UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549-1004
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
[_] OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________________ to _________________
Commission File Number 0-13084
WARRANTECH CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 13-3178732
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
150 Westpark Way, Euless TX 76040
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (800) 544-9510
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last year)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.
Common stock, par value $.007 per share 15,245,288 shares
--------------------------------------- -------------------------------
Class Outstanding at January 31, 2002
1
WARRANTECH CORPORATION AND SUBSIDIARIES
I N D E X
Page No.
--------
PART I - Financial Information
Item 1: Financial Statements
Condensed Consolidated Statements of Operations -
For the Three Months and Nine Months Ended December 31, 2001
and 2000 (Unaudited).............................................. 3
Condensed Consolidated Balance Sheets at December 31, 2001
(Unaudited) and March 31, 2001.................................... 4
Condensed Consolidated Statements of Cash Flows
For the Three Months and Nine Months Ended December 31, 2001
and 2000 (Unaudited).............................................. 6
Notes to Condensed Consolidated Financial Statements..................... 7
Item 2: Management's Discussion and Analysis of
Financial Condition and Results of Operations .................... 13
PART II - Other Information
Item 1: Legal Proceedings................................................... 18
Item 5: Other Information................................................... 18
Item 6: Exhibits and Reports on Form 8-K.................................... 18
Signature ................................................................... 19
2
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------------- -------------------------------
2001 2000 2001 2000
-------------- -------------- -------------- --------------
Earned Administrative Fees (net of amortization of deferred costs) $8,549,955 $11,724,995 $27,043,540 $37,022,003
-------------- -------------- -------------- --------------
Costs and expenses
Service, selling, and general and administrative 7,394,418 9,177,970 23,242,498 29,014,602
Legal settlement -- -- (824,332) --
Depreciation and amortization 737,360 1,476,477 3,439,123 4,858,697
Loss on abandonment of assets -- -- -- 1,049,552
-------------- -------------- -------------- --------------
Total costs and expenses 8,131,778 10,654,447 25,857,289 34,922,851
-------------- -------------- -------------- --------------
Income from operations 418,177 1,070,548 1,186,251 2,099,152
Other income (expense) 357,627 238,966 698,623 643,751
-------------- -------------- -------------- --------------
Income before provision for income taxes 775,804 1,309,514 1,884,874 2,742,903
Provision for income taxes 284,600 399,587 714,200 899,993
-------------- -------------- -------------- --------------
Net income $491,204 $909,927 $1,170,674 $1,842,910
============== ============== ============== ==============
Earnings per share:
Basic $0.03 $0.06 $0.08 $0.12
============== ============== ============== ==============
Diluted $0.03 $0.06 $0.08 $0.12
============== ============== ============== ==============
Weighted average number of shares outstanding:
Basic 15,243,095 15,280,549 15,221,757 15,318,259
============== ============== ============== ==============
Diluted 15,243,095 15,280,549 15,221,757 15,318,259
============== ============== ============== ==============
See accompanying notes to condensed consolidated financial statements.
3
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, March 31,
2001 2001
----------- -----------
ASSETS
Current assets:
Cash and cash equivalents $6,655,955 $3,001,924
Investments in marketable securities 960,821 196,154
Accounts receivable, (net of allowances of
$848,881 and $1,079,946, respectively) 12,627,581 12,152,515
Other receivables, net 5,353,918 7,065,531
Income tax receivable 211,014 5,378,648
Deferred income taxes 1,711,882 571,182
Prepaid expenses and other current assets 691,396 964,929
----------- -----------
Total current assets 28,212,567 29,330,883
----------- -----------
Property and equipment, net 10,024,243 11,898,890
Other assets:
Excess of cost over fair value of assets acquired
(net of accumulated amortization of $5,825,405) 1,637,060 1,637,290
Deferred income taxes 5,201,968 2,724,096
Deferred direct costs 27,402,744 46,258,971
Investments in marketable securities 1,408,250 3,094,176
Restricted cash 800,000 800,000
Split dollar life insurance policies 799,262 708,262
Notes receivable 1,982,121 599,796
Other assets 64,809 64,809
----------- -----------
Total other assets 39,926,214 55,887,400
----------- -----------
Total Assets $77,533,024 $97,117,173
=========== ===========
See accompanying notes to condensed consolidated financial statements
4
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31, March 31,
2001 2001
-------------- --------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt and capital lease obligations $866,970 $801,265
Insurance premiums payable 21,663,515 19,100,164
Accounts and commissions payable 6,106,949 6,346,872
Accrued expenses and other current liabilities 4,083,197 5,890,078
-------------- --------------
Total current liabilities 32,720,631 32,138,379
-------------- --------------
Deferred revenues 39,145,878 60,057,704
Long-term debt and capital lease obligations 1,026,292 1,209,853
Deferred rent payable 216,550 293,293
-------------- --------------
Total liabilities 73,109,351 93,699,229
-------------- --------------
Commitments and contingencies
Stockholders' equity:
Preferred stock - $.0007 par value authorized - 15,000,000 shares
issued - none at December 31, 2001 and March 31, 2001 -- --
Common stock - $.007 par value authorized - 30,000,000 shares
issued - 16,525,324 shares at December 31, 2001 and
16,514,228 shares at March 31, 2001 115,609 115,580
Additional paid-in capital 23,745,113 23,742,868
Loans to directors and officers (10,083,038) (9,833,244)
Accumulated other comprehensive income, net of taxes (25,301) (31,949)
Retained earnings (deficit) (5,063,431) (6,234,105)
-------------- --------------
8,688,952 7,759,150
Treasury stock - at cost, 1,274,443 shares at December 31, 2001
and 1,415,171 shares at March 31, 2001 (4,265,279) (4,341,206)
-------------- --------------
Total Stockholders' Equity 4,423,673 3,417,944
-------------- --------------
-------------- --------------
Total Liabilities and Stockholders' Equity $77,533,024 $97,117,173
============== ==============
See accompanying notes to condensed consolidated financial statements.
