TFC ENTERPRISES, INC.
1997 Annual Report
To Our Shareholders:
TFC Enterprises, Inc.'s mission in 1997 was to continue improving on the goals
established in 1996 and to rebuild the Company's volume of business. I am
pleased to report significant progress was accomplished during 1997. TFC
Enterprises, Inc., returned to profitability reporting a net income of $0.7
million, or $0.06 per share as compared to a net loss of $(7.6) million, or
$(0.67) per share in 1996, and a net loss of $(6.5) million or $(0.57) per share
in 1995.
Business volume at The Finance Company (TFC) during 1997 was $155.9 million
compared to $120.0 million during 1996, a 30% increase. Our decision to utilize
regional loan production offices was a primary reason for this increase in new
business acquired. Each of these five loan production offices located in
Killeen, Texas; San Diego, California; Jacksonville, Florida; and two in
Norfolk, Virginia, are managed by seasoned professionals who deserve recognition
for their accomplishments.
TFC's net contract receivables balance at December 31, 1997 represents a slight
decrease of $0.6 million from December 31, 1996. This compares with a decrease
in receivables during 1996 of $49.2 million. Receivables actually grew during
the fourth quarter of 1997 by $5.3 million. It is significant that receivables
generated during 1995 and prior years have liquidated to $20.6 million at
December 31, 1997, and represent only 12% of total receivables. By the end of
1998, receivables acquired prior to 1996 will be a small percentage of the total
outstanding.
During this period of growth, TFC's 60 day and over delinquency declined from
10.28% at year end 1996 to 9.28% at year end 1997. Also, net charged off of
loans declined from $40.1 million during 1996 to $27.5 million during 1997. This
improvement in large part was attributable to the Point-of-Sale Service Center
located in Norfolk, Virginia. Under the direction of our General Manager and an
excellent staff, the service center continued to show substantial improvement in
reducing delinquency and charge-off.
Another of our subsidiaries, First Community Finance, was a steady producer.
First Community Finance, which extends small direct consumer loans, grew its
volume from $13.2 million in 1996 to $16 million in 1997, a 21% increase, and
increased its net outstanding receivables from $8.8 million at year end 1996 to
$11.7 million at year end 1997, a 33% increase. The number of branch offices
increased from ten at year end 1996 to 15 at year end 1997. Sixty (60) day and
over delinquency ended 1997 at 3.14% as compared to 2.75% at year end 1996, a
slight increase.
Thinking back to early 1996 when I resumed the position of President and CEO, we
were faced with many challenges: inappropriate underwriting and inadequate
pricing resulted in more than a $30 million charge to equity to cover the
charge-off of loans made during late 1994 and throughout 1995; the Company's
servicing abilities were strained because of a serious delinquency problem;
operating expenses had grown to an all time high; and, the management team
needed to be re-evaluated to ensure the strongest possible team would be in
place to move the Company forward. Because of the experience and strength of the
new management team, the Company met these challenges.
All in all, 1997 proved to be a solid year in our rebuilding process. In
addition to all of the positive trends mentioned above, 1997 was a year where we
continued to see a number of our competitors experience problems. This has
resulted in many of these companies either suspending or curtailing their loan
acquisitions.
Our objectives for 1998 will be to maintain solid underwriting standards, while
showing patience in increasing our business volume, continue our efforts to
increase our yields through improved pricing, and further reduce delinquency and
charge-off. Additionally, we will attempt to improve our cost of funds, increase
our credit lines and increase our capital base to accommodate the growth
opportunities that will surely surface during 1998.
Your support in the past is greatly appreciated. We look forward to meeting the
opportunities of 1998 and beyond.
Robert S. Raley, Jr.
Chairman of the Board, President and
Chief Executive Officer
1
The Year in Review
TFC Enterprises, Inc., reported a net income of $0.7 million, or $0.06 per
common share, in 1997, compared to a net loss of $(7.6) million, or $(0.67) per
common share, in 1996, and net loss of $(6.5) million, or $(0.57) per common
share, in 1995.
TFC Enterprises, Inc., achieved success in a number of areas during 1997.
Highlights for 1997 included:
o The Company returned to profitability. The Company achieved these
results while absorbing the cost of opening six new offices, four of
which were in the fourth quarter.
o We purchased $171.9 million of contracts as compared to $133.2 million
in 1996.
o The performance of the entire contract portfolio through year end, with
charge-offs totaling 18.6% of gross contracts purchased compared to
22.3% for 1996 and 60-day delinquency rates at 8.9% compared to 9.9%
for 1996, indicates that our underwriting and collection performance
has returned to acceptable levels.
o In the Fourth Quarter, a Point-of-Sale Loan Production Office was
opened in Jacksonville, Florida. The office shares existing leased
space with the Jacksonville Portfolio Service Center. Loans purchased
by this office are serviced at our Point-of-Sale Service Center in
Norfolk, Virginia. Early results from this office are very favorable.
o In December, the Point-of-Sale Loan Production Office was re-located to
Killeen, Texas from Dallas, Texas. This re-location positioned the
office much closer to the largest concentration of military personnel
in the Southwest. This move immediately resulted in an increase in
business from the Killeen area with no reduction in business from the
other geographic areas that had been served from the Dallas office.
o Our consumer finance company, First Community Finance (FCF), completed
another successful year of continued expansion in Virginia and North
Carolina, growing from ten to 15 branches. FCF has proven that it can
originate high quality contracts while expanding rapidly, finishing
1997 with a 60-day delinquency rate of 3.1% and total charge-off during
the year representing 4.0% of average receivables. Additional expansion
of new branches in 1998 is being evaluated.
Additional areas of focus in 1998 will include:
o Controlling credit quality. The Company continues its centralized
control of the underwriting function under its chief lending officer,
who closely monitors the contract origination activity of all loan
production offices. This control is enhanced by utilization of TFC's
Automated Application Processing system, which permits on-line review
of all contract application processing from corporate headquarters in
Norfolk.
o Pricing strategy. In order to improve earnings the Company is
implementing a strategy to improve pricing. Given the decrease in
competition, management feels this will be achievable.
o Collections. To continue to improve collections, the Company will focus
on employee retention through better benefits, employee rewards
programs, and training. The Company will continue to aggressively
pursue recovery of charged-off accounts.
o Expansion. Additional TFC Loan Production Offices and FCF Branches are
being evaluated. Given the decrease in competition within our industry,
new offices are expected to generate increased volume levels while
maintaining credit quality.
o Improving liquidity and funding. With the Company's improved
performance in 1997, we are committed to evaluating alternative funding
sources to allow us to improve the interest margin. The Company is
currently evaluating capital sources, securitizations, participating
lenders, and subordinated debt.
2
FINANCIAL HIGHLIGHTS
(dollars in thousands, except
per share amounts)
- -----------------------------------------------------------------------------------------------------------------------
For the year 1997 1996 1995
Net income (loss) $ 707 $ (7,596) $ (6,461)
Net income (loss) per common basic/diluted share 0.06 (0.67) (0.57)
Average common and common equivalent
shares outstanding (in thousands) 11,290 11,290 11,283
- --------------------------------------------------------------- ---------------- ------------------ ------------------
Performance ratios:
Return on average common equity 2.30% NM NM
Return on average assets 0.47 NM NM
Yield on interest earning assets 21.30 21.51% 23.16%
Cost of interest bearing liabilities 10.85 9.54 8.61
Net interest margin 13.38 14.36 17.28
Operating expense as a percentage of
average interest earning assets (a) 13.17 12.83 10.62
Total net charge-offs to average
gross contract receivables
net of unearned interest 18.60 22.25 21.22
60 day delinquencies to period end
gross contract receivables 8.85 9.89 6.80
Total allowance and nonrefundable
reserve to period end gross contract
receivables net of unearned interest 14.70 17.88 19.66
Equity to assets, period end 21.02 18.83 16.92
- --------------------------------------------------------------- ---------------- ------------------ ------------------
Average balances:
Interest earning assets (b) $151,743 $188,239 $213,154
Total assets 148,932 186,040 205,509
Interest bearing liabilities 110,812 140,943 145,540
Equity 30,731 36,386 45,539
- --------------------------------------------------------------- ---------------- ------------------ ------------------
Note: Throughout this report, ratios are based on unrounded numbers and factors
contributing to changes between periods are noted in descending order of
materiality.
NM - Not meaningful.
(a) Excludes a $1.8 million charge for severance benefits and a $0.6 million
charge for restructuring in 1996.
(b) Average interest-bearing deposits and gross contract receivables, net of
unearned interest revenue and unearned discount.
3
The Five-Year Summary of Selected Financial Data should be reviewed in
conjunction with Management's Discussion and Analysis of Financial Condition and
Results of Operations and with the accompanying Consolidated Financial
Statements of TFC Enterprises, Inc., including notes thereto.
Five-Year Summary of Selected Financial Data
Years ended December 31
(in thousands) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Statement of Operations data:
Net interest revenue $20,298 $27,033 $36,825 $27,958 $19,401
Provision for credit losses 719 8,733 26,500 53 1,688
-------- -------- ------ -------- -------
Net interest revenue after provision
for credit losses 19,579 18,300 10,325 27,905 17,713
Other revenue 1,105 1,436 2,292 2,685 2,238
Operating expense:
Amortization of intangible assets 1,091 1,091 1,091 1,091 1,267
Contingent interest on convertible notes (a) - - - - 2,994
Contingent earnout payments (b) - - - - 1,645
Severance benefits - 1,804 - - -
Restructuring charge - 590 - - -
Other 18,886 23,055 21,551 17,389 13,315
------ ------ ------ ------ ------
Total operating expense 19,977 26,540 22,642 18,480 19,221
------ ------ ------ ------ ------
Income (loss) before income taxes 707 (6,804) (10,025) 12,110 730
Provision for (benefit from) income taxes - 792 (3,564) 4,879 2,472
----- -------- -------- ------- -------
Net income (loss) $ 707 $(7,596) $(6,461) $ 7,231 $(1,742)
======== ======== ======== ======= ========
4
Five-Year Summary of Selected Financial Data (continued)
Years ended December 31
(dollars in thousands, except per share) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
Net income (loss) per common share :
Basic $0.06 $(0.67) $(0.57) $0.64 NA
Diluted $0.06 $(0.67) (0.57) $0.64 NA
Pro forma net income (loss) per
common share: (c)
Primary (d) - - - - $(0.11)
Supplemental (e) - - - - 0.41
Balance Sheet data:
Net contract receivables $128,503 $126,252 $171,051 $139,176 $ 93,193
Total assets 147,833 156,508 215,146 166,552 126,396
Total debt 109,786 120,378 170,459 115,531 87,997
Shareholders' equity 31,080 29,862 36,404 42,845 28,459
(a) Contingent interest expense reflects the change in value of the put/call
option relating to the Company's 13.50% Subordinated Convertible Notes,
which were retired with the proceeds of the Company's initial public
offering. See Note 5 of the Notes to Consolidated Financial Statements.
(b) Contingent earnout payments reflect the amount of earnout payments in
excess of the amount that was accrued at May 1, 1990, when RSR Associates
acquired 100% of the common stock of TFC Enterprises, Inc.
(c) Pursuant to a Securities and Exchange Commission requirement, historical
earnings (loss) per share are not presented for periods prior to 1994,
other than on a pro forma basis, because of the lack of comparability
resulting from the significant withdrawals of capital, raised through the
initial public offering, to fund earnout payments and to purchase
contingent stock rights.
(d) Pro forma primary net income per common share for the year ended December
31, 1993, is calculated assuming the issuance, on January 1, 1993, of that
portion of the initial public offering sufficient to fund earnout payments
and to purchase contingent stock rights.
(e) Pro forma supplemental net income per common share for the year ended
December 31, 1993, is calculated assuming issuance, on January 1, 1993, of
the entire initial public offering, including the underwriter's
over-allotment of 675,000 shares.
NA - Not applicable.
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Cautionary statement under the "Safe-Harbor" provisions of the Private
Securities Litigation Reform Act of 1995: Included in this Report and other
written and oral information presented by management from time to time,
including but not limited to, reports to shareholders, quarterly shareholder
letters, filings with the Securities and Exchange Commission, news releases and
investor presentations, are forward-looking statements about business
strategies, market potential, potential for future point-of-sale and portfolio
purchases, future financial performance and other matters that reflect
management's expectations as of the date made. Without limiting the foregoing,
the word "believes," "anticipates," "plans," "expects,""seeks," and similar
expressions are intended to identify forward-looking statements. Future events
and the Company's actual results could differ materially from the results
reflected in these forward-looking statements. There are a number of important
factors that could cause the Company's actual results to differ materially from
those indicated by such forward-looking statements. These factors include,
without limitation: the Company's dependence on its line of credit, the
fluctuating interest rates associated with its line of credit and the impact of
installment contract defaults. Please refer to a discussion of these and other
factors in this Report and the Company's other Securities and Exchange
Commission filings. See "Risk Factors" below. The Company disclaims any intent
or obligation to update these forward-looking statements, whether as a result of
new information, future events or otherwise.
This section should be reviewed in conjunction with the Five-Year Summary
of Selected Financial Data and the accompanying Consolidated Financial
Statements of TFC Enterprises, Inc., including notes thereto.
General
TFC Enterprises, Inc. ("TFCE"or the "Company") conducts its consumer
finance operations through two wholly-owned subsidiaries, The Finance Company
("TFC") and First Community Finance, Inc. ("FCF"). Through TFC, the Company is
engaged in purchasing and servicing installment sales contracts originated by
automobile and motorcycle dealers in the sale of used automobiles, vans, light
trucks, and new and used motorcycles (collectively "vehicles"). The Company
focuses its business on installment sales contracts originated by dealers with
consumers who are either United States military enlisted personnel, primarily in
the E-1 through E-5 grades or, civilians with limited access to traditional
sources of consumer credit. Installment sales contracts with military personnel
are acquired primarily on an individual basis after the Company has reviewed and
approved the vehicle purchaser's credit application (a "point-of-sale
purchase"). Contracts with civilians are acquired primarily on a group basis
through purchase of a dealer's portfolio of existing installment sales contracts
(a "portfolio purchase"). To achieve an acceptable rate of return and provide
for credit risks, contracts are purchased from dealers at a discount to the
remaining principal balance. Most of the discount is held in a nonrefundable
reserve against which credit losses are first applied.
