================================================================================
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: September 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.)
4020 E. Indian School Road
Phoenix, Arizona 85018
(Address of principal executive (Zip Code)
offices)
(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 November 12, 2001, there were approximately 12,274,000 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.
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UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page
Part I - FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets-- September 30, 2001 and December 31, 2000 1
Condensed Consolidated Statements of Operations-- Three and Nine Months Ended
September 30, 2001 and 2000 2
Condensed Consolidated Statements of Cash Flows-- Nine Months Ended
September 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 24
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 25
SIGNATURES 25
ITEM 1.
UGLY DUCKLING CORPORATION
Consolidated Balance Sheets
(In thousands, except share amounts)
(Unaudited)
September 30, December 31,
2001 2000
------------------ -----------------
ASSETS
Cash and Cash Equivalents $ 7,384 $ 8,805
Finance Receivables, Net 501,048 500,469
Note Receivable from Related Party 12,000 12,000
Inventory 47,414 63,742
Property and Equipment, Net 39,487 38,679
Intangible Assets, Net 11,808 12,527
Other Assets 34,555 11,724
Net Assets of Discontinued Operations 4,044 4,175
------------------ -----------------
$ 657,740 $ 652,121
================== =================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 3,104 $ 2,239
Accrued Expenses and Other Liabilities 42,268 36,830
Notes Payable - Portfolio 386,572 406,551
Other Notes Payable 41,646 16,579
Subordinated Notes Payable 32,600 34,522
------------------ -----------------
Total Liabilities 506,190 496,721
------------------ -----------------
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 12,275 and
12,292 outstanding, respectively 19 19
Additional Paid-in Capital 173,741 173,723
Retained Earnings 18,141 21,772
Treasury Stock, at cost (40,351) (40,114)
------------------ -----------------
Total Stockholders' Equity 151,550 155,400
Commitments and Contingencies - -
------------------ -----------------
$ 657,740 $ 652,121
================== =================
See accompanying notes to Condensed Consolidated Financial Statements.
1
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Nine Months Ended September 30, 2001 and 2000
(In thousands, except cars sold and earnings per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ------------------------------
2001 2000 2001 2000
============================ ==============================
Sales of Used Cars $110,237 $ 126,636 $ 346,342 $ 380,949
Less:
Cost of Used Cars Sold 62,622 70,760 196,102 212,119
Provision for Credit Losses 48,755 36,092 119,985 102,877
---------------------------- ------------------------------
(1,140) 19,784 30,255 65,953
---------------------------- ------------------------------
Other Income (Expense):
Interest Income 35,000 31,436 103,744 86,838
Portfolio Interest Expense (7,489) (7,318) (23,500) (18,344)
---------------------------- ------------------------------
Net Interest Income 27,511 24,118 80,244 68,494
---------------------------- ------------------------------
Income before Operating Expenses 26,371 43,902 110,499 134,447
Operating Expenses:
Selling and Marketing 6,084 7,187 19,945 22,748
General and Administrative 26,807 27,523 81,462 78,253
Depreciation and Amortization 2,339 2,285 7,181 6,724
---------------------------- ------------------------------
Operating Expenses 35,230 36,995 108,588 107,725
---------------------------- ------------------------------
Income (loss) before Other Interest Expense (8,859) 6,907 1,911 26,722
Other Interest Expense 2,695 2,360 8,648 7,237
---------------------------- ------------------------------
Earnings (loss) before Income Taxes (11,554) 4,547 (6,737) 19,485
Income Taxes (Benefit) (4,737) 1,864 (2,762) 7,971
---------------------------- ------------------------------
Earnings (loss) before Extraordinary Item (6,817) 2,683 (3,975) 11,514
Extraordinary Item - Gain on early
extinguishment of debt, net - - 344 -
---------------------------- ------------------------------
Net Earnings (loss) $ (6,817) $ 2,683 $ (3,631) $ 11,514
============================ ==============================
Earnings (loss) per Common Share before Extraordinary Item:
Basic $ (0.56) $ 0.21 $ (0.32) $ 0.83
============================ ==============================
Diluted $ (0.56) $ 0.21 $ (0.32) $ 0.82
============================ ==============================
Net Earnings (loss) per Common Share:
Basic $ (0.56) $ 0.21 $ (0.30) $ 0.83
============================ ==============================
Diluted $ (0.56) $ 0.21 $ (0.30) $ 0.82
============================ ==============================
Weighted Average Shares Used in Computation:
Basic Shares Outstanding 12,276 12,597 12,289 13,847
============================ ==============================
Diluted Shares Outstanding
12,276 12,747 12,289 14,044
============================ ==============================
See accompanying notes to Condensed Consolidated Financial Statements.