5
WARRANTECH CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
For the Nine Months Ended
December 31,
----------------------------------
2001 2000
-------------- --------------
Cash flows from operating activities:
Net income $1,170,674 $1,842,910
Total Adjustments to reconcile net income to net cash
provided by operating activities: 4,621,385 (711,679)
-------------- --------------
Net cash flows provided by operating activities 5,792,059 1,131,231
-------------- --------------
Cash flows from investing activities:
Property and equipment purchased-net of retirements (1,179,920) (1,302,880)
Purchase of marketable securities (330,000) (475,000)
Decrease in notes receivable 366,037 527,053
Proceeds from sales of marketable securities 1,315,304 1,300,000
-------------- --------------
Net cash provided by investing activities 171,421 49,173
-------------- --------------
Cash flows from financing activities:
Purchase treasury stock -- (308,920)
Issuance of treasury stock -- 191,881
Increase in notes receivable (1,748,362) --
Repayments, notes and capital leases (561,087) (1,019,201)
-------------- --------------
Net cash used in financing activities (2,309,449) (1,136,240)
-------------- --------------
Net increase in cash and cash equivalents 3,654,031 44,164
Cash and cash equivalents at beginning of period 3,001,924 10,035,003
-------------- --------------
Cash and cash equivalents at end of period $6,655,955 $10,079,167
-------------- --------------
Supplemental Cash Flow Information:
Cash payments for:
Interest $163,925 $188,021
-------------- --------------
Income taxes $-- $265,599
-------------- --------------
Non-Cash Investing and financing activities:
Property and equipment financed through capital leases $443,232 $399,195
Capital leases refinanced $151,727 --
Increase in loans to officers and directors ($249,794) ($233,224)
Issuance of treasury stock $75,927 --
See accompanying notes to condensed consolidated financial statements.
6
WARRANTECH CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2001
(Unaudited)
1. THE COMPANY
Warrantech, through its wholly owned subsidiaries, markets and administers
service contracts and extended warranties. The Company is a third party
administrator for a variety of dealer/clients in selected industries and offers
call center and technical computer services. The Company assists dealer/clients
in obtaining insurance policies from highly rated independent insurance
companies for all contracts and programs offered. The insurance company is then
responsible for the cost of repairs or replacements for the contracts
administered by Warrantech.
The Company operates in three major business segments: Automotive, Consumer
Products and International. The Automotive segment markets and administers
extended warranties on automobiles, light trucks, recreational vehicles,
motorcycles and automotive components. Franchised and independent automobile
dealers, leasing companies, repair facilities, retail stores and financial
institutions, principally sell these products. The Consumer Products segment
markets and administers extended warranties on household appliances, electronics
and homes. These products include home appliances, consumer electronics,
televisions, computers, home office equipment and homes. Retailers,
distributors, manufacturers, utility companies, mortgage brokers, managing
general agencies and financial institutions principally sell these products.
Warrantech also direct markets these products to the ultimate consumer through
telemarketing and direct mail campaigns. The International segment markets and
administers outside the United States predominately the same products and
services of the other business segments. The International segment is currently
operating in Central and South America, Puerto Rico and the Caribbean.
The terms of the service contracts, extended warranties and replacement
contracts generally range from twelve (12) to eighty-four (84) months. The
Company acts as a third party administrator on behalf of the dealer/clients and
insurance companies. Authorized independent third party repair facilities or
dealers perform the actual repairs and/or replacements required under the
agreements. The cost of these repairs is borne by the insurance companies, which
have the ultimate responsibility for the claims. The insurance policy
indemnifies the dealer/clients against losses resulting from service contract
claims and protects the consumer by ensuring their claims will be paid.
Authorities in a limited number of jurisdictions in which the service contracts
are sold and in which the Company administers the contracts may seek to impose
the obligation to pay on the Company, even where it has acted solely as
administrator and was not the "obligor" under such service contracts. These
contracts are covered by insurance as well.
Although the Company's obligations were insured by various insurance companies,
it marketed and administered some service contracts which were sold prior to
April 1, 2000, in which it was the obligor. Some of those service contracts have
not expired and are still in effect.
The Company's service contract programs benefit consumers with expanded and/or
extensions of product coverage for a specified period of time (and/or mileage in
the case of automobiles and recreational vehicles), similar to that provided by
manufacturers under the terms of their product warranties. The coverage
generally provides for the repair or replacement of the product, or a component
thereof, in the event of its failure. The Company's service contract programs
benefit the dealer/clients by providing enhanced value to the goods and services
they offer. They also provide the opportunity for increased revenue and income
while outsourcing the costs and responsibilities of operating an extended
warranty program.