6
The Company has been engaged in consumer finance activities since its
founding in 1977. From 1991 through 1995, the Company increased contract
purchase volume significantly, from $67.1 million to $299.4 million,
representing a compound annual growth rate of 45%. Due to the significant credit
losses caused by 1995 volume's poor credit quality and inadequate pricing the
Company revised its business strategy in 1996 and purchase volume totaled $133.2
million. In 1997 contract volume increased to $171.9 million. Improvement in
delinquency and charge-off in 1997 support the conclusion that this growth was
achieved without sacrificing credit quality and price.
The Company's point-of-sale business emphasizes the purchase of installment
sales contracts relating primarily to vehicles purchased by United States
military enlisted personnel. Point-of-sale purchases provide the Company with
the ability to direct the credit underwriting process at the initiation of the
installment sales contract. Participating dealers benefit by having a source of
financing for a group of customers who typically find financing difficult to
obtain, thereby increasing the number of vehicles sold and improving dealer
profitability. The military personnel also benefit because the financing
provided by the Company enables them to purchase a vehicle that they otherwise
might not be able to buy. As of December 31, 1997, $111.3 million, or 60%, of
the Company's gross contract receivables represented point-of-sale purchases,
compared to $125.6 million, or 67%, at December 31, 1996.
During 1994 and 1995, to increase volume, the Company expanded its
point-of-sale operations into the civilian market. At that time, the Company
faced significant competition in this business line. To meet the competition,
the Company purchased a substantial number of contracts at prices that, in
hindsight, did not adequately reflect the credit risk of the obligor.
Compounding this problem was the significantly greater day-to-day servicing
requirements and risk of non-payment associated with civilian point-of-sale
contracts as compared to more traditional military point-of-sale contracts. When
the Company recognized the problems in late 1995, it took action to improve the
risk adjusted returns of the Company's portfolio by redirecting the Company
toward military point-of-sale and civilian portfolio business lines.
The Company's portfolio purchase business emphasizes acquisitions of
portfolios of seasoned installment sales contracts. These contracts normally
have a payment history of at least three months. While the typical portfolio
purchase involves less than 100 individual contracts, the Company has, at times,
purchased portfolios totaling more than 1,000 contracts. Portfolio purchases
provide the Company with demographic diversification, as the majority of
customers are not military enlisted personnel. They also provide a payment
history on which to evaluate and price the credit risk of the contracts and a
relatively efficient mechanism for establishing dealer relationships in new
areas. The Company's portfolio purchases benefit dealers by providing an
immediate source of liquidity, which in turn benefits the consumers who want to
purchase vehicles from these dealers. As of December 31, 1997, $60.0 million, or
33%, of the Company's portfolio of gross contract receivables was attributable
to portfolio purchases, compared to $51.8 million, or 28%, at December 31, 1996.
7
Through First Community Finance, Inc. the Company is involved in the direct
origination and servicing of consumer finance contracts. FCF began operations in
the first quarter of 1995 with the opening of two branch offices in Richmond,
Virginia. Four additional branches were opened in Virginia in 1995 and four
branches were opened in North Carolina in 1996. In 1997 one additional branch
was opened in Virginia and four branches were opened in North Carolina. The
Company is evaluating additional branch openings in 1998. Gross contract
receivables relating to FCF at December 31, 1997, were $12.9 million, or 7%, of
the Company's gross contract receivables portfolio, compared to $9.6 million, or
5%, at December 31, 1996.
Results of Operations
Net income (loss) and earnings (loss) per common share
The Company reported net income of $0.7 million, or $0.06 per common share,
in 1997, compared to a net loss of $(7.6) million, or $(0.67) per common share
in 1996, and a net loss of $(6.5) million, or $(0.57) per common share in 1995.
The Company's return to profitability was primarily the result of continuing
improvement in the performance of its contract receivables and a 24.7% reduction
in operating expenses resulting from the restructuring during 1996. The net loss
in 1996 was attributable to an $8.7 million provision for credit losses,
severance benefits of $1.8 million related to management downsizing, and
approximately $0.6 million of restructuring charges related to closing the
Company's Dallas service center. In addition, the net loss for 1996 was higher
than the 1995 net loss because of $0.8 million in tax expense recognized in 1996
compared to a tax benefit of $3.6 million recognized in 1995. (See the Provision
for income taxes section later in this "Results of Operations" discussion). The
reported loss in 1995 was attributable to a $26.5 million provision for credit
losses which resulted from a significant increase in delinquencies and credit
losses relating to the Company's Jacksonville and Dallas service centers. The
provision for credit losses and the credit quality of the Company's portfolio of
contract receivables are discussed more fully in the "Credit Quality and
Reserves" discussion.
Volume
Gross contracts purchased or originated in 1997 totaled $171.9 million,
compared to $133.2 million in 1996 and $299.4 million in 1995. The increase in
1997 volume compared to 1996 reflected growth in both the Company's
point-of-sale and portfolio business lines. Point-of-sale originations increased
$26.7 million reflecting the Company's increase in marketing efforts to the
military point-of-sale market. Portfolio purchases increased $9.1 million
reflecting a continued marketing emphasis in this business line. The decrease in
volume in 1996 compared to 1995 came as a result of tightened underwriting
standards and from discontinuation of substantially all civilian point-of-sale
business in 1996. Contract purchase volume relating to civilian point-of-sale
purchases was not significant in 1997 or 1996 as compared to 1995. The 1995
record volume, attributable to a $92.9 million increase in point-of-sale
purchases, primarily reflected growth in contract volume related to civilian,
rather than military obligors. As a result of the substantial losses incurred in
1995, as discussed above, management took action to improve the risk adjusted
8
returns of the Company's portfolio of contract receivables by redirecting the
Company toward military point-of-sale and civilian portfolio purchase business
lines. As a result, contract purchase volume in 1997 and 1996 was substantially
below the 1995 levels. Also contributing to the slower growth rate in 1996
contract purchase volume was the Company's liquidity and funding situation,
which is discussed more fully in Note 5 of the Notes to Consolidated Financial
Statements.
Gross contracts purchased or originated were as follows for 1997, 1996, and
1995:
Gross contract volume
1997 1996 1995
---- ---- ----
(dollars in thousands) Amount Percent Amount Percent Amount Percent
------ ------- ------ ------- ------ -------
Contracts purchased
or originated:
Auto finance:
Point-of-sale $ 85,311 49.7% $ 58,623 44.0% $231,877 77.4%
Portfolio 70,520 41.0 61,391 46.1 61,261 20.5
Consumer finance 16,023 9.3 13,174 9.9 6,257 2.1
------ --- ------ --- ----- ---
Total $171,854 100.0% $133,188 100.0% $299,395 100.0%
-------- ====== -------- ====== ======== ======
Number of contracts purchased or originated:
Auto finance:
Point-of-sale 7,411 25.9% 6,154 25.0% 24,095 58.2%
Portfolio 14,157 49.4 11,853 48.1 14,084 34.0
Consumer finance 7,093 24.7 6,623 26.9 3,254 7.8
----- ---- ----- ---- ----- ---
Total 28,661 100.0% 24,630 100.0% 41,433 100.0%
====== ====== ====== ====== ====== ======
At year end 1997, the Company was purchasing point-of-sale motor vehicle
finance contracts through four Loan Production Offices ("LPO's") located in
Norfolk, Virginia; Killeen, Texas; Jacksonville, Florida; and San Diego,
California. In December 1997 the Company moved the Dallas LPO to Killeen to be
closer to a higher concentration of military installations. In May 1998, the
Company intends to open an LPO in Tacoma, Washington. Portfolio purchases are
acquired through the portfolio purchase LPO located in Norfolk, Virginia.
In 1997, FCF originated $16.0 million in consumer finance contracts,
compared to $13.1 million in 1996. All consumer finance contract originations
are produced and serviced by 15 FCF offices located in Virginia and North
Carolina. FCF expanded by adding one new office in Virginia and four new offices
in North Carolina during 1997. Management believes there are significant growth
opportunities in this segment of the market and is evaluating the impact of
further FCF expansion in 1998.
9
Net interest revenue
Years ended December 31
(dollars in thousands) 1997 1996 1995
---- ---- ----
Average interest earning assets (a) $151,743 $188,239 $213,154
Average interest bearing liabilities 110,812 140,943 145,540
-------- -------- ---------
Net interest earning assets $ 40,931 $ 47,296 $ 67,614
========= ========= =========
Interest and other finance revenue $ 32,317 $ 40,484 $ 49,358
Interest expense 12,019 13,451 12,533
-------- -------- ---------
Net interest revenue $ 20,298 $ 27,033 $ 36,825
======== ======== =========
Yield on interest earning assets 21.30% 21.51% 23.16%
Cost of interest bearing liabilities 10.85 9.54 8.61
------ ------ ------
Net interest spread 10.45% 11.97% 14.55%
====== ====== ======
Net interest margin (b) 13.38% 14.36% 17.28%
====== ====== ======
(a) Average interest bearing deposits and gross contract receivables, net of
unearned interest revenue and unearned discount.
(b) Net interest margin is net interest revenue divided by average interest
earning assets.
Net interest revenue
Net interest revenue decreased to $20.3 million in 1997 compared to $27.0
million in 1996 and $36.8 million in 1995. The decrease in 1997 compared to 1996
and 1996 compared to 1995 was the result of the reduction in interest-earning
assets and a decrease in the net interest spread, as shown in the table above.
Average interest-earning assets decreased in 1997 and 1996 as a result of the
lower contract purchase volume in 1996 compared to 1995 and the high level of
contract charge-offs in 1996 related to 1995 volume. The net interest spread
decreased in 1997 compared to 1996 because of the increased cost of
interest-bearing liabilities caused by the amended financing agreements signed
in 1997 described in the "Liquidity and Capital Resources" section of this
discussion. The net interest spread decreased in 1996 compared to 1995 because
of reduced yield on interest-earning assets, caused by the Company's decision to
reduce its purchases of civilian point-of-sale contracts which generally yield a
higher return than military point-of-sale contracts, increased competition of
contract purchases and the lower rate earned on the Company's restricted cash
balances. The net interest spread also decreased because of increased cost of
interest-bearing liabilities, caused by the Company's forbearance arrangements
with lenders as described in the "Liquidity and Capital Resources" section of
this discussion.
10
Other revenue
Other revenue was $1.1 million in 1997, compared to $1.4 million in 1996
and $2.3 million in 1995. The decrease in 1997 compared to 1996 was caused by a
decrease in commission income on ancillary products as the result of lower sales
of warranty programs. The decrease in 1996 compared to 1995 was caused by a
decrease in commission on ancillary products as the result of reduced new
contract volume in 1996.
Operating expense
Operating expense was $20.0 million in 1997 compared to $26.5 million in
1995 and $22.6 million in 1995. The decrease of $4.1 million in 1997, excluding
the 1996 charge for severance benefits and restructuring, compared to 1996 was
attributable to a decrease in salaries of $2.2 million due to the reduction in
the number of employees after the aforementioned restructuring and a decrease of
$1.3 million in repossession expense. The increase of $3.9 million in 1996 over
1995 was caused by severance benefits of $1.8 million paid in 1996, $1.5 million
additional repossession and collection expenses in 1996, restructuring charges
of $0.6 million in 1996, and $0.7 million of higher expenses resulting from the
expansion of FCF. In connection with the termination of the employment
agreements with four senior officers with the Company during 1996, notes
receivable from these individuals in the amount of $0.4 million were forgiven
and are reported as a component of severance benefits.
Effective September 30, 1996, the Company restructured its senior
management as part of its plan to reduce operating expenses. The restructuring
involved the termination of the employment agreements of four key executives in
exchange for approximately $1.8 million in combined cash payments of $1.4
million and cancellation of certain notes receivable from these executives in
the amount of $0.4 million. The notes receivable were related to 1995 profit
sharing amounts owed to the Company.
The Company closed its Dallas service center and relocated its corporate
finance and accounting office from Manassas to Norfolk, Virginia; in November
1996, as part of its plan to reduce operating expenses. Receivables serviced
from the Dallas service center were moved to the Company's Norfolk, Virginia,
and Jacksonville, Florida, service centers. The Norfolk service center is
responsible for servicing all point-of-sale contracts. The Jacksonville service
center is responsible for servicing all portfolio purchase contracts. The total
cost of restructuring the operations of the service centers and the finance and
accounting office was approximately $0.6 million.
Operating expense as a percentage of average interest-earning assets
increased to 13.17% in 1997 compared to 12.83% in 1996 excluding severance
benefits and restructuring charges and 10.62% in 1995. The increase in the
operating expense ratio in 1997 resulted from the decrease in average
interest-earning assets which is attributable to the decrease in net contract
receivables. The increase in the operating expense ratio in 1996 resulted from
the increase in operating expenses described above and the decrease in net
contract receivables in 1996 compared to 1995.
11
Provision for income taxes
The Company recorded no income tax provision in 1997, compared to a tax
provision of $0.8 million in 1996 and a tax benefit of $3.6 million in 1995. No
income tax expense was provided for 1997 due to the reversal of a portion of a
deferred tax valuation allowance recorded at year-end 1996. The tax expense in
1996 provided on a pre-tax loss of $6.8 million was caused primarily by the fact
that no tax benefit could be recognized on most of the $8.7 million provision
for credit losses recorded in 1996 pending the reporting of sufficient future
profits by the Company. The tax benefit of $3.6 million in 1995 was attributable
to a significantly higher level of provision for credit losses in 1995, while
the Company's cumulative profitability still was sufficient to permit
recognition of the tax benefit.
