Credit Acceptance Corporation (CACC) Q1 2012 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the Credit Acceptance Corporation First Quarter 2012 Earnings Call. Today's call is being recorded. A webcast and transcript of today's earnings call will be made available on Credit Acceptance's website. At this time, I would like to turn the call over to Credit Acceptance Senior Vice President and Treasurer, Doug Busk.

Thank you, Mary. Good afternoon, and welcome to the Credit Acceptance Corporation First Quarter 2012 Earnings Call. As you read our news release posted on the Investor Relations section of our website at creditacceptance.com and as you listen to this conference call, please recognize that both contain forward-looking statements within the meaning of federal securities law. These forward-looking statements are subject to a number of risks and uncertainties, many of which are beyond our control and which could cause actual results differ materially from such statements. These risks and uncertainties include those spelled out in the Cautionary Statement Regarding Forward-Looking Information included in the news release. Consider all forward-looking statements in light of those and other risks and uncertainties. Additionally, I should mention that to comply with the SEC's Regulation G, please refer to the Adjusted Financial Results section of our news release, which provides tables showing how non-GAAP measures reconcile to GAAP measures. This afternoon, Brett Roberts, our Chief Executive Officer, and I will provide some comments relating to our operational and financial results, as well as our liquidity position. After we have concluded our prepared remarks, we have set aside some time for questions. To assist us in answering your questions, we also have Ken Booth, our Chief Financial Officer, with us today. At this time, I'd like to turn the call over to Brett.

Thank you, Doug, and thanks to everyone who has joined us this afternoon for the call. In our earnings releases, we report both GAAP and adjusted results. Internally, we focus on adjusted results as we believe the adjusted results more closely reflect our true economic performance. The results that I will refer to in the next few minutes are all on an adjusted basis. For the most recent quarter, we earned $49 million compared to $46.2 million for the same quarter in 2011. Earnings per diluted share were $1.86, a 10.7% increase over the $1.68 reported last year. Our primary financial performance metric is economic profit. Economic profit is a function of 3 variables: the return on capital; the cost of capital; and the amount of capital invested. Our incentive plans are based on growing economic profit. Over the last 10 years, we have been successful at both growing the amount of invested capital and improving the spread between our return and cost of capital. As a result, economic profit improved from a negative $5 million in 2001 to a positive $143 million in 2011. During the most recent quarter, economic profit was $35.4 million, a 7.5% increase over the $32.9 million reported in the same quarter of the prior year. Economic profit increased during the quarter due to an increase in the amount of capital invested in our business and a decrease in our cost of capital, partially offset by a decrease in our return on capital. Average capital invested for the quarter was $1.6 billion, which is up 32.9% from the first quarter of 2011. Our return on capital declined by 340 basis points, while our weighted average cost of capital declined by 130 basis points. In 2010 and 2011, we made pricing changes that have reduced the return we expect to earn on new business in exchange for more volume. The objective of these pricing changes is not to achieve a fixed growth target, but instead, they are intended to maximize the amount of economic profit we generate on new originations. This requires us to appropriately balance unit volume and profitability per loan. We are confident that the pricing changes we have made thus far have been consistent with this objective. At this time, Doug will provide some additional comments on our operating and financial results, as well as on our liquidity position.