7
2. BASIS OF PRESENTATION
The accompanying consolidated financial statements have been prepared by
management and are unaudited. These interim financial statements have been
prepared on the basis of accounting principles generally accepted in the United
States of America ("GAAP") for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all information and footnotes required by accounting principles
generally accepted in the United States of America for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation of the
financial position and operating results of the Company for the interim period
have been included. Operating results for the three and nine months ended
December 31, 2001 are not necessarily indicative of the results that may be
expected for the fiscal year ending March 31, 2002. For further information,
refer to the consolidated financial statements and footnotes thereto included in
the Company's Annual Report on Form 10K for the year ended March 31, 2001.
3. NEW ACCOUNTING STANDARD
On June 29, 2001, the Financial Accounting Standards Board (FASB) approved for
issuance Statement of Financial Accounting Standards ("SFAS") 142, "Goodwill and
Intangible Assets," which is effective for fiscal years beginning after December
15, 2001. SFAS 142 provides that goodwill and intangible assets with indefinite
lives not be amortized, and instead, be tested for impairment annually and
whenever there is an impairment indicator. Early adoption of SFAS 142 is
permitted for companies with fiscal years beginning after March 15, 2001 but
only if they have not issued their first quarter financial statements prior to
adoption. The Company adopted SFAS 142 effective April 1, 2001 and ceased
amortization of its goodwill. The following table presents pro forma condensed
consolidated statements of operations of the Company for the three months and
nine months ended December 31, 2001 and 2000, as though SFAS 142 had not been
adopted. The pro forma condensed consolidated statements of operations reflects
$149,817 and $449,451 of amortization of goodwill in the three months and nine
months ended December 31, 2001, respectively. This goodwill would have been
reflected in the statements of operations prior to the adoption of SFAS 142.
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------------- -------------------------------
2001 2000 2001 2000
-------------- -------------- -------------- --------------
Earned Administrative Fee (net of amortization of deferred costs) $8,549,955 $11,724,995 $27,043,540 $37,022,003
-------------- -------------- -------------- --------------
Costs and expenses
Service, selling, and general and administrative 7,394,418 9,177,970 23,242,498 29,014,602
Legal settlement -- -- (824,332) --
Depreciation and amortization 887,177 1,476,477 3,888,574 4,858,697
Loss on abandonment of assets -- -- -- 1,049,552
-------------- -------------- -------------- --------------
Total costs and expenses 8,281,595 10,654,447 26,306,740 34,922,851
-------------- -------------- -------------- --------------
Income from operations 268,360 1,070,548 736,800 2,099,152
Other income (expense) 357,627 238,966 698,623 643,751
-------------- -------------- -------------- --------------
Income before provision for income taxes 625,987 1,309,514 1,435,423 2,742,903
Provision (benefit) for income taxes 284,600 399,587 714,200 899,993
-------------- -------------- -------------- --------------
Net income $341,387 $909,927 $721,223 $1,842,910
============== ============== ============== ==============
Earnings per share:
Basic & Diluted $0.02 $0.06 $0.05 $0.12
============== ============== ============== ==============
8
4. OTHER COMPREHENSIVE INCOME
The components of other comprehensive income are as follows:
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
------------------------------ ------------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Net income $491,204 $909,927 $1,170,674 $1,842,910
Other comprehensive income, net of tax
Unrealized gain (loss) on investments 36,054 6,626 8,700 13,393
Foreign currency translation adjustments (31,915) (115) (2,052) 78,919
------------- ------------- ------------- -------------
Comprehensive income $495,343 $916,438 $1,177,322 $1,935,222
============= ============= ============= =============
Comprehensive income per share:
Basic & Diluted $0.03 $0.06 $0.08 $0.13
============= ============= ============= =============
The components of accumulated comprehensive income, net of related tax, for
the periods ended December 31, 2001 and March 31, 2001, are as follows:
December 31, March 31,
2001 2001
-------- --------
Unrealized gain/ (loss) on investments $21,969 $13,269
Accumulated translation adjustments (47,270) (45,218)
-------- --------
Accumulated other comprehensive income ($25,301) ($31,949)
======== ========
5. EARNINGS PER SHARE
The computations of earnings per share are as follows:
For the Three Months Ended For the Nine Months Ended
December 31, December 31,
----------------------------- -----------------------------
2001 2000 2001 2000
------------- ------------- ------------- -------------
Numerator:
Net income applicable to common stock $491,204 $909,927 $1,170,674 $1,842,910
============= ============= ============= =============
Denominator:
Average outstanding shares used in the
computation of per share earnings:
Common Stock issued-Basic shares 15,243,095 15,280,549 15,221,757 15,318,259
Stock Options (treasury method) -- -- -- --
------------- ------------- ------------- -------------
Diluted shares 15,243,095 15,280,549 15,221,757 15,318,259
============= ============= ============= =============
Earnings per common share:
Basic $0.03 $0.06 $0.08 $0.12
============= ============= ============= =============
Diluted $0.03 $0.06 $0.08 $0.12
============= ============= ============= =============
9
6. SEGMENTS
The Company defines its operations into three business segments:
Automotive, Consumer Products and International. The category "Other"
includes general corporate income and expenses, inter-segment sales and
expenses and other corporate assets not related to these business segments.