At December 31, 1997, recoverable taxes totaled $1.2 million, which
represented the benefit of state net operating loss carrybacks available to the
Company as a result of a tax-basis loss in 1996. At December 31, 1996,
recoverable income taxes totaled $5.8 million, which represented the benefit of
net operating loss carrybacks available to the Company as the result of a
tax-basis loss incurred in 1996. At December 31, 1995, recoverable income taxes
totaled $6.0 million, which primarily included the Company's 1995 federal
quarterly estimated tax payments of $3.5 million and the $2.4 million benefit of
net operating loss carrybacks available to the Company as a result of the
tax-basis loss incurred in 1995. In early 1996, the Company filed a request with
the Internal Revenue Service for an accelerated refund of its $3.5 million in
1995 estimated tax payments. These estimated tax payments were received in the
first quarter of 1996. Most of the refund balance due from the 1995 net
operating loss carryback was received in the second quarter of 1997. Proceeds
from these tax refunds were used to reduce the Company's indebtedness.
In 1993, contingent interest on the Company's convertible notes was treated
as non-deductible for Federal income tax purposes. To the extent that the
contingent interest on convertible notes is ultimately determined to be
deductible for Federal income tax purposes, the benefit, which totals $2.1
million, will be recognized in the period that the determination is made.
Other matters
Until recently computer programs were written to store only two digits of
date-related information in order to more efficiently handle and store data.
Thus the programs were unable to properly distinguish between the year 1900 and
the year 2000. Utilizing both internal and external resources, the Company is in
the process of defining, assessing and converting, or replacing, various
programs and hardware systems to make them Year 2000 compatible. The Company's
Year 2000 project is comprised of business applications which consist of the
Company's computer systems, as well as the computer systems purchased from
third-party suppliers. It is estimated that the cost of addressing the year 2000
problem and making the Company's computer systems year 2000 compliant will not
be material.
12
Financial Condition
Assets
Total assets decreased by $10.8 million, or 7%, to $147.8 million at
December 31, 1997, from $158.6 million at December 31, 1996. The decrease was
due primarily to the reduction in restricted cash and recoverable income taxes.
Net contract receivables
Net contract receivables were $128.5 million, or 87% of total assets at
December 31, 1997, compared to $126.3 million, or 80% of total assets at
December 31, 1996. The increase in auto finance receivables in 1997 was
attributable to portfolio purchases, resulting from increased management
emphasis on this line of business. Consumer finance volume also increased in
1997 due to a 27% increase in volume from the four offices opened in 1996 and
the five offices opened in 1997.
Net contract receivables
December 31,
(dollars in thousands) 1997 1996
---- ----
Auto finance:
Point-of-sale $ 75,197 $ 80,725
Portfolio 41,612 36,711
Consumer finance 11,694 8,816
------ ------
Total $128,503 $126,252
======== ========
Liabilities
Total liabilities were $116.8 million at December 31, 1997, a decrease of
$11.9 million, or 9%, from $128.7 million at December 31, 1996. The decrease in
liabilities in 1997 was primarily attributable to the repayment of the Company's
Automobile Receivables-Backed notes and term notes offset partially by the
increase in the revolving line of credit as described in the "Liquidity and
Capital Resources" section of this discussion. As a percentage of total
liabilities and equity, liabilities represented 79% and 81%, respectively, at
December 31, 1997 and 1996.
13
Credit Quality and Reserves
Net charge-offs of auto finance contract receivables
Net charge-offs to the allowance for credit losses and nonrefundable
reserve were $27.5 million in 1997, or 19.7% of average net contract
receivables, compared to $40.1 million, or 23.0%, in 1996, and $45.5 million, or
21.2% in 1995. The relatively high level of net charge-offs in 1996 and 1995, as
compared to 1997, was primarily attributable to higher net charge-offs relating
to receivables purchased in 1995 in the Jacksonville and Dallas service centers.
The dramatic rise in delinquencies and resultant charge-offs in 1995
reflected in part the aggressive competition among buyers of installment sales
contracts that resulted in a substantial number of contracts, especially
civilian point-of-sale installment sales contracts, being purchased at prices
that, in hindsight, did not adequately reflect the credit risk of the obligor.
In response to this competition, management redirected the Company toward the
military point-of-sale and civilian portfolio purchase business lines. These
programs are focused on sectors of the market in which management believes the
pricing more closely reflects the risk inherent in the business.
Also among the factors contributing to the increase in charge-offs of
contracts purchased in 1995 was the difficulty in servicing the substantially
higher volume of installment sales contracts, specifically civilian
point-of-sale contracts which involve more risk than military point-of-sale
contracts. During 1994 and 1995, the composition of the Company's portfolio of
contract receivables shifted from predominantly military point-of-sale contracts
to civilian point-of-sale contracts. The day-to-day servicing requirements and
risks of non-payment associated with civilian point-of-sale contracts are
significantly greater than the Company's more traditional military point-of-sale
contracts. As a result of the Company's dramatic growth during 1994 and 1995,
the civilian point-of-sale contracts were not adequately serviced by the
Company's personnel. Management took action to improve the servicing of the
Company's portfolio of contract receivables. These actions included expanding
the number of Collection Department personnel assigned to troubled credits,
tripling the automatic dialing capacity of the Company through investment in two
new automatic dialers, increasing senior management involvement in the credit
decision process, closing the Southwest Regional Service Center in Dallas in
order to consolidate all servicing in the Point-of-Sale and Portfolio Service
Centers, located in Norfolk and Jacksonville, respectively, and temporarily
transferring the underwriting function of the Southern region to the Norfolk LPO
(subsequently moved to the new Jacksonville LPO). The latter action improved the
Company's control over the underwriting process by reducing the number of
locations at which contracts are purchased and increased focus on the collection
process. Unfortunately the disruptions associated with the consolidation of
servicing in late 1996 led to an increase in delinquencies and charge-offs
during the fourth quarter of 1996 and early 1997, which, in turn, combined with
the other factors mentioned in this report, caused the Company to provide an
additional $6 million reserve for credit losses as of year-end 1996.
14
An additional factor which contributed to the increase in net charge-offs
on the 1995 contract portfolio was a modest tightening of the Company's
charge-off guidelines. Prior to the change in charge-off guidelines, credits on
which no payments had been received for 120 days were generally charged off when
they became 180 days contractually past due. In the second half of 1995, the
payment recency guideline was reduced from 120 days to 90 days.
Provision for credit losses on auto finance contract receivables
The Company's primary business involves purchasing installment sales
contracts at a discount to the remaining principal balance. An amount ranging
from 80 percent to 100 percent of the discount, based on experience, is held in
a nonrefundable reserve against which credit losses are first applied.
Additional provisions for credit losses, if necessary, are charged to income in
amounts considered by management to be adequate to absorb future credit losses
on the outstanding contract receivables. Improved credit quality and servicing
of the Company's auto finance contracts eliminated the need for an additional
loss provision on auto finance receivables in 1997 compared to $8.4 million in
1996 and $26.3 million in 1995. The higher provision for credit losses in 1995,
compared with 1996 and 1997, resulted from the dramatically higher level of
delinquencies and charge-offs experienced primarily on contracts purchased in
1995. The $8.4 million provision for credit losses in 1996 resulted from a $6
million provision for credit losses at year-end 1996 primarily related to
contracts purchased in 1995 that was caused by the increased fourth quarter
delinquencies and charge-offs resulting from service disruptions due to the
closing of the Southwest Regional Service Center and relocation of the servicing
of those contracts.
Provision for credit losses is dependent on a number of factors, including,
but not limited to, the level and trend of delinquencies and net charge-offs,
the amount of nonrefundable and refundable dealer reserves and the overall
economic conditions in the markets in which the Company operates. Due to the
inherent uncertainty involved in predicting the future performance of these
factors, there can be no assurance regarding the future level of provision for
credit losses.
Reserves on auto finance contract receivables
At December 31, 1997, the combination of allowance for credit losses and
nonrefundable reserve totaled $22.3 million, or 15.5%, of gross auto finance
contract receivables, net of unearned interest revenue compared to $28.2
million, or 18.7% at December 31, 1996. The decrease in reserves and in the
percentage of reserves to contract receivables in 1997 compared to 1996 is the
result of the improved credit quality and servicing. The decrease in reserves
and in the percentage of reserves to contract receivables in 1996 compared to
1995 is the result of the decrease in contract receivables outstanding in 1996
compared to 1995 and to the improved credit quality of the contracts purchased
in 1996 compared to 1995.
The Company's refundable dealer reserve decreased to $2.0 million at
December 31, 1997, compared with $2.2 million at December 31, 1996. Under
certain of the Company's programs,
15
contracts from dealers are purchased under a refundable, rather than
nonrefundable reserve relationship. Under certain circumstances, the Company may
have to remit some or all of the refundable reserve back to the dealer. No such
liability exists under a nonrefundable reserve relationship. Accordingly, the
refundable reserve is carried as a liability on the Company's Consolidated
Balance Sheet and is not included in the calculation of the Company's reserve
ratio.
Consumer finance charge-offs and reserves
Net charge-offs of consumer finance contracts totaled $0.4 million or 4.00%
in 1997 compared to $0.2 million or 7.45% in 1996. The provision for credit
losses was $0.7 million in 1997 compared to $0.3 million in 1996, and the
allowance for credit losses was $0.7 million or 5.31% of outstanding gross
contract receivables at December 31, 1997, compared to $0.4 million or 4.04% of
contract receivables at December 31, 1996. Management has established the level
of the allowance that it considers to be adequate based on FCF's experience
through December 31, 1997.
16
Allowance and reserves for contract receivables
Years ended December 31
(dollars in thousands) 1997 1996 1995
---- ---- ----
Beginning of period $ 28,575 $ 43,482 $ 29,840
Provision for credit losses 719 8,733 26,500
Charge-offs (32,556) (46,916) (48,360)
Allocation for credit losses 21,635 16,620 32,672
Recoveries 4,656 6,656 2,830
------ ------ -------
End of period $23,029 $28,575 $43,482
======= ======= =======
Average net contract receivables (a) $149,982 $180,950 $214,528
End of period net contract receivables (a) $156,693 $159,833 $221,161
Total net charge-offs as a percent of average
net contract receivables 18.60% 22.25% 21.22%
====== ====== ======
Allowance and nonrefundable reserve as a percent
of net contract receivables (period end) 14.70% 17.88% 19.66%
====== ====== ======
(a) Gross contract receivables, net of unearned interest revenue.
Net charge-offs by line of business for 1997, 1996, and 1995 were as follows:
Years ended December 31
(in thousands) 1997 1996 1995
---- ---- ----
Auto finance:
Point-of-sale $19,192 $34,064 $35,247
Portfolio 8,283 6,034 10,280
Consumer finance 425 162 3
------- ------- -------
Total $27,900 $40,260 $45,530
------- ------- -------
17
Delinquencies
Gross auto finance contract receivables that were 60 days or more past due
totaled $15.9 million, or 9.28% of gross auto finance contract receivables at
December 31, 1997, compared to $18.2 million, or 10.28%, at December 31, 1996.
This improvement in delinquency was the result of improved underwriting and
increased collection efforts.
Gross consumer finance receivables that were 60 days or more past due
totaled $0.4 million, or 3.1% of gross receivables at December 31, 1997,
compared to $0.3 million, or 2.8% at December 31, 1996.
Consistent with standard industry practice, the Company measures
delinquency at each month end by classifying a contract that is unpaid for two
monthly payments as 30 days delinquent and a contract that is unpaid for three
monthly payments as 60 days delinquent.
Delinquency
Years ended December 31
(dollars in thousands) 1997 1996 1995
---- ---- ----
Gross contract receivables
60 days and over delinquent $ 16,310 $ 18,495 $ 18,441
Gross contract receivables 184,242 187,033 271,039
Percent 8.85% 9.89% 6.80%
Liquidity and Capital Resources
Liquidity management
As shown on the Consolidated Statements of Cash Flows, cash and cash
equivalents decreased by $0.7 million in 1997, to $2.0 million at December 31,
1997. The decrease reflected $4.8 million of net cash used in financing
activities and $3.3 million in net cash used in investing activities, partially
offset by $7.4 million of net cash provided by operating activities. Net cash
used for financing activities reflected a $15.8 million repayment on borrowings
on automobile receivables-backed notes, $19.5 million repayment on term notes,
and $1.3 million in repayments of other debt, offset in part by $26.3 million in
net borrowings under the Company's revolving line of credit facility and a
decrease in restricted cash of $5.5 million. Net cash used by investing
activities reflected the net cost of acquiring contract receivables in excess of
the repayments received on contract receivables.
18
Net cash used for financing activities totaled $44.8 million in 1996
principally reflecting a $31.4 million repayment on borrowings on automobile
receivables-backed notes, $30.5 million repayment on term notes, and $1.3
million in repayments of other debt, offset in part by $13.5 million in net
borrowings under the Company's revolving line of credit facility. Net cash
provided by financing activities totaled $44.4 million in 1995, principally
reflecting $47.2 million increase in net borrowings on automobile
receivables-backed notes, $25.0 million in borrowings on a term note, and $7.9
million in net borrowings on other debt, offset in part by $25.3 million in net
payments under the Company's revolving line of credit facility.
The Company has subordinated debt principal payments due in June and October
1998 of $2,000,000 and $1,287,000, respectively. The Company intends to fund
these payments through cash flow from operations. These payments do however
impact the availability under the Company's primary line of credit and could
limit the Company's ability to grow its portfolio of contract receivables. With
the improved performance in 1997, the Company is committed to evaluating
alternative funding sources to increase liquidity and improve the interest
margin. The Company is currently evaluating capital resources, securitizations
participating lenders, and additional subordinated debt.
