================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2001
Commission File Number 000-20841
UGLY DUCKLING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification no.)
2525 E. Camelback Road, Suite 500,
Phoenix, Arizona 85016
(Address of principal executive offices) (Zip Code)
(602) 852-6600
(Registrant's telephone number, including area code)
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.
[X] Yes [ ] No
---------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES
OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At August 13, 2001, there were approximately 12,302,000 shares of Common
Stock, $0.001 par value, outstanding.
This document serves both as a resource for analysts, shareholders, and
other interested persons, and as the quarterly report on Form 10-Q of Ugly
Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission,
which has taken no action to approve or disapprove the report or pass upon its
accuracy or adequacy. Additionally, this document is to be read in conjunction
with the consolidated financial statements and notes thereto included in Ugly
Duckling's Annual Report on Form 10-K, for the year ended December 31, 2000.
================================================================================
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page
Part I - FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets-- June 30, 2001 and December 31, 2000..........................1
Condensed Consolidated Statements of Operations-- Three and Six Months Ended
June 30, 2001 and 2000.........................................................................2
Condensed Consolidated Statements of Cash Flows-- Six Months Ended
June 30, 2001 and 2000...........................................................................3
Notes to Condensed Consolidated Financial Statements.................................................4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............10
Item 3. MARKET RISK.........................................................................................24
Part II.-- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS...................................................................................25
Item 2. CHANGES IN SECURITIES...............................................................................25
Item 3. DEFAULTS UPON SENIOR SECURITIES.....................................................................25
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................25
Item 5. OTHER INFORMATION...................................................................................25
Item 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................................26
SIGNATURES..........................................................................................27
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
June 30,
2001 December 31,
(unaudited) 2000
----------------- -------------------
----------------- -------------------
ASSETS
Cash and Cash Equivalents $ 7,059 $ 8,805
Finance Receivables, Net 544,585 500,469
Note Receivable from Related Party 12,000 12,000
Inventory 40,772 63,742
Property and Equipment, Net 40,278 38,679
Intangible Assets, Net 12,048 12,527
Other Assets 18,474 11,724
Net Assets of Discontinued Operations 3,734 4,175
----------------- -------------------
$ 678,950 $ 652,121
================= ===================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 1,498 $ 2,239
Accrued Expenses and Other Liabilities 25,525 36,830
Notes Payable - Portfolio 415,877 406,551
Other Notes Payable 42,495 16,579
Subordinated Notes Payable 34,951 34,522
----------------- -------------------
Total Liabilities 520,346 496,721
----------------- -------------------
Stockholders' Equity:
Preferred Stock $.001 par value, 10,000 shares authorized
none issued and outstanding - -
Common Stock $.001 par value, 100,000 shares authorized,
18,764 issued and 12,302 and 12,292 outstanding 19 19
Additional Paid-in Capital 173,741 173,723
Retained Earnings 24,958 21,772
Treasury Stock, at cost (40,114) (40,114)
----------------- -------------------
Total Stockholders' Equity 158,604 155,400
Commitments and Contingencies - -
----------------- -------------------
$ 678,950 $ 652,121
================= ===================
See accompanying notes to Condensed Consolidated Financial Statements.
1
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Six Months Ended June 30, 2001 and 2000
(In thousands, except earnings per share amounts)
(unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------------------------
2001 2000 2001 2000
------------------------------------------------------
Cars Sold 11,607 14,369 26,458 30,171
======================================================
Total Revenues $ 140,819 $ 151,398 $ 304,849 $ 309,715
======================================================
Sales of Used Cars $ 105,919 $ 121,527 $ 236,105 $ 254,313
Less: Cost of Used Cars Sold 60,639 68,417 133,480 141,359
Provision for Credit Losses 32,210 32,212 71,230 66,785
------------------------------------------------------
13,070 20,898 31,395 46,169
------------------------------------------------------
Other Income (Expense):
Interest Income 34,900 29,871 68,744 55,402
Portfolio Interest Expense (7,492) (5,997) (16,011) (11,026)
------------------------------------------------------
Net Interest Income 27,408 23,874 52,733 44,376
------------------------------------------------------
Income before Operating Expenses 40,478 44,772 84,128 90,545
Operating Expenses:
Selling and Marketing 6,235 7,426 13,861 15,561
General and Administrative 27,217 25,192 54,655 50,730
Depreciation and Amortization 2,435 2,231 4,842 4,439
------------------------------------------------------
Operating Expenses 35,887 34,849 73,358 70,730
------------------------------------------------------
Operating Income 4,591 9,923 10,770 19,815
Other Interest Expense 2,862 2,585 5,953 4,877
------------------------------------------------------
Earnings before Income Taxes 1,729 7,338 4,817 14,938
Income Taxes 709 2,990 1,975 6,107
------------------------------------------------------
Earnings before Extraordinary Item 1,020 4,348 2,842 8,831
Extraordinary Item - Gain on Early Extinguishment of Debt, net 344 - 344 -
------------------------------------------------------
Net Earnings $ 1,364 $ 4,348 $ 3,186 $ 8,831
======================================================
Earnings per Common Share before Extraordinary Item:
Basic $ 0.08 $ 0.31 $ 0.23 $ 0.61
======================================================
Diluted $ 0.08 $ 0.31 $ 0.23 $ 0.60
======================================================
Net Earnings per Common Share:
Basic $ 0.11 $ 0.31 $ 0.26 $ 0.61
======================================================
Diluted $ 0.11 $ 0.31 $ 0.26 $ 0.60
======================================================
Shares Used in Computation:
Basic Weighted Average Shares Outstanding 12,299 14,052 12,296 14,479
======================================================
Diluted Weighted Average Shares Outstanding 12,330 14,248 12,328 14,700
======================================================
See accompanying notes to Condensed Consolidated Financial Statements.
2
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months ended June 30, 2001 and 2000
(In thousands)
(unaudited)
Six Months Ended
June 30,
-----------------------------------
2001 2000
---------------- ----------------
Cash Flows from Operating Activities:
Net Earnings $ 3,186 $ 8,831
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 71,230 66,785
Depreciation and Amortization 6,912 6,459
Loss from Disposal of Property and Equipment 399 3
Collections from Residuals in Finance Receivables Sold 1,136 8,743
Decrease in Inventory 22,970 17,000
Increase in Other Assets 250 316
Increase (Decrease) in Accounts Payable, Accrued Expenses and Other liabilities (10,033) 1,860
Decrease in Income Taxes Payable (2,013) (2,300)
---------------- ----------------
Net Cash Provided by Operating Activities 94,037 107,697
---------------- ----------------
Cash Flows Used in Investing Activities:
Increase in Finance Receivables (213,732) (261,882)
Collections on Finance Receivables 124,646 102,059
Decrease in Investments Held in Trust on Finance Receivables Sold 1,398 5,937
Proceeds from Sale of Property and Equipment 1,760 1,766
Purchase of Property and Equipment (8,122) (6,511)
---------------- ----------------
Net Cash Used in Investing Activities (94,050) (158,631)
---------------- ----------------
Cash Flows from Financing Activities:
Initial Deposits at Securitization into Investments Held in Trust (6,407) (14,619)
Additional Deposits into Investments Held in Trust (69,358) (3,767)
Release of Investments Held in Trust 46,972 11,526
Additions to Notes Payable Portfolio 349,350 314,456
Repayment of Notes Payable Portfolio (341,464) (275,483)
Additions to Other Notes Payable 37,168 881
Repayment of Other Notes Payable (11,720) (9,854)
Repayment/Extinguishment of Subordinated Notes Payable (6,733) -
Proceeds from Issuance of Common Stock 18 432
Acquisition of Treasury Stock - (114)
---------------- ----------------
Net Cash Provided (Used) by Financing Activities (2,174) 23,458
---------------- ----------------
Net Cash Provided by Discontinued Operations 441 27,920
---------------- ----------------
Net Increase (Decrease) in Cash and Cash Equivalents (1,746) 444
Cash and Cash Equivalents at Beginning of Period 8,805 3,683
---------------- ----------------
Cash and Cash Equivalents at End of Period $ 7,059 $ 4,127
================ ================
Supplemental Statement of Cash Flows Information:
Interest Paid $ 20,130 $ 15,678
================ ================
Income Taxes Paid $ 12,071 $ 8,405
================ ================
Acquisition of Treasury Stock with Subordinated Debt $ - $ 8,005
================ ================
See accompanying notes to Condensed Consolidated Financial Statements.
3
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Our accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and pursuant to rules
and regulations of the Securities and Exchange Commission. Accordingly, they do
not include all of the information and footnotes required by such accounting
principles generally accepted in the United States of America for a complete
financial statement presentation. In our opinion, such unaudited interim
information reflects all adjustments, consisting only of normal recurring
adjustments, necessary to present our financial position and results of
operations for the periods presented. Our results of operations for interim
periods are not necessarily indicative of the results to be expected for a full
fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 2000
was derived from our audited consolidated financial statements as of that date
but does not include all the information and footnotes required by accounting
principles generally accepted in the United States of America. For a complete
financial statement presentation, we suggest that these condensed consolidated
financial statements be read in conjunction with the audited consolidated
financial statements included in our Annual Report on Form 10-K, for the year
ended December 31, 2000. All amounts are in thousands with the exception of per
share, per unit and per car data, unless otherwise noted.
Note 2. Summary of Finance Receivables
A summary of Finance Receivables, net, follows:
June 30, December 31,
2001 2000
----------------- -----------------
Contractually Scheduled Payments $ 723,882 $ 696,220
Unearned Finance Charges (189,116) (181,274)
----------------- -----------------
Principal Balances 534,766 514,946
Accrued Interest 5,463 5,655
Loan Origination Costs 7,411 7,293
----------------- -----------------
Principal Balances, net 547,640 527,894
Investments Held in Trust 98,534 71,139
Residuals in Finance Receivables Sold - 1,136
----------------- -----------------
Finance Receivables 646,174 600,169
Allowance for Credit Losses (101,589) (99,700)
----------------- -----------------
Finance Receivables, net $ 544,585 $ 500,469
================= =================
Allowance as a % of Ending Principal Balances 19.0% 19.4%
================= =================
Investments Held in Trust represent funds held by trustees on behalf of our
securitization bond holders. The balance of Investments Held in Trust increased
from December 31, 2000 due to deposits into the trust accounts arising from an
additional securitization completed during the first and second quarters of
2001, including a pre-funded amount of approximately $25.2 million related to
the securitization completed in the second quarter of 2001. The increase was
partially offset by the distribution of funds associated with portfolios
securitized during prior periods.
