10-Q 1 d10q.txt FORM 10-Q DATED 6/30/2002 THIS REPORT HAS BEEN FILED WITH THE SECURITIES AND EXCHANGE COMMISSION VIA EDGAR --------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ------------------------------------------------------------------------------ FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2002 Commission File No. 0-22910 T F C E N T E R P R I S E S, I N C. (Exact name of registrant as specified in its charter) Delaware 54-1306895 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 5425 Robin Hood Road Suite 101 B Norfolk, Virginia 23513 (Address of principal executive offices) (zip code) Registrant's telephone number, including area code -- (757) 858-1400 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes |X| No ---- ------- As of August 13, 2002, there were 11,541,033 outstanding shares of the registrant's $.01 par value per share common stock. TFC ENTERPRISES, INC. QUARTERLY REPORT ON FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2002 Table of Contents and 10-Q Cross Reference Index Part I - Financial Information Page No. ------------------------------ -------- Financial Highlights 3 Financial Statements- unaudited (Item 1) Consolidated Balance Sheets 4 Consolidated Statements of Income 5-6 Consolidated Statements of Changes in Shareholders' Equity 7 Consolidated Statements of Cash Flows 8 Notes to Consolidated Financial Statements 9 Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 2) 14 Quantitative and Qualitative Disclosures about Market Risk (Item 3) 21 Part II - Other Information --------------------------- Exhibits and Reports on Form 8-K (Item 6) 22 Signatures 23 Index to Exhibits 24 2 TFC ENTERPRISES, INC. FINANCIAL HIGHLIGHTS (Unaudited)

Note: Throughout this report, ratios are based on unrounded numbers and factors contributing to changes between periods are noted in descending order of materiality. (a) Gross contract receivables net of unearned interest revenue. (b) Before cumulative effect of change in accounting principle. 3 TFC ENTERPRISES, INC. CONSOLIDATED BALANCE SHEETS (Unaudited)

See accompanying Notes to Consolidated Financial Statements. (a) Numbers are extracted from audited information. 4 TFC ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

See accompanying Notes to Consolidated Financial Statements 5 TFC ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF INCOME (Unaudited) Three months ended June 30, June 30, ------------------------------------------------------------------------------ (in thousands, except per share amounts) 2002 2001 ------------------------------------------------------------------------------ Interest and other finance revenue $9,995 $13,464 Interest expense 3,617 5,017 ------------------------------------------------------------------------------ Net interest revenue 6,378 8,447 ------------------------------------------------------------------------------ Provision for credit losses 611 324 ------------------------------------------------------------------------------ Net interest revenue after provision for credit losses 5,767 8,123 Other revenue: Commissions on ancillary products 159 225 Other 201 346 ------------------------------------------------------------------------------ Total other revenue 360 571 ------------------------------------------------------------------------------ Total net interest and other revenue 6,127 8,694 Operating expense: Salaries 2,408 3,062 Employee benefits 493 529 Occupancy 367 289 Equipment 321 349 Amortization of intangible assets 75 278 Other 1,271 1,342 ------------------------------------------------------------------------------ Total operating expense 4,935 5,849 ------------------------------------------------------------------------------ Income before income taxes 1,192 2,845 Provision for income taxes 449 1,166 ------------------------------------------------------------------------------ Net income $ 743 $ 1,679 ------------------------------------------------------------------------------ Net income per common share: Basic $ 0.06 $ 0.15 Diluted $ 0.06 $ 0.14 See accompanying Notes to Consolidated Financial Statements. 6 TFC ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) Six months ended June 30, ------------------------------------------------------------------ (in thousands) 2002 2001 ------------------------------------------------------------------ Common stock Balance at beginning and end of period $ 51 $ 50 ================================================================== Additional paid-in capital Balance at beginning of period $ 56,187 $ 56,105 Stock options exercised 7 8 ------------------------------------------------------------------ Balance at end of period $ 56,194 $ 56,113 ================================================================== Accumulated deficit Balance at beginning of period $ (5,157) $(10,233) Net income (loss) (a) (4,994) 2,978 ------------------------------------------------------------------ Balance at end of period $(10,151) $ (7,255) ================================================================== (a) There are no adjustments to net income to determine comprehensive income for the periods presented. See accompanying Notes to Consolidated Financial Statements. 7 TFC ENTERPRISES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