The Company's current financial condition, caused by net operating losses
in 1995 and 1996, reduces the Company's degree of access to the credit and
capital markets for new financing in the future compared to the past. Reduced
access to those markets for new financing could have a material adverse effect
on the Company's funds availability and could limit the Company's ability to
grow its portfolio of contract receivables. This, in turn, could have a material
adverse effect on the Company's operating performance in the future.
Agreements with lenders
As a result of the reported loss of $(6.5) million in 1995 and increases in
delinquencies and credit losses, the Company was in technical default under its
revolving line of credit, term note and subordinated note agreements at December
31, 1995 and throughout 1996. To resolve the situation, the Company reached
agreement with its lenders in 1996 to forbear in the exercise of their rights
and remedies relating to the technical defaults through December 31, 1996.
The new revolving line of credit agreement with its primary lender signed
in December 1996, was amended in April 1997 to correct out-of-compliance
conditions that arose as of December 31, 1996, primarily as a result of the
provision for credit losses recorded in the fourth quarter. This amended
agreement also provided for the consolidation of substantially all of the
Company's debt under its term notes into the revolving line of credit.
Pursuant to the amended revolving line of credit agreement dated April
1997, the Company's primary lender has agreed to provide a credit line of $110
million through January 1, 1999, at 30-day LIBOR plus 4.00% and total line fees
of $0.5 million for 1997 and $0.4 million for 1998. The new terms and conditions
of this agreement included less restrictive financial covenants, as well as
several additional operational and reporting requirements. In addition, the
agreement reflects a reduction in the primary advance rate available under the
facility from 80% to 76%. The agreement also grants GECC warrants to purchase a
cumulative total of approximately 1.1 million shares of the Company's common
stock at $1 per share over a 5-year period. Pursuant to its rights under the
Amended and Restated Registration Rights Agreement, GECC has demanded that the
Company register the common stock underlying their warrants. The Company intends
to file this registration statement with the SEC in April 1998.
The Company also signed an amended credit agreement relating to its
subordinated notes. The new credit agreements cured the technical defaults that
existed during 1996, but also increased the Company's funding costs by
approximately 10 basis points for 1997 compared to
19
1996. The forbearance agreements executed with the Company's lenders in 1996 had
also increased funding costs by approximately 100 basis points for 1997 and 1996
compared to 1995. A complete discussion of the Company's outstanding debt is
included in Note 5 of the Notes to Consolidated Financial Statements.
On January 31, 1998, the covenant requirement related to the 60 day delinquency
calculated on a six month rolling average dropped from 14% to 13.5%. The Company
exceeded this amount by .38%. In February 1998, the revolving line of credit
agreement with the primary lender was amended. The amendment increased the
requirement to 14.5% and reduced the primary advance rate under the facility
from 76% to 73%.
Dividends
The Company did not declare dividends on its common stock during the years
ended December 31, 1997, 1996 and 1995, nor does it anticipate paying cash
dividends in the foreseeable future. If and when the Company decides to declare
cash dividends, the amount would be limited by certain provisions of the
Company's various credit agreements.
Risk Factors
In evaluating the Company, prospective investors should consider carefully
all of the information set forth throughout this Report and, in particular,
should evaluate the following risk factors.
Fluctuating Interest Rates and Dependence on Line of Credit
The Company's operations require substantial borrowing to provide funding
for the installment contracts purchased by TFC and originated by FCF.
Consequently, profitability is impacted by the difference between the rate of
interest paid on the funds it borrows and the rate of interest charged on the
installment contracts, which rate in some states is limited by law. Currently,
the principal source of borrowing by the Company is its revolving line of
credit, guaranteed by TFCEI (the "Line of Credit") with General Electric Capital
Corporation ("G.E. Capital"). The maximum amount of borrowings available under
the Line of Credit was $110 million at December 31, 1997. At December 31, 1997,
TFC had $90 million outstanding under the Line of Credit. The floating interest
rate for borrowings under the Line of Credit is equal to the average 30-day
London Interbank Offered Rate ("LIBOR") plus 4.00%. Thus, future increases in
interest rates could adversely affect the Company's profitability. In an effort
to reduce its exposure to an increase in interest rates, TFC has purchased an
interest rate cap which ensures that the interest rate on $75 million of the
borrowings under the Line of Credit will not exceed a LIBOR ceiling of 6.5%.
This interest rate cap expires September 30, 1998. In addition to the purchase
of interest rate caps, the Company believes it has certain flexibility to
increase the discount at which installment contracts are purchased, or to
increase the rate of interest charged
20
on future installment contracts (to the extent not limited by state law), in
order to offset the adverse impact of any interest rate increase on
profitability.
The Finance Company has maintained a Line of Credit with G.E. Capital since
1992. The current Line of Credit was executed in December 1996, amended in April
1997, and expires January 1, 1999. There is no assurance that a new Line of
Credit will be executed when the current Line of Credit expires. If the new Line
of Credit is not executed, TFC would be required to seek alternative financing
sources and repay its outstanding balance on or before the expiration of the
current Line of Credit on January 1, 1999. No assurance can be given that
alternative financing sources would be available in such event. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Liquidity and Capital Resource."
Defaults on Installment Contracts
The Company is engaged primarily in purchasing installment contracts
entered into by dealers with consumers who have limited access to traditional
sources of consumer credit. The inability of an individual to finance a used
automobile purchase by means of traditional credit sources is generally due to
such individual's past credit history or insufficient cash to make the required
down payment on an automobile. As a result, installment contracts purchased by
the Company are generally with purchases of automobiles who are considered to
have a higher risk of default on an installment contract than certain other
automobile purchasers. Accordingly, the consumer loan activities engaged in by
the Company typically have a higher risk of loss than those of other consumer
financings. While the Company believes that its expertise in used automobile
financing, particularly for enlisted military personnel, enables it to evaluate
and price accurately the higher risk associated with the Company's business, a
significant economic downturn in the markets in which the Company operates could
materially increase the number of charged-off and delinquent installment
contracts experienced by TFC as compared to its historical losses. If TFC were
to experience a material increase in charge-offs or delinquencies, its
profitability could be adversely affected. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Credit Losses and
Delinquency."
Dependence Upon Key Executive
The Company's growth and development to date have been largely dependent
upon the services of Robert S. Raley, Jr., Chairman of the Board, President and
Chief Executive Officer. The loss of Mr. Raley's services could have a material
adverse effect on the Company.
21
Competition
There are numerous providers of financing for the purchase of used
automobiles either through the direct financing of such purchases or on an
indirect basis through a dealer. Those financing sources include commercial
banks, savings and loan associations, consumer finance companies, credit unions,
financing divisions of automobile manufacturers or automobile retailers, small
sales contract companies and other consumer lenders. Many of those providers of
automobile financing have significantly greater financial resources than TFC and
have relationships with established dealer networks. The Company has focused on
a segment of the market composed of consumers who typically do not meet the more
stringent credit requirements of the traditional consumer financing sources and
whose needs, as a result, have not been addressed consistently by such financing
sources. If, however, the other providers of consumer finance were to assert a
significantly greater effort to penetrate TFC's targeted market segment, TFC
could be materially and adversely affected.
Regulation
The Company's business is subject to regulation and licensing under various
federal, state and local statutes and regulations. The Company's business
operations are conducted in approximately 30 states and, accordingly, the laws
and regulations of such states govern the Company's operations conducted in
those states. Most states where the Company operates limit the interest rate,
fees and other charges that may be imposed by, or prescribe certain other terms
of, the contracts that the Company purchases and define the Company's rights to
repossess and sell collateral. In addition, the Company is required to be, and
is, licensed to conduct its operations in certain states. As the Company expands
its operations into other states, it will be required to comply with the laws of
such states.
An adverse change in those laws or regulations could have a material
adverse effect on the Company's profitability by, among other things, limiting
the states in which the Company may operate or the interest rate that may be
charged on installment contracts or restricting the Company's ability to realize
the value of any collateral securing contracts. The Company is not aware of any
materially adverse legislation currently pending in any jurisdiction where it
currently transacts business.
Restrictions on the Payment of Dividends
The Company currently intends to retain its earnings to finance the growth
and development of its business and, therefore, does not anticipate paying any
cash dividends in the foreseeable future. Any future dividend payments will
depend upon the financial condition, funding requirements and earnings of TFC as
well as other factors that the Company's Board of Directors may deem relevant.
As the Company is a legal entity separate and distinct from TFC and as its
revenues depend on the payment of dividends by TFC, limitations on the ability
of TFC to pay dividends to the Company will in turn limit the ability of the
Company to pay dividends to its
22
stockholders. There are certain restrictions on the payment of dividends in the
form of various affirmative and negative covenants included in the TFC's Line of
Credit and the Note Purchase Agreement relating to the Subordinated
NonConvertible Notes due October 15, 1998 and the Note Purchase agreement
relating to the Senior Subordinated Notes due June 30, 2002.
Effect of Certain Charter, Bylaw and Statutory Provisions
Certain provisions of the Company's Amended and Restated Certificate of
Incorporation (the "Certificate of Incorporation") and Amended and Restated
Bylaws (the "Bylaws") could delay or frustrate the removal of incumbent
directors and could make more difficult a merger, tender offer or proxy contest
involving the Company, even if such events could be beneficial, in the short
term, to the interest of the stockholders. For example, the Certificate of
Incorporation provides for a classified Board of Directors and for certain
limitations on the calling of a special meeting of stockholders and the Bylaws
require advance notice of stockholder proposals and nominations of directors.
The Company also is subject to provisions of Delaware corporation law that
prohibit a publicly-held Delaware corporation from engaging in a broad range of
business combinations with a person who, together with affiliates and
associates, owns 15% or more of the corporation's common stock (an "interested
stockholder") for three years after the person became an interested stockholder,
unless the business combination is approved in a prescribed manner. Those
provisions could discourage or make more difficult a merger, tender, offer or
similar transaction, even if favorable to the Company's stockholders.
Authorized Preferred and Common Stock
Pursuant to the Certificate of Incorporation, shares of preferred stock and
Common Stock may be issued in the future without further stockholder approval
and upon such terms and conditions, and having such rights, privileges and
preferences, as the Board of Directors may determine. The rights of the holders
of Common Stock will be subject to, and may be adversely affected by, any
preferred stock that may be issued in the future. The issuance of preferred
stock, while providing desirable flexibility in connection with possible
acquisitions and other corporation transactions, could have the effect of making
it more difficult for a third party to acquire, or effectively preventing a
third party from acquiring, a majority of the outstanding voting stock of the
Company. The Company has no present plans to issue any shares of preferred
stock.
New Accounting Standards
Statement of Financial Accounting Standards No. 128 (FAS No. 128),
"Earnings per Share," replaced the calculation of primary and fully diluted
earning per share. Unlike primary earnings per share, basic earnings per share
is based only on the weighted average number of common shares outstanding,
excluding any dilutive effects of options and convertible securities. Diluted
earnings per share is similar to the previously reported fully diluted earnings
per share and is based
23
on the weighted average number of common and common equivalent shares, including
dilutive stock options and convertible securities outstanding during the year.
Earnings per share for all periods have been restated. FAS No. 128 was adopted
in the 4th quarter of 1997.
Statement of Financial Accounting Standards (FAS No. 130), "Reporting
Comprehensive Income," establishes standards for reporting and display of
comprehensive income, its components and accumulated balances. Comprehensive
income is defined to include all changes in equity except those resulting from
investments by owners and distributions to owners. Among other disclosures, FAS
No. 130 requires that all items that are required to be recognized under current
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements.
Statement of Financial Accounting Standards (FAS No. 131), "Disclosure
about Segments of a Business Enterprise," establishes standards for the way that
public enterprises report information about operating segments in annual
financial statements and requires reporting of selected information about
operating segments in interim financial statements issued to the public. It also
establishes standards for disclosures regarding products and services,
geographic areas and major customers. FAS No. 131 defines operating segments as
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and in assessing performance.
FAS No. 130 and FAS No. 131 are effective for financial statements for
periods beginning after December 15, 1997 and require comparative information
for earlier years to be restated. Management does not anticipate the application
of FAS No. 130 and FAS No. 131 to have a significant impact on financial
disclosures.
Common Shares and Shareholder Information
The common stock of TFC Enterprises, Inc., began trading on the NASDAQ
Stock Market under the symbol TFCE on December 23, 1993, and is designated a
National Market Security. At December 31, 1997, there were approximately 2,194
registered and beneficial owners of the security. Share price information for
the years ended December 31, 1997 and 1996 is presented in the Selected
quarterly data table on the next page.