Note 3. Related Party Transactions
The Note Receivable - Related Party originated from the Company's December
1999 sale of its Cygnet Dealer Finance subsidiary to Cygnet Capital Corporation,
an entity controlled by Ernest C. Garcia II, Chairman and principal shareholder
of the Company. The $12.0 million note from Cygnet Capital Corporation has a
10-year term, with interest payable quarterly at 9%, due December 2009. The note
is secured by the capital stock of Cygnet Capital Corporation and guaranteed by
Verde Investments, Inc. ("Verde"), an affiliate of Mr. Garcia. Under the terms
of the agreement, Mr. Garcia will be allowed to reduce the principal balance up
to a maximum of $8.0 million by surrendering to the Company shares of Ugly
Duckling common stock (valued at 98% of the average of the closing prices of the
stock on NASDAQ for the ten trading days prior to the surrender) as long as Mr.
Garcia's ownership interest of the Company voting stock does not fall below 15%
and the acceptance of such stock by the Company does not result in a breach of a
covenant.
4
In May 2001, Verde purchased one of the Company properties at its
approximate book value of $1,650,000. Verde has leased the property back to the
Company under a 20-year lease, which expires May 2021. The lease is a triple net
lease with an increase of approximately 2% in year two and annual CPI
adjustments thereafter.
Verde is expected to purchase another property, with a scheduled close date
of August 2001. The purchase price is $800,000 which approximates book value.
The Company currently sublets this property thus there will not be a subsequent
leaseback with Verde.
Note 4. Notes Payable
Notes Payable, Portfolio
A summary of Notes Payable, Portfolio at June 30, 2001 and December 31, 2000:
June 30, December 31,
2001 2000
----------------- -----------------
Revolving Warehouse Facility with GE Capital, secured by substantially $ - $ 53,326
all assets of the Company, terminated April 2001
Revolving Warehouse Facility with Greenwich Capital Financial Products, Inc,
secured by substantially all assets of the Company 17,620 -
Class A obligations issued pursuant to the Company's Securitization Program,
secured by underlying pools of finance receivables and investments held in trust
totaling $592.1 million at June 30, 2001 401,854 355,972
----------------- -----------------
Subtotal 419,474 409,298
Less: Unamortized Loan Fees 3,597 2,747
----------------- -----------------
Total $ 415,877 $ 406,551
================= =================
Effective April 2001, the Company replaced the warehouse receivables
portion of the GE Capital facility. The new warehouse receivables revolving
facility allows for maximum borrowings of $75 million during the period May 1
through November 30 and increases to $100 million during the period December 1
through April 30. The term of the facility is 364 days with a renewal option,
upon mutual consent, for an additional 364-day period. The borrowing base
consists of up to 65% of the principal balance of eligible loans originated from
the sale of used cars. The lender maintains an option to adjust the advance rate
on the principal to reflect changes in market conditions or portfolio
performance. The interest rate on the facility is LIBOR plus 2.80% (6.96% at
June 30, 2001). The facility is secured with substantially all Company assets.
The line is subject to several covenants, including certain financial and loan
portfolio related covenants. At June 30, 2001, the Company was in compliance
with all required covenants.
Class A obligations have interest payable monthly at rates ranging from
4.74% to 7.26%. Monthly principal reductions on Class A obligations approximate
70% of the principal reductions on the underlying pool of finance receivable
loans. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Securitizations" for further information on the Class A
bonds.
Other Notes Payable
A summary of Other Notes Payable at June 30, 2001 and December 31, 2000 follows:
June 30, December 31,
2001 2000
----------------- -----------------
Note payable, secured by the capital stock of UDRC and UDRC II and certain other
receivables $ 32,000 $ 11,141
Other notes payable bearing interest at rates ranging from 7.5% to 11% due through
July 2003, secured by certain real property and certain property and equipment 6,491 5,637
Revolving Inventory Facility for $25.0 million with GE Capital, secured by
substantially all Company assets 5,000 -
----------------- -----------------
Subtotal 43,491 16,778
Less: Unamortized Loan Fees 996 199
----------------- -----------------
Total $ 42,495 $ 16,579
================= =================
5
Effective April 2001, the Company secured an option to extend the $25
million inventory line of credit portion of the facility with GE Capital from
June 30, 2001 until December 31, 2001. The extension on the inventory line of
credit with GE Capital requires the payment of a fee for each quarterly
extension after June 30, 2001, and, after June 30, 2001, the interest rate on
the line increases by 50 basis points to LIBOR plus 3.65%. The interest rate in
effect on this line was 7.31% at June 30, 2001. The facility agreement contains
various reporting and performance covenants, including the maintenance of
certain ratios and limitations on additional borrowings from other sources. At
June 30, 2001, the Company was in compliance with these covenants with the
exception of interest coverage ratios, for which the Company has obtained a
waiver.
As of the date of this report, the Company has signed a term sheet with a
lender for a replacement to the inventory line of credit and expects to close on
the final documents by August 31, 2001.
Subordinated Notes Payable
A summary of Subordinated Notes Payable at June 30, 2001 and December 31, 2000
follows:
June 30, December 31,
2001 2000
----------------- -----------------
$13.5 million senior subordinated notes payable to unrelated parties, bearing $ 8,000 $ 11,500
interest at 15% per annum payable quarterly, principal due February 2003
and senior to subordinated debentures
$7.0 million senior subordinated note payable to a related party, bearing
interest at LIBOR plus 6% per annum payable quarterly, principal due February 2010 6,600 -
$17.5 million subordinated debentures, interest at 12% per annum
(approximately 18.8% effective rate) payable semi-annually, principal
balance due October 23, 2003 13,839 17,479
$11.9 million subordinated debentures, interest at 11% per annum
(approximately 19.7% effective rate) payable semi-annually, principal
balance due April 15, 2007 11,940 11,940
----------------- -----------------
Subtotal 40,379 40,919
Less: Unamortized Loan Fees - 31
Unamortized Discount - subordinated debentures 5,428 6,366
----------------- -----------------
Total $ 34,951 $ 34,522
================= =================
In June 2001, the Company repurchased in the open market and retired
approximately $3.6 million of the $17.5 million in subordinated debentures for
approximately $2.6 million. The after tax impact of the transaction was a gain
from extinguishment of debt of $0.3 million. The gain has been classified as
"Extraordinary Item - Gain on Early Extinguishment of Debt" on the Condensed
Consolidated Statement of Operations.
6
Note 5. Common Stock Equivalents
Net Earnings per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding for the three
and six-month periods ended June 30, 2001, and 2000.
Net earnings per common share are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ --------------------------
2001 2000 2001 2000
------------------------------ --------------------------
Earnings before Extraordinary Item
$ 1,020 $ 4,348 $ 2,842 $ 8,831
Net Earnings
$ 1,364 $ 4,348 $ 3,186 $ 8,831
============================== ==========================
Basic Earnings Per Share before Extraordinary Item $ 0.08 $ 0.31 $ 0.23 $ 0.61
============================== ==========================
============================== ==========================
Diluted Earnings Per Share before Extraordinary Item $ 0.08 $ 0.31 $ 0.23 $ 0.60
============================== ==========================
============================== ==========================
Basic Net Earnings Per Share $ 0.11 $ 0.31 $ 0.26 $ 0.61
============================== ==========================
Diluted Net Earnings Per Share $ 0.11 $ 0.31 $ 0.26 $ 0.60
============================== ==========================
Basic EPS-Weighted Average Shares Outstanding 12,299 14,052 12,296 14,479
Effect of Dilutive Securities:
Warrants 31 12 32 13
Stock Options - 184 - 208
------------------------------ --------------------------
Diluted EPS-Weighted Average Shares Outstanding 12,330 14,248 12,328 14,700
============================== ==========================
Warrants Not Included in Diluted EPS Since Antidilutive 795 1,124 795 1,124
============================== ==========================
Stock Options Not Included in Diluted EPS Since Antidilutive 1,423 846 1,434 864
============================== ==========================
Note 6. Business Segments
The Company has three distinct business segments. These consist of retail
car sales operations (Retail Operations), the income resulting from the finance
receivables generated at the Company dealerships (Portfolio Operations), and
corporate and other operations (Corporate Operations). In computing operating
profit by business segment, the following items were considered in the Corporate
Operations category: portions of administrative expenses, interest expense and
other items not considered direct operating expenses. Identifiable assets by
business segment are those assets used in each segment of Company operations.