2
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months ended September 30, 2001 and 2000
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
-----------------------------
2001 2000
-----------------------------
Cash Flows from Operating Activities:
Net Earnings (Loss) $ (3,631) $ 11,514
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 119,985 102,877
Depreciation and Amortization 10,632 10,453
(Gain) Loss from Disposal of Property and Equipment 755 3
Collections from Residuals in Finance Receivables Sold 1,136 13,055
Decrease in Inventory 16,328 19,126
(Increase) Decrease in Other Assets (16,068) 600
Increase (Decrease) in Accounts Payable, Accrued Expenses and Other Liabilities (499) 14,040
Increase (Decrease) in Income Taxes Payable 6,802 (558)
-----------------------------
Net Cash Provided by Operating Activities 135,440 171,110
-----------------------------
Cash Flows Used in Investing Activities:
Increase in Finance Receivables (313,376) (392,788)
Collections on Finance Receivables 184,926 157,067
Decrease in Investments Held in Trust on Finance Receivables Sold 1,398 7,969
Proceeds from Disposal of Property and Equipment 2,542 3,142
Purchase of Property and Equipment (10,569) (11,625)
-----------------------------
Net Cash Used in Investing Activities (135,079) (236,235)
-----------------------------
Cash Flows from Financing Activities:
Initial Deposits at Securitization into Investments Held in Trust (6,407) (20,738)
Additional Deposits into Investments Held in Trust (69,358) (10,849)
Collections from Investments Held in Trust 81,118 17,544
Additions to Notes Payable Portfolio 447,328 554,153
Repayment of Notes Payable Portfolio (469,638) (469,481)
Additions to Other Notes Payable 44,232 1,267
Repayment of Other Notes Payable (19,873) (20,133)
Repayment of Subordinated Notes Payable (9,333) (1,500)
Proceeds from Issuance of Common Stock 18 437
Acquisition of Treasury Stock - (11,114)
-----------------------------
Net Cash (Used)Provided by Financing Activities (1,913) 39,586
-----------------------------
Net Cash Provided by Discontinued Operations 131 28,411
-----------------------------
Net Increase (Decrease) in Cash and Cash Equivalents
(1,421) 2,872
Cash and Cash Equivalents at Beginning of Period 8,805 3,683
-----------------------------
Cash and Cash Equivalents at End of Period $ 7,384 $ 6,555
=============================
Supplemental Statement of Cash Flows Information:
Interest Paid $ 28,437 $ 20,712
=============================
Income Taxes Paid $ 4,258 $ 8,524
=============================
Acquisition of Treasury Stock with Subordinated Debt $ - $ 8,005
=============================
Acquisition of Treasury Stock in Conjunction with Severance Agreement $ 237 $ -
=============================
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:
September 30, December 31,
2001 2000
----------------- -----------------
Contractually Scheduled Payments $ 727,051 $ 696,220
Unearned Finance Charges (189,105) (181,274)
----------------- -----------------
Principal Balances, net 537,946 514,946
Accrued Interest 5,981 5,655
Loan Origination Costs 7,233 7,293
----------------- -----------------
Principal Balances, net 551,160 527,894
Investments Held in Trust 64,388 71,139
Residuals in Finance Receivables Sold - 1,136
----------------- -----------------
Finance Receivables 615,548 600,169
Allowance for Credit Losses (114,500) (99,700)
----------------- -----------------
Finance Receivables, net $ 501,048 $ 500,469
================= =================
Allowance as % of Ending Principal Balances, net 21.3% 19.4%
================= =================
Investments Held in Trust represent funds held by trustees on behalf of our
securitization bondholders.
Note 3. Related Party Transactions
On September 21, 2001, Mr. Ernest C. Garcia II, the Company's Chairman of
the Board and largest shareholder, confirmed to the Board of Directors the
withdrawal of his offer to purchase all of the outstanding stock of the Company
not owned by him.
In May 2001, Verde purchased one of the Company properties at its book
value of approximately $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 approximately 2% in year two and annual CPI adjustments
thereafter.
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
4
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.