24
Selected quarterly data *
1997
-----------------------------------------------------
(dollars in thousands, except Dec. Sept. June March
per share amounts) 31 31 30 31
Statements of operations:
Net interest revenue $ 5,153 $4,789 $5,108 $5,248
Provision for credit losses 253 214 160 92
Other revenue 293 218 318 276
Operating expense 5,311 4,863 4,850 4,953
------ ----- ----- -----
Income (loss) before
income taxes ( 118) (70) 416 479
Provision for (benefit
income taxes
from) income taxes -- -- (283) 283
----- ----- ----- ---
income taxes
Net income (loss) $ ( 118) $ (70) $ 699 $196
======= ===== ===== ====
Net income (loss) per basic
diluted common share $(0. 01) $(0.01) $0.06 $0.02
------------ ------------- ------------ ----------------
Performance ratios:
Return on average equity NM NM 9.12% 2.62%
Return on average assets NM NM 1.87 0.51
Yield on interest earning
assets 21.62% 21.11% 21.73 21.05
Cost of interest bearing
liabilities 11.05 11.25 10.99 10.28
Net interest margin 13.70 13.01 13.63 13.35
Operating expense as a
percentage of average
interest earning assets 14.12 13.21 12.95 12.60
Total net charge-offs to
average gross contract
receivables net of
unearned interest 16.99 16.19 19.98 21.15
60 day delinquencies to
period end gross
contract receivables 8.85 8.66 8.13 9.01
Total allowance and
nonrefundable reserve to
period end gross contract
receivables net of
unearned interest 14.70 15.17 15.66 16.60
Equity to assets, period end 21.02 21.94 21.03 19.76
- ------------------------------- ------------ ------------- ------------ ----------------
Average balances:
Interest earning assets $150,480 $147,261 $149,857 $157,236
Total assets 145,395 145,002 149,380 155,144
Interest bearing liabilities 107,839 106,001 110,350 117,777
Equity 31,143 31,277 30,641 29,944
- ------------------------------- ------------ ------------- ------------ ----------------
Common stock data:
Market price range:
High $2.00 $2.06 $2.00 $2.13
Low 0.66 1.00 1.13 1.13
Average 1.34 1.48 1.54 1.56
Close 0.94 1.34 1.38 1.31
- ------------------------------- ------------ ------------- ------------ ----------------
NM - Not meaningful.
* Unaudited.
Selected quarterly data *
1996
-----------------------------------------------------
(dollars in thousands, except Dec. Sept. June March
per share amounts) 31 31 30 31
Statements of operations:
Net interest revenue $ 5,766 $6,270 $6,840 $8,157
Provision for credit losses 6,103 130 1,500 1,000
Other revenue 53 375 454 554
Operating expense 6,023 8,069 6,162 6,286
----- ----- ----- -----
Income (loss) before
income taxes (6,307) (1,554) (368) 1,425
Provision for (benefit
income taxes
from) income taxes 749 (638) (4) 685
---- ----- ---- ---
income taxes
Net income (loss) $ (7,056) $(916) $(364) $740
======== ====== ====== ====
Net income (loss) per basic
diluted common share $ (0.63) $(0.08) $(0.03) $0.07
------------ ------------ ------------- ------------
Performance ratios:
Return on average equity NM NM NM 8.02%
Return on average assets NM NM NM 1.43
Yield on interest earning
assets 20.84% 21.45% 21.56% 22.23
Cost of interest bearing
liabilities 9.58 9.68 9.60 9.48
Net interest margin 13.69 14.24 14.41 15.09
Operating expense as a
percentage of average
interest earning assets 12.44 14.53 12.98 11.63
Total net charge-offs to
average gross contract
receivables net of
unearned interest 21.36 19.11 25.81 22.66
60 day delinquencies to
period end gross
contract receivables 9.89 7.94 7.74 9.14
Total allowance and
nonrefundable reserve to
period end gross contract
receivables net of
unearned interest 17.88 15.71 17.02 18.53
Equity to assets, period end 18.83 21.14 20.61 18.95
- ------------------------------- ------------ ------------ ------------- ------------
Average balances:
Interest earning assets $168,430 $176,097 $189,828 $216,214
Total assets 168,133 177,027 187,993 209,622
Interest bearing liabilities 125,737 131,723 141,410 162,700
Equity 34,735 36,909 37,250 36,930
- ------------------------------- ------------ ------------ ------------- ------------
Common stock data:
Market price range:
High $2.75 $2.47 $4.00 $6.13
Low 0.75 1.00 1.63 1.63
Average 1.52 1.80 2.59 3.36
Close 1.63 1.50 2.38 3.93
- ------------------------------- ------------ ------------ ------------- ------------
NM - Not meaningful.
* Unaudited.
25
TFC Enterprises, Inc. Report of Management
Shareholders
TFC Enterprises, Inc.
The management of TFC Enterprises, Inc. is responsible for the preparation,
content, integrity, and objectivity of the following financial statements. These
financial statements have been prepared in accordance with generally accepted
accounting principles.
Management is further responsible for maintaining a system of internal controls
designed to provide reasonable assurance as to the protection of the Company's
assets and the integrity of its financial statements. This company-wide system
of controls includes written policies and procedures, proper delegation of
authority, division of responsibility, and the selection and training of
qualified personnel. Management believes that the system of internal controls
provides reasonable assurance that financial transactions are recorded properly
to permit the preparation of reliable financial statements.
The Audit Committee of the Board of Directors is comprised of three outside
directors and has the responsibility along with the Shareholders for the
selection of the independent auditors. The Audit committee meets with management
and the independent auditors to review the scope of audits and their results,
and to discuss other matters affecting the Company's internal controls and
financial reporting. The independent auditors have free access to the Audit
Committee.
Robert S. Raley, Jr. Craig D. Poppen
Chairman, President and Vice President, Treasurer and
Chief Executive Officer Chief Financial Officer
26
Report of Ernst & Young LLP, Independent Auditors
Board of Directors
TFC Enterprises, Inc.
We have audited the accompanying consolidated balance sheets of TFC Enterprises,
Inc. as of December 31, 1997 and 1996, and the related consolidated statements
of operations, changes in shareholders' equity, and cash flows for each of the
three years in the period ended December 31, 1997. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of TFC Enterprises,
Inc. at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Washington, D.C.
February 12, 1998
27
CONSOLIDATED BALANCE SHEETS
December 31
(dollars in thousands) 1997 1996
---- ----
Assets
Cash and cash equivalents $ 1,975 $ 2,688
Restricted cash - 5,532
Net contract receivables 128,503 126,252
Recoverable income taxes 1,229 5,831
Property and equipment, net 2,297 2,823
Intangible assets, net 12,070 13,161
Deferred income taxes 188 188
Other assets 1,571 2,108
----- -----
Total assets $147,833 $158,583
-------- --------
Liabilities and shareholders' equity
Liabilities:
Revolving lines of credit $ 98,572 $ 72,562
Term notes - 19,464
Automobile receivables-backed notes - 15,843
Subordinated notes 11,214 12,509
Accounts payable and accrued expenses 2,841 3,960
Income taxes 2,075 2,075
Refundable dealer reserve 1,987 2,208
Other liabilities 64 100
-- ---
Total liabilities 116,753 128,721
Shareholders' equity:
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none outstanding - -
Common stock, $.01 par value, 40,000,000 shares
authorized; 11,290,308 shares issued and outstanding in
1997 and 1996 49 49
Additional paid-in capital 55,844 55,333
Retained deficit (24,813) (25,520)
-------- --------
Total shareholders' equity 31,080 29,862
------ ------
Total liabilities and shareholders' equity $147,833 $158,583
-------- --------
See accompanying Notes to Consolidated Financial Statements.
28
CONSOLIDATED STATEMENTS OF OPERATIONS
<caption
Years ended December 31
(in thousands, except per share amounts) 1997 1996 1995
---- ---- ----
Interest and other finance revenue $32,317 $40,484 $49,358
Interest expense 12,019 13,451 12,533
------ ------ ------
Net interest revenue 20,298 27,033 36,825
Provision for credit losses 719 8,733 26,500
--- ----- ------
Net interest revenue after provision
for credit losses 19,579 18,300 10,325
Other revenue:
Commissions on ancillary products 780 1,341 2,124
Other 325 95 168
--- -- ---
Total other revenue 1,105 1,436 2,292
Operating expense:
Salaries 9,866 12,107 12,073
Employee benefits 1,511 1,957 2,007
Occupancy 896 1,053 712
Equipment 1,253 1,379 1,117
Amortization of intangible assets 1,091 1,091 1,091
Severance benefits - 1,804 -
Restructuring charge - 590 -
Other 5,360 6,559 5,642
----- ----- -----
Total operating expense 19,977 26,540 22,642
------ ------ ------
Income (loss) before income taxes 707 (6,804) (10,025)
Provision for (benefit from) income taxes - 792 (3,564)
- --- -------
Net income (loss) $ 707 $(7,596) $(6,461)
======== ======== ========
Net income (loss) per common share:
Basic $ 0.06 $ (0.67) $ (0.57)
========== =========== ===========
Diluted $ 0.06 $ (0.67) $ (0.57)
========== =========== ===========
See accompanying Notes to Consolidated Financial Statements.
29
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Number of Additional Retained
(in thousands) Shares Common Paid-in Earnings
Outstanding Stock Capital (Deficit) Total
BALANCE AT DECEMBER 31, 1994 11,281 49 54,259 (11,463) 42,845
Net loss - - - (6,461) (6,461)
Stock options exercised 3 - 20 - 20
------ ----- ------- -------- -------
BALANCE AT DECEMBER 31, 1995 11,284 49 54,279 (17,924) 36,404
Net loss (7,596) (7,596)
Issuance of stock warrants - - 423 - 423
Stock options exercised 6 - 12 - 12
Deferred compensation termination,
net of taxes of $348,000 - - 619 - 619
------ ----- ------- -------- -------
Balance at December 31, 1997 11,290 $ 49 $55,333 $(25,520) $29,862
Net income - - - 707 707
Issuance of stock warrants - - 511 - 511
------ ----- ------- -------- -------
BALANCE AT DECEMBER 31, 1997 11,290 $ 49 $55,844 $(24,813) $31,080
====== ======== ======= ========= =======
See accompanying Notes to Consolidated Financial Statements.
30
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31
(in thousands) 1997 1996 1995
------ ------ ------
Operating activities
Net income (loss) $ 707 $ (7,596) $ (6,461)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Amortization of intangible assets 1,091 1,091 1,091
Depreciation and other amortization 1,053 1,431 1,273
(Benefit from) provision for deferred
income taxes - 6,375 (2,055)
Provision for credit losses 719 8,733 26,500
(Gain) loss on disposal of assets 3 28 (7)
Changes in operating assets and liabilities:
Decrease (increase) in recoverable income
taxes 4,602 148 (3,807)
Decrease (increase) in other assets 582 1,834 (2,709)
(Decrease) increase in accounts payable and
accrued liabilities (1,119) (186) 699
Decrease in income taxes payable - - (1,968)
(Decrease) increase in refundable dealer
reserve (221) (1,042) 1,046
(Decrease) increase in other liabilities (36) 179 331
------ ------ ------
Net cash provided by operating activities 7,381 10,995 13,933
Investing activities
Net cost of acquiring contract receivables (104,342) (86,711) (153,732)
Repayment of contract receivables 101,372 122,777 95,357
Purchase of property and equipment (367) (1,639) (1,161)
Proceeds on disposal of assets 25 - 7
----------- ------------ ----------
Net cash provided by (used in) investing
activities (3,312) 34,427 (59,529)
See accompanying Notes to Consolidated Financial Statements.
31
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Years ended December 31
(in thousands) 1997 1996 1995
- --- ---------- ---- ---- ----
Financing activities
Net (payments) borrowings on the
revolving lines of credit 26,280 13,510 (25,317)
Borrowings on term notes - - 25,000
Payments on term notes (19,464) (30,536) -
Borrowings on automobile
receivables - backed notes - - 49,087
Payments on automobile
receivables - backed notes (15,843) (31,408) (1,835)
Borrowings on subordinated notes - - 10,111
Payments on subordinated notes (1,287) (1,287) (2,251)
Decrease (increase) in restricted cash 5,532 4,865 (10,397)
Proceeds from stock options exercised - 12 20
Net cash (used in) provided by financing (4,782) (44,844) 44,418
------- -------- ------
Increase (decrease) in cash and cash equivalents (713) 578 (1,178)
Cash and cash equivalents at beginning of year 2,688 2,110 3,288
------ ------ ------
Cash and cash equivalents at end of year $1,975 $2,688 $2,110
====== ====== ======
Supplemental disclosures:
Interest paid $ 11,315 $12,438 $11,724
Income taxes paid - - 4,274
Noncash transactions:
Issuance of stock warrants $ 511 $ 423 -
Deferred compensation terminated
and transferred to paid-in capital - 619 -
See accompanying Notes to Consolidated Financial Statements.
32
Notes to Consolidated Financial Statements
1. Summary of significant accounting policies
Organization and business
TFC Enterprises Inc. ("TFCE") is a holding company that owns two primary
subsidiaries, The Finance Company ("TFC") and First Community Finance, Inc.
("FCF"). TFCE has no significant operations of its own. TFC specializes in
purchasing and servicing installment sales contracts originated by automobile
and motorcycle dealers in the sale of used automobiles, vans, light trucks, and
new and used motorcycles (collectively "vehicles") both on an individual basis
("point-of-sale" purchase) and on a portfolio basis ("portfolio" purchase).
Based in Norfolk, Virginia, TFC also has offices in Killeen, Texas;
Jacksonville, Florida; San Diego, California and expects to open an office in
Tacoma, Washington in May 1998. FCF is involved in the direct origination and
servicing of small consumer loans. FCF operates 15 branches throughout Virginia
and North Carolina.
Principles of consolidation
The accompanying financial statements include the accounts of TFCE and its
wholly-owned subsidiaries, TFC and FCF (collectively, the "Company"). All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Cash and cash equivalents
Cash and cash equivalents are defined as cash and overnight repurchase
agreements, exclusive of restricted cash.
Income recognition
Interest revenue from precomputed contract receivables, simple
interest-bearing contract receivables and revenue from insurance commissions are
recognized using the interest method.
The portion of the discount arising from purchases of contract receivables
which is not considered to be nonrefundable reserve for credit losses (see
discussion below) is recorded as a dealer discount. Dealer discounts are
deferred and accreted to income using the interest method over the contractual
life of the related receivables.
Accrual of interest revenue and accretion of dealer discounts continue
until contracts are collected in full, become ninety days contractually
delinquent, or are charged off (see discussion below) consistent with practices
generally applied by consumer finance companies.