7
A summary of operating activity by business segment for the three and
six-month periods ended June 30, 2001 and 2000 follows:
Retail Portfolio Corporate Total
------ --------- --------- -----
Three Months Ended June 30, 2001
Sales of Used Cars $ 105,919 $ - $ - $ 105,919
Less: Cost of Cars Sold 60,639 - - 60,639
Provision for Credit Losses 21,898 10,312 - 32,210
------------- ------------- -------------- --------------
23,382 (10,312) - 13,070
Net Interest Income - 27,408 - 27,408
------------- ------------- -------------- --------------
Income before Operating Expenses 23,382 17,096 - 40,478
------------- ------------- -------------- --------------
Operating Expenses:
Selling and Marketing 6,235 - - 6,235
General and Administrative 14,855 7,359 5,003 27,217
Depreciation and Amortization 1,363 232 840 2,435
------------- ------------- -------------- --------------
22,453 7,591 5,843 35,887
------------- ------------- -------------- --------------
Operating Income (Loss) $ 929 $ 9,505 $ (5,843) $ 4,591
============= ============= ============== ==============
Capital Expenditures $ 1,157 $ 358 $ 3,434 $ 4,949
============= ============= ============== =============
Identifiable Assets $ 79,837 $ 538,393 $ 56,986 $ 675,216
============= ============= ============== ==============
Three Months Ended June 30, 2000 Retail Portfolio Corporate Total
------ --------- --------- -----
Sales of Used Cars $ 121,527 $ - $ - $ 121,527
Less: Cost of Cars Sold 68,417 - - 68,417
Provision for Credit Losses 24,738 7,474 - 32,212
------------- ------------- -------------- --------------
28,372 (7,474) - 20,898
Net Interest Income - 23,764 110 23,874
------------- ------------- -------------- --------------
Income before Operating Expenses 28,372 16,290 110 44,772
------------- ------------- -------------- --------------
Operating Expenses:
Selling and Marketing 7,426 - - 7,426
General and Administrative 14,593 5,416 5,183 25,192
Depreciation and Amortization 1,133 280 818 2,231
------------- ------------- -------------- --------------
23,152 5,696 6,001 34,849
------------- ------------- -------------- --------------
Operating Income (Loss) $ 5,220 $ 10,594 $ (5,891) $ 9,923
============= ============= ============== ==============
Capital Expenditures $ 2,220 $ 195 $ 1,818 $ 4,233
============= ============= ============== ==============
Six Months Ended June 30, 2001 Retail Portfolio Corporate Total
------ --------- --------- -----
Sales of Used Cars $ 236,105 $ - $ - $ 236,105
Less: Cost of Cars Sold 133,480 - - 133,480
Provision for Credit Losses 48,550 22,680 - 71,230
------------- ------------- -------------- --------------
54,075 (22,680) - 31,395
Net Interest Income - 52,603 130 52,733
------------- ------------- -------------- --------------
Income before Operating Expenses 54,075 29,923 130 84,128
------------- ------------- -------------- --------------
Operating Expenses:
Selling and Marketing 13,861 - - 13,861
General and Administrative 29,513 15,367 9,775 54,655
Depreciation and Amortization 2,689 496 1,657 4,842
------------- ------------- -------------- --------------
46,063 15,863 11,432 73,358
------------- ------------- -------------- --------------
Operating Income (Loss) $ 8,012 $ 14,060 $ (11,302) $ 10,770
============= ============= ============== ==============
Capital Expenditures $ 3,244 $ 587 $ 4,291 $ 8,122
============= ============= ============== ==============
Identifiable Assets $ 79,837 $ 538,393 $ 56,986 $ 675,216
============= ============= ============== ==============
8
Six Months Ended June 30, 2000 Retail Portfolio Corporate Total
------ --------- --------- -----
Sales of Used Cars $ 254,313 $ - $ - $ 254,313
Less: Cost of Cars Sold 141,359 - - 141,359
Provision for Credit Losses 51,832 14,953 - 66,785
------------- ------------- -------------- --------------
61,122 (14,953) - 46,169
Net Interest Income - 44,156 220 44,376
------------- ------------- -------------- --------------
Income before Operating Expenses 61,122 29,203 220 90,545
------------- ------------- -------------- --------------
Operating Expenses:
Selling and Marketing 15,561 - - 15,561
General and Administrative 28,783 11,493 10,454 50,730
Depreciation and Amortization 2,204 580 1,655 4,439
------------- ------------- -------------- --------------
46,548 12,073 12,109 70,730
------------- ------------- -------------- --------------
Operating Income (Loss) $ 14,574 $ 17,130 $ (11,889) $ 19,815
============= ============= ============== ==============
Capital Expenditures $ 3,493 $ 294 $ 2,724 $ 6,511
============= ============= ============== ==============
Note 7. Use of Estimates
The preparation of our condensed consolidated financial statements requires
us to make estimates and assumptions that affect the reported amount of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from our estimates.
Note 8. Reclassifications
We have made certain reclassifications to previously reported information
to conform to the current presentation.
9
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
Introduction
We operate the largest chain of buy here-pay here used car dealerships in
the United States. At June 30, 2001, we operated 77 dealerships located in
eleven metropolitan areas in eight states. We have one primary line of business:
to sell and finance quality used vehicles to customers within what is referred
to as the sub-prime segment of the used car market. The sub-prime market is
comprised of customers who typically have limited credit histories, low incomes
or past credit problems. References to Ugly Duckling Corporation as the largest
chain of buy-here pay-here used car dealerships in the United States is
management's belief based upon the knowledge of the industry and not on any
current independent third party study.
As a buy here-pay here dealer, we offer the customer certain advantages
over more traditional financing sources including:
o expanded credit opportunities,
o flexible payment terms, including structuring loan payment due dates
as weekly or biweekly, often coinciding with the customer's payday,
o the ability to make payments in person at the dealerships. This is
an important feature to many sub-prime borrowers who may not have
checking accounts or are otherwise unable to make payments by the due
date through use of the mail due to the timing of paydays.
We distinguish our retail operations from those of typical buy here-pay
here dealers through our:
o dedication to customer service, o advertising and marketing programs,
o larger inventories of used cars, o upgraded facilities, and
o network of multiple locations, o centralized purchasing.
We finance substantially all of the used cars that we sell at our
dealerships through retail installment loan contracts. Subject to certain
underwriting standards and the discretion of our dealership or sales managers,
potential customers must meet our formal underwriting guidelines before we will
agree to finance the purchase of a vehicle. Our employees analyze and verify the
customer credit application information and subsequently make a determination
whether to provide financing to the customer.
Our business is divided into three operating segments; retail, portfolio
and corporate. Information regarding our operating segments can be found in Note
(6) of the Notes to Condensed Consolidated Financial Statements contained
herein. Operating segment information is also included in "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Business Segment Information" found below.
In December 1999, we sold the Cygnet Dealer Finance (CDF) subsidiary and
also decided to abandon any efforts to acquire third party loans or servicing
rights to additional third party portfolios. As a result, CDF, Cygnet Servicing
and the associated Cygnet Corporate segment assets and liabilities are
classified as net assets from discontinued operations. We plan to complete the
servicing of the portfolios that we currently service.
In the following discussion and analysis, we explain the results of
operations and general financial condition of Ugly Duckling and its
subsidiaries. In particular, we analyze and explain the changes in the results
of operations of our business segments for the three and six-month periods ended
June 30, 2001 and 2000. All amounts are presented in thousands except per share,
per unit and per car data, unless otherwise noted.
10
UGLY DUCKLING CORPORATION
SELECTED CONSOLIDATED FINANCIAL DATA
(Amounts in millions, except per share, per unit data,
share and number of loans data)
(Unaudited)
At or For the Three Months Ended
--------------------------------------------------------------------------------
Operating Data: June 2001 Mar 2001 Dec 2000 Sept 2000 June 2000 Mar 2000
--------- -------- -------- --------- ---------- --------
Total Revenues $ 140.8 $ 164.0 $ 135.2 $ 158.1 $ 151.4 $ 158.3
Sales of Used Cars $ 105.9 $ 130.2 $ 102.3 $ 126.6 $ 121.5 $ 132.8
Net Earnings per Share $ 0.11 $ 0.15 $ (0.20) $ 0.21 $ 0.31 $ 0.30
EBITDA $ 14.5 $ 17.1 $ 8.7 $ 16.5 $ 18.2 $ 17.1
E-Commerce Revenue as Percent of Sales of Used Cars 14.4% 11.6% 13.6% 9.5% 5.3% 4.3%
Number Dealerships in Operation 77 77 77 77 77 75
Average Sales per Dealership per Month 50 64 51 64 62 70
Number of Used Cars Sold 11,607 14,851 11,874 14,825 14,369 15,802
Sales Price - Per Car Sold $ 9,125 $ 8,766 $ 8,618 $ 8,542 $ 8,458 $ 8,403
Cost of Sales - Per Car Sold $ 5,224 $ 4,905 $ 4,727 $ 4,773 $ 4,761 $ 4,616
Gross Margin - Per Car Sold $ 3,901 $ 3,861 $ 3,891 $ 3,769 $ 3,696 $ 3,787
Provision - Per Car Sold $ 2,775 $ 2,627 $ 3,292 $ 2,435 $ 2,242 $ 2,188
Total Operating Expense - Per Car Sold $ 3,092 $ 2,523 $ 2,832 $ 2,495 $ 2,425 $ 2,271
Total Operating Income - Per Car Sold $ 396 $ 416 $ (168) $ 466 $ 691 $ 626
Total Operating Income $ 4.6 $ 6.2 $ (2.0) $ 6.9 $ 9.9 $ 9.9
Earnings before Income Taxes $ 1.7 $ 3.1 $ (4.2) $ 4.5 $ 7.3 $ 7.6
Cost of Used Cars as Percent of Sales 57.3% 56.0% 54.8% 55.9% 56.3% 54.9%
Gross Margin as Percent of Sales 42.7% 44.0% 45.2% 44.1% 43.7% 45.1%
Provision - % of Originations 31.1% 31.0% 38.8% 29.0% 27.1% 27.0%
Total Operating Expense - % of Total Revenues 25.5% 22.8% 24.9% 23.4% 23.0% 22.7%
Segment Operating Expense Data:
Retail Operating Expense - Per Car Sold $ 1,934 $ 1,590 $ 1,710 $ 1,549 $ 1,611 $ 1,481
Retail Operating Expense-% of Used Car Sales 21.2% 18.1% 19.8% 18.1% 19.1% 17.6%
Corporate/Other Expense - Per Car Sold $ 503 $ 376 $ 417 $ 428 $ 418 $ 387
Corporate/Other Expense - % of Total Revenue 4.1% 3.4% 3.7% 4.0% 4.0% 3.9%
Portfolio Exp. Annualized - % of End of Period Managed
Principal 5.8% 6.2% 6.7% 6.1% 5.0% 5.5%
Balance Sheet Data:
Finance Receivables, net $ 544.6 $ 522.9 $ 500.5 $ 491.9 $ 451.2 $ 407.3
Inventory $ 40.8 $ 43.4 $ 63.7 $ 43.7 $ 45.9 $ 49.1
Total Assets $ 679.0 $ 659.5 $ 652.1 $ 618.5 $ 577.5 $ 548.0
Portfolio Notes Payable $ 415.9 $ 390.6 $ 406.6 $ 362.3 $ 316.0 $ 282.9
Subordinated Notes Payable $ 35.0 $ 40.8 $ 34.5 $ 36.1 $ 37.3 $ 28.9
Total Debt $ 493.3 $ 470.9 $ 457.7 $ 416.3 $ 381.0 $ 345.2
Total Stockholder's Equity $ 158.6 $ 157.2 $ 155.4 $ 158.5 $ 166.8 $ 170.6
Common Shares Outstanding - End of Period 12,302 12,292 12,292 12,378 13,899 14,980
Book Value per Share $ 12.89 $ 12.79 $ 12.64 $ 12.81 $ 12.00 $ 11.39
Tangible Book Value per Share $ 11.91 $ 11.79 $ 11.62 $ 11.78 $ 11.02 $ 10.43
Total Debt to Equity 3.1 3.0 2.9 2.6 2.3 2.0
Loan Portfolio Data:
Interest Income $ 34.9 $ 33.8 $ 32.9 $ 31.4 $ 29.9 $ 25.5