Consumer Reportable
Automotive Products International Segments Other Total
---------- -------- ------------- -------- ----- -----
Three Months Ended
December 31, 2001
-----------------
Earned administrative fee $4,085,973 $4,334,599 $252,948 $8,673,520 ($123,566) $8,549,954
Profit (loss) from operations 2,371,997 384,187 (422,394) 2,333,790 (1,915,613) 418,177
Pretax Income (Loss) 1,267,119 (221,108) (374,944) 671,067 104,737 775,804
Net Interest Income 15,298 38,119 6,981 60,397 136,703 197,100
Depreciation/Amortization 84,768 376,195 18,059 479,022 258,338 737,360
December 31, 2000
-----------------
Earned administrative fee $2,509,866 $9,023,575 $266,511 $11,799,952 ($74,957) $11,724,995
Profit (loss) from operations 682,982 3,995,214 (462,276) 4,215,920 (3,145,372) 1,070,548
Pretax Income (Loss) (384,685) 1,988,289 (556,781) 1,046,823 262,692 1,309,515
Net Interest Income 17,309 39,314 0 56,623 176,904 233,527
Depreciation/Amortization 205,564 447,269 18,580 671,413 805,064 1,476,477
Nine Months Ended
December 31, 2001
-----------------
Earned administrative fee $12,512,742 $12,767,819 $2,166,643 $27,447,204 ($403,664) $27,043,540
Profit (loss) from operations 7,013,121 (839,925) (236,419) 5,936,777 (4,750,526) 1,186,251
Pretax Income (Loss) 4,510,382 (2,683,592) (491,873) 1,334,917 549,957 1,884,874
Net Interest Income 49,510 44,268 18,177 111,955 553,481 665,436
Depreciation/Amortization 288,674 1,234,189 55,810 1,578,673 1,860,450 3,439,123
Total Assets 32,988,790 36,384,644 3,693,341 73,066,775 4,466,249 77,533,024
December 31, 2000
-----------------
Earned administrative fee $11,654,587 $24,395,660 $1,244,929 $37,295,176 ($273,173) $37,022,003
Profit (loss) from operations 6,140,450 9,295,148 (384,381) 15,051,217 (12,952,065) 2,099,152
Pretax Income (Loss) 3,202,205 3,690,129 7,546,446 14,438,780 (11,695,877) 2,742,903
Net Interest Income 46,658 51,564 (15,853) 82,369 542,570 624,939
Depreciation/Amortization 628,391 1,388,672 750,128 2,767,191 2,091,506 4,858,697
Total Assets 49,260,611 52,312,487 2,786,255 104,359,353 13,253,282 117,612,635
7. LEGAL PROCEEDINGS
American Home Assurance Co., et al, v. Warrantech Automotive, Inc., 99 Civ.
12040 (BSG)
Service Guard Insurance Agency, Inc. v. Warrantech Automotive, Inc., New
Hampshire Insurance Company, Ronald Glime and Christopher Ford, Cause No.
99-12650, 126th Judicial District Court of Travis County, Texas
National Union Fire Insurance Company of Pittsburgh, PA v. Warrantech
Corporation and Warrantech Automotive, Inc., United States District Court
(S.D.N.Y.)
Each of the matters set forth above was settled pursuant to a certain
Settlement Agreement and Release of Claims, effective as of July 25, 2001
(the "Agreement"). As referenced in the title of the Agreement, each party
released all other relevant parties from all claims asserted in any of the
litigations and all claims that could have been asserted in any of said
litigations. Furthermore, releases were granted with respect to all
potential future claims arising out of the subject matter of any of the
litigations. The financial impact for this settlement is reflected in the
Management's Discussion and Analysis beginning on page 14 in this quarterly
report on Form 10Q.
10
Staples the Office Superstore, Inc.
Staples the Office Superstore, Inc. v. ACE Property and Casualty Insurance
Company, Warrantech Consumer Product Services, Inc. and Warrantech Help
Desk, Inc., No. 2001-02277, District Court of Harris County, Texas. In
accordance with a Service Contract Administration Agreement, Warrantech
administered a service contract program for Staples. For a period of time,
that program was underwritten by ACE Property and Casualty Insurance
Company (f/k/a CIGNA Property and Casualty Insurance Company). In December
2000, ACE informed Warrantech that it was implementing changes in the
process pursuant to which claims underwritten by ACE were to be adjusted
and paid. Although Warrantech would continue to take inbound calls and
validate coverage, ACE would now confirm diagnoses, dispatch service and
pay servicer invoices. Shortly after implementation of these changes,
Staples reported that it had witnessed a material increase in complaints
from customers holding service contracts underwritten by ACE. These
complaints were primarily focused on inordinate delays in service delivery.
Although Staples discussed these problems with Warrantech, ACE continued to
operate under the new claims handling procedures. In an effort to satisfy
customer complaints, Staples states that it has spent a substantial amount
of its own funds to repair or replace covered products.
This action has two distinct components. Initially, Staples sought a
Temporary Injunction against ACE and Warrantech. The motion, as filed,
asked that (i) Staples be given control of the toll free telephone lines on
which customers call for service and (ii) ACE be required to re-institute
those claims handling procedures that were in place prior to December 2000.
That motion has been denied but the parties have entered into an Agreed
Order that governs the administration of the Staples portfolio of service
contracts.
Staples is also pursuing an action for damages against both ACE and
Warrantech. It seeks to recover the amounts it has spent to satisfy its
customers and certain unspecified amounts representing loss of business and
damage to its reputation. Its entitlement to these amounts is based on a
variety of theories including breach of contract, fraud and tortuous
interference with business. Warrantech believes the claims as asserted
against it are without merit. Warrantech also believes it has meritorious
claims against ACE arising out of these allegations which claims may be
asserted in this litigation or in the arbitration referred to below. The
document production phase of discovery has been completed and the parties
are presently engaged in depositions. Settlement discussions have commenced
and are continuing. Although no resolution of the issues has been
finalized, Warrantech believes that a negotiated settlement is possible
before the end of the year.