33
Notes to Consolidated Financial Statements (continued)
1. Summary of significant accounting policies (continued)
Credit losses
The Company's primary business involves purchasing installment sales
contracts at a discount to the remaining principal balance on both a portfolio
and point-of-sale basis. A portion of this discount represents anticipated
credit loss and, based upon projected loss experience, is held in a
nonrefundable reserve against which future credit losses will first be applied.
The remaining portion, if any, of the discount is recorded as dealer discount as
discussed above. Additional provisions for credit losses, if necessary, are
charged to income in amounts sufficient to maintain the combined allowance for
credit losses and nonrefundable reserve at an amount considered by management to
be adequate to absorb estimated future credit losses.
It is generally the Company's policy to charge its nonrefundable reserve
and then the allowance for credit losses for all contract receivables which are
both 180 days past due and which have had no significant payment activity for 90
days. Any amounts collected subsequent to being charged off are restored to the
allowance for credit losses. In 1995, the Company revised its charge-off policy
to the aforementioned guidelines. Prior to the change in charge-off guidelines,
credits on which no payments had been received for 120 days were generally
charged-off when they became 180 days contractually past due.
The carrying value of repossessed assets is reduced, through charge-off, to
the lower of the unpaid contract balance or anticipated liquidation proceeds,
regardless of delinquency status.
The Company's policy related to unsecured consumer contracts originated by
FCF is to charge its allowance for credit losses for all consumer finance
receivables which are 180 days past due. Any amounts collected subsequent to
being charged off are restored to the allowance for credit losses.
Property and equipment
Property and equipment are recorded at cost, less accumulated depreciation.
Depreciation expense is computed using the straight-line method over each
asset's estimated useful life, generally five to seven years.
Intangible assets
Intangible assets consist of a purchased dealer list and goodwill, which
are being amortized using the straight-line method over periods of 15 years and
20 years, respectively. The carrying value of goodwill is reviewed on an ongoing
basis. If this review indicates that goodwill will not be fully recoverable, as
determined based on estimated undiscounted cash flows of the Company
34
Notes to Consolidated Financial Statements (continued)
1. Summary of significant accounting policies (continued)
over the remaining life of the goodwill, its carrying value will be reduced to
the recoverable amount.
Income taxes
The Company uses the liability method to account for income taxes. Under
the liability method, deferred tax assets and liabilities are determined based
on differences between the financial statement carrying amounts and the tax
basis of assets and liabilities (i.e., temporary differences) and are measured
at the enacted rates that will be in effect when these differences reverse.
Earnings per share
In 1997, the Financial Accounting Standards Board issued Statement No. 128,
"Earnings per Share." The overall objective of Statement No. 128 is to simplify
the calculation of earnings per share. Unlike primary earnings per share, basic
earnings per share is based only on the weighted average number of common shares
outstanding, excluding any dilutive effects of options and convertible
securities. Diluted earnings per share is similar to the previously reported
fully diluted earnings per share and is based on the weighted average number of
common and common equivalent shares, including dilutive stock options and
convertible securities outstanding during the year. Earnings per share for all
periods have been restated.
Interest rate protection agreements
The Company purchased an interest-rate cap agreement that is designed to
limit its exposure to increasing interest rates and is designated as a hedge of
its revolving line of credit. An interest rate cap entitles the Company to
receive a payment from the counterparty equal to the excess, if any, of the
hypothetical interest expense (strike price) on a specified notional amount at a
current market interest rate over an amount specified in the agreement. The only
amount the Company is obligated to pay to the counterparty is an initial
premium. The strike price of these agreements exceeds the current market levels
at the time they are entered into. The interest rate indices specified by the
cap agreement has been and is expected to be highly correlated with the interest
rates that Company incurs on its revolving line of credit. Payments to be
received as a result of the specified interest rate index exceeding the strike
price are accrued in other assets and are recognized as a reduction of interest
expense. The cost of the agreement is included in other assets and amortized to
interest expense ratably during the life of the agreement.
Use of estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts
35
Notes to Consolidated Financial Statements (continued)
1. Summary of significant accounting policies (continued)
reported in the financial statements and accompanying notes. Actual results
could differ from those estimates.
Reclassifications
Certain reclassifications have been made to the 1996 and 1995 financial
statements in order to conform with the 1997 presentation.
2. Contract receivables
The following is a summary of contract receivables at December 31:
(in thousands) 1997 1996
---- ----
Contract receivables:
Auto finance $171,356 $177,388
Consumer finance 12,886 9,645
------ -----
Gross contract receivables 184,242 187,033
Less:
Unearned interest revenue 27,549 27,200
Unearned discount 729 504
Unearned commissions 672 1,132
Unearned service fees 629 324
Payments in process 2,617 2,560
Escrow for pending acquisitions 514 486
Allowance for credit losses 684 11,730
Nonrefundable reserve 22,345 16,845
------ ------
Net contract receivables $128,503 $126,252
======== ========
The effective rate of interest earned on contract receivables was 21.60%,
22.23%, and 23.21% for the years ended December 31, 1997, 1996, and 1995,
respectively.
At December 31, 1997, contractual maturities of contract receivables were
as follows:
(in thousands)
1998 $ 89,579
1999 52,772
2000 28,537
2001 9,259
2002 4,095
-------
Gross contract receivables $ 184,242
---------
Notes to Consolidated Financial Statements (continued)
2. Contract receivables (continued)
It has been the Company's experience that a substantial portion of the
portfolio generally is prepaid before contractual maturity dates. The above
tabulation, therefore, should not be regarded as a forecast of future cash
collections.
Changes in the allowance for credit losses and nonrefundable reserve were
as follows:
(in thousands)
1997 1996 1995
---- ---- ----
Beginning Balance $ 28,575 $43,482 $ 9,840
Allocation for credit losses 21,635 16,620 32,672
Provision for credit losses 719 8,733 26,500
Charge-offs (32,556) (46,916) (48,360)
Recoveries 4,656 6,656 2,830
-------- ---------- -------
Ending Balance $ 23,029 $28,575 $43,482
======== ========== =======
3. Property and equipment
The following is a summary of property and equipment at December 31:
(in thousands) 1997 1996
---- ----
Leasehold improvements $ 209 $ 185
Computer equipment and software 3,543 3,685
Furniture and office equipment 2,028 2,105
Automobiles 143 158
------ ------
Property and equipment 5,923 6,133
Less: accumulated depreciation and amortization 3,626 3,310
------ ------
Property and equipment, net $2,297 $2,823
====== ======
Depreciation and amortization of property and equipment for the years ended
December 31, 1997, 1996, and 1995, were $0.9 million, $0.7 million, and $0.6
million, respectively.
36
Notes to Consolidated Financial Statements (continued)
Note 4. Intangible assets
The following is a summary of intangible assets at December 31:
(in thousands) 1997 1996
----- ----
Goodwill $16,265 $16,265
Dealer list 4,172 4,172
Less: accumulated amortization (8,367) (7,276)
------- -------
Intangible assets, net $12,070 $13,161
======= =======
5. Debt
Debt outstanding at December 31 consisted of the following:
(in thousands) 1997 1996
---- ----
Revolving line of credit (a) $ 98,572 $ 72,562
Term Notes:
7.92% term note - 6,964
7.56% term note - 12,500
6.14% automobile receivables-backed notes - 15,843
Subordinated Notes:
Senior subordinated notes, due annually 1998 to 2002 10,000 10,000
Subordinated non-convertible notes due
1994 with final payment due 1998 (b) 1,214 2,509
to 1998, net of discount(b)
-------- --------
Total debt $109,786 $120,378
======== ========
(a) The revolving line of credit is net of unamortized discount totaling $0.7
million and $0.4 million at December 31, 1997 and 1996, respectively.
(b) The subordinated non-convertible notes are net of unamortized discount
totaling $0.1 million at December 31, 1997 and 1996.
Agreements with lenders
As a result of the reported loss of $(6.5) million in 1995 and increases in
delinquencies and credit losses, the Company was in technical default under its
revolving line of credit, term note and subordinated note agreements at December
31, 1995 and throughout 1996. To resolve the
37
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
situation, the Company reached agreement with its lenders in 1996 to forbear in
the exercise of their rights and remedies relating to the technical defaults
through December 31, 1996.
The new revolving line of credit agreement with its primary lender signed
in December 1996, was amended in April 1997 to correct out-of-compliance
conditions that arose as of December 31, 1996, primarily as a result of the
provision for credit losses recorded in the fourth quarter. This amended
agreement also provided for the consolidation of substantially all of the
Company's debt under its term notes into the revolving line of credit.
Pursuant to the amended revolving line of credit agreement dated April
1997, the Company's primary lender has agreed to provide a credit line of $110
million through January 1, 1999, at 30-day LIBOR plus 4.00% and total line
fees of $0.5 million for 1997 and $0.4 million for 1998. The new terms and
conditions of this agreement include less restrictive financial covenants, as
well as several additional operational and reporting requirements. In addition,
the agreement reflects a reduction in the primary advance rate available under
the facility from 80% to 76%. The agreement also grants GECC warrants to
purchase a cumulative total of approximately 1.1 million shares of the Company's
common stock at $1 per share over a 5-year period.
The Company also signed an amended credit agreement relating to its
subordinated notes. The new credit agreements cured the technical defaults that
existed during 1996, but also increased the Company's funding costs by
approximately 10 basis points for 1997 compared to 1996. The forbearance
agreements executed with the Company's lenders in 1996 had also increased
funding costs by approximately 100 basis points for 1997 and 1996 compared to
1995.
On January 31, 1998, the covenant requirement related to the 60 day
delinquency calculated on a six month rolling average decreased from a maximum
of 14% to 13.5%. As of January 31, 1998, the Company's six month rolling average
60 day delinquency percentage was 13.88%, which exceeded the covenant
requirement. In February 1998, the revolving line of credit agreement was
amended. The amendment increased the maximum allowable delinquency percentage to
14.5% and 14.0% for the periods through June 1998 and December 1998,
respectively, and reduced the primary advance rate under the facility from 76%
to 73%.
Revolving lines of credit
In 1995, the Company's revolving line of credit facility with its primary
lender was increased from $120.0 million to $150.0 million and the contractual
term of the facility was extended through December 1996. As indicated above, the
Company signed a new loan and security agreement in December 1996, that extended
the term of the facility through December 1998,
38
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
and then signed an amended agreement in April 1997, to correct out-of-compliance
conditions that arose as of December 31, 1996. The revolving line of credit is
secured by certain contract receivables of TFC and is guaranteed by TFC. On a
daily basis, TFC remits all cash receipts relating to those receivables to the
lender. These daily cash receipts are first applied to accrued interest on the
revolving line of credit and the remainder to principal. Borrowings under the
revolving line of credit, totaled $73.0 million and $59.5 million at December
31, 1997 and 1996, respectively. The advance rate used to determine availibility
on this line is limited to a percentage of eligible collateral as specified in
this amended decreased from 80% to 76% during 1997. Unused availability under
this facility totaled $6.0 million and $11.4 million at December 31, 1997 and
1996, respectively, based on collateral in existence at that time.
Interest on the revolving line of credit is paid at a floating rate
equivalent to 30-day LIBOR plus a borrowing spread.
The borrowing spread on the Company's revolving line of credit was as
follows for the years ended December 31, 1997, 1996, and 1995:
Borrowing
Spread
-------
January 1, 1995 to September 30, 1995 1.45%
October 1, 1995 to December 31, 1995 2.25
January 1, 1996 to January 31, 1996 3.00
February 1, 1996 to December 31, 1997 4.00
For the period January 1, 1995 through September 30, 1995, the borrowing
spread was temporarily reduced to 1.45% in conjunction with negotiations with
the Company's primary lender regarding a new credit facility. These negotiations
with the Company's primary lender were terminated in June 1995. Consequently,
the borrowing spread increased as noted above.
On January 1, 1996, the borrowing spread returned to 3.00%, the level in
effect prior to the initiation of the negotiations. The borrowing spread was
increased to 4.00% effective February 1, 1996, as a result of the forbearance
agreement executed in March 1996, and continued at that rate under the new
contract and security agreement signed in December 1996 and amended in April
1997.
39
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
The average outstanding balance on the revolving line of credit totaled
$82.8 million, $60.7 million, and $98.3 million, respectively, in 1997, 1996,
and 1995. The average interest rate paid on the revolving line of credit was
9.63% in 1997, 9.23% in 1996, and 7.63% in 1995. At December 31, 1997, 1996, and
1995, respectively, one-month LIBOR was 5.71%, 5.40%, and 5.83% and the total
interest rate was 9.71%, 9.40%, and 8.08%. At December 31, 1997 the used line of
credit totaled $89.8 million.
In March 1997, the Company signed a $15 million line of credit with another
lender. At December 31, 1997, the used line of credit totaled $9.5 million. The
average outstanding balance on the revolving line of credit totaled $8.2
million. The average interest paid on the revolving line of credit was 9.50% in
1997.
7.92% Term Note
In August 1995, TFC issued a $12.5 million two-year term note. Borrowings
under the facility totaled $7.0 million and $12.5 million at December 31, 1996
and 1995, respectively. As part of the forbearance agreement relating to this
note, the interest rate on this note was increased to 9.08% effective January 1,
1996. The debt due under this note was consolidated into the revolving line of
credit in April 1997.
7.56% Term Note
In September 1995, TFC issued a $12.5 million two-year term note.
Borrowings under the facility totaled $12.5 million at December 31, 1996 and
1995. As part of the forbearance agreement relating to this note, the interest
rate on this note was increased to 8.72% effective January 1, 1996. The debt due
under this note was consolidated into the revolving line of credit in April
1997.