Note 4. Notes Payable
Notes Payable, Portfolio
A summary of Notes Payable, Portfolio at September 30, 2001 and December 31, 2000:
September 30, December 31,
2001 2000
---------------- ----------------
Revolving Facility for $125.0 million with GE Capital, secured by substantially all
assets of the Company, terminated April 2001 $ - $ 53,326
Revolving Facility for $75.0 - $100.0 million with Greenwich Capital Financial Products,
Inc, secured by substantially all assets of the Company, not otherwise pledged 64,476 -
Class A obligations issued pursuant to the Company's Securitization Program,
secured by underlying pools of finance receivables and investments held in trust
totaling $482.5 million and $543.0 million at September 30, 2001, and December 31,
2000, respectively 325,024 355,972
---------------- ----------------
Subtotal 389,500 409,298
Less: Unamortized Loan Fees 2,928 2,747
---------------- ----------------
Total $ 386,572 $ 406,551
================ ================
Effective April 2001, the Company replaced the warehouse receivables
portion of the GE Capital facility. The new warehouse 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% (6.18% at September 30, 2001). At September 30, 2001, the
Company was not in compliance with the interest coverage ratio covenant of this
facility and received a waiver from the lender. The Company was in compliance
with all other required covenants.
Class A obligations have interest payable monthly at rates ranging from
3.44% to 7.26%. 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 September 30, 2001 and December 31, 2000
follows:
September 30, December 31,
2001 2000
----------------- -----------------
Note payable, secured by the capital stock of UDRC II, UDRC III, UDRC IV, and
certain other receivables $ 29,000 $ 11,141
Revolving Facility for $36.0 million with Automotive Finance Corporation, secured by the
Company's automobile inventory 7,105 -
Other notes payable bearing interest at rates ranging from 7.5% to 11% due through
October 2015, secured by certain real property and certain property and equipment 6,340 5,637
----------------- -----------------
Subtotal 42,445 16,778
Less: Unamortized Loan Fees 799 199
----------------- -----------------
Total $ 41,646 $ 16,579
================= =================
Effective August 31, 2001, the Company replaced the inventory line of
credit portion of the GE Capital facility. The new revolving inventory facility
is for $36 million, an $11 million increase from the prior facility, and expires
in June of 2003. The borrowing base is calculated on advance rates on inventory
purchased, ranging from 80% to 100% of the purchase price. The interest rate on
the facility is PRIME plus 6.0% (12.0% at September 30, 2001). The facility is
secured with the Company's automobile inventory. At September 30, 2001, the
Company was not in compliance with certain interest coverage ratios and received
a waiver from the lenders. The Company was in compliance with all other required
covenants.
5
Subordinated Notes Payable
A summary of Subordinated Notes Payable at September 30, 2001 and December 31,
2000 follows:
September 30, December 31,
2001 2000
----------------- -----------------
$13.5 million senior subordinated notes payable to unrelated parties, bearing
interest at 15% per annum payable quarterly, principal due February 2003
and is senior to subordinated debentures $ 6,000 $ 11,500
$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
$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 6,000 -
----------------- -----------------
Subtotal
37,779 40,919
Less: Unamortized Loan Fees - 915
Unamortized Discount - subordinated debentures 5,179 5,482
----------------- -----------------
Total $ 32,600 $ 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, net associated unamortized
discount, 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.
Note 5. Common Stock Equivalents
Net Earnings (Loss) per common share amounts are based on the weighted average number of common shares and common
stock equivalents outstanding for the three and nine-month periods ended September 30, 2001, and 2000.
Net Earnings (Loss) per common share are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- -----------------------------
2001 2000 2001 2000
-------------------------------- -----------------------------
Net Earnings (Loss) before Extraordinary Item $ (6,817) $ 2,683 $ (3,975) $ 11,514
================================ =============================
Net Earnings (Loss) $ (6,817) $ 2,683 $ (3,631) $ 11,514
================================ =============================
Basic Earnings (Loss) Per Share before Extraordinary Item $ (0.56) $ 0.21 $ (0.32) $ 0.83
================================ =============================
Diluted Earnings (Loss) Per Share before Extraordinary Item $ (0.56) $ 0.21 $ (0.32) $ 0.82
================================ =============================
Basic Net Earnings (Loss) Per Share $ (0.56) $ 0.21 $ (0.30) $ 0.83
================================ =============================
Diluted Net Earnings (Loss) Per Share $ (0.56) $ 0.21 $ (0.30) $ 0.82
================================ =============================
Basic EPS-Weighted Average Shares Outstanding
12,276 12,597 12,289 13,847
Effect of Diluted Securities:
Stock Options - 147 - 187
Warrants - 3 - 10
-------------------------------- -----------------------------
Dilutive EPS-Weighted Average Shares Outstanding
12,276 12,747 12,289 14,044
================================ =============================
Warrants Not Included in Diluted EPS Since Antidilutive 351 1,124 351 1,124
================================ =============================
Stock Options Not Included in Diluted EPS Since Antidilutive 1,430 845 1,453 857
================================ =============================
In the three-month period ending September 30, 2001, under severance
agreements, the Company acquired approximately $237,000 of treasury stock in
satisfaction of three former officers' notes payable to the Company.