Average Yield on Portfolio 26.7% 26.3% 26.1% 26.1% 26.8% 26.2%
Portfolio Interest Expense 7,492 8,519 8,354 7,318 5,997 5,029
Average Borrowing Cost 8.3% 8.9% 8.7% 10.7% 8.6% 8.0%
Principal Balances Originated $ 103.6 $ 126.0 $ 100.8 $ 124.4 $ 118.8 $ 128.1
Principal Balances Originated as % of Sales 97.8% 96.8% 98.5% 98.2% 97.7% 96.5%
Number of Loans Originated 11,558 14,776 11,906 14,748 14,291 15,721
Average Original Amount Financed $ 8,965 $ 8,528 $ 8,468 $ 8,433 $ 8,311 $ 8,150
Number of Loans Originated as % of Units Sold 99.6% 99.5% 100.3% 99.5% 99.5% 99.5%
Portfolio Delinquencies:
Current 76.4% 78.6% 66.1% 72.4% 71.9% 74.8%
1 to 30 days 16.8% 15.7% 26.1% 19.3% 20.9% 19.9%
31 to 60 days 4.1% 3.3% 4.7% 4.9% 4.5% 3.4%
Over 60 days 2.7% 2.4% 3.1% 3.4% 2.7% 1.9%
Principal Outstanding - Retained $ 534.8 $ 535.0 $ 514.9 $ 512.8 $ 472.3 $ 418.9
Number of Loans Outstanding - Retained 86,446 87,033 82,598 79,848 71,518 62,459
11
Second Quarter highlights include:
o Total revenues were $140.8 million
o E-Commerce generated $15.2 million in revenues and 1,686 cars sold
during the second quarter of 2001 as compared to $15.1 million in
revenues and 1,725 cars sold during the first quarter of 2001
o Loan portfolio principal balance was $534.8 million, representing a 13%
increase over the year-ago quarter
o New loan originations were $103.6 million, a 13% decrease from the
year ago quarter
o Closed 20th Securitization with loan principal balances of
approximately $142.3 million and Class A bonds issued of $100.8 million
o Our Chairman of the Board and largest shareholder, Ernest C. Garcia II,
made an offer to purchase all of our outstanding stock
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- Percentage ------------------------------ Percentage
2001 2000 Change 2001 2000 Change
----------------------------- -------------- ------------------------------ --------------
Number of Used Cars Sold 11,607 14,369 (19.2%) 26,458 30,171 (12.3%)
============================= ==============================
Sales of Used Cars $ 105,919 $ 121,527 (12.8%) $ 236,105 $ 254,313 (7.2%)
Cost of Used Cars Sold 60,639 68,417 (11.4%) 133,480 141,359 (5.6%)
----------------------------- ------------------------------
Gross Margin $ 45,280 $ 53,110 (14.7%) $ 102,625 $ 112,954 (9.1%)
============================= ==============================
Gross Margin % 42.7% 43.7% 43.5% 44.4%
Per Car Sold:
Sales $ 9,125 $ 8,458 7.9% $ 8,924 $ 8,429 $ 5.9%
Cost of Used Cars Sold
5,224 4,761 9.7% 5,045 4,684 7.7%
----------------------------- ------------------------------
Gross Margin 3,901 3,696 5.5% 3,879 3,744 3.6%
============================= ==============================
For the three and six-month periods ended June 30, 2001, the number of cars
sold decreased by 19.2% and 12.3%, respectively, over the same periods of the
prior year and Used Car Sales revenues decreased 12.8% and 7.2%, respectively,
over the same periods in 2000. During the latter half of 2000, we developed a
risk management department, which is currently focusing on credit risk modeling
techniques. We believe the decrease in both units sold and revenues is primarily
the result of initiatives which have put more stringent guidelines in place
regarding income qualifications and down payment requirements in an effort to
improve the quality of loans generated from used car sales. To a lesser extent,
we believe a general softening of the economy has led to reduced retail activity
in the sub-prime market.
Our Internet site continues to be a valuable tool generating a steady flow
of credit applications and sales. We accept credit applications from potential
customers via our website, located at http://www.uglyduckling.com. Credit
inquiries received over the web are reviewed by our employees, who then contact
the customers and schedule appointments. Internet applications continue to
provide an increasing amount of Used Cars Sold revenues. During the second
quarter of 2001, through our internet site, we sold 1,686 cars generating $15.2
million in revenue versus 1,725 cars totaling $15.1 million in revenue during
the first quarter of 2001 and up from 1,553 cars sold and $13.7 million in
revenue during the fourth quarter of 2000. We continue to find that the
E-commerce customer group generally outperforms other customers in terms of loan
performance. Accordingly, we continue to monitor and enhance our Internet
application levels.
The Cost of Used Cars Sold for the three and six-month periods ended June
30, 2001 decreased 11.4% and 5.6%, respectively, over the comparable periods of
the previous year. The decrease is due to a decline in the number of used cars
sold, partially offset by an increase in the Cost of Used Cars Sold. The Cost of
Used Cars Sold on a per car basis increased 9.7% and 7.7% for the three and
six-month periods ended June 30, 2001, respectively, over the same periods of
the prior year. The increase is due to an effort to purchase higher quality
vehicles as a result of research completed by our risk management department,
which indicated better loan performance on the loans associated with the higher
cost inventory. This increase was offset by an increase in the sales price
12
earned per car. The gross margin on used car sales (Sales of Used Cars less Cost
of Used Cars Sold excluding Provision for Credit Losses) as a percentage of
related revenue decreased to 42.7% and 43.5% for the three and six-months ended
June 30, 2001 versus 43.7% and 44.4% for the three and six-month periods ended
June 30, 2000. The decrease is due to the cost of used cars sold rising at a
higher pace than the related revenues. For the three months ended June 30, 2001
as compared with the three months ended June 30, 2000, gross margin on a per car
sold basis increased $205 to $3,901 per car and increased $135 to $3,879 for the
six month period ended June 30, 2001 from $3,744 during the same period of the
previous year. This increase is due to an increase in the overall revenue earned
per car, partially offset by the increase in the per unit cost of used cars
sold.
We finance substantially all of our used car sales. The percentage of cars
sold financed and the percentage of sales revenue financed has remained
relatively constant for both the three and six-month periods ended June 30, 2001
versus the comparable periods of 2000. The following table indicates the
percentage of sales units and revenue financed:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------ -----------------------
2001 2000 2001 2000
------------------------ -----------------------
Percentage of used cars sold financed 99.6% 99.5% 99.5% 99.5%
======================== =======================
Percentage of sales revenue financed 97.8% 97.7% 97.3% 97.1%
======================== =======================
Provision for Credit Losses
The following is a summary of the Provision for Credit Losses:
Three Months Ended Six Months Ended
June 30, Percentage June 30, Percentage
-------------------------- --------------------------
2001 2000 Change 2001 2000 Change
-------------------------- -------------- -------------------------- --------------
Provision for Credit Losses $ 32,210 $ 32,212 0.0% $ 71,230 $ 66,785 6.7%
========================== ==========================
Provision per loan originated $ 2,787 $ 2,254 23.6% $ 2,705 $ 2,225 21.6%
========================== ==========================
Provision as a percentage of
principal balances originated 31.1% 27.1% 31.0% 27.0%
========================== ==========================
The Provision for Credit Losses is the amount we charge to current
operations on each car sold to establish an allowance for credit losses.
Measured for financial analysis purposes as a percentage of loan originations,
the Provision for Credit Losses has increased for the three and six-month
periods ended June 30, 2001 over the same periods of the prior year. The
increase was primarily due to an increase in the overall provision charged from
27% of loans originated during the three and six-months ended June 30, 2000 to
31% of loans originated during the same periods of 2001. The increase was
necessary to establish an adequate allowance for the finance receivables. The
provision per loan originated increased 23.6% and 21.6% for the three and
six-month periods ended June 30, 2001 over the same periods of the previous
year. The rise is due to the increase in the overall provision mentioned above,
coupled with an increase of $654 in the average amount financed for the
three-month period ended June 30, 2001 to $8,965 per unit versus $8,311 during
the same period of the previous year. For the six-month period ended June 30,
2001, the average amount financed increased $493 to $8,720 from $8,227 financed
in the equivalent period of the previous year.
See "Static Pool Analysis" below for further Provision for Credit Loss
discussion.
13
Net Interest Income
Three Months Ended Six Months Ended
-------------------------- ------------------------
June 30, Percentage June 30, Percentage
-------------------------- ------------------------
2001 2000 Change 2001 2000 Change
-------------------------- ------------- ------------------------ -------------
Interest Income $ 34,900 $ 29,871 16.8% $ 68,744 $ 55,402 $ 24.1%
Portfolio Interest Expense (7,492) (5,997) 24.9% (16,011) (11,026) 45.2%
-------------------------- ------------------------
Net Interest Income $ 27,408 $ 23,874 14.8% $ 52,733 $ 44,376 18.8%
========================== ========================
Average Effective Yield 26.7% 26.8% 26.5% 26.5%
Average Borrowing Cost 8.3% 9.7% 8.6% 9.4%
Interest Income consists primarily of interest on finance receivable
principal balances retained on our balance sheet. Retained principal balances,
net grew to $544.6 million at June 30, 2001 from $451.2 million at June 30,
2000. The growth in retained principal balances is primarily due to the change
in the way we structure our securitizations to the collateralized borrowing
method during the fourth quarter of 1998. Since that time, all securitized loans
are retained on our balance sheet and the income is recognized over the life of
the loan.
Portfolio interest expense increased to $7.5 million and $16.0 million for
the three and six-month periods ending June 30, 2001, respectively, versus $6.0
million and $11.0 million, respectively, for the same periods of the previous
year. The increase is due to the increase in Portfolio Notes Payable, which
consist of our Class A obligations related to our securitization program, along
with our revolving warehouse facility. This increase in interest expense is
offset by the additional interest income earned from the growth in finance
receivables retained on our balance sheet.
Income before Operating Expenses
Income before Operating Expenses decreased 9.6% to $40.5 million for the
three-month period ended June 30, 2001 and decreased 7.1% to $84.1 million for
the six-month period ended June 30, 2001 as compared to $44.8 million and $90.5
million for the three and six-month periods ended June 30, 2000, respectively.
The decrease resulted from a decrease in Used Car Sales and an increase in the
amount charged to current operations for the provision for credit losses from
27% during 2000 to 31% in the first half of 2001, and an increase in interest
expense resulting from additional portfolio notes payable, partially offset by
an increase in interest income due to the growth in the finance receivables
portfolio.