ACE Property and Casualty Insurance Company
In the Matter of the Arbitration between ACE Property and Casualty
Insurance Company f/k/a CIGNA Property and Casualty Insurance Company v.
Warrantech Corporation, Warrantech Consumer Product Services, Inc., WCPS of
Florida, Inc. and Warrantech Help Desk, Inc.
In accordance with that certain Administrative Agreement, effective as of
August 1, 1997, between the various named Warrantech entities and CIGNA,
ACE has made demand for arbitration in accordance with the terms of the
Agreement. ACE asserts a variety of claims against the Warrantech entities
that can be divided into two general categories. The first arises out of
Warrantech's administration of its service contract program with CompUSA,
both prior to and immediately following the termination of the relationship
between Warrantech and CompUSA. The remaining claims relate to Warrantech's
general claims handling procedures. Although all claims have not been set
forth with specificity, it is evident that ACE is seeking to recover
damages in an amount in excess of twenty million dollars ($20,000,000).
ACE has provided Warrantech with its Preliminary Statement, an arbitration
panel has been appointed and an arbitration schedule has been agreed to.
Minimal discovery has been commenced and all parties have significant
discovery work to complete. Preliminary settlement discussions have been
held, but, at this stage of the discussions, it is impossible to predict
whether or not such discussions will be successful.
11
Michael A. Basone
Mr. Basone was a former Executive Vice President and Chief Operating
Officer of Warrantech Corporation. He resigned his position in February
2000. Several months after resigning, Mr. Basone contacted the Company
through his attorney requesting a payment equal in amount to what Mr.
Basone would have received had he completed the term of his employment
agreement on the theory that the Company's conduct was such that he was
forced to resign, thereby resulting in his "constructive termination"
without cause. The Company believes this assertion is completely without
merit and has rejected Mr. Basone's demand for payment. In accordance with
the terms of his employment agreement, Mr. Basone has filed a Demand for
Arbitration with the American Arbitration Association that seeks damages in
the amount of $300,000. The document production phase of discovery has been
completed and the parties are presently engaged in depositions.
Warrantech is not able to estimate its potential liability in any of the
above actions although Warrantech believes that these matters are without
merit, and accordingly, no reserves for potential liabilities have been
provided for any of these actions.
8. STOCK OPTIONS
On August 24, 2001, simultaneously with the settlement of the litigation
among Service Guard Insurance Agency, Inc., American International Group,
Inc. ("AIG") and related entities which is described in Footnote 7 above,
the Company granted AIG options to purchase two (2) million shares of
Warrantech's common stock at a price of $2.00 per share. The options are
exercisable for a period of five years. Warrantech has the right to redeem
the options at any time if its shares trade at a price of $3.00 per share
or more on any five consecutive trading days. The redemption price is $.001
per option. However, if Warrantech elects to redeem the options, AIG will
have the right to exercise the options immediately prior to the redemption.
If AIG exercises all of the options, it would own approximately 12% of the
Company's outstanding common shares.
12
WARRANTECH CORPORATION AND SUBSIDIARIES
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward Looking Statement
Except for the historical information contained herein, the matters discussed
below or elsewhere in this quarterly report may contain forward-looking
statements that involve risks and uncertainties that could cause actual results
to differ materially from those contemplated by the forward-looking statements.
The Company makes such forward-looking statements under the provisions of the
"safe harbor" section of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements reflect the Company's views and assumptions, based on
information currently available to management. Such views and assumptions are
based on, among other things, the Company's operating and financial performance
over recent years and its expectations about its business for the current and
future fiscal years. Although the Company believes that the expectations
reflected in such forward-looking statements are reasonable, it can give no
assurance that such expectations will prove to be correct. Such statements are
subject to certain risks, uncertainties and assumptions, including, but not
limited to, (a) prevailing economic conditions which may significantly
deteriorate, thereby reducing the demand for the Company's products and
services, (b) availability of technical support personnel or increases in the
rate of turnover of such personnel, resulting from increased demand for such
qualified personnel, (c) changes in the terms or availability of insurance
coverage for the Company's programs, (d) regulatory or legal changes affecting
the Company's business, (e) loss of business from or significant change in
relationship with, any major customer of the Company, (f) the ability to
successfully identify and contract new business opportunities, both domestically
and internationally, (g) ability to secure necessary capital for general
operating or expansion purposes, (h) ability to secure an alternate source of
payment of claims under the vehicle service contracts,(i) the amount of claims
required to be paid by the Company under the service contacts or (j) adverse
outcomes of litigation. Additionally, if any of the insurance companies which
insure the service contracts marketed and administered by the Company were
unable to pay the claims under the service contracts, it could have a materially
adverse effect on the Company's business. Should one or more of these or any
other risks or uncertainties materialize or develop in a manner adverse to the
Company, or should the Company's underlying assumptions prove incorrect, actual
results of operations, cash flows or the Company's financial condition may vary
materially from those anticipated, estimated or expected.
Results of Operations
Three Months Ended December 31, 2001 Compared to the Three Months Ended December
31, 2000
Net earned administrative fees for the three month period ended December 31,
2001 decreased to $8,549,955 as compared with $11,724,995 for the same period
last year, a decrease of $3,175,040 or 27.1%. The change was primarily due to
the loss of Staples as a customer and a lower amount of deferred revenue
recognized in the current quarter, partially offset by an increase in the
Automotive segment's business.