See accompanying Notes to Consolidated Financial Statements. 8 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements 1. Summary of significant accounting policies Organization and business TFC Enterprises Inc. ("TFCE") is a holding company with two primary wholly-owned 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 involved in the sale of new and used automobiles, vans, light trucks, and motorcycles (collectively "vehicles") on an individual basis ("point-of-sale" purchase). Based in Norfolk, Virginia, TFC also has contract production offices throughout the United States. FCF specializes in the direct origination and servicing of small consumer loans. FCF operates branches throughout Virginia and North Carolina. Basis of presentation The unaudited consolidated financial statements of the Company are prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. These financial statements should be read in conjunction with the Company's 2001 Annual Report on Form 10-K/A. In the opinion of management, all normal recurring adjustments which management of the Company considers necessary for a fair presentation of the financial position and results of operations for the periods are reflected in the financial statements including a one-time charge for impairment of goodwill. Operating results for the three and six months ended June 30, 2002 are not necessarily indicative of the results that may be expected for the entire year ending December 31, 2002. Certain amounts have been reclassified to conform to the current quarter's presentation. 2. Contract receivables The following is a summary of contract receivables at June 30, 2002, and December 31, 2001: June 30, Dec. 31, (in thousands) 2002 2001 ------------------------------------------------------------------- Contract receivables: Auto finance $ 217,945 $ 248,048 Consumer finance 26,432 28,616 Other 1,096 1,806 ------------------------------------------------------------------- Gross contract receivables 245,473 278,470 Less: Unearned interest revenue 41,022 45,236 Unearned discount 1,331 2,622 Unearned commissions 1,025 1,196 Unearned service fees, net of costs 932 1,040 Payments in process (6) 5,312 Allowance for credit losses 1,180 971 Nonrefundable reserve 8,346 12,802 ------------------------------------------------------------------- Net contract receivables $ 191,643 $ 209,291 =================================================================== 9 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements (continued) 2. Contract receivables (continued) Changes in the allowance for credit losses and nonrefundable reserve for the three months and six months ended June 30, 2002 and 2001 were as follows: Three months ended Six months ended June 30, June 30, -------------------------------------------------------------------------------- (in thousands) 2002 2001 2001 2001 -------------------------------------------------------------------------------- Balance at beginning of period $ 10,818 $ 23,046 $ 13,773 $ 22,945 Provision for credit losses 611 324 1,179 522 Allocation for credit losses 4,959 6,373 10,905 15,817 Charge-offs (8,629) (10,496) (19,799) (21,750) Recoveries 1,767 1,628 3,468 3,341 -------------------------------------------------------------------------------- Balance at end of period $ 9,526 $ 20,875 $ 9,526 $ 20,875 ================================================================================ 3. Computation of primary and fully diluted earnings per share Basic and diluted earnings per share for the three and six months ended June 30, 2002 and 2001 were as follows: Three months ended Six months ended June 30, June 30, -------------------------------------------------------------------------------- (in thousands, except per share amounts) 2002 2001 2002 2001 -------------------------------------------------------------------------------- Numerator: Net income before cumulative effect of change in accounting principle $ 734 $ 1,679 $ 1,783 $ 2,978 Cumulative effect of change in accounting principle $ - $ - $(6,777) $ - Net (loss) income 743 1,679 (4,994) 2,978 -------------------------------------------------------------------------------- Denominator: Denominator for basic earnings per share-weighted-average