Operating Expenses
Three Months Ended Six Months Ended
June 30, Percentage June 30, Percentage
------------------------- ------------------------
2001 2000 Change 2001 2000 Change
-------------------------------------- ------------------------ -------------
Operating Expenses $ 35,887 $ 34,849 3.0% $ 73,358 $ 70,730 3.7%
========================= ========================
Per Car Sold $ 3,092 $ 2,425 27.5% $ 2,773 $ 2,344 18.3%
========================= ========================
As % of Total Revenue 25.5% 23.0% 24.1% 22.8%
========================= ========================
Operating expenses, which consist of selling, marketing, general and
administrative and depreciation/amortization expenses, increased slightly
quarter over quarter and for the six months ended June 30, 2001 versus 2000 but
remained relatively constant as a percentage of total revenues. Included in
these expenses for the six-month period ended June 30, 2001, is a pre-tax charge
of approximately $600,000, taken during the first quarter of 2001, for the
closing of the collection and loan administration centers in Florida and Texas.
During the first quarter of 2001, we initiated a plan to close our collections
and loan administration operations in Clearwater, Florida, Plano, Texas and
Dallas, Texas and move them to our stores or to our Gilbert, Arizona collection
facility. As a result of these closings, we took an after tax charge of
approximately $368,000 to cover payroll, severance and certain property related
expenses. We had estimated to take additional restructuring charges in the
second quarter related to costs of abandoned assets still in use with a carrying
value of approximately $500,000. We have taken a charge of approximately
14
$230,000 related to the cost of abandoned assets in Plano, Texas with the
remaining charge for the Clearwater facility expected to be taken during the
third quarter of 2001. The impact resulting from the shut down of these
operations, including the impact of future charges, is estimated to be break
even over the remainder of 2001 and to decrease operating expenses by $1.5
million annually beginning in 2002.
Other Interest Expense
Interest expense arising from our other, non-portfolio debt totaled $2.9
million and $6.0 million for the three and six-months periods ended June 30,
2001 versus $2.6 million and $4.9 million for the comparable periods of the
prior year. The increase is primarily attributable to interest expense arising
from our exchange debt on the exchange offer completed in April 2000.
Income Taxes
Income taxes totaled $0.7 million and $2.0 million for the three and
six-month periods ended June 30, 2001, respectively, versus $3.0 million and
$6.1 million, respectively, for same equivalent periods in 2000. Our effective
tax rate was 41% for all periods presented.
Earnings before Extraordinary Item
Earnings before Extraordinary Item totaled $1.0 million and $2.8 million
for the three and six-month periods ended June 30, 2001, respectively, versus
$4.3 million and $8.8 million, respectively, for the same periods of the
previous year. The decrease is primarily a result of the increase in the
Provision for Credit Loss from 27% to 31% of originations and an increase in
portfolio interest expense, partially offset by an increase in interest income.
Gain on Early Extinguishment of Debt
During the three-months ended June 30, 2001, we repurchased in the open
market and retired approximately $3.2 million of our exchange offer debt due
October 2003, for approximately $2.6 million. The after tax impact of the
purchase was a gain from extinguishment of debt of $0.3 million.
Net Earnings
Net Earnings totaled $1.4 million and $3.2 million for the three and
six-months ended June 30, 2001, respectively, as compared with $4.3 million and
$8.8 million for the same periods of the prior year. The decrease is primarily a
result of a decrease in Used Cars Sold, an increase in the provision for credit
loss from 27% to 31% of originations and an increase in portfolio interest
expense, partially offset by an increase in interest income.
Business Segment Information
We report our operations based on three operating segments. These segments
are reported as Retail, Portfolio and Corporate. These segments were previously
reported as Company Dealership, Company Dealership Receivables and Corporate and
Other, respectively. See Note 6 to the Condensed Consolidated Financial
Statements.
Operating Expenses for our business segments, along with a description of
the included activities, for the three and six-month periods ended June 30, 2001
and 2000 are as follows:
Retail Operations. Operating expenses for our Retail segment consist of
Company marketing efforts, maintenance and development of dealership and
inspection center sites, and direct management oversight of used car
acquisition, reconditioning and sales activities. A summary of retail operating
expenses follows:
15
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------------- ---------------------------------------
2001 2000 2001 2000
------------------- ----------------- ----------------- --------------------
Retail Operations
Selling and Marketing $ 6,235 $ 7,426 $ 13,861 $ 15,561
General and Administrative 14,855 14,593 29,513 28,783
Depreciation and Amortization 1,363 1,133 2,689 2,204
------------------- ----------------- ----------------- --------------------
Retail Expense $ 22,453 $ 23,152 $ 46,063 $ 46,548
=================== ================= ================= ====================
Per Car Sold:
Selling and Marketing $ 537 517 524 516
General and Administrative 1,280 1,016 1,115 954
Depreciation and Amortization 117 79 102 73
------------------- ----------------- ----------------- --------------------
Total $ 1,934 $ 1,612 $ 1,741 $ 1,543
=================== ================= ================= ====================
As % of Used Cars Sold Revenue:
Selling and Marketing 5.9% 6.1% 5.9% 6.1%
General and Administrative 14.0% 12.0% 12.5% 11.3%
Depreciation and Amortization 1.3% 0.9% 1.1% 0.9%
------------------- ----------------- ----------------- --------------------
Total 21.2% 19.1% 19.5% 18.3%
=================== ================= ================= ====================
Selling and Marketing expenses on a per car sold basis have increased due
to a decrease in the amount of cars sold without a proportionate decrease in
expenses, for both the three and six-months ended June 30, 2001, versus the same
period of the previous year. However, selling and marketing costs as a
percentage of Used Cars Sold Revenue have remained relatively constant primarily
due to an increase of $667 and $495 in the average sales price per car for the
three and six months ended June 30, 2001, respectively.
General and Administrative expenses increased both on a per car sold basis
as well as on a percentage of related revenue basis for the three and six-month
periods ended June 30, 2001, principally due to a reduction in the amount of
cars sold and a high proportion of fixed general and administrative costs. We
are in the process of implementing cost savings initiatives across the company
in an effort to improve profitability.
Portfolio Operations. Operating expenses for our Portfolio segment consist
of loan servicing and collection efforts, securitization activities, and other
operations pertaining directly to the administration and collection of the loan
portfolio.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------ --------------------------------------
2001 2000 2001 2000
------------------ ---------------- ------------------ ------------------
Portfolio Expense:
General and Administrative $ 7,359 $ 5,416 $ 15,367 $ 11,493
Depreciation and Amortization 232 280 496 580
------------------ ---------------- ------------------ ------------------
Portfolio Expense $ 7,591 $ 5,696 $ 15,863 $ 12,073
================== ================ ================== ==================
Expense per Month per Loan Serviced $ 29.25 $ 24.06 $ 30.37 $ 26.36
================== ================ ================== ==================
Annualized Expense as % of EOP Managed
Principal Balances 5.8% 5.0% 6.0% 5.3%
================== ================ ================== ==================
The increase in portfolio expenses as well as the expense per month per
loan serviced for the three and six-month periods ended June 30, 2001 for our
Portfolio segment is primarily a result of the increased number of loans in our
portfolio. Also attributing to the increase was approximately $600,000 for the
six-month period ended June 30, 2001, respectively, for costs incurred in
relation to the closing of the collection and loan administration facilities in
Florida and Texas during the first quarter of 2001.
16
Corporate Operations. Operating expenses for our Corporate segment consist
of costs to provide managerial oversight, financings and reporting for the
Company, develop and implement policies and procedures, and provide expertise to
the Company in areas such as finance, legal, human resources and information
technology.
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------ ---------------------------------------
2001 2000 2001 2000
------------------ ---------------- ----------------- --------------------
Corporate Expense:
General and Administrative $ 5,003 $ 5,183 $ 9,775 $ 10,454
Depreciation and Amortization 840 818 1,657 1,655
------------------ ---------------- ----------------- --------------------
Corporate Expense $ 5,843 $ 6,001 $ 11,432 $ 12,109
------------------ ---------------- ----------------- --------------------
Per Car Sold $ 503 $ 418 $ 432 $ 401
================== ================ ================= ====================
As % of Total Revenues 4.1% 4.0% 3.8% 3.9%
================== ================ ================= ====================
Operating expenses related to our Corporate segment as a percent of total
revenue remained relatively consistent for the three and six-months ended June
30, 2001, versus the same period of 2000. However, on a per car sold basis
corporate expenses increased $85 and $31 per car for the three and six-months
ended June 30, 2001, respectively, as compared to the same periods of the
previous year. The increase on a per car sold basis is due to a decline in used
cars sold for both the three and six-months ended June 30, 2001 without a
proportionate reduction in expenses. As mentioned previously, we are taking
steps to implement a cost savings plan in an effort to reduce overall company
expenses.
Financial Position
The following table represents key components of our financial position:
June 30, December 31, Percentage
2001 2000 Change
--------------------------------------------------
Total Assets $ 678,950 $ 652,121 4.1%
Inventory 40,772 63,742 (36.0%)
Finance Receivables, Net 544,585 500,469 8.8%
Net Assets of Discontinued Operations 3,734 4,175 (10.6%)
Total Debt 493,323 457,652 7.8%
Notes Payable - Portfolio 415,877 406,551 2.3%
Other Notes Payable 42,495 16,579 156.3%
Subordinated Notes Payable 34,951 34,522 1.2%
Stockholders' Equity $ 158,604 $ 155,400 2.1%
Total Assets. Total assets has increased slightly due to an increase in
Finance Receivables, Net, partially offset by the decrease in Inventory.
Inventory. Inventory represents the acquisition and reconditioning costs of
used cars located at our dealerships and our inspection centers. Our strong
sales periods are typically the first and second quarters of the year.
Consequently, management increases inventory levels at year-end in preparation
for the upcoming increase in demand. As the increase in demand diminishes,
inventory levels return to normal operating levels, thus the lower inventory
amount as of June 30, 2001.
Growth in Finance Receivables, net. Due to the lack of growth in the volume
of cars sold, Finance Receivables, net as of June 30, 2001 increased only 8.8%
from December 31, 2000. See Note (2) to the Condensed Consolidated Financial
Statements for the details of the components of Finance Receivables, net.
17
The following table reflects the growth in principal balances retained on
our balance sheet measured in terms of the principal balances and the number of
loans outstanding.