The Automotive segment net earned administrative fees increased to $4,085,973
for the quarter ending December 31, 2001 as compared to $2,509,866 in the same
quarter last year. The increase resulted from the recognition of more deferred
revenues from prior periods this quarter versus the same quarter last year, plus
greater sales amounts during the current quarter compared to the prior year
quarter.
The Consumer Products segment net earned administrative fees decreased to
$4,334,599 for the quarter ended December 31, 2001 from $9,023,575, a decrease
of $4,688,976 or 52.0% for same period last year. The change was primarily
attributable to the loss of Staples as a customer, partially offset by increases
in business from other dealers within the segment.
13
The International segment net earned administrative fees remained flat at
$252,948 for the three month period ended December 31, 2001 from $266,511 for
the same period a year ago. The South American market contributed higher volumes
from new customers in Peru and Chile and increased market penetration from
existing customers in Chile, offsetting the loss of a large South American
customer.
Service, selling and general and administrative expenses (SG&A) for the three
months ended December 31, 2001 were reduced by $1,783,552 or 19.4% to $7,394,418
as compared to $9,177,970 for the three months ended December 31, 2000. The
decrease reflects the Company's improved call center technologies, cost
containment measures and lower legal expenses. Total employee and payroll
related costs were down 18.3% from $5,161,769 for the quarter ended December 31,
2000 to $4,267,327 in the current quarter. Outside services, including
consulting and legal fees, were down $363,189 or 27.3% from $1,330,368 in the
quarter ended December 31, 2000 to $967,179 in the current quarter.
Depreciation and amortization expenses were reduced by $739,117 or 50.1% to
$737,360 for the three months ended December 31, 2001 as compared to $1,476,477
for the same period last year. Decreases in depreciation and amortization
resulted from a decrease in the depreciable asset base and the early adoption of
SFAS 142, which allowed the Company to elect not to amortize its remaining
goodwill.
Income from operations for the third quarter 2002 was $418,177 compared to
$1,070,548 for the third quarter 2001. Income decreases, as a result of the loss
of the Staples account, were partially offset by the overall reduction in SG&A
and depreciation and amortization.
The provision for income taxes was $284,600 for the third quarter 2002 compared
to $399,587 for the same period last year.
Net income for the three months ended December 31, 2001 was $491,204 or $0.03
per basic and diluted share compared to a net income of $909,927 or $0.06 per
basic and diluted share for the comparable period last year. This change is the
result of factors as described above.
Nine Months Ended December 31, 2001 Compared to the Nine Months Ended December
31, 2000
Net earned administrative fees for the nine month period ended December 31, 2001
decreased to $27,043,540 as compared with $37,022,003 for the same period last
year, a decrease of $9,978,463 or 27.0%. The change was primarily due to the
loss of Staples as a customer. Excluding the loss of Staples, the Company
experienced a slight increase in net earned administrative fees from its
existing and new dealers.
The Automotive segment net earned administrative fees increased $858,155 or 7.4%
to $12,512,742 for the nine months ending December 31, 2001 from $11,654,587 in
the same period last year, resulting from an increase in deferred revenue from
prior periods.
The Consumer Products segment net earned administrative fees decreased
$11,627,841 or 47.7% to $12,767,819 from $24,395,660 for same period last year.
The change was primarily attributed to the loss of Staples as a customer,
partially offset by increases in business from other dealers within the segment.
Additionally, lower net earned administrative fee during the first nine months
compared to the prior year nine months were partially offset by increased
deferred revenues from prior periods, which were recognized this period versus
the same period last year.
The International segment net earned administrative fees increased $921,714 or
74.0% to $2,166,643 for the nine month period ended December 31, 2001 from
$1,244,929 for the same period a year ago. The South American market contributed
higher volumes from new customers in Peru and Chile and increased market
penetration from existing customers in Chile. These increases more than offset
the loss of net earned administrative fees from the United Kingdom, which was
closed September 30, 2000.
Service, selling and general and administrative expenses for the nine months
ended December 31, 2001, including the legal settlement were reduced by
$6,596,436 or 22.7% to $22,418,166 as compared to
14
$29,014,602 for the nine months ended December 31, 2000. The decrease reflects
the Company's improved call center technologies, cost containment measures and
the closing of the United Kingdom operations. Total employee and payroll related
costs were down $3,029,801 or 18.0% from $16,806,171 for the nine months ended
December 31, 2000 to $13,776,370 for the nine months ended December 31, 2001.
Additionally, the decrease in SG&A expenses reflects the reimbursement by AIG of
$824,332 in legal fees associated with its lawsuit against the Company. Outside
services, including consulting and legal fees, were down $2,313,271 or 55.2%
from $4,192,010 in the nine months ended December 31, 2000 to $1,878,739 in the
nine months ended December 31, 2001, primarily due to the settlement with AIG.
Rent costs for the nine months ended December 31, 2001 decreased $705,382 from
the same period last year as a result of the closing of the United Kingdom
offices and relocation of the Company's headquarters to Texas.
Depreciation and amortization expenses were reduced by $1,419,574 or 29.2% to
$3,439,123 for the nine months ended December 31, 2001 as compared to $4,858,697
for the same period last year, as a result of the closing of the United Kingdom
operations and the early adoption of SFAS 142, which allowed the Company to
elect not to amortize its remaining goodwill. Additionally, deprecation was
lower in the current nine months versus the prior year as the Company's net
property and equipment matured.