shares 11,539 11,457 11,537 11,454 ---------------------------------------- Effect of dilutive securities: Employee stock options 31 55 19 43 Warrants 435 421 394 326 ---------------------------------------- Dilutive potential common shares 466 476 413 369 ---------------------------------------- Denominator for diluted earnings per share-adjusted weighted- average shares and assumed conversions 12,005 11,933 11,950 11,823 -------------------------------------------------------------------------------- Basic earnings per share before cumulative effect of change in accounting principle $ 0.06 $ 0.15 $ 0.15 $ 0.26 Diluted earnings per share before cumulative effect of change in accounting principle $ 0.06 $ 0.14 $ 0.15 $ 0.25 Basic earnings per share $ 0.06 $ 0.15 $ (0.43) $ 0.26 Diluted earnings per share $ 0.06 $ 0.14 $ (0.42) $ 0.25 10 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements (continued) 4. Segments Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. The Company is a specialty finance company with two business segments. Through TFC, the auto finance segment, the Company is engaged in purchasing and servicing installment sales contracts originated by automobile and motorcycle dealers involved in the sale of new and used automobiles, vans, light trucks, and motorcycles (collectively "vehicles") throughout the United States. This segment consists of two business units (i) point-of-sale which contracts are acquired on an individual basis from dealers after the Company has reviewed and approved the purchasers credit application and (ii) bulk which contracts were acquired through the purchase of dealer portfolios which was phased out in March 2001. Through FCF, the consumer finance segment, the Company is involved in the direct origination and servicing of small consumer loans through a branch network in Virginia and North Carolina. The other column consists of smaller subsidiaries and corporate support functions not allocated to either of the business segments. All revenue is generated from external customers in the United States. 11 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements (continued) 4. Segments (continued) The accounting policies are the same as those described in the summary of significant accounting policies as presented in the annual report at December 31, 2001. --------------------------------------------------------------------- (in thousands) Auto Consumer Finance Finance Other Total --------------------------------------------------------------------- Three months ended June 2002 Interest revenues $ 8,407 $ 1,533 $ 55 $ 9,995 ----------------------------------------- Interest expense $ 3,360 $ 245 $ 12 $ 3,617 ----------------------------------------- Income (loss) before taxes: $ 1,436 $ (5) $(85) $ 1,346 Unallocated amounts: Intangible amortization (70) Corporate expenses (84) --------- Consolidated income before taxes $ 1,192 ----------------------------------------- Net contract receivables $166,701 $23,962 $ 980 $191,643 Other assets 24,163 --------- Total assets $215,806 ----------------------------------------- -------------------------------------------------------------------- Auto Consumer Finance Finance Other Total --------------------------------------------------------------------- Three months ended June 2001 Interest revenues $ 11,704 $ 1,566 $ 194 $ 13,464 ----------------------------------------- Interest expense $ 4,563 $ 404 $ 50 $ 5,017 ----------------------------------------- Income (loss) before taxes: $ 3,071 $ 126 $ 18 $ 3,215 Unallocated amounts: Intangible amortization (273) Corporate expenses (97) --------- Consolidated income before taxes $ 2,845 ----------------------------------------- Net contract receivables $193,697 $26,528 $2,407 $222,632 Other assets 39,583 --------- Total assets $262,215 ----------------------------------------- 12 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements (continued) 4. Segments (continued) ---------------------------------------------------------------------- (in thousands) Auto Consumer Finance Finance Other Total ---------------------------------------------------------------------- Six months ended June 2002 Interest revenues $ 17,578 $ 3,049 $ 128 $ 20,755 ----------------------------------------- Interest expense $ 6,957 $ 493 $ 28 $ 7,478 ----------------------------------------- Income (loss) before taxes: $ 3,263 $ (13) $(65) $ 3,185 Unallocated amounts: Intangible amortization (139) Corporate expenses (156) --------- Consolidated income before taxes and cumulative effect of change in accounting principle $ 2,890 ----------------------------------------- Net contract receivables $166,701 $23,962 $ 980 $191,643 Other assets 24,163 --------- Total assets $215,806 ----------------------------------------- ---------------------------------------------------------------------- Auto Consumer Finance Finance Other Total ---------------------------------------------------------------------- Six months ended June 2001 Interest revenues $ 23,825 $ 3,090 $ 489 $ 27,404 ----------------------------------------- Interest expense $ 9,229 $ 876 $ 127 $ 10,232 ----------------------------------------- Income (loss) before taxes: $ 5,777 $ 221 $(124) $ 5,874 Unallocated amounts: Intangible amortization (546) Corporate expenses (247) --------- Consolidated income before taxes $ 5,081 ----------------------------------------- Net contract receivables $193,697 $26,528 $2,407 $222,632 Other assets 39,583 --------- Total assets $262,215 ----------------------------------------- 13 TFC ENTERPRISES, INC. Notes to Consolidated Financial Statements (continued) 5. Accounting Change Effective January 1, 2002, the Company adopted FASB Statement Number 142, Goodwill and Other Intangible Assets. As of June 30, 2002, the Company has determined the impairment of goodwill is $6.8 million and is recorded as a change in accounting principle. Among its provisions is a requirement to disclose what reported net income would have been in all periods presented exclusive of amortization expense (net of related income tax effects) recognized in those periods related to goodwill, intangible assets no longer being amortized, and changes in amortization periods for intangible assets that will continue to be amortized together with related per share amounts. Per FAS 142, no amortization expense was recognized in relation to goodwill for the first or second quarter of 2002 compared to $0.4 million for the first six months of 2001. Additionally, net income as of March 31, 2002 has been restated to reflect the cumulative effect of change in accounting principle. The effect of this change in accounting principle for the three-months ended March 31, 2002 resulted in an increase in accumulated deficit and a decrease in net income of $6.8 million, to a net loss of $5.8 million. 6. Subsequent Event In June 2001, THE Finance Company completed a $75 million warehouse facility for the interim financing of motor vehicle retail installment contracts. The facility has an expiration date of January 1, 2004 with an option to extend for one year. Interest on the facility is LIBOR plus 250 basis points. The transaction was completed with Westside Funding Corporation, a special purpose funding vehicle administered by Westdeutsche Landesbank Girozentrale, New York Branch (WestLB). WestLB will assist TFC as placement agent for structuring Securitization Transactions from the related collateral in the warehouse facility. In July 2002, THE Finance Company (TFC), renegotiated this warehouse credit facility. Under the amended facility the line changed from $75 million to $40 million and expires July 2003. 14 TFC ENTERPRISES, INC. 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 Commission, news releases, discussions with analysts and investor presentations, are forward-looking statements about business strategies, market potential, potential for future point-of-sale purchases, delinquency and charge-off rates, future financial performance and other matters that reflect management's expectations as of the date made. Without limiting the foregoing, the words "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. The following are factors that could cause the Company's actual results to differ materially from those expressed or implied by such forward-looking statements: the inability of the Company to obtain favorable credit facilities to replace its current facility with its principal lender, a rise in interest rates, inability to finance through the securitization market, a deterioration of credit experience, competitive pricing and other factors, the loss of or reduction in its credit facilities, or if the Company were to face increased competition. Investors are encouraged to review TFC Enterprise's SEC filings for more information about the factors affecting the Company's business. The Company disclaims any intent or obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise. Results of Operations --------------------- Net (loss) income and earnings per basic common share Net income for the second quarter of 2002 was $0.7 million, or $0.06 per basic common share, compared to net income of $1.7 million, or $0.15 per basic common share, in the second quarter of 2001. Net income before cumulative effect of change in accounting principle for the first six months of 2002 decreased to $1.8 million, or $0.15 per basic common share, compared to net income of $3.0 million, or $0.26 per basic common share, for the first six months of 