Risk Factors
There are various risks in purchasing our securities and investing in our
business, including those described below. You should carefully consider these
risk factors together with all other information included in this Form 10-Q.
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 and 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 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; and 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. Forward-looking statements speak only as
of the date the statement was made. Future events and actual results could
differ materially from the forward-looking statements. When considering each
forward-looking statement, you should keep in mind the risk factors and
cautionary statements found throughout this Form 10-Q and specifically those
found below. 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. 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.
Our majority stockholder can control substantially all matters put to a
vote of stockholders. Ernest C. Garcia II, our Chairman, is the beneficial owner
of a majority of our outstanding common stock. Mr. Garcia is now in a position
to control the election of our directors or the approval of any merger,
reorganization or other business combination transaction submitted to a vote of
our shareholders or other extraordinary transaction. Mr. Garcia could vote to
approve such a transaction on terms, which might be considered more favorable to
Mr. Garcia than to unaffiliated stockholders. The terms of any such transaction
could require stockholders other than Mr. Garcia to dispose of their shares of
common stock for cash or other consideration even if the stockholders would
prefer to continue to hold their shares of our common stock for investment. Any
such transaction could also result in Ugly Duckling's common stock being
delisted from the Nasdaq National Market or being held of record by fewer than
300 persons and, therefore, eligible for termination of registration pursuant to
Section 12(g)(4) of the Securities Exchange Act of 1934. In filings with the
Securities and Exchange Commission, Mr. Garcia has expressed a continuing
interest in taking us private. For a description of his most recent offer to
purchase our outstanding common stock, see Item 5 of "Part II - Other
Information" included herein.
Future losses could impair our ability to raise capital or borrow money and
consequently affect our stock price. Although we recorded earnings from
continuing operations of $3.2 million for the six months ended June 30, 2001 and
$8.8 million for the six months ended June 30, 2000, we cannot assure you that
we will be profitable in future periods. Losses in future periods could impair
our ability to raise additional capital or borrow money as needed and could
affect our stock price.
We may not be able to continue to obtain the financing we need to fund our
operations and, as a result, our business and profitability could be materially
adversely affected. Our operations require large amounts of capital. We have
borrowed, and will continue to borrow, substantial amounts to fund our
operations. If we cannot obtain the financing we need on a timely basis and on
favorable terms, our business and profitability could be materially adversely
affected. As a result of our primary lender, GE Capital Corporation, exiting the
automobile finance business, our portfolio performance, and a general tightening
in the credit markets, we have recently experienced a less favorable borrowing
environment than in the past. We currently obtain financing through four primary
sources:
o a warehouse facility with Greenwich Capital Financial Products, Inc.
("Greenwich"); o an inventory facility with General Electric Capital
Corporation ("GECC") o securitization transactions; and o loans from other
sources.
Warehouse Facility with Greenwich. When our prior warehouse lender, GE
Capital Corporation, announced that it was exiting the automobile finance
market, we had to replace our GE credit facility with a new facility. Our new
warehouse facility with Greenwich is now our primary source of operating
capital. We have pledged substantially all of our assets to Greenwich to secure
the borrowings we make under this facility. The warehouse facility expires in
April 2002. Under our securitizations, we are required to have a credit facility
reasonably acceptable to the insurer on April 30th of each year. Failure to
maintain such a facility would constitute a termination event under our
securitizations. If we are unable to obtain a replacement facility for the
warehouse facility, our liquidity would be materially adversely affected.
Inventory Line of Credit with GECC. We have extended the $25 million
inventory line of credit portion of our previous revolving credit facility with
GECC from June 30, 2001 to December 31, 2001. If we are unable to obtain a
replacement facility for the inventory line of credit, our liquidity could be
materially adversely affected.
Securitization Transactions. We restore capacity under the warehouse
facility from time to time by securitizing portfolios of finance receivables.
Our ability to successfully and efficiently complete securitizations may be
affected by several factors, including:
o the condition of securities markets generally;
o conditions in the asset-backed securities markets specifically;
o the credit quality of our loan portfolio; and
o the performance of our servicing operations.
In recent periods, we have experienced a tightening of the restrictive
covenants in our securitization transactions as well as increases in the credit
enhancements required to close our securitizations. High delinquency levels and
charge offs or other events, such as our failure to have a warehouse facility
acceptable to the insurer of our securitization transactions in place on April
30 of each year, can also cause a "termination event" under our securitization
transactions, which could result in our being replaced as servicer under those
securitizations or in a liquidation and sale of the securitized portfolios.
These types of occurrences could also cause a "portfolio performance event,"
which could result in all cash flow from the securitized receivables otherwise
distributable on the junior obligations held by us being retained in the trust
as additional security for senior securities. Any of these consequences could
have a material adverse effect on our business and financial condition.