Managed Loans Outstanding
-----------------------------------------------------------------------
-----------------------------------------------------------------------
Principal Balances Number of Loans
-----------------------------------------------------------------------
June 30, December 31, June 30, December 31,
2001 2000 2001 2000
-----------------------------------------------------------------------
Principal - Managed $ 534,766 $ 519,005 86,446 84,864
Less: Principal - Securitized and Sold - 4,059 - 2,266
-----------------------------------------------------------------------
Principal - Retained on Balance Sheet $ 534,766 $ 514,946 $ 86,446 $ 82,598
=======================================================================
At June 30, 2001, the entire loan portfolio is on balance sheet. Principal
Balances - Retained on Balance Sheet has increased 3.8%. As we continue to focus
on enhanced underwriting guidelines, we do not expect the portfolio balance to
grow as significantly as in past quarters. The number of loans originated were
11,558 for the quarter ended June 30, 2001, versus 14,291 during the same
quarter of the prior year. For the six-months ended June 30, the number of loans
originated totaled 26,334 in 2001 versus 30,012 in 2000. Although the volume of
loans originated is declining and the number of loans outstanding is leveling,
we believe the quality of the loans written is improving, with the ultimate goal
of reducing loan losses.
The following table reflects activity in the Allowance for Credit Losses,
as well as information regarding charge off activity, for the three and six
months ended June 30, 2001 and 2000:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------------------------------------------------------
2001 2000 2001 2000
------------------ ------------------------------------ -----------------
Allowance Activity:
Balance, Beginning of Period $ 102,000 $ 87,585 $ 99,700 $ 76,150
Provision for Credit Losses 32,210 32,212 71,230 66,785
Other Allowance Activity
(48) (1,104) (6) (1,000)
Net Charge Offs
(32,573) (20,160) (69,335) (43,402)
------------------ ------------------------------------ -------------------
Balance, End of Period $ 101,589 $ 98,533 $ 101,589 $ 98,533
================== ==================================== =================
Allowance as % Ending Principal Balances 19.0% 20.9% 19.0% 20.9%
================== ==================================== =================
The Allowance for Credit Losses is maintained at a level that in
management's judgment is adequate to provide for estimated probable credit
losses inherent in our retail portfolio for the next 12 months. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Static Pool Analysis" below.
Charge offs, net of recoveries, for the three months ended June 30, 2001
and 2000 were $32.6 million and $20.2 million, respectively. As a percentage of
average principal balances, net charge offs for the same periods were 6.1% and
4.1%, respectively. For the six-month periods ended June 30, 2001 and 2000, net
charge offs were $69.4 million and $43.4 million, respectively. Net charge offs
as a percentage of average principal balances for the same periods were 13.0%
and 9.3%, respectively.
During the second quarter of 2001, we inserted 31-60 day collectors into
the majority of the dealerships. Upon initial deployment of the 31-60 day
collectors, we experienced some negative performance as the collectors and
collection managers adapted to collecting and managing the mid-range
delinquencies and a decentralized environment. Adjustments were subsequently
made in an attempt to address the negative performance issues and we ultimately
expect to improve collection performance as a result of the relocation of these
collectors.
While we continue to monitor the adequacy of our allowance for finance
receivables, there can be no assurance that our provision rate, currently 31% of
originations, will be adequate to maintain an allowance balance that will cover
net charge offs for the next twelve months. In particular, the current level of
the allowance is premised in part on projected improvements in collections and
improved underwriting on more recent originations, which, if they don't
materialize, may result in the need for a higher level for the allowance as
early as the third quarter. Consequently, dependent upon our allowance
evaluations in the future, the rate of provision charged may need to be
increased in future quarters.
18
Static Pool Analysis
We use a "static pool" analysis to monitor performance for loans we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge offs for each pool
separately. We calculate the cumulative net charge offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge off. The table below
displays the cumulative net charge offs of each pool as a percentage of original
loan cumulative balances, based on the quarter the loans were originated. The
table is further stratified by the number of payments made by our customers
prior to charge off. For periods denoted by "x", the pools have not seasoned
sufficiently to allow us to compute cumulative losses. For periods denoted by
"-", the pools have not yet reached the indicated cumulative age. While we
monitor static pools on a monthly basis, for presentation purposes we are
presenting the information in the table below on a quarterly basis.
Currently reported cumulative losses may vary from those previously
reported due to ongoing collection efforts on charged off accounts, and the
difference between final proceeds on the sale of repossessed collateral versus
our estimates of the sale proceeds. Management, however, believes that such
variation will not be material.
The following table sets forth as of July 31, 2001, the cumulative net
charge offs as a percentage of original loan cumulative (pool) balances, based
on the quarter of origination and segmented by the number of monthly payments
completed by customers before charge off. The table also shows the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
Pool's Cumulative Net Losses as Percentage of Pool's Original
Aggregate Principal Balance
($ in thousands)
Monthly Payments Completed by Customer Before Charge Off
----------------------------------------------------------------------------------
Orig. 0 3 6 12 18 24 TLI Reduced
---------- -------- -------- -------- -------- -------- -------- -------- --------
1993 $ 12,984 8.8% 22.1% 28.5% 33.8% 35.9% 36.5% 36.8% 100.0%
1994 $ 23,589 5.3% 14.8% 19.9% 25.6% 28.0% 28.7% 28.8% 100.0%
1995 $ 36,569 1.9% 8.1% 13.1% 19.0% 22.2% 23.5% 24.1% 100.0%
1996: $ 48,996 1.5% 8.1% 13.9% 22.1% 26.2% 27.9% 28.9% 100.0%
1997:
1st Quarter $ 16,279 2.1% 10.7% 18.2% 24.8% 29.8% 32.0% 33.5% 100.0%
2nd Quarter $ 25,875 1.5% 9.9% 15.8% 22.7% 27.4% 29.4% 30.6% 100.0%
3rd Quarter $ 32,147 1.4% 8.3% 13.2% 22.4% 26.9% 29.1% 30.6% 99.9%
4th Quarter $ 42,529 1.4% 6.8% 12.6% 21.8% 26.0% 28.7% 29.9% 99.9%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.4% 20.9% 26.3% 28.7% 29.9% 99.8%
2nd Quarter $ 66,908 1.1% 8.1% 14.2% 21.7% 27.2% 29.2% 30.2% 98.4%
3rd Quarter $ 71,027 1.0% 7.9% 13.3% 23.0% 27.7% 30.2% 30.9% 99.1%
4th Quarter $ 69,583 0.9% 6.6% 13.1% 24.2% 29.0% 31.4% 31.9% 97.2%
1999:
1st Quarter $ 103,068 0.8% 7.4% 15.0% 23.5% 29.4% 31.6% 31.9% 93.5%
2nd Quarter $ 95,768 1.1% 9.9% 16.7% 25.3% 31.4% x 33.4% 88.2%
3rd Quarter $ 102,585 1.0% 8.3% 14.2% 25.2% 30.8% -- 31.8% 82.4%
4th Quarter $ 80,641 0.7% 5.9% 12.6% 23.6% x -- 28.3% 74.6%
2000:
1st Quarter $ 128,123 0.3% 6.5% 14.6% 24.2% -- -- 26.3% 66.1%
2nd Quarter $ 118,778 0.6% 8.6% 15.9% x -- -- 24.2% 56.1%
3rd Quarter $ 124,367 0.7% 7.8% 14.4% -- -- -- 18.1% 43.7%
4th Quarter $ 100,823 0.6% 6.7% x -- -- -- 11.1% 29.9%
2001:
1st Quarter $ 126,015 0.4% x -- -- -- -- 4.2% 18.1%
2nd Quarter $ 103,615 x -- -- -- -- -- 0.3% 5.5%
19
The following table sets forth the principal balances delinquency status as
a percentage of total outstanding contract principal balances from dealership
operations.
June 30, 2001 June 30, 2000 December 31, 2000
----------------- ----------------- ----------------------
Days Delinquent:
Current 76.4% 71.9% 66.1%
1-30 Days 16.8% 20.9% 26.1%
31-60 Days 4.1% 4.5% 4.7%
61-90 Days 2.7% 2.7% 3.1%
----------------- ----------------- ----------------------
Total Portfolio 100.0% 100.0% 100.0%
================= ================= ======================
In accordance with our charge off policy, there are no accounts more than
90 days delinquent as of June 30, 2001.
Delinquencies rose during the second quarter of 2001 versus the first
quarter of this year, primarily due to seasonality. However, current and 1-30
day delinquencies have improved over the same quarter of the prior year. The
current accounts, those not one day late, have improved to 76.4% as compared to
71.9% for the second quarter of 2000. Current accounts at March 31, 2001 were
78.6% and were 72.4% and 66.1% at the end of the third and fourth quarters of
2000, respectively. The improvements in 2001 over the prior year quarters are
attributable to the success of the Company's in store collectors which service
the 1-30 day accounts. During the second quarter of 2001, the Company also
inserted 31-60 day collectors into the majority of the dealerships in order to
achieve the same successes as the roll out of the 1-30 day collectors and
continue to make improvements in the loans losses of this category.
Based upon our continued review of the adequacy of the Allowance for Credit
Losses, we have recorded a provision for loan losses for the three and six
months ended June 30, 2001 at 31% of originations. The 31% provision is 1%
higher than the effective 30% provision for 2000 and 4% greater than the 27%
recorded during the first and second quarters of 2000, as losses on our
existing, older portfolio continue to emerge at higher than expected levels.
With the provision recorded during this quarter, we believe the allowance
balance as of June 30, 2001 remains at a level that we estimate to be adequate
to cover net charge offs for the next 12 months.
Securitizations
Under the current legal structure of our securitization program, we sell
loans to our bankruptcy remote subsidiaries that then securitize the loans by
transferring them to separate trusts that issue several classes of notes and
certificates collateralized by the loans. The securitization subsidiaries then
sell Class A bonds or certificates (Class A obligations or Notes Payable)
representing approximately 71% of the total finance receivable balance for the
most recent securitizations to investors and subordinate classes are retained by
us. We continue to service the securitized loans.
The Class A obligations have historically been structured so as to receive
investment grade ratings. To secure the payment of the Class A obligations, the
securitization subsidiaries obtain an insurance policy from MBIA Insurance
Corporation that guarantees payment of amounts to the holders of the Class A
obligations. Additionally, we also establish a cash "reserve" account for the
benefit of the Class A obligation holders. The cash reserve accounts are
classified in our condensed consolidated financial statements as Investments
Held in Trust and are a component of Finance Receivables, net.