6.14% Automobile Receivables-Backed Notes
On December 7, 1995, TFC completed a debt financing consisting of $49.1
million of 6.14% Automobile Receivables-Backed Notes, Series 1995-A. The notes
were issued through TFC's wholly-owned bankruptcy remote receivables subsidiary,
TFC Receivables Corporation ("TRC"), and are rated "Aaa" by Moody's Investors
Service, Inc. and "AAA" by Standard & Poor's Ratings Services. The notes were
collateralized by the assets of TRC. Principal and interest payments under the
notes were guaranteed pursuant to a financial guaranty insurance policy issued
by Financial Security Assurance, Inc. In 1996, approximately $4.1 million of the
notes were prepaid. In August 1997, the notes were redeemed in whole. The
pay-out consisted of the restricted cash balance as of this date as well as an
additional $1.0 million advance from the revolving line of credit.
40
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
Senior Subordinated Notes, due 2002
In June 1995, the Company issued $10.0 million of 9.38% Senior Subordinated
Notes due June 30, 2002. Interest on the Senior Subordinated Notes is payable
semi-annually. The notes may be prepaid subject to a "make-whole " prepayment
penalty. Beginning in June 1998, annual principal payments of $2 million are due
with the final payment due June 2002. As part of the forbearance agreement
relating to this note, the interest rate on this note was increased to 10.38%
effective February 1, 1996. Under the terms of an amendment to the notes signed
in April 1997, the interest rate was increased to 10.48% effective April 1,
1997, and the holder agreed to waive the technical defaults and adjust various
financial and operational covenants.
Subordinated Non-Convertible Notes, due 1998
In conjunction with the financing of the purchase of the Company by Chicago
Holdings, Inc. on October 27, 1988, the Company issued 13.50% Subordinated
Non-Convertible Notes in the amount of $6.4 million and 13.50% Subordinated
Convertible Notes with an original principal amount of $65,000. The final
principal payment of $1.3 million is due October 1998. The 13.50% Subordinated
Non-Convertible Notes may be prepaid subject to a "make-whole" prepayment
penalty. As part of the forbearance agreement relating to this note, the
interest rate on this note was increased to 14.50% effective February 1, 1996.
Under the terms of an amendment to the notes signed in April 1997, the interest
rate was increased to 14.60% effective April 1, 1997, and the holder agreed to
waive the technical defaults and adjust various financial and operational
covenants.
The 13.50% Subordinated Convertible Notes allowed conversion into 20% of
the common stock of TFC, subject to certain antidilutive provisions, and
included a put/call option. The put/call option price was computed as 20% of the
greater of two times the net worth of TFC or six times TFC's operating profit,
as defined. The liability for the put/call option price was periodically
adjusted to reflect its current value with the changes charged to expense as
contingent interest on convertible notes. The holders exercised their put option
on October 18, 1993, and on December 31, 1993, the Company paid $5.5 million
received from the proceeds of the Company's initial public offering to discharge
this liability.
The Company originally recorded the fair market value of the put/call
option, which was $682,000, as debt discount. This discount was amortized, as an
adjustment to interest expense, over the term of the Subordinated
Non-Convertible Notes, resulting in an effective yield
41
Notes to Consolidated Financial Statements (continued)
5. Debt (continued)
of 16.56%. The remaining unamortized discount related to these Notes, which
totaled $0.1 million at December 31, 1995, was amortized during 1996. During
1997, The Company recorded $0.1 million for additional discount related to the
April 1997 amendment.
Interest rate protection agreement
TFC has entered into an interest rate protection agreement (cap) that
limits TFC's exposure to increases in its borrowing cost relating to an increase
in the one-month LIBOR rate. As discussed above, LIBOR is the base rate used in
connection with the revolving line of credit. The agreement has a notional
principal amount of $75 million, a LIBOR ceiling of 6.5% and an expiration date
of September 30, 1998. The cap subjects the Company to credit risk that the
counterparty may fail to perform under the terms of the agreement.
Dividend restrictions
The Company did not declare dividends on its common stock during the years
ended December 31, 1997, 1996, and 1995, nor does it anticipate paying cash
dividends in the foreseeable future. If and when the Company decides to declare
cash dividends, the amount would be limited by certain provisions of the
Company's various credit agreements. Additionally, the various credit agreements
provide restrictions on TFC's ability to transfer funds to TFCE in the form of
dividends.
42
Notes to Consolidated Financial Statements (continued)
6. Income taxes
Significant components of deferred tax assets and liabilities were as
follows as of December 31:
(in thousands) 1997 1996
----- ----
Deferred tax assets:
Excess of book nonrefundable reserve over tax $ 8,493 $ 6,452
Excess of book allowance for credit losses over tax 259 4,588
Excess of tax over book product warranty income 51 66
Vacation accrual 67 -
Net operating loss 1,502 -
Other 95 191
---------- --------
Total deferred tax assets 10,467 11,297
Deferred tax liabilities:
Recognition of dealer discount income for book purposes
in advance of tax recognition 6,788 6,951
Temporary differences relating to intangible assets 775 888
Temporary difference relating to employee benefits 296 383
Excess of tax over book depreciation 202 227
--------- -------
Total deferred tax liabilities 8,061 8,449
Valuation allowance (2,218) (2,660)
-------- -------
Net deferred tax assets $ 188 $ 188
========= =======
The following is a summary of the income tax provision (benefit) for the
years ended December 31:
(in thousands) 1997 1996 1995
---- ---- ----
Current provision (credit):
Federal $ - $(5,047) $(1,303)
State - (536) (206)
------- ------- -------
- (5,583) (1,509)
Deferred provision (credit):
Federal 372 3,332 (1,738)
State 70 383 (317)
---- ------ --------
442 3,715 (2,055)
Valuation allowance (442) 2,660 -
------ ------ --------
Total $ - $ 792 $(3,564)
========= ========= ========
43
Notes to Consolidated Financial Statements (continued)
6. Income taxes (continued)
The differences between income taxes computed at the statutory Federal rate
and actual amounts were as follows for the years ended December 31:
(in thousands) 1997 1996 1995
----- ----- -----
Computed at statutory Federal rate $ 240 $(2,314) $(3,414)
State taxes, net of Federal tax benefit 28 (269) (345)
Amortization of intangible assets 277 277 277
Non-recognition of net operating
losscarryforw
carryforwardq
loss carryforward 510 510 -
Valuation allowance (442) 2,660 -
Other items (103) (72) (82)
-------- ------- ---------
Computed at effective rate $ - $ 792 $(3,564)
======== ======= ========
At December 31, 1997, recoverable income taxes totaled $1.2 million, which
primarily consisted of state income tax refunds for amended 1993, 1994, 1995,
and 1996 returns for the carryback of the 1996 operating loss. At December 31,
1996, recoverable income taxes totaled $5.8 million, which primarily consisted
of Federal and state income tax refunds of $5.0 million related to amended tax
returns for 1993 and 1994.
At December 31, 1997, the Company had a Federal tax loss carryforward
totaling $3.6 million that expires beginning 2011. In 1993, contingent interest
on the Company's convertible notes was treated as non-deductible for Federal
income tax purposes. To the extent that the contingent interest on convertible
notes is ultimately determined to be deductible for Federal income tax purposes,
the benefit, which totals $2.1 million, will be recognized in the period that
the determination is made.
7. Employee benefit plan
The Company has a defined contribution savings plan covering all permanent
employees working 20 or more hours per week and with more than one year of
service. Under the terms of the plan, the Company matches 50% of employees'
contributions up to 10% of each employee's earnings as defined. In addition,
employees have the option of contributing additional amounts. The Company's plan
expense for 1997, 1996, and 1995 was $0.1 million, $0.2 million, and $0.2
million, respectively.
44
Notes to Consolidated Financial Statements (continued)
8. Stock Plans
Employee Stock Purchase Plan
The Company has an Employee Stock Purchase Plan (the "Stock Purchase
Plan"), which allows for options to be granted to employees, including eligible
officers, of the Company, TFC and any future majority-owned subsidiary to
purchase common stock. A total of 530,000 shares of common stock have been
reserved for issuance under the Stock Purchase Plan. The Company granted 110,000
options to certain eligible employees on February 28, 1994. These stock options
were fully vested at the date of grant. Approximately, 12,000 were exercised and
the remaining 98,000 expired in May 1996.
Any employee who is customarily employed for at least 20 hours per week and
more than five months per calendar year by the Company is eligible to
participate in the Stock Purchase Plan.
No employee is permitted to purchase shares under the Stock Purchase Plan
if such employee owns 5% or more of the total of the Company. In addition, no
employee is entitled to purchase more than $25,000 of common stock (based upon
the fair market value of the shares of common stock at the time the option is
granted) in any calendar year. The price at which shares of common stock were
sold under the Stock Purchase Plan was the lower of 85% of the fair market value
on the date of grant or the purchase date of such shares.
Long-term Incentive Plan
On October 27, 1994, the Company established the 1995 Long-Term Incentive
Plan ("Incentive Plan"), which provides incentive stock options, non-qualified
stock options and restricted stock for certain executives of the Company. The
options generally vest over a period of five years. A total of 1.5 million
shares of common stock have been reserved for issuance under the Incentive Plan.
The remaining 495,000 options granted at an exercise price of $11.50 under this
plan in 1995 expire on December 31, 1999. All other outstanding options expire
five years from the vesting date.
Pro forma information regarding net income and earnings per share is
required by Statement of Financial Accounting Standards No. 123 ("FAS No. 123"),
which also requires that the information be determined as if the Company has
accounted for its employee stock options granted subsequent to December 31,
1994, under the fair value method of that Statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighed-average assumptions: risk free interest rate of
6%; dividend yield of 0% for 1997 and 1996; volatility factor of the expected
market price of the Company's common stock of 0.789 for 1997 and 0.915 for 1996;
and a weighted-average expected life of the options ranging from 2 years to 10
years.
45
Notes to Consolidated Financial Statements (continued)
8. Stock Plans (continued)
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of the Company's stock options. For purposes of
pro forma disclosures, the estimated fair value of the options was amortized to
expense over the options' vesting periods. The effects of applying FAS No. 123
for providing pro forma disclosures are not likely to be representative of the
effects on reported net income for future years. The Company's pro forma net
income (loss) (in thousands) and pro forma income (loss) per share based on
options issued during 1997, 1996 and 1995 were as follows:
Years ended December 31
-----------------------
1997 1996 1995
---- ---- ----
Pro forma net income (loss) $ 660 $(7,718) $(6,506)
Pro forma net income (loss) per share $ 0.06 $(0.68) $(0.58)
A summary of the activity for the Company's stock options with exercise
prices equal to the grant-date market value for the three years ended December
31 was as follows:
1997 1996 1995
-------------------------------------------------------------------------------------
Shares Weighted Shares Weighted Shares Weighted
Under Average Under Average Under Average
Option Exercise Option Exercise Option Exercise
(In 000s) Price (In 000s) Price (In 000s) Price
-------------------------------------------------------------------------------------
Outstanding at beginning of year 806 $10.11 1,368 $11.57 1,234 $11.11
Granted 300 1.26 150 1.17 180 13.87
Exercised - - (6) 1.86 (3) 8.08
Forfeited (80) 1.25 (706) 11.08 (43) 4.79
---- ----- ----
Outstanding at end of year 1,026 8.22 806 10.11 1,368 11.57
===== === =====
Exercisable at end of year 637 11.13 527 11.84 336 10.74
=== === ====
Weighted-average fair value of
options granted during the year
of options granted during
the year $0.84 $0.97 $7.22
Notes to Consolidated Financial Statements (continued)
8. Stock Plans (continued)
For stock options outstanding at December 31, 1997, the range of exercise prices
and the weighted-average remaining contractual life were as follows:
Stock Options Granted in
------------------------
1997 1996 1995
---- ---- ----
Range of exercise prices $0.96-1.44 $1.125-1.25 $11.50-14.00
Weighted-average remaining contractual life 10 years 7.5 years 3 years
9. Earnings (loss) per share
Earnings (loss) per share for the years ended December 31 were as follows:
1997 1996 1995
---- ---- ----
Numerator:
Net income (loss) $707 $(7,596) $(6,461)
Denominator:
Denominator for basic earnings (loss) per 11,290,308 11,289,558 11,282,897
share-weighted- average shares
Effect of dilutive securities:
Employee stock options 38,477 10,371 7,612
Warrants 276,149 - -
------- - -
Dilutive potential common shares 314,626 10,371 7,612
------- ------ -----
Denominator for diluted earnings (loss) per
share-adjusted weighted-average shares
and assumed conversions 11,604,934 11,299,929 11,290,509
========== ========== ==========
Basic earnings (loss) per share $0.06 $(0.67) $(0.57)
===== ======= =======
Diluted earnings (loss) per share $0.06 $(0.67) $(0.57)
===== ======= =======
46
Notes to Consolidated Financial Statements (continued)
10. Commitments
The Company is obligated in 1998 to pay incentive compensation equal to
3.91%, in the aggregate, of TFC's pre-tax income, as defined, to certain key
executives. The chairman and chief executive officer is guaranteed the greater
of 3.00% or $300,000 with the remaining .91% relating to other key executives. .
In 1996, the chairman and chief executive officer voluntarily terminated
his deferred compensation agreement. Since the chairman and chief executive
officer is considered a principal shareholder of the Company, the voluntary
termination of the agreement and the resultant elimination of the Company's
obligation with respect thereto, aggregating $1.0 million ($0.62 million after
taxes), was reported as an equity contribution in 1996.
The Company conducts its business in leased facilities with terms of one to
eleven years with renewal options for additional periods. These leases are
classified as operating leases. Certain equipment, including automobiles, is
leased for terms of one to five years and is classified as operating leases.
Options to purchase are also included in certain equipment lease agreements.
Rent expense for the years ended December 31, 1997, 1996, and 1995 was
approximately $0.9 million, $1.1 million, and $0.7 million, respectively.