Thanks, Brett. The first thing I'd like to discuss is consumer loan performance. Consumer loan performance is one of the most important variables that determine our financial results. The most important time to assess consumer loan performance is at the time of origination, since that is when we determine the amount of the advance, or onetime payment, to the dealer. If we are able to accurately assess consumer loan performance at the time the loan is originated, we will likely attain our target return on capital and produce successful financial results. Since assessing consumer loan performance at the time of origination with precision is difficult, we set advance rates so that even if loan performance is worse than we expect, the loans that we originate are still highly likely to be profitable. Overall, consumer loan performance during the quarter ended March 31, 2012, was generally consistent with our expectations at the beginning of the quarter. Forecasted collection rates for loans originated in 2011 declined slightly, while the forecasted collection rates for loans originated in other years were generally consistent with our expectations at the start of the period. Moving to loan volume. The dollar and unit volume of consumer loan originations increased 10.7% and 10.6%, respectively, during the first quarter of 2012 as compared to the same period in 2011. We believe the decline in our 2012 unit volume growth rate from 2011 level is the result of increased competition. Moving to financial results. We reported strong financial results for the quarter, with GAAP net income of $50.3 million, or $1.92 per diluted share, compared to net income of $43.2 million, or $1.57 per diluted share, for the same period in 2011. As Brett mentioned, we also disclosed adjusted financial results. We do so to help shareholders better understand our financial performance. Our adjusted results include several adjustments to our reported GAAP results. An explanation of the material adjustments is contained in our earnings release. On an adjusted basis, consolidated net income for the quarter was $49 million, or $1.86 per diluted share, compared to $46.2 million, or $1.68 per diluted share, for the same period in 2011. The increases in both GAAP and adjusted net income for the quarter were primarily due to an increase in the finance charges due to growth in our loan portfolio. The growth was a result of an increase in active dealer partners. In addition, our GAAP results were positively impacted by a decrease in the provision for credit losses. The provision for credit losses decreased to a provision of $5.2 million for the quarter from a provision of $8.9 million for the same period a year ago. Under GAAP, when the present value of forecasted future cash flows decline, relative to our expectations at the time of loan origination, a provision for credit losses is recorded immediately as a current period expense and a corresponding allowance for credit losses is established. For purposes of calculating the allowance, dealer loans are grouped by dealer partner and purchased loans are grouped by month of purchase. As a result, regardless of the overall performance of the portfolio of consumer loans, a provision can be required if any individual loan pool performs worse than expected. Additionally, both our GAAP and adjusted results were negatively impacted by a $6.5 million increase in operating expenses due to a $3.3 million increase in salaries and wages, a $1.8 million increase in general, administrative expenses and a $1.4 million increase in sales and marketing expenses. The increase in salaries and wages includes an increase of $1.4 million for loan servicing, $0.8 million for support functions and a $0.9 million increase in fringe benefits, primarily related to medical claims. The increase in general and administrative expenses includes a $0.6 million increase in information technology expense, a $0.6 million increase in property taxes, as a result of a property tax refund it recognized in the first quarter of 2011, and a $0.5 million increase in legal expenses. Sales and marketing expense increased primarily due to an increase in the size of our field sales force. The last topic I want to mention today is our liquidity. We completed a $201.3 million asset-backed secured financing during the quarter and continue to be in a very strong liquidity position, with approximately $404 million of unutilized borrowing capacity under our revolving credit facilities as of March 31, 2012. And now, I'd like to turn it back over to Brett.

Thanks, Doug. We will now take your questions.

[Operator Instructions] We have a question from John Rowan from Sidoti & Company.

Doug, you discussed the liquidity. Can you just go over the number again?

At the end of the quarter, we had approximately $400 million of unutilized borrowing capacity on our $680 million in revolving credit facilities.

Okay, but that doesn't include any maturities that you have later this year and in 2013, right?

That is correct. That's just unutilized capacity on our facilities today.

Can you remind me how much you do have due -- coming due at any point in 2012 and then into 2013?

There are no revolving credit maturities in 2012. We have a $75 million warehouse facility that matures in the third quarter of 2013. The other thing to consider is that the securitization that we completed in 2010 will begin to amortize later that year, so there will be debt run-off associated with that financing. In total, that's a $100 million piece of financing and we expect that it will pay out over an approximate 12-month period in 2012 and 2013.

Okay. And then you guys give a lot of detail on some of the other -- or some of the cost and expenses. Obviously, the other income I know it was down year-over-year because of the change in accounting on your GAAP program. I'm just trying to get an understanding what the run rate is going forward. Because at this type of run rate, it's going to be down year-over-year. I would assume that that's not going to be the case. Is there still any lumpiness that's going to be left in that line item for GAAP income or even other -- some of the dealer support products and those types of payments that come in, in one period?

Well, I think because of the change in our accounting for the GAAP profit sharing income that the vast majority of the lumpiness has likely been eliminated. If you look over the last 4 quarters, other income has ranged from a low of $4.8 million to a high of $6 million. So it's been in a reasonably tight range.

Okay. All right. And then maybe, Doug -- maybe you guys can just go over the computation again. I know you just, obviously, as a means [indiscernible]. I know you talked about lower loan volumes driving comp -- or lower -- higher competition driving lower loan volumes, where is the competition coming from, just anecdotally?

I don't think there's any one thing -- it's a vast market. There's hundreds of companies that write loans in our space, thousands if you include the credit unions and the buy-here, pay-here dealers. So it's a very, very large market. Some of the big players are growing pretty aggressively, but it's a very, very large market. Nobody has a large market share.

Are people growing because there's better access to capital, so they have obviously more funding capabilities? Or is it just an organic function of people wanting to get into this market?

No. We go through cycles and it follows the availability of capital, and obviously, there's a lot of capital available right now and has been for some time. So we probably won't see a change in the competitive environment until something happens to those sources of capital.

Yes. And if you look at the volume of asset-backed issuance in the auto space in the first 3 months of this year, it's been going along at a pretty heavy clip. You couple that with the fact that credit spreads and underlying base rates are pretty tight and you have a combination of capital being readily available and quite cheap.

Okay. And just one last question. Brett, obviously, you guys published the shareholder letter recently and it kind of goes through some competitive cycles, which I appreciate. But how do you view leverage in the business? Obviously, historically, you're not at any type of peak leverage, but where does that go? I mean, does it trend down? Does it go higher from here? The way I look at it, it's not quite at the peak levels, but it's at a relatively high cyclical level.

I think we try to approach it conservatively, and the way we think about it is we just run models that make sure that if we go through another financial crisis like we went through recently that we'll have enough capital to be able to continue to grow the business. So the leverage is somewhere around 2:1 when you run those models, which is probably where you'll see us going forward.

[Operator Instructions] Our next question comes from Alex Furmanski from Safe Harbor Investments.

Just following up on the competitive environment, can you obviously give us a sense for, in relation to past cycles, how you feel it? I mean, are we -- is this akin to what you're seeing in '05? Is it more like in '07 in terms of competition? And then I have 2 other questions.

I think it's hard to compare periods. We grew at 10.7%. We didn't make a pricing change, so I think those numbers are probably the clearest picture of where we are from a competitive standpoint. Obviously, our growth rate in 2011 was a lot higher than that. We are still priced more aggressively than we were in the comparable quarter of last year. So 10.7% growth, I think, speaks to the fact that there's more competition than a year ago. To go back to compare it to '06 or '07, I think, is difficult to do at this point.

Okay. And then on the cost side, you obviously had a lot of things in there that might be kind of oneoff. But going forward for the rest of the year, do you feel that the investments you've made, in terms of people and infrastructure and what not, are enough to kind of support the growth that you anticipate for the rest of the year or do you expect additional cost as the year ramps up, as a percent of your revenue?

I think the general trend we've seen is as long as we continue to grow the size of the business, we've seen operating expenses decline as a percentage of average capital. On a year-over-year basis, that continued in the first quarter. Obviously, on a sequential basis, expenses went up. I think we gave quite a bit of color on that in the release to explain why that occurred. But I think we would expect to see the same trends going forward. As long as we can grow the business, we will continue to see operating expenses decline as a percentage of capital.

Okay, great. And the last question is, can you give us an update on the thinking on the share buybacks?

I think that our thinking on the share buybacks is consistent with what it's been historically. Historically, we bought back shares when we are confident in -- that we had the capital required to originate the forecasted level of new loans and we were able to buy the stock back at less than our conservative estimate of intrinsic value. So we'd expect to employ the same criteria going forward.

With no further questions in the queue, I would like to turn the conference back to Mr. Busk for any additional or closing remarks.

We would like to thank everyone for their support and for joining us on our conference call today. If you have any additional follow-up questions, please direct them to our Investor Relations mailbox at ir@creditacceptance.com. We look forward to talking to you again next quarter. Thank you.

Once again, this does concludes today's conference. We thank you for your participation.