Credit Acceptance Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 15, 2004 /s/ Brett A. Roberts - ------------------------- Chief Executive Officer
EXHIBIT 31 (B) I, Douglas W. Busk, certify that: 1. I have reviewed this annual report on Form 10-K of Credit Acceptance Corporation; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. March 15, 2004 /s/ Douglas W. Busk - ------------------------ Chief Financial Officer
EXHIBIT 32 (A) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Credit Acceptance Corporation (the "Company") on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Brett A. Roberts, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. /s/ Brett A. Roberts ------------------------ Chief Executive Officer March 15, 2004
EXHIBIT 32 (B) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Credit Acceptance Corporation (the "Company") on Form 10-K for the period ending December 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Douglas W. Busk, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. /s/ Douglas W. Busk ------------------------- Chief Financial Officer March 15, 2004