Future minimum annual lease payments for property and equipment under lease
at December 31, 1997 were as follows:
(in thousands)
1998 $ 770
1999 703
2000 659
2001 418
2002 412
2003 through 2006 1,527
-----
Total $4,489
The Company is party to several legal actions which are ordinary, routine
litigation incidental to its business. The Company believes that none of those
actions, either individually or in the aggregate, will have a material adverse
effect on the results of operations or financial position of the Company.
47
Notes to Consolidated Financial Statements (continued)
11. Related party transactions
As a result of the Company's 1995 net loss, a profit sharing payment
totaling $0.4 million, which was made to the Chief Executive Officer during
1995, was required to be repaid to the Company. The Company received an executed
note and recorded the required profit sharing repayment as a note receivable.
The note, totaling $0.4 million as of December 31, 1997 is non-interest bearing
and is due January 1, 1999 and provides that the Company may offset bonus
payments against principal and interest due under the note.
12. Financial instruments with off-balance-sheet risk and concentrations of
credit risks
In its normal course of business, the Company engages in consumer lending
activities with a significant number of consumers (obligors) throughout the
United States. In addition, the Company is party to certain off-balance-sheet
financial instruments, specifically an interest rate cap, which subjects the
Company to credit risk in the event market conditions cause the interest rate
cap to experience an unrealized gain and the counterparty to the transaction
should fail to honor the contract. The maximum risk of accounting loss from
these on- and off-balance-sheet financial instruments with these counterparties,
assuming all collateral is deemed worthless, is represented by their respective
balance sheet amounts and the replacement cost of the off-balance- sheet
financial instruments. At December 31, 1997, the replacement cost for the
Company's interest rate cap was immaterial.
At December 31, 1997, approximately 68% of the Company's contract
receivables portfolio is related to obligors in Texas (22%), Virginia (20%) ,
California (14%) and Florida (12%). Although the Company's contract receivables
portfolio includes consumers living throughout the United States, a substantial
portion of the obligors' ability to honor their obligations to the Company may
be dependent on economic conditions in these states. All such contracts, other
than contracts originated by FCF, are collateralized by the related vehicles.
The Company does not have any other material concentration of credit risk.
13. Estimated fair value of financial instruments
Statement of Financial Accounting Standards No. 107 (FAS No. 107),
"Disclosures about Fair Value of Financial Instruments," requires the disclosure
of the estimated fair value of on- and off-balance-sheet financial instruments.
A financial instrument is defined by FAS No. 107 as cash, evidence of an
ownership interest in an entity, or a contract that creates a contractual
obligation or right to deliver to or receive cash or another financial
instrument from a second entity on potentially favorable terms.
Fair value estimates are made at a point in time, based on relevant market
data and information about the financial instrument. FAS No. 107 specifies that
fair values should be
48
Notes to Consolidated Financial Statements (continued)
13. Estimated fair value of financial instruments (continued)
calculated based on the value of one trading unit without regard to any premium
or discount that may result from concentrations of ownership of a financial
instrument, possible tax ramifications, estimated transaction costs that may
result from bulk sales or the relationship between various financial
instruments. Fair value estimates are based on judgments regarding current
economic conditions, interest rate risk characteristics, loss experience and
other factors. Many of these estimates involve uncertainties and matters of
significant judgment and cannot be determined with precision. Therefore, the
estimated fair value may not be realizable in a current sale of the instrument.
Changes in assumptions could significantly affect the estimates.
Fair value estimates exclude all non-financial assets and liabilities
including property and equipment, goodwill and other intangibles, prepaid
assets, deferred tax assets, accrued liabilities, taxes payable, and contract
loss reserves. Accordingly, the estimated fair value amounts of financial
instruments do not represent the entire value of the Company.
The following methods and assumptions were used by the Company in
estimating the fair value of its financial instruments at December 31, 1997 and
1996:
Short-term financial instruments
The carrying amounts reported on the Company's balance sheet generally
approximate fair value for financial instruments that mature in 90 days or less,
with no significant change in credit risk. The carrying amounts approximate fair
value for cash and cash equivalents, restricted cash and certain other assets
and liabilities. Financial instruments included in other assets and liabilities
primarily include trade accounts receivable and payable. In addition, the 1995
profit-sharing receivable from employee of $0.4 million at December 31, 1997 and
1996, is included in other assets. Management believes the carrying amount for
this receivable approximates fair value.
Contract receivables
The estimated fair value of contract receivables was calculated using
market rates of return required for a portfolio purchase of contract receivables
with similar credit and interest rate characteristics. The estimated fair value
of contract receivables that did not meet the criteria for a portfolio purchase,
generally contracts that were more than 30 days past due, was calculated based
upon the liquidation value of the collateral.
Revolving lines of credit, term notes, automobile receivables-backed notes, and
subordinated notes
The estimated fair values for the revolving lines of credit, term notes,
automobile receivable- backed notes, and subordinated notes were based on
indicative market prices for debt with similar terms and remaining maturities
currently available to companies with similar credit ratings.
49
Notes to Consolidated Financial Statements (continued)
13. Estimated fair value of financial instruments
Interest rate protection agreements
The estimated fair value of the Company's interest rate protection
agreements was based on market quotes at December 31, 1997 and 1996.
The estimated fair values of the Company's financial instruments at
December 31, 1997 and 1996 were as follows (in thousands):
1997 1996
------ -----
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
Financial assets:
Cash and cash equivalents $ 1,975 $ 1,975 $ 2,688 $ 2,688
Restricted cash - - 5,532 5,532
Net contract receivables 128,503 113,779 126,252 114,619
Other assets 825 825 844 844
--------- ----------- --------- -----------
Total financial assets $131,303 $116,579 $135,315 $123,683
======== ======== ======== ========
Financial liabilities:
Revolving lines of credit $ 98,572 $ 78,858 $ 72,562 $ 58,000
Term notes - - 19,464 15,600
Automobile receivables-backed notes - - 15,843 15,843
notes
Subordinated notes 11,214 6,728 12,509 7,500
Other liabilities 2,006 2,006 2,420 2,420
---------- ---------- ---------- ----------
Total financial liabilities $111,792 $ 87,592 $122,798 $ 99,363
======== ======== ======== =========
Off-balance-sheet financial instruments
Interest rate protection agreements $ 18 $ 5 $ 57 $ 6
14. Bankruptcy remote subsidiary - TFC Receivables Corporation
TRC Receivables Corporation is a wholly-owned bankruptcy remote subsidiary
of TFC that was formed in May 1995 to facilitate certain asset-backed financing
transactions requiring a bankruptcy remote structure. Bankruptcy remote refers
to a legal structure in which it is expected that the applicable entity would
not be included in any bankruptcy filing by its parent or affiliates. In
December 1995, TRC issued $49.1 million of 6.14% Automobile Receivables-Backed
Notes, Series 1995-A. Proceeds from the issuance were used to purchase certain
assets from TFC, which collateralize the notes. In August 1997, TRC paid off the
6.14% Automobile Receivables- Backed Notes. The 6.14% Automobile
Receivables-Backed Notes are further discussed in Note 5 of the Notes to
Consolidated Financial Statements.
50
TFC Enterprises, Inc. Directors, Officers and Shareholder Information
Board of Directors *
Robert S. Raley, Jr. (1)
Chairman of the Board,
President and Chief Executive
Officer
Walter S. Boone, Jr. (1)(2)
President, Virginia General
Investment, Inc.
Douglas E. Bywater (1)(3)
Partner, Tate &
Bywater, Ltd.
Andrew M. Ockershausen (3)
Director of Business
Development, Home
Team Sports
Phillip R. Smiley (2)
Field Services Regional
Manager, UNISYS
Linwood R. Watson (2)
Managing Principal,
Thompson, Greenspon
& Co., P.C.
(1) Member of Executive
Committee
(2) Member of Audit
Committee
(3) Member of
Compensation Committee
* As of March 1998
Executive Officers
Robert S. Raley, Jr.
Chairman of the Board,
President and Chief
Executive Officer
Craig D. Poppen
Vice President, Treasurer
and Chief Financial
Officer
Ronald G. Tray
Vice President and
Assistant Secretary
Fletcher A. Cooke
Secretary and General Counsel
Shareholder Contact
Craig D. Poppen
Vice President, Treasurer
and Chief Financial
Officer
5425 Robin Hood Road,
Suite 101B,
Norfolk, Virginia 23513
(757) 858-4054 ext. 355
FAX: (757) 858-4093
Transfer Agent and
Registrar
American Stock Transfer
& Trust Company
40 Wall Street
New York, New York
10005
Annual Meeting
The annual shareholders'
meeting will be held
Tuesday, May 12, 1998,
at 3:00 p.m. at the
Airport Hilton Hotel,
Norfolk, Virginia
Form 10-K
Copies of TFC Enterprises, Inc.'s Annual Report on Form 10-K are filed with the
Securities and Exchange Commission and may be obtained from the Shareholder
Relations Department, 5425 Robin Hood Road, Suite 101B, Norfolk, Virginia 23513
Stock Trading
TFC Enterprises, Inc. Common Stock trades on The NASDAQ Stock Market under the
symbol TFCE and is designated a National Market Security. The listing found in
most newspapers is TFCENT.
Independent
Auditors
Ernst & Young LLP
1225 Connecticut Ave.,
NW
Washington, DC 20036
Outside Corporate
Counsel
Clark & Stant
One Columbus Center
Suite 900
Virginia Beach, Virginia
23462
The Finance Company Officers and Locations
The Finance
Company Officers*
Robert S. Raley, Jr.
Chairman of the Board,
President and Chief Executive
Officer
Craig D. Poppen
Executive Vice President,
Treasurer and Chief Financial
Officer
Ronald G. Tray
Executive Vice President,
Chief Operating Officer and
Assistant Secretary
Rick S. Lieberman
Senior Vice President
and Chief Lending Officer
Fletcher A. Cooke
Secretary and General Counsel
Delma H. Ambrose
Vice President
Timothy Ivey
Vice President
Kevin J. Obal
Vice President
M. Patricia Piccola
Vice President
David Hall
Assistant Vice President
Susan Barrett
Assistant Vice President
Guy H. Putman III
Assistant Vice President
* As of March 1998
Corporate Executive Office
5425 Robin Hood Road,
Suite 101B
Norfolk, Virginia 23513
(757) 858-4054
FAX: (757) 858-4093
Point-of- Sale
Service Center
5425 Robin Hood Road,
Suite 101A
Norfolk, Virginia 23513
(757) 858-1400
FAX: (757) 858-5499
Norfolk
Loan Production Office
5425 Robin Hood Road,
Suite 101A
Norfolk, Virginia 23513
(757) 858-1400
FAX: (757) 858-5499
Jacksonville
Loan Production Office
8000 Arlington Expressway,
Suite 400
Jacksonville, Florida 32211
(904) 725-5222
FAX: (904) 725-5833
Killeen
Loan Production Office
2201 South W.S. Young
Suite 105C
Killeen, Texas 76543
(254) 526-8390
FAX: (800) 221-8698
San Diego
Loan Production Office
6170 Cornerstone Court
East, Suite 260
San Diego, California
92121
(619) 546-1336
FAX: (619) 546-0360
Portfolio
Service Center
8000 Arlington
Expressway, Suite 400
Jacksonville, Florida 32211
(904) 725-5222
FAX: (904) 725-5833
Norfolk
Loan Production Office
5425 Robin Hood Road,
Suite 101A
Norfolk, Virginia 23513
(757) 858-1400
FAX: (757) 858-5499
First Community Finance, Inc. Officers and Locations
First Community
Finance, Inc. Officers*
Robert S. Raley, Jr.
Chairman of the Board
and Executive Vice President
G. Kent Brooks
President and Chief
Executive Officer
Walter Owings
Vice President and Secretary
Robert Boykin
Vice President and
Assistant Secretary
Craig D. Poppen
Vice President, Treasurer and Chief
Financial Officer
* As of March 1998
Corporate Office
4900 Augusta Avenue
Suite 104
Richmond, Virginia 23230
(804)353-4900
FAX:(804)353-7818
Branches
71 S. Airport Drive
Highland Springs, Virginia
23075
(804) 737-8218
FAX: (804) 737-4135
9903 Hull Street Road
Richmond, Virginia 23236
(804) 745-3743
FAX: (804) 745-3898
2028 Nickerson Blvd.
Hampton, Virginia 23663
(757) 850-0670
FAX: (757) 850-0556
101-A North Brunswick Avenue
South Hill, Virginia 2970
(804) 447-5778
FAX: (804) 447-6077
1327-B West Broad Street
Waynesboro, Virginia 22980
(540) 946-2633
FAX: (540) 946-2601
150 Walker Street
Lexington, Virginia 24450
(540) 464-3160
FAX: (540) 464-1760
Washington Square
Shopping Center
5338-E George
Washington Memorial
Hwy.
Grafton, Virginia 23692
(757) 874-6775
FAX:(757)874-6090
1312-C West Grantham
Street Goldsboro, North
Carolina 27530
(919) 736-9912
FAX: (919) 736-9807
232 Greenville Blvd. S. E.
Greenville, North Carolina
27858
(919) 355-7540
FAX: (919) 355-0050
121 East Gordon Street
Kinston, North Carolina
28501
(919) 939-1665
FAX: (919) 939-9521
1060 Tiffany Square
Rocky Mount, North
Carolina 27802
(919) 977-0250
FAX: (919) 977-9649
3308 Bragg Boulevard
Suite 132
Fayetteville, North Carolina
28303
(910)868-9411
FAX:(910)868-9013
4119-D Arendell Street
Wellons Center
Morehead City, North
Carolina 28557
(919)247-2494
FAX:(919)247-1189
715 Gum Branch Center, Unit
#4
Jacksonville, North Carolina
28546
(910)455-8818
FAX:(910)455-9440
2326 Forest Hills Road
Wilson, North Carolina 27893
(919)234-2754
FAX:(919)234-2752