Reserve Account Requirements. Under our current securitization structure,
we make an initial cash deposit into a reserve account, generally equivalent to
3.0%-6.0% of the initial underlying Finance Receivables principal balance, and
pledge this cash to the reserve account agent. The trustee then makes additional
deposits to the reserve account out of collections on the securitized
receivables as necessary to fund the reserve account to a specified percentage,
ranging from 8.0% to 11.0%, of the underlying Finance Receivables' principal
balance. The trustee makes distributions to us when:
o the reserve account balance exceeds the specified percentage,
o the required periodic payments to the Class A certificate holders are
current, and
o the trustee, servicer and other administrative costs are current.
Certain Financial Information Regarding Our Securitizations
20
During June 2001, we closed our 20th securitization in which we securitized
$142.3 million of loans, $35.5 million of which was pre-funded, and issued
$100.8 million in Class A certificates with an annual interest rate of 4.74%, a
significant rate improvement from our securitizations closed during 2000.
Liquidity and Capital Resources
We require capital for:
o increases in our loan portfolio, o the seasonal purchase of inventories, and
o working capital and general corporate purposes, o the purchase or lease of property and equipment.
o equity or debt repurchases,
We fund our capital requirements primarily through:
o operating cash flow, o our revolving warehouse and inventory credit lines, and
o securitization transactions, o supplemental borrowings.
While to date we have met our liquidity requirements as needed, there can
be no assurance that we will be able to continue to do so in the future.
Cash Flow
Net cash provided by operating activities decreased $13.7 million to $94.0
million in the six months ended June 30, 2001. The decrease is primarily due to
a significant decrease in accrued liabilities at June 30, 2001 and a decrease in
collections of residuals in finance receivables sold, offset by a decrease in
inventory levels.
Net cash used in investing activities decreased $64.5 million to $94.1
million during the six months ended June 30, 2001 as compared to $158.6 million
used during the same period of 2000. The decrease is due to increased
collections on finance receivables and a decline in the increase of finance
receivables.
Financing activities used $2.2 million for the six months ended June 30,
2001, versus generating $23.5 million during the six months ended June 30, 2000.
The change is primarily due to net payments made on Notes Payable and an
increase in additional deposits into investments held in trust.
Financing Resources
Revolving Facility. In April 2001, we replaced our warehouse receivables
facility, previously with GE Capital, and have extended the $25 million
inventory line of credit portion of the prior facility from June 30, 2001 until
December 31, 2001.
The extension on the inventory line of credit requires us to pay a fee for
each quarterly extension after June 30, 2001, and after June 30, 2001, the
interest rate on the line increases by 50 basis points to LIBOR plus 3.65% and
is secured by substantially all company assets. The interest rate in effect on
this line was 7.31% at June 30, 2001. Currently, we have signed a term sheet
with a lender to replace the inventory line of credit and expect to close on
this facility by August 31, 2001.
Our new revolving facility is with Greenwich Capital Financial Products,
Inc. and allows for maximum borrowings of $75 million during the period May 1
through November 30 increasing to $100 million during the period December 1
through April 30. The term of the facility is 364 days with a renewal option,
upon mutual consent, for an additional 364-day period. The borrowing base
consists of up to 65% of the principal balance of eligible loans originated from
the sale of used cars. The lender maintains an option to adjust the advance rate
to reflect changes in market conditions or portfolio performance. The interest
rate on the facility is LIBOR plus 2.80% (6.96% at June 30, 2001). The facility
is secured with substantially all Company assets. The line is subject to several
covenants, including certain financial and loan portfolio related covenants. At
June 30, 2001, we were in compliance with all of the covenants.
21
Securitizations. Our securitization program is a primary source of our
working capital. Securitizations generate cash flow for us from the sale of
Class A obligations, ongoing servicing fees, and excess cash flow distributions
from collections on the loans securitized after payments on the Class A
obligations, payment of fees, expenses, and insurance premiums, and required
deposits to the reserve accounts.
Securitization also allows us to fix our cost of funds for a given loan
portfolio. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Securitizations" for a more complete description of our
securitization program.
Supplemental Borrowings. In January 2001, we entered into a $35 million
senior secured loan facility as a renewal for our $38 million senior loan
facility originated in May 1999. The new facility has a term of 25 months. Per
the agreement we must make principal payments of $1.0 million per month during
months 4 through 22. Thereafter through maturity, the agreement requires minimum
payments of the greater of $3.0 million per month or 50% of the cash flows from
classes of notes issued through securitization that are subordinate to the A
notes.Interest is payable monthly at LIBOR plus 600 basis points (10.16% at June
30, 2001). The balance on this note was $32.0 million at June 30, 2001.
As a condition to the $35 million senior secured loan agreement, Verde
Investments, Inc., an affiliate of Mr. Garcia, was required to invest $7 million
in us through a subordinated loan. The funds were placed in escrow as additional
collateral for the $35 million senior secured loan. The funds were to be
released in July 2001 if, among other conditions, we had at least $7 million in
pre-tax income through June of 2001 and, at that time, Mr. Garcia would have
guaranteed 33.3% of the $35 million facility. If the loan with Verde and the
guarantee of the $35 million senior secured loan were not removed by July 25,
2001, Mr. Garcia was entitled to receive warrants from us for 1.5 million shares
of stock, vesting over a one-year period, at an exercise price of $4.50 subject
to certain conditions. Under the terms of the senior secured loan agreement, any
necessary shareholder approval is a condition of the issuance of the warrants.
We have been advised by NASDAQ that shareholder approval is required. We, with
Mr. Garcia's consent, have delayed obtaining shareholder approval until after
the resolution of Mr. Garcia's offer to purchase our outstanding common stock.
See item 5 under "Part II -Other Information" for further information on Mr.
Garcia's offer. Also as consideration for the loan, we released all options to
purchase real estate that were then owned by Verde and leased to us. We also
granted Verde the option to purchase, at book value, any or all properties
currently owned by us, or acquired by us prior to the earlier of December 31,
2001, or the date the loan is repaid. Verde agreed to lease the properties back
to us, on terms similar to our current leases, if it exercises its option to
purchase any of the properties. The loan is secured by residual interests in our
securitization transactions but is subordinate to the senior secured loan
facility. The loan requires quarterly interest payments at LIBOR plus 600 basis
points (10.16% at June 30, 2001) and is subject to pro rata reductions if
certain conditions are met. An independent committee of our board reviewed and
negotiated the terms of this subordinated loan and we also received an opinion
from an investment banker, which deemed the loan fair from a financial point of
view both to our shareholders and us. The balance of the note with Verde was
$6.6 million at June 30, 2001.
Capital Expenditures and Commitments
In November 2000, Verde Investments, Inc. ("Verde"), an affiliate of Mr.
Garcia, purchased a certain property located in Phoenix, Arizona and
simultaneously leased the property to us pursuant to among other terms the
following: 20 year term which expires December 31, 2020; rent payable monthly
with 5% annual rent adjustments; triple net lease; four five-year options to
renew; and an option to purchase the property upon prior notice and at Verde's
cost. Subsequently, we surrendered this option as part of the $7 million
subordinated loan with Verde. We are in the process of building a new
headquarters at this location and anticipate an occupancy date of August 2001.
Accounting Matters
In July 2001, the FASB issued Statement No. 141, Business Combinations, and
Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires
that the purchase method of accounting be used for all business combinations
initiated after June 30, 2001 as well as all purchase method business
combinations completed after June 30, 2001. Statement 141 also specifies
criteria intangible assets acquired in a purchase method business combination
must meet to be recognized and reported apart from goodwill. Statement 142 will
require that goodwill and intangible assets with indefinite useful lives no
longer be amortized, but instead tested for impairment at least annually in
accordance with the provisions of Statement 142. Statement 142 will also require
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of.
22
The Company is required to adopt the provisions of Statement 141
immediately and Statement 142 effective January 1, 2002. Furthermore, any
goodwill and any intangible asset determined to have an indefinite useful life
that are acquired in a purchase business combination completed after June 30,
2001 will not be amortized, but will continue to be evaluated for impairment in
accordance with the appropriate pre-Statement 142 accounting literature.
Goodwill and intangible assets acquired in business combinations completed
before July 1, 2001 will continue to be amortized prior to the adoption of
Statement 142.
Statement 141 will require upon adoption of Statement 142, that the Company
evaluate its existing intangible assets and goodwill that were acquired in a
prior purchase business combination, and make any necessary reclassifications in
order to conform with the new criteria in Statement 141 for recognition apart
from goodwill. Upon adoption of Statement 142, the Company will be required to
reassess the useful lives and residual values of all intangible assets acquired
in purchase business combinations, and make any necessary amortization period
adjustments by the end of the first interim period after adoption. In addition,
to the extent an intangible asset is identified as having an indefinite useful
life, the Company will be required to test the intangible asset for impairment
in accordance with the provisions of Statement 142 within the first interim
period. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle in the
first interim period.
As of January 1, 2002, the Company expects to have unamortized goodwill of
approximately $11.6 million and no unamortized identifiable intangible assets.
The goodwill will be subject to the transition provisions of Statements 141 and
142. Amortization expense related to goodwill was approximately $1.0 million,
$0.2 million and $0.5 million for the year ended December 31, 2000 and for the
three and six months ended June 30, 2001, respectively. Because of the extensive
effort needed to comply with adopting Statements 141 and 142, it is not
practicable to reasonably estimate the impact of adopting these Statements on
the Company's financial statements at the date of this report, including whether
any transitional impairment losses will be required to be recognized as the
cumulative effect of a change in accounting principle.
In September 2000, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No.
140). SFAS No. 140 replaces SFAS No. 125 and revises the standards for
accounting for securitizations and other transfers of financial assets and
collateral. This statement is effective for transfers and servicing of financial
assets and extinguishments of liabilities occurring after March 31, 2001. This
statement is effective for recognition and reclassification of collateral and
for disclosures relating to securitization transactions and collateral for
fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did
not have a material impact on us.
In June 2000, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities" (SFAS No. 138). SFAS No. 138 amends
a limited number of issues causing implementation difficulties for entities that
apply SFAS No. 133. SFAS No. 138 is effective for fiscal years beginning after
June 15, 2000. Statement of Financial Accounting Standards No. 133, "Accounting
for Derivative Instruments and Hedging Activities" (SFAS No. 133) required all
derivatives to be recorded on the balance sheet at fair value and establishes
new accounting rules for hedging instruments. The adoption of SFAS No. 138 or
No. 133 did not have a material effect on us.