Loss on abandonment of assets was $1,049,552 for the nine months ended December
31, 2000. Effective September 30, 2000, the Company ceased operations in the
United Kingdom as a result of unprofitable operations and recorded a loss on its
operations.
Income from operations for the nine months ended December 31, 2001 was
$1,186,251 as compared to $2,099,152 for the nine months ended December 31,
2000. Income decreases, as a result of the loss of the Staples account, were
partially offset by the reduction in losses from the United Kingdom operations,
the benefit from the legal settlement with AIG and lower SG&A expenses and lower
depreciation and amortization.
Net income for the nine months ended December 31, 2001 was $1,170,674 or $0.08
per basic and diluted share compared to a net income of $1,842,910 or $0.12 per
basic and diluted share for the comparable period last year. This change is the
result of factors as described above.
Liquidity and Financial Resources
Recent Developments - Significant insurer in liquidation
A number of uncertainties exist at December 31, 2001 that could have an impact
on the Company's future financial condition, including but not limited to, the
effect on the Company of the liquidation of Reliance Insurance Company
("Reliance"). During the second quarter 2001, the Pennsylvania Insurance
Commissioner informed the Company that Reliance will be liquidated and cease
making payments on claims. The Pennsylvania Insurance Commissioner determined
that Reliance is not likely to be able to satisfy all of the claims that will be
submitted to it due to the circumstances arising out of the September 11, 2001
terrorist attacks on the World Trade Center. Reliance underwrote approximately
48% of the automotive service contracts that were sold during a period of
approximately one and one-half years ending in November 2000. Approximately 52%
of the automotive service contracts sold by Warrantech Automotive, a wholly
owned subsidiary of the Company, during that time period are not affected by the
Reliance liquidation. Service contracts sold before and after that period are
not affected because they are underwritten by other carriers.
The Company is attempting to ascertain from the Pennsylvania Insurance
Department, the amount of Reliance assets that will be available to pay the
vehicle service contract claims and when such funds will become available.
Additionally, the Company must wait to ascertain the amount of Pennsylvania
Insurance Department Insurance Funds and any other state guaranty funds, if any,
which are available and if any Federal subsidies to the insurance industry in
general or Reliance specifically, if any, will be made available as a result of
the terrorist attacks to pay vehicle service contract claims. The above
situations could take years before resolution is obtained. Additionally, the
Company is considering several alternative arrangements to cover claims under
the vehicle service contracts, including a long-term arrangement with its
current underwriter (See
15
"Letter of Understanding" below). The Company anticipates such alternative
arrangements will be consummated before the fiscal year end.
If assets from Reliance are not available to pay the claims and/or alternative
arrangements are not made, Warrantech Automotive may ultimately be required to
honor claims on contracts in which it is named as obligor. Such potential claims
represent approximately 48% of the total automotive service contracts
underwritten by Reliance. If required to honor claims, the Company's working
capital and its ability to meet its obligations in a timely manner may be
severely restricted and could have a material adverse effect on the Company, its
results of operations, financial condition and cash flows.
Due to the terrorist attacks on the World Trade Center on September 11, 2001,
the Company is aware that significant financial pressures have been placed on
insurance companies; however, the Company is not aware that either American
International Group, Inc. ("AIG") or Great American Insurance Company, which
insure most of the obligations under the other service contracts marketed and
administered by the Company, are under any such financial pressures. If, for any
reason, the insurance companies were not able to cover claims under the service
contracts marketed and administered by the Company due to financial insolvency
or other reasons, there could be a material adverse effect on the Company's
future business.
Letter of Understanding
The Letter of Understanding, which has been executed by Warrantech and its
insurer, provides for the payment of Reliance claims from a fund created for
that purpose. Warrantech Automotive made an initial interest-bearing loan of $1
million to establish the fund and thereafter the Company will make specified
contributions for each new service contract administered by Warrantech
Automotive. Under the proposed arrangement set forth in the Letter of
Understanding, the insurer will make loans available on an "as needed" basis in
the event the fund balance is inadequate to make the requisite claims payments.
In addition to providing financial support for the claims fund, the Letter of
Understanding provides for the insurer to extend a separate line of credit for
an amount up to $3 million to Warrantech, subject to certain adjustments, to
fund unanticipated working capital requirements. Interest will be paid on monies
made available for either purpose.
As part of the transaction proposed in the Letter of Understanding, the insurer
will be receiving options to purchase up to 1,650,000 shares of Warrantech's
common stock at a stock price of $2.00 per share subject to certain adjustments.
In the event that the insurer exercises all the options, it would own
approximately 10.8% of the Company's outstanding shares.
Although the terms described in the Letter of Understanding are non-binding and
subject to due diligence by the insurer and the execution of a definitive
agreement, the parties have agreed to implement and fund the plan immediately on
an interim basis, commencing on November 19, 2001, prior to the execution of a
definitive written agreement. During the quarter ended December 31, 2001, the
Company and its insurer established a claims payment fund. Approximately
$2,164,335 in claims has been paid during the quarter from the fund, under the
terms of the Letter of Understanding.
During the last quarter of fiscal year 2002, the Company plans to continue its
expansion into Canada to better service Warrantech's Canadian customer base and
increase the Company's Canadian market penetration for consumer products, home
and automotive service contracts and extended warranties.