6
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). Identifiable assets by
business segment are those assets used in each segment of Company operations.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Business Segment Information" for further Business Segment
information.
A summary of operating activity by business segment for the three and
nine-month periods ended September 30, 2001 and 2000 follows:
Retail Portfolio Corporate Total
------------- ------------- ------------- -------------
Three months ended September 30, 2001
Sales of Used Cars $ 110,237 $ - $ - $ 110,237
Less: Cost of Cars Sold 62,622 - - 62,622
Provision for Credit Losses 23,223 25,532 - 48,755
------------- ------------- ------------- -------------
24,392 (25,532) - (1,140)
Net Interest Income - 27,511 - 27,511
------------- ------------- ------------- -------------
Income before Operating Expenses 24,392 1,979 - 26,371
------------- ------------- ------------- -------------
Operating Expenses:
Selling and Marketing 6,084 - - 6,084
General and Administrative 13,867 7,286 5,654 26,807
Depreciation and Amortization 1,419 236 684 2,339
------------- ------------- ------------- -------------
21,370 7,522 6,338 35,230
------------- ------------- ------------- -------------
Operating Income (Loss) before Other Interest Expense $ 3,022 $ (5,543) $ (6,338) $ (8,859)
============= ============= ============= =============
Capital Expenditures $ 273 $ 131 $ 2,043 $ 2,447
============= ============= ============= =============
Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 84,344 $ 496,775 $ 72,577 $ 653,696
============= ============= ============= =============
Retail Portfolio Corporate Total
------------- ------------- ------------- -------------
Three months ended September 30, 2000:
Sales of Used Cars $ 126,636 $ - $ - $ 6,636
Less: Cost of Cars Sold 70,760 - - 70,760
Provision for Credit Losses 26,162 9,930 - 36,092
------------- ------------- ------------- -------------
29,714 (9,930) - 19,784
Net Interest Income - 24,006 112 24,118
------------- ------------- ------------- -------------
Income before Operating Expenses 29,714 14,076 112 43,902
------------- ------------- ------------- -------------
Operating Expenses:
Selling and Marketing 7,187 - - 7,187
General and Administrative 14,570 7,411 5,542 27,523
Depreciation and Amortization 1,201 278 806 2,285
------------- ------------- ------------- -------------
22,958 7,689 6,348 36,995
------------- ------------- ------------- -------------
Operating Income (Loss) before Other Interest Expense $ 6,756 $ 6,387 $ (6,236) $ 6,907
============= ============= ============= =============
Capital Expenditures $ 2,161 $ 615 $ 2,338 $ 5,114
============= ============= ============= =============
Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 78,542 $ 516,377 $ 19,353 $ 614,272
============= ============= ============= =============
7
Retail Portfolio Corporate Total
------------- ------------- ------------- -------------
Nine Months Ended September 30, 2001
Sales of Used Cars $ 346,342 $ - $ - $ 346,342
Less: Cost of Cars Sold 196,102 - - 196,102
Provision for Credit Losses 71,773 48,212 - 119,985
------------- ------------- ------------- -------------
78,467 (48,212) - 30,255
Net Interest Income - 80,114 130 80,244
------------- ------------- ------------- -------------
Income before Operating Expenses 78,467 31,902 130 110,499
------------- ------------- ------------- -------------
Operating Expenses:
Selling and Marketing 19,945 - - 19,945
General and Administrative 43,380 22,653 15,429 81,462
Depreciation and Amortization 4,108 732 2,341 7,181
------------- ------------- ------------- -------------
67,433 23,385 17,770 108,588
------------- ------------- ------------- -------------
Operating Income (Loss) before Other Interest Expense $ 11,034 $ 8,517 $ (17640) $ 1,911
============= ============= ============= =============
Capital Expenditures $ 3,517 $ 718 $ 6,334 $ 10,569
============= ============= ============= =============
Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 84,344 $ 496,775 $ 72,577 $ 653,696