We Make Forward Looking Statements
This report includes statements that constitute forward-looking statements
within the meaning of the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. We claim the protection of the safe-harbor for
our forward looking statements. Forward-looking statements are often
characterized by the words "may," "anticipates," "believes," "estimates,"
"projects," "expects" or similar expressions and do not reflect historical
facts. Forward-looking statements in this report relate, among other matters,
to: anticipated financial results, such as sales, other revenues and loan
portfolios, improvements in underwriting, adequacy of the allowance for credit
losses, and improvements in recoveries and loan performance, including
delinquencies and charge offs; the closing of the replacement inventory line of
credit; roll-out of collectors to our dealerships; the success of cost control
related initiatives; improvements in inventory and inventory mix; and e-commerce
related growth and loan performance. Forward looking statements include risks,
uncertainties and other factors which may cause our actual results, performance
or achievements to be materially different from those expressed or implied by
such forward looking statements, some of which we cannot predict or quantify.
Factors that could affect our results and cause or contribute to differences
from these forward-looking statements include, but are not limited to: any
decline in consumer acceptance of our car sales strategies or marketing
campaigns; any inability to finance our operations in light of a tight credit
market for the sub-prime industry and our current financial circumstances; any
deterioration in the used car finance industry or increased competition in the
used car sales and finance industry; any inability to monitor and improve our
underwriting and collection processes; any changes in estimates and assumptions
in, and the ongoing adequacy of, our allowance for credit losses; any inability
to continue to reduce operating expenses as a percentage of sales; increases in
interest rates; adverse economic conditions; any material litigation against us
or material, unexpected developments in existing litigation; any new or revised
accounting, tax or legal guidance that adversely affect used car sales or
financing; and developments with respect to Mr. Garcia's offer to take us
private. Future events and actual results could differ materially from the
forward-looking statements.
23
When considering each forward-looking statement, you should keep in mind the
risk factors and cautionary statements found in the sections entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Risk Factors," in our most recent report on Form 10-K, in Exhibit
99 attached to this Quarterly Report on Form 10-Q and elsewhere in our
Securities and Exchange Commission filings. In addition, the foregoing factors
may affect generally our business, results of operations and financial position.
There may also be other factors that we are currently unable to identify or
quantify, but may arise or become known in the future. Forward looking
statements speak only as of the dated the statement was made. We are not
obligated to publicly update or revise any forward looking statements, whether
as a result of new information, future events, or for any other reason.
ITEM 3.
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use financial instruments for trading purposes or to
manage interest rate risk. Our earnings are substantially affected by our net
interest income, which is the difference between the income earned on
interest-bearing assets and the interest paid on interest bearing notes payable.
Increases in market interest rates could have an adverse effect on
profitability.
Our financial instruments consist primarily of fixed rate finance receivables,
residual interests in pools of fixed rate finance receivables, short-term
variable rate revolving Notes Receivable, and variable and fixed rate Notes
Payable. Our finance receivables are classified as subprime loans and generally
bear interest at the lower of 29.9% or the maximum interest rate allowed in
states that impose interest rate limits. At June 30, 2001, the scheduled
maturities on our finance receivables ranged from one to 48 months, with a
weighted average maturity of 23.6 months. The interest rates we charge our
customers on finance receivables has not changed as a result of fluctuations in
market interest rates, although we may increase the interest rates we charge in
the future if market interest rates increase. A large component of our debt at
June 30, 2001 is the Collateralized Notes Payable (Class A obligations) issued
under our securitization program. Issuing debt through our securitization
program allows us to mitigate our interest rate risk by reducing the balance of
the variable revolving line of credit and replacing it with a lower fixed rate
note payable. We are subject to interest rate risk on fixed rate Notes Payable
to the extent that future interest rates are lower than the interest rates on
our existing Notes Payable.
We believe that our market risk information has not changed materially from
December 31, 2000.
24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We sell our cars on an "as is" basis. We require all customers to
acknowledge in writing on the date of sale that we disclaim any obligation for
vehicle-related problems that subsequently occur. Although we believe that these
disclaimers are enforceable under applicable laws, there can be no assurance
that they will be upheld in every instance. Despite obtaining these disclaimers,
in the ordinary course of business, we receive complaints from customers
relating to vehicle condition problems as well as alleged violations of federal
and state consumer lending or other similar laws and regulations. Most of these
complaints are made directly to us or to various consumer protection
organizations and are subsequently resolved. However, customers occasionally
name us as a defendant in civil suits filed in state, local, or small claims
courts. Additionally, in the ordinary course of business, we are a defendant in
various other types of legal proceedings, and are the subject of regulatory or
governmental investigations. Although we cannot determine at this time the
amount of the ultimate exposure from such matters, if any, we do not expect the
final outcome to have a material adverse effect on us.
There has also been litigation filed in connection with or related to the
intent and/or offer of our chairman, Mr. Garcia, to purchase all of our
outstanding common stock not owned by him (See Item 5 below). On March 20, 2001,
a shareholder derivative complaint was filed, purportedly on behalf of Ugly
Duckling Corporation, in the Court of Chancery for the State of Delaware in New
Castle County, captioned Berger v. Garcia, et al., No. 18746NC. The complaint
alleges that our current directors breached fiduciary duties owed to us in
connection with certain transactions between us and Mr. Garcia and various
entities controlled by Mr. Garcia. The complaint was amended on April 17, 2001
to add a second cause of action, on behalf of all persons who own our common
stock, and their successors in interest, which alleges that our current
directors breached fiduciary duties in connection with the proposed acquisition
by Mr. Garcia of all of the outstanding shares of Ugly Duckling common stock.
Ugly Duckling is named as a nominal defendant in the action. The original cause
of action seeks to void all transactions deemed to have been approved in breach
of fiduciary duty and recovery by Ugly Duckling of alleged compensatory damages
sustained as a result of the transactions. The second cause of action seeks to
enjoin us from proceeding with the proposed acquisition by Mr. Garcia, or, in
the alternative, awarding compensatory damages to the class.
Following Mr. Garcia's offer in early April 2001, five additional and
separate purported shareholder class action complaints were filed between April
17 and April 25, 2001 in the Court of Chancery for the State of Delaware in New
Castle County. They are captioned Turberg v. Ugly Duckling Corp., et al., No.
18828NC, Brecher v. Ugly Duckling Corp., et al., No. 18829NC, Suprina v. Ugly
Duckling Corporation, et al., No. 18830NC, Benton v. Ugly Duckling Corp., et
al., No. 18838NC, and Don Hankey Living Trust v. Ugly Duckling Corporation, et
al., No. 18843NC. Each complaint alleges that Ugly Duckling, and its directors,
breached fiduciary duties in connection with the proposed acquisition by Mr.
Garcia of all of the outstanding shares of the Ugly Duckling common stock. The
complaints seek to enjoin the proposed acquisition by Mr. Garcia and to recover
compensatory damages caused by the proposed acquisition and the alleged breach
of fiduciary duties.
These cases were consolidated in June 2001. We intend to vigorously defend
against the plaintiff's allegations and believe that the actions are without
merit.
Item 2. Changes in Securities and Use of Proceeds.
(a) None
(b) None
(c) None
(d) Not Applicable
Item 3. Defaults Upon Senior Securities.
We recently obtained waiver letters for financial ratio covenant breaches
under our revolving credit facility and our senior secured loan facility.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
On April 16, 2001, as previously announced, Mr. Ernest Garcia, II, made an
offer to the board of directors to purchase all of the outstanding shares of our
common stock not already held by him. Under the terms of the offer, the holders
of the outstanding shares of common stock would receive $7.00 per share, $2.00
in cash and $5.00 in subordinated debentures from the acquiring company. The
25
subordinated debentures would have interest payable at 10%, interest only
payments semiannually until maturity and a ten-year term. Mr. Garcia's offer
also states that Greg Sullivan, our chief executive officer and president, would
receive an option to purchase a 20% interest in the acquiring company. The board
of directors established a special transaction committee, composed of
disinterested directors, which is in the process of evaluating the proposal.
There can be no assurance that the proposed transaction regarding Mr.
Garcia's offer to take us private referenced in this Form 10-Q will be
consummated on the proposed terms or any revised terms. In the event that we
accept the proposed transaction, we, and the acquiring company, will likely be
required to file a joint proxy statement/prospectus and to make certain other
filings regarding the proposed transaction with the Securities and Exchange
Commission. Investors and security holders are advised to read all such filings
regarding the proposed transaction, when and if the transaction proceeds and
such filings are made, because they will contain important information.
Investors and security holders may obtain free copies of any such filings (when
and if they become available) and other documents filed by us with the
Commission at the Commission's website at www.sec.gov. Information concerning
any participants in any solicitation of Ugly Duckling stockholders that is made
in connection with the proposed transaction will be disclosed when available.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 99 - Statement Regarding Forward Looking Statements and Risk Factors
(b) Reports on Form 8-K.
During the second quarter of 2001, the Company filed four reports on Form
8-K. The first report on Form 8-K, dated April 19, 2001 and filed April 20,
2001, reported Ugly Duckling's closing of a warehouse receivables loan facility,
the closing of its 19th securitization and the extension of its inventory line
of credit, and filed as an exhibit to the Form 8-K, was a press release dated
April 16, 2001, entitled "Ugly Duckling Announces Closing of Warehouse
Receivables Facility and 19th Securitization, and Extension of Inventory Line of
Credit." The second report on Form 8-K dated April 19, 2001 and filed April 20,
2001, reported the receipt of an offer to purchase the Company, and filed as an
exhibit to the Form 8-K was a press release dated April 16, 2001 entitled "Ugly
Duckling Confirms Receipt of Offer to Purchase Company from Chairman/Largest
Shareholder." The third report on Form 8-K, dated April 27, 2001 and filed April
30, 2001, reported Ugly Duckling's first quarter 2000 earnings, and filed as an
exhibit to the Form 8-K was a press release dated April 25, 2001 entitled "Ugly
Duckling Reports First Quarter 2001 Results." The fourth report filed on Form
8-K, dated May 16, 2001 and filed May 17, 2001, reported the hiring of an
investment banker to evaluate the offer to purchase the Ugly Duckling by our
chairman and litigation issues in connection with the offer.
26
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UGLY DUCKLING CORPORATION
/s/ STEVEN T. DARAK
-----------------------------------------------------------------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: August 14, 2001
EXHIBIT INDEX
Exhibit
Number Description
99 Statement Regarding Forward Looking Statements and Risk Factors