Recent Developments - Other
During the final fiscal quarter, the Company signed a three-year agreement with
BoatU.S., the nation's largest recreational boating Association, to offer to its
530,000 member base the Warrantech Xchange Product Replacement Program. BoatU.S.
is the Company's first client in the boating industry and represents the third
new market Warrantech has penetrated during the last twelve months in addition
to motorcycles and golf carts.
The Company continues to improve customer service and technology with the
introduction in the final quarter of fiscal 2002 of its innovative web-based
platform from its Consumer Products Services segment. WCPS Online will provide
real-time capabilities that meet the needs of dealers, service providers and
consumers. It is designed to reduce paperwork and cut the time and costs of
administering warranties for dealers and service providers while providing a
better experience and faster service for their customers.
The Company also announced in the final fiscal 2002 quarter that an agreement
had been reached with Automotive Investment Group, to provide marketing services
for reinsurance programs for large automobile dealerships. The terms of the
contract call for Warrantech Automotive, to begin marketing a new reinsurance
program to the nation's larger automobile dealerships on January 1, 2002.
Financial Position
As of December 31, 2001, total cash and short-term investments totaled
$7,616,776, up from $3,198,078 at fiscal year end March 31, 2001. Cash generated
from operating activities increased from $1,131,231 for the nine months ended
December 31, 2000 to $5,792,059 for the nine months ended December 31, 2001. The
Company's primary sources of cash during the first nine months of fiscal year
2002 were cash provided by operating activities of $5,792,059 and proceeds from
the sales of marketable securities of $1,315,304. Increases in cash generated
from operating activities primarily resulted from advances to the fund from the
insurer as described in the Letter of Understanding.
Working capital at December 31, 2001 was negative $4,508,064, an increase from
negative $2,807,496 at March 31, 2001. The change in working capital primarily
resulted from advances made by the Company to the claims payment fund described
in the Letter of Understanding. The Company believes that internally generated
funds, resulting primarily from a continuation of reducing its average days
outstanding accounts receivable and the $3 million line of credit from the
insurer, will be sufficient to finance its current operations for at least the
16
next twelve months. The Company is aggressively pursuing new business both
domestically and internationally to fund future working capital. The Company
plans to continue to contain its SG&A costs and utilize technologies for
operational efficiencies to further enhance both its operating income and cash
flows from operating activities.
During the nine months ended December 31, 2001, the Company spent $1,179,920 for
property and equipment compared to $1,302,880 for the same period last year.
These expenditures primarily result from software development costs and computer
equipment, as the Company continues to invest to enhance its technologies, adapt
its systems for Spanish to improve customer service and to improve operational
efficiencies. The Company has ongoing relationships with equipment financing
companies and intends to continue financing certain future equipment needs
through lease/purchase transactions. The total amount financed through these
transactions during the nine months ended December 31, 2001 amounted to $443,232
compared to $399,195 during the nine months ended December 31, 2000. The Company
repaid $561,087 in notes and capital leases in the first nine months of fiscal
year 2002. Additionally, the Company used $1,748,362 to fund the account to be
used for payment of claims related to the Reliance liquidation.
The effects of inflation have not been significant to the Company. Management
does not expect inflation to have a significant impact on the results of
operations or financial condition in the foreseeable future.
17
PART II. Other Information
Item 1. Legal Proceedings
Litigation - The Company from time to time is involved in
litigation incidental to the conduct of its business. Reference
is made to Footnote 7 to the Financial Statements in this
Quarterly Report regarding information associated with legal
proceedings.
Item 2. Changes in Securities
Not applicable.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6 (a) Exhibits
10(u) Insurance policy between Warrantech Consumer Product
Services, Inc. and Warrantech Carribean LTD and Great
American Insurance Company pertaining to Service Plan
Agreement.
10(v) Schedule 10(v) identifying contracts that are substantially
similar to Exhibit 10(u), the Insurance policy between
Warrantech Consumer Product Services, Inc. and Warrantech
Carribean LTD and Great American Insurance Company
pertaining to Service Plan Agreement, in all material
respects except as to the parties thereto, the dates of
execution, or other details.
Item 6 (b) Reports on 8-K
On October 23, 2001, the Company filed a Current Report on Form
8-K. In this Current Report, the Company reported, under Item 5,
that one of its subsidiaries, Warrantech Automotive, Inc., was
informed by the Insurance Commissioner of the Commonwealth of
Pennsylvania that Reliance Insurance Company will be liquidated
and cease making payments on claims. See Item 2. Management's
Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Financial Resources in this Quarterly
Report.
18
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WARRANTECH CORPORATION
---------------------------------------------------------
(Registrant)
S/N/S Richard F. Gavino
---------------------------------------------------------
Richard F. Gavino - Executive Vice President, Chief
Financial Officer, Chief Accounting Officer and Treasurer
(Chief Financial Officer and Duly Authorized Officer)
Date: February 14, 2002
19
WARRANTECH CORPORATION AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit # Description
--------- -----------
10(u) Insurance policy between Warrantech Consumer
Product Services, Inc. and Warrantech Carribean
LTD and Great American Insurance Company
pertaining to Service Plan Agreement.
10(v) Schedule 10(v) identifying contracts that are
substantially similar to Exhibit 10(u), the
Insurance policy between Warrantech Consumer
Product Services, Inc. and Warrantech Carribean
LTD and Great American Insurance Company
pertaining to Service Plan Agreement, in all
material respects except as to the parties
thereto, the dates of execution, or other details.