Contractual Restrictions. The warehouse facility, the inventory line of
credit, the securitization program, and our other credit facilities contain
various restrictive covenants, including financial tests. Failure to satisfy the
covenants in our credit facilities or our securitization program could result in
a default (and could preclude us from further borrowing under the defaulted
facility), could cause cross defaults to our other debt, and could prevent us
from securing alternate sources of funds necessary to operate our business. Any
of these events would have a material adverse effect on our business and
financial condition. From time to time, we incur technical or other breaches
under our material credit facilities, and we have obtained waivers from the
applicable lenders. There can be no assurance we will continue to receive
waivers and our inability to obtain these waivers may cause cross defaults to
our other debt and have a material impact on our ability to obtain or retain
operating capital.
We have a high risk of credit losses because of the poor creditworthiness
of our borrowers. Substantially all the sales financing we extend and the loans
that we service are with "sub-prime" borrowers. Sub-prime borrowers generally
cannot borrow money from traditional lending institutions, such as banks,
savings and loans, credit unions, and captive finance companies owned by
automobile manufacturers, because of their poor credit histories and/or low
incomes. Loans to sub-prime borrowers are difficult to collect and are subject
to a high risk of loss. We have established an allowance for credit losses to
cover our anticipated credit losses. We periodically review and may make upward
or downward adjustments to the allowance based upon whether we believe the
allowance is adequate to cover our anticipated credit losses. However, our
allowance may not be sufficient to cover our credit losses and we may need to
increase our provision or allowance if certain adverse factors arise, including
material increases in delinquencies or charge-offs. A significant variation in
the timing of or increase in credit losses in our portfolio or a substantial
increase in our allowance or provision for credit losses would have a material
adverse effect on our net earnings.
We could have a system failure if our current contingency plan is not
adequate, which could adversely affect our ability to collect on loans and
comply with statutory requirements. We depend on our loan servicing and
collection facilities and on long-distance and local telecommunications access
to transmit and process information among our various facilities. We use a
standard program to prepare and store off-site backup tapes of our main system
applications and data files on a routine basis. We regularly revise our
contingency plan. However, the plan as revised may not prevent a systems failure
or allow us to timely resolve any systems failures. Also, a natural disaster,
calamity, or other significant event that causes long-term damage to any of
these facilities or that interrupts our telecommunications networks could have a
material adverse effect on our operations and profitability.
We have slowed our growth, which, eventually, could negatively affect our
earnings and profitability. Since 1999, we have slowed our growth in favor of an
accelerated stock buy back program. Our ability to continue our growth is now
limited by our access to capital. We are also committed to slowing our growth
until we improve our loan loss experience. As additional capital is secured, we
will consider whether to resume or accelerate our expansion plans or to continue
repurchasing our stock or debt. We do not expect a slowdown in growth to
adversely impact revenues or earnings in 2001. Thereafter, we expect that a
failure to grow could eventually affect our earnings and/or profitability.
Even if we make acquisitions, such acquisitions may be unsuccessful or
strain or divert our resources from more profitable operations. Although we have
decided to slow our growth during the foreseeable future, we intend to consider
additional acquisitions, alliances, and transactions involving other companies
that could complement our existing business if we can do so with little or no
capital or if we can raise capital sufficient for any such transaction. However,
we may not be able to identify suitable acquisition parties, joint venture
candidates, or transaction counter parties. Even if we can identify suitable
parties, we may not be able to consummate these transactions on terms that we
find favorable.
We may also not be able to successfully integrate any businesses that we
acquire into our existing operations. If we cannot successfully integrate any
future acquisitions, our operating expenses may increase, which would affect our
net earnings. Moreover, these types of transactions may result in the incurrence
of additional debt and amortization of expenses related to goodwill and
intangible assets, all of which could adversely affect our profitability. These
transactions also involve numerous other risks, including the diversion of
management attention from other business concerns, entry into markets in which
we have had no or only limited experience, and the potential loss of key
employees of acquired companies. Occurrence of any of these risks could have a
material adverse effect on us.
We have continuing risks relating to the First Merchants transactions. We
have entered into several transactions in the bankruptcy proceedings of First
Merchants Acceptance Corporation. We have the right to 17.5% of recoveries on
First Merchants' residual interests in certain securitized loan pools and other
loans. However, if we lose our right to service these loans, our share of these
residual interests could be reduced or eliminated. This could affect our future
cash flow and profitability.
Interest rates affect our profitability. Much of our financing income
results from the difference between the rate of interest that we pay on the
funds we borrow and the rate of interest that we earn on the loans in our
portfolio. While we earn interest on the loans that we own at a fixed rate, we
pay interest on our borrowings under our warehouse facility and certain other
debt at a floating rate. When interest rates increase, our interest expense
increases and our net interest margins decrease. Increases in our interest
expense that we cannot offset by increases in interest income will lower our
profitability.