============= ============= ============= =============
Retail Portfolio Corporate Total
Nine Months Ended September 30, 2000 ------------- ------------- ------------- -------------
Sales of Used Cars $ 380,949 $ - $ - 380,949
Less: Cost of Cars Sold 212,119 - - 212,119
Provision for Credit Losses 77,994 24,883 - 102,877
------------- ------------- ------------- -------------
90,836 (24,883) - 65,953
Net Interest Income - 68,162 332 68,494
------------- ------------- ------------- -------------
Income before Operating Expenses 90,836 43,279 332 134,447
------------- ------------- ------------- -------------
Operating Expenses:
Selling and Marketing 22,748 - - 22,748
General and Administrative 43,353 18,904 15,996 78,253
Depreciation and Amortization 3,405 858 2,461 6,724
------------- ------------- ------------- -------------
69,506 19,762 18,457 107,725
------------- ------------- ------------- -------------
Operating Income (Loss) before Other Interest Expense $ 21,330 $ 23,517 $ (18,125) $ 26,722
============= ============= ============= =============
Capital Expenditures $ 5,654 $ 909 $ 5,062 $ 11,625
============= ============= ============= =============
Identifiable Assets, Excluding Net Assets of Discontinued Operations $ 78,542 $ 516,377 $ 19,353 $ 614,272
============= ============= ============= =============
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.
Note 9. Subsequent Events
In October 2001, a special transaction committee of the board recommended
and the board approved a $10 million repurchase program under which the company
is authorized to repurchase its common stock and/or subordinated debentures, or
any combination of both, subject to certain conditions, including any required
lender approvals and further committee and board approval of stock repurchases
over $3 million.
8
In October 2001, the Company completed its 21st securitization, consisting
of approximately $145.9 million in principal balances and the issuance of
approximately $103.6 million in Class A bonds, including a pre-funded amount of
approximately $25.9 million. The Company will subsequently provide an additional
$36.5 million of the $145.9 million in loans as collateral for the pre-funded
amount. The coupon rate on the Class A bonds is 3.44%, the initial deposit into
the Reserve Account was 2.25% and the Reserve Account maximum is 8%.
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 September 30, 2001, we operated 76 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 thedealerships. 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 upgrading 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 Operations. 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 end 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 nine-month periods
ended September 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
($ and shares in millions, except per share, per unit data and number of loan data)
(Unaudited)
At or For the Three Months Ended
--------------------------------------------------------------------
Selected Consolidated Financial Data Sept June Mar Dec Sept June Mar
2001 2001 2001 2000 2000 2000 2000
--------- ------- ------- ------- ------- ------ ------
Operating Data:
Total Revenues $ 145.2 $140.8 $164.0 $ 135.2 $158.1 $151.4 $158.3
Sales of Used Cars $ 110.2 $105.9 $130.2 $ 102.3 $126.6 $121.5 $132.8
Net Earnings (Loss) per Share $ (0.56) $ 0.11 $ 0.15 $(0.20) $ 0.21 $ 0.31 $ 0.30
EBITDA $ 1.0 $ 14.5 $ 17.1 $ 8.7 $ 16.5 $ 18.2 $ 17.1
E-Commerce Sales as % of Sales of Used Cars 14.2% 14.4% 11.6% 13.6% 9.5% 5.3% 4.3%
Number Dealerships in Operation 76 77 77 77 77 77 75
Average Sales per Dealership per Month 52 50 64 51 64 62 70
Number of Used Cars Sold 11,907 11,607 14,851 11,874 14,825 14,369 15,802
Sales Price - Per Car Sold $ 9,258 $9,125 $8,766 $8,618 $8,542 $8,458 $8,403
Cost of Sales - Per Car Sold $ 5,259 $5,224 $4,905 $4,727 $4,773 $4,761 $4,616
Gross Margin - Per Car Sold $ 3,999 $3,901 $3,861 $3,891 $3,769 $3,696 $3,787
Provision - Per Car Sold $ 4,095 $2,775 $2,627 $3,292 $2,435 $2,242 $2,188
Total Operating Expense - Per Car Sold $