Item #7: Management's Discussion and Analysis of Financial Condition and Results of Operations
On December 6, 1995, the Company, through a wholly owned subsidiary, acquired the operating assets of FALK Finance Company (FFC), a Norfolk, Virginia based specialized financial services company. As a result of this acquisition, the Company's primary business is to purchase non-prime automobile receivables from new and used automobile dealers. The Company services these dealers by providing specialized financing programs for buyers who typically have impaired credit histories and are unable to access traditional sources of available consumer credit.
The Company's principal revenue source is the net interest income, or net spread, earned on its automobile receivables. This net spread is the differential between interest income received on loans receivable and the interest expense on related loans payable. The following table summarizes the pertinent data on the Company's automobile receivables portfolio as of and for the year ended December 31, 1996 and the seven months ended December 31, 1995:
Interest revenue $11,167,000 $ 741,000 Interest expense 3,839,000 284,000 ----------- ----------- Net interest income $ 7,328,000 $ 457,000 ----------- -----------
(1) Net interest margin is net interest income divided by average loans outstanding.
(2) Average amounts are for the period from December 6, 1995 through December 31, 1995.
Operating expenses for the year ended December 31, 1996 of $6,913,000 were attributable to the Company's non-prime automobile financing business ($5.5 million), the long distance telephone service business ($.4 million) and corporate expenses ($1.0 million).
The acquisition of FFC in December 1995 included a portfolio of non-prime automobile receivables of approximately $31 million of which approximately 80% had been acquired by FFC from Charlie Falk's Auto Wholesalers, Incorporated (CFAW"). In addition to the tangible assets acquired, the Company entered into a Non-Compete Agreement and a 10 year Purchase Agreement with CFAW which, among other provisions, provided for the continued purchase of automobile receivables based upon established underwriting criteria at the sole discretion and option of the Company. During the year ended December 31, 1996, the quality of the automobile receivables acquired from CFAW, both prior to the acquisition date and subsequent thereto, as evidenced by the number of repossessions and the charge-off losses incurred, came into question. The Company determined to cease acquiring automobile receivables from CFAW and accordingly, effective December 31, 1996, the Company entered into a Modification and Termination Agreement with CFAW.
As a result of this action and other factors, the Company has deemed a significant portion of the goodwill associated with the acquisition of FFC as well as the Non-Compete and Purchase Agreements are of no
Revenues of $2,232,000 for the seven month period ended December 31, 1995 were derived from the non-prime auto finance business for the month of December ($772,000), the Company's long distance telephone services business ($440,000) and investment income ($1,020,000).
Depreciation and amortization expense for the seven month period ended December 31, 1995 was $85,000 and consisted primarily of the amortization of goodwill and other intangible assets associated with the acquisition of FFC in December 1995.
For the year ended May 31, 1995 the Company's revenues were derived from the sale of long distance telephone services ($1,030,000) and investment income ($568,000). Total revenues for the year ended May 31, 1995 were $1,599,000, a decrease of 23% or $477,000 compared with total revenues of $2,076,000 for the prior year. The Company's telephone reseller division experienced a decline in revenue of $771,000 due primarily to reduced network usage levels and volume rebates from A T & T ($200,000) received in the prior fiscal year in connection with the achievement of certain network usage levels. Investment income increased by $294,000 as a direct result of the investment of the proceeds in April 1995 from the sale of the assets of the Orion Network, Compass Network, Checkmate Computer Systems, and Insurance Parts Locator businesses.
Interest expense was $316,000, an increase of $185,000 over $131,000 for the prior year. This was directly related to the $4,000,000 subordinated notes issued by the Company in January 1994 and notes payable in connection with an acquisition in January 1994.
Operating expenses for the year ended May 31, 1995 decreased by 12% to $1,864,000 from $2,118,000 for the prior year. The decrease was primarily related to the reduction in direct costs associated with providing the Company's long distance telephone services and was directly related to the decline in revenues.
Depreciation and amortization expense for the year ended May 31, 1995 decreased by 25% to $25,000 from $34,000 for the prior year.
Loss from continuing operations before taxes for the year ended May 31, 1995 was $2,410,000 compared to $207,000 in the prior year, an increase of $2,203,000. This increase is attributable to the write-off of the Company's Preferred Stock investment in ComputerLogic, Inc. ($1,804,000) and the impact of the decline in revenue in the Company's Telephone Reseller Division.
The income tax benefit for the year ended May 31, 1995 was $332,000, or14% of the loss before income taxes compared to $64,000 or 31% in the prior year. The decrease in percentage was the result of the write-off of the company's Preferred Stock investment with no current tax benefit. The net loss from continuing operations was $2,078,000 for the year ended May 31, 1995 an increase of $1,935,000 as compared to $143,000 in the prior year.
Income from discontinued operations for the year ended May 31, 1995 was $1,519,000 as compared to $2,164,000 in the prior year, a decrease of $645,000. The income for fiscal year 1995 reflects the ten month period up to the date of sale. In addition, the decrease was caused by lower margins on the sale of computer systems ($200,000) and the impact of reduced revenues from the sale of automotive supplies ($60,000).
The gain on the sale of discontinued operations for the year ended May 31, 1995 relates solely to the sale of the operating assets of the Company's Orion Network, Compass Network, Checkmate Computer Systems and Insurance Parts Locator businesses on April 1, 1995 to ADP Claims Solutions Group, Inc. The gross proceeds of $30,350,000 in cash resulted in a gain of $8,886,000 after applicable taxes of $7,659,000.
Since its entry into the Non-Prime Automobile industry in December 1995, the Company has funded its operations with payments received from automobile receivables, borrowings under senior credit facilities and the issuance of asset backed secured notes.
The Company has outstanding $10.2 million of subordinated debt. Of this amount, $8.2 million of 12% notes was included with the liabilities assumed with the acquisition of Falk Finance Company, Inc. ("FFC") in December 1995 and $2.0 million of 7.55% notes issued by the Company in 1994.
The total amount of debt outstanding as of December 31, 1996 and 1995 was $60.4 million and $32.7 million, respectively. This following table presents the Company's debt instruments and weighted average interest rates on such instruments as of December 31, 1996 and 1995, respectively:
The Company's ability to continue to acquire automobile receivables as well as plan for future expansion is directly related to its ability to secure required capital. The Company has demonstrated the ability to secure warehouse lines of credit, issue receivable secured notes and obtain subordinated debt. The Company plans to continue to meet its capital needs through the cash flow generated from the payment of principal and interest on its outstanding automobile portfolio, the utilization of its senior credit facility, the issuance of receivable backed notes and the issuance of subordinated debt instruments. As of December 31, 1996, $81.9 million is available under the Company's senior credit facility. The Company believes that it has sufficient liquid assets and available lines of credit to meet its short and long-term capital requirements.
The response to this item is submitted as a separate section of this Report beginning on page.