Laws that limit the interest rates that we can charge can adversely affect
our profitability. We operate in many states that impose limits on the interest
rate that a lender may charge. When a state limits the amount of interest that
we can charge on our installment sales loans, we may not be able to offset any
increased interest expense caused by rising interest rates or greater levels of
borrowings under our credit facilities. Therefore, these interest rate
limitations can adversely affect our profitability.
Government regulations may limit our ability to recover and enforce
receivables or to repossess and sell collateral. We are subject to ongoing
regulation, supervision, and licensing under various federal, state, and local
statutes, ordinances, and regulations. If we do not comply with these laws, we
could be fined or certain of our operations could be interrupted or shut down.
Failure to comply could, therefore, have a material adverse effect on our
operations.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. We may not,
however, be able to remain in compliance with such laws. In addition, the
adoption of additional statutes and regulations, changes in the interpretation
of existing statutes and regulations, or our entry into jurisdictions with more
stringent regulatory requirements could also have a material adverse effect on
our operations.
We are subject to pending actions and investigations relating to our
compliance with various laws and regulations. While we do not believe that
ultimate resolution of these matters will result in a material adverse effect on
our business or financial condition (such as fines, injunctions or damages),
there can be no assurance in this regard.
Increased competition could adversely affect our operations and
profitability. Our primary competitors are the numerous small buy-her pay-here
used car dealers that operate in the sub-prime segment of the used car sales
industry. We attempt to distinguish ourselves from our competitors through name
recognition and other factors. However, the advertising and infrastructure
required by these efforts increase our operating expenses. There is no assurance
that we can successfully distinguish ourselves and compete in this industry. In
addition, in recent years, a number of larger companies with significant
financial and other resources have entered or announced plans to enter the used
car sales industry. Although these companies do not currently compete with us in
the sub-prime segment of the market, they compete with us in the purchase of
inventory, which can result in increased wholesale costs for used cars and lower
margins. They could also enter the sub-prime segment of the market at any time.
Increased competition may cause downward pressure on the interest rates
that we charge on loans originated by our dealerships. Either change could have
a material effect on the value of our securities.
The success of our operations depends on certain key personnel. We believe
that our ability to successfully implement our business strategy and to operate
profitably depends on the continued employment of our senior management team.
The unexpected loss of the services of any of our key management personnel or
our inability to attract new management when necessary could have a material
adverse effect on our operations. We do not currently maintain key person life
insurance on any member of our senior management team other than Gregory B.
Sullivan, our President and Chief Executive Officer.
We may issue stock in the future that will dilute the value of our existing
stock. We have the ability to issue common stock or securities exercisable for
or convertible into common stock, which may dilute the securities our existing
stockholders now hold. In particular, issuance of some or all of the following
securities may dilute the value of the securities that our existing stockholders
now hold:
o we have granted warrants to purchase a total of approximately 700,000
shares of our common stock to various parties, with exercise prices ranging
from $6.75 to $10.81 per share;
o we may issue additional warrants in connection with future transactions;
o we may issue common stock under our various stock option plans; and
o we may issue common stock in the First Merchants transaction in exchange
for an increased share of collections on certain loans that we service for
First Merchants.
o we have committed to issue 1.5 million warrants to Mr. Garcia, subject to
certain conditions.
There is a potential anti-takeover or dilutive effect if we issue preferred
stock. Our certificate of incorporation authorizes us to issue "blank check"
preferred stock. Our board of directors may fix or change from time to time the
designation, number, voting powers, preferences, and rights of this stock. Such
issuances could make it more difficult for a third party to acquire us by
reducing the voting power or other rights of the holders of our common stock.
Preferred stock can also reduce the market value of the common stock.
There may be adverse consequences from issuing blank check common stock,
including a potential anti-takeover or dilutive effect. Our certificate of
incorporation authorizes us to issue additional series of common stock, which we
refer to as "blank check" common stock. Our board of directors may create new
series of common stock from time to time in addition to the existing common
stock and may fix:
o the designation, voting powers, liquidation rights, conversion rights,
redemption rights, dividends and distributions, preferences and relative,
participating, optional and other rights, if any, of each such series;
o the qualifications, limitations or restrictions, if any, of each such
series; and
o the number of shares constituting each such series.
Blank check common stock could also:
o negatively affect shareholder rights and the value of existing common
stock;
o have rights that are preferential or superior to the existing common stock;
o track the performance of certain assets, groups of assets, businesses or
subsidiaries of the company;
o increase the complexity and administrative costs of our capital structure,
which could negatively impact our financial condition and the value of our
common stock;
o create potential conflicts of interest and our board of directors could
make decisions that adversely affect holders of our existing common stock;
and/or
o give rise to occasions when the interests of holders of one series might
diverge or appear to diverge from the interests of holders of another
series.
Blank check common stock also may be viewed as being an "anti-takeover" device.
Our board could create and issue series of common stock with terms that could
make a takeover attempt by a third party more difficult to complete and such
stock may also be used in connection with the issuance of a stockholder rights
plan, sometimes called a "poison pill."