2001. Net (loss) income for the first six months of 2002 decreased to $(5.0) million, or $(0.43) per basic common share, compared to net income of $3.0 million, or $0.26 per basic common share, for the first six months of 2001. Effective January 1, 2002, the Company adopted FASB Statement Number 142, Goodwill and Other Intangible Assets. As of June 30, 2002, the Company has determined the impairment of goodwill is $6.8 million and is recorded as a change in accounting principle. Among its provisions is a requirement to disclose what reported net income would have been in all periods presented exclusive of amortization expense (net of related income tax effects) recognized in those periods related to goodwill, intangible assets no longer being amortized, and changes in amortization periods for intangible assets that will continue to be amortized together with related per share amounts. Per FAS 142, no amortization expense was recognized in relation to goodwill for the first or second quarter of 2002 compared to $0.4 million for the first six months of 2001. Additionally, net income as of March 31, 2002 has been restated to reflect the cumulative effect of change in accounting principle. The effect of this change in accounting principle for the three-months ended March 31, 2002 resulted in an increase in accumulated deficit and a decrease in net income of $6.8 million, to a net loss of $5.8 million. Volume Gross contracts purchased or originated totaled $34.5 million in the second quarter of 2002, compared to $55.6 million purchased in the second quarter of 2001. For the first six months of 2002, gross contracts purchased or originated totaled $70.9 million compared to the $128.4 million purchased during the first six months of 2001. As previously announced, the Company ceased purchasing contracts in bulk acquisitions in March 2001. Point of Sale contract purchases volume is down as a result of increased competition for the military contract purchases and a more selective buying program in the company's non-military purchases because of limited funding advances available under the Company's credit facilities. First Community Finance business volume has been affected by less consumer interest since September 11, 2001 resulting in lower volume for the quarter. 15 TFC ENTERPRISES, INC. Gross contracts purchased or originated were as follows for the three and six months ended June 30, 2002 and 2001: Three months ended Six months ended June 30, June 30, ------------------------------------------------------------------------------- (in thousands) 2002 2001 2002 2001 ------------------------------------------------------------------------------- Contracts purchased or originated: Auto finance: Point-of-sale $25,756 $45,116 $57,204 $ 96,849 Bulk -- 132 -- 13,651 Consumer finance 8,738 10,313 13,713 17,877 ------------------------------------------------------------------------------- Total $34,494 $55,561 $70,917 $128,377 =============================================================================== Number of contracts purchased or originated: Auto finance: Point-of-sale 1,670 3,191 3,841 8,511 Bulk -- 25 -- 622 Consumer finance 4,044 5,042 6,264 8,257 ------------------------------------------------------------------------------- Total 5,714 8,258 10,105 17,390 =============================================================================== Net interest revenue The yield on interest-earning assets was 18.98% in the second quarter of 2002, compared to 20.77% in the second quarter of 2001. For the first half of 2002, the yield on interest-earning assets was 19.04% compared to 21.15% for the first half of 2001. The decrease in yield reflects a more competitive program for our military dealers while continuing to maintain prudent underwriting standards as well as a decrease in the bulk portfolio, which carried a higher yield. During the second and first quarter of 2002, $0.4 million and $0.5 million, respectively was not accreted to income but rather reclassified to nonrefundable reserve. The reclassification was due to the uncertain economic conditions. This reclassification also allows the company to maintain reserves at adequate levels. In comparison, during the first and second quarter of 2001, $1.2 million and $1.4 million, respectively was accreted to income from unearned discount. The cost of interest-bearing liabilities decreased to 8.45% for the second quarter of 2002 from 9.91% for the second quarter of 2001 and decreased to 8.51% for the first six months of 2002, compared with 10.11% for the first six months of 2001. Provided there are no increases in interest rates during 2002, the Company anticipates it will further benefit from the many recent interest rate reductions. 16 TFC ENTERPRISES, INC. Net interest revenue, net interest spread, and net interest margin were as follows for the three and six months ended June 30, 2002 and 2001: Three months ended Six months ended June 30, June 30, -------------------------------------------------------------------------------- (in thousands) 2002 2001 2002 2001 -------------------------------------------------------------------------------- Average interest -earning assets (a) $210,614 $259,342 $218,023 $259,186 Average interest-bearing liabilities 171,159 202,487 175,697 202,379 -------------------------------------------------------------------------------- Net interest earning assets $ 39,455 $ 56,855 $ 42,326 $ 56,807 ================================================================================ Interest and other finance revenue $ 9,995 $ 13,464 $ 20,755 $ 27,404 Interest expense 3,617 5,017 7,478 10,232 -------------------------------------------------------------------------------- Net interest revenue $ 6,378 $ 8,447 $ 13,277 $ 17,172 ================================================================================ Yield on interest-earning assets 18.98% 20.77% 19.04% 21.15% Cost of interest-bearing liabilities 8.45 9.91 8.51 10.11 -------------------------------------------------------------------------------- Net interest spread 10.53% 10.86% 10.53% 11.04% ================================================================================ Net interest margin (b) 12.11% 13.03% 12.18% 13.25% ================================================================================ (a) Gross contract receivables net of unearned interest revenue. (b) Net interest margin is annualized net interest revenue divided by average interest-earning assets. Operating expense Operating expense as a percentage of interest-earning assets, calculated on an annualized basis, increased to 9.37% for the second quarter of 2002 from 9.02% for the second quarter of 2001 and decreased to 9.18% for the first six months of 2002 from 9.74% for the first six months of 2001. Additionally, per FAS 142, no amortization expense was recognized in relation to goodwill for the first or second quarter of 2002 compared to $0.4 million for the first six months of 2001. Provision for income taxes The effective tax rate for the second quarter and first half of 2002 of approximately 38% and the second quarter and first half of 2001 of approximately 41% for book purposes is higher than the expected statutory rate primarily due to the amortization of certain intangible assets and the effect of state income taxes. 17 TFC ENTERPRISES, INC. Financial Condition ------------------- Assets Total assets decreased by $31.0 million, or 12.6%, to $215.8 million at June 30, 2002, from $246.8 million at December 31, 2001. The decrease was primarily attributable to a decrease in net contract receivables and the decrease of goodwill due to impairment. Net contract receivables were as follows at June 30, 2002 and December 31, 2001: June 30, Dec. 31, (in thousands) 2002 2001 -------------------------------------------------------------------------- Auto finance: Point-of-sale $ 152,023 $ 156,737 Bulk 14,678 24,725 Consumer finance 24,942 27,829 -------------------------------------------------------------------------- Total $ 191,643 $ 209,291 ========================================================================== Liabilities Total liabilities were $169.7 million at June 30, 2002, a decrease of $26.0 million, or 13.2%, from $195.7 million at December 31, 2001. The decrease in liabilities was primarily attributable to decreased borrowings under the Company's credit facilities resulting from the decrease in net contract receivables. Credit Quality and Reserves --------------------------- Auto finance contract receivables- Net charge-offs Net charge-offs to the allowance for credit losses and nonrefundable dealer reserve were $6.3 million in the second quarter of 2002, representing an annualized rate of 13.8% of average contract receivables net of unearned interest revenue. This compares to $8.0 million, or 14.0%, in the second quarter of 2001. For the first six months of 2002, net charge-offs were $15.2 million, or 16.0%, of average contract receivables net of unearned interest revenue. This compares to $17.0 million, or 14.9%, of average contract receivables net of unearned interest revenue in the first six months of 2001. Auto finance contract receivables- Provision for credit losses TFC's primary business involves purchasing installment sales contracts at a discount from the principal balance. 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 of the discount, if any, is recorded as unearned discount and accreted to income using the interest method over the contractual life of the related receivables. Additional amounts necessary to cover estimated future credit losses are first reclassified from unearned discount to nonrefundable reserve then, if necessary, an amount is charged to income 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 on the outstanding contract receivables. 18 TFC ENTERPRISES, INC. 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-off, the amount of nonrefundable and refundable dealer reserves, recoveries from charged-off accounts and the overall economic conditions in the markets in which we operate. 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. Auto finance contract receivables- Reserves The static pool reserve methodology is used to analyze and reserve for our credit losses. This methodology allows us to stratify our portfolio into separate and identifiable annual pools. The loss performance of these annual pools is analyzed monthly to determine the adequacy of the reserves. The loss performance to date combined with estimated future losses by pool year establishes the estimated loss for each pool year. These combined estimated losses are reduced by estimated future recoveries that are based on historical recovery performance to establish the estimated required reserve for credit losses. Estimates are reviewed regularly and if necessary, will be revised to reflect historical experience if it deviates materially from the estimates. At June 30, 2002 the combination of TFC's allowance for credit losses, nonrefundable dealer reserve and unearned discount totaled $10.9 million, or 5.3%, of contract receivables net of unearned interest revenue. This compares to $15.1 million, or 7.4%, at December 31, 2001. TFC's refundable dealer reserve, which is available to absorb losses relating to contracts purchased from certain dealers, totaled $0.5 million at June 30, 2002 and $0.7 million at December 31, 2001. Under certain of TFC's programs, contracts from dealers were purchased under a refundable, rather than nonrefundable reserve relationship. Under certain circumstances, TFC 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 Sheets. The reserves as a percentage of gross auto finance contract receivables net of unearned interest at June 30, 2002, of 5.3% are less than net charge-offs as a percentage of average net contracts receivable for the six months ended June 30, 2002, of 16.0% on an annualized basis. This difference exists primarily because the reserves include an estimate of future recoveries on prior year charge-off and future recoveries on current year charge-offs that are not reflected in the current year charge-offs percentage. These estimated future recoveries are based on historical recovery performance and this estimate is an integral part of the evaluation of the adequacy of the reserves performed by management monthly. In addition, we have increased our penetration of ancillary products such as warranty and other products that minimize the loss incurred because of the difference between the debtors insurance coverage and the contract balance that occurs when the collateral is a total loss or is stolen. Finally the ratio is lower due to an increase in the portion of the portfolio with lower expected loss because of the credit profile of the debtor. Consumer finance charge-offs, provision for credit losses and reserves (FCF) Net charge-offs to the allowance for credit losses were $0.4 million in the second quarter of 2002 and $0.3 million in the second quarter of 2001, representing an annualized rate of 6.1% and 4.1% of average gross contract receivables net of unearned interest revenue, respectively. For the first six months of 2002 and 2001, net charge-offs to the allowance for credit losses were $0.8 million and $0.5 million, representing an annualized rate of 6.1% and 3.5%, respectively. The provision for credit losses was $0.5 19 TFC ENTERPRISES, INC. million for the second quarter of 2002 and $0.3 million for the second quarter of 2001 and the allowance for credit losses and nonrefundable reserve was $1.3 million or 5.18% and $1.1 million or 3.93% of outstanding gross contract receivables at June 30, 2002 and December 31, 2001, respectively. Management has established the level of allowance that it considers to be adequate based on FCF's experience through June 30, 2002. Charge-offs net of recoveries, by line of business, for the three and six months ended June 30, 2002 and 2001, were as follows: Three months ended Six months ended June 30, June 30, --------------------------------------------------------------------------- (in thousands) 2002 2001 2002 2001 --------------------------------------------------------------------------- Auto finance: Point-of-sale $ 5,939 $ 5,383 $13,595 $11,683 Bulk 404 2,656 1,656 5,380 Consumer finance 408 284 823 476 Other 111 545 257 870 =========================================================================== Total $ 6,862 $ 8,868 $16,331 $18,409 =========================================================================== Delinquencies Gross auto finance contract receivables that were 60 days or more past due totaled $9.8 million, or 4.5% of gross auto finance contract receivables at June 30, 2002, compared to $15.2 million, or 6.1%, at December 31, 2001. Gross auto finance contract receivables that were 30 days or more past due totaled $15.0 million, or 6.9% of gross auto finance contract receivables at June 30, 2002, compared to $22.5 million, or 9.1%, at December 31, 2001. Gross consumer finance receivables, originated by First Community Finance, that were 60 days or more past due totaled $1.3 million, or 4.8% of gross receivables at June 30, 2002, compared to $1.3 million, or 4.7% at December 31, 2001. Gross consumer finance receivables that were 30 days or more past due totaled $1.9 million, or 7.3% of gross receivables at June 30, 2002, compared to $2.0 million, or 6.8% at December 31, 2001. Delinquency at June 30, 2002 and December 31, 2001 was as follows: June 30, Dec. 31, (in thousands) 2002 2001 ------------------------------------------------------------------------------- Gross contract receivables $245,473 $278,470 Gross contract receivables 60+ days and over delinquent Gross contract amount $ 11,237 $ 16,732 Percent of total gross contract receivables 4.58% 6.01% Gross contract receivables 30+ days and over delinquent Gross contract amount $ 17,146 $ 24,830 Percent of total gross contract receivables 6.98% 8.92% 20 TFC ENTERPRISES, INC. Liquidity and Capital Resources ------------------------------- Liquidity management As shown on the Consolidated Statements of Cash Flows, cash and cash equivalents increased by $1.0 million in the first six months of 2002, to $1.4 million at June 30, 2002. The increase reflected $23.5 million of net cash provided by investing activities and $2.6 million of net cash provided by operating activities, offset by $25.1 million of net cash used in financing activities. Net cash used in financing activities reflected net payments on the revolving lines of credit and net borrowings on automobile receivables-backed notes. For the first six months of 2001, cash and cash equivalents decreased by $1.0 million in the first six months of 2001, to $0.6 million at June 30, 2001. The decrease reflected $4.9 million of net cash provided by financing activities and $4.4 million of net cash provided by operating activities, offset by $10.2 million of net cash used in investing activities. Net cash provided by financing activities reflected net borrowings on the revolving lines of credit and net borrowings on automobile receivables-backed notes used to fund the increase in net contract receivables. The Company believes cash flows provided by operating activities and current availability under its credit facilities will be adequate to meet the Company's liquidity requirements for fiscal 2002. Management is currently exploring additional sources of liquidity. Quantitative and Qualitative Disclosures about Market Risk ---------------------------------------------------------- Our operations require substantial borrowing to provide funding for the retail installment contracts purchased by The Finance Company and originated by First Community Finance. Consequently, profitability is impacted by the difference between the rate of interest paid on the funds we borrow and the rate of interest charged on the retail installment contracts, which rate in some states is limited by law. The floating interest rate for borrowings under the line of credit are equal to the average one-month London Interbank Offered Rate, or LIBOR rate, plus a spread. Thus, future increases in interest rates could adversely affect our profitability. During 2001 and 2000, we mitigated a substantial portion of this interest rate risk by the placement of asset backed securities with fixed interest rates over the anticipated period required for those receivables to liquidate. 21 PART II. OTHER INFORMATION ITEM 6. Exhibits and Reports of Form 8-K (a) Exhibits Exhibit 99.1 Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. (b) Reports on Form 8-K None. 22 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. TFC ENTERPRISES, INC. (Registrant) Date: August 13, 2002 By: /s/ Robert S. Raley Jr. ------------------------ Robert S. Raley, Jr. Chairman, Chief Executive Officer and Director Date: August 13, 2002 By: /s/ Ronald G. Tray ------------------- Ronald G. Tray President and Chief Financial Officer 23 Index to Exhibits Exhibit 99.1 Statement of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350. 24

TFC ENTERPRISES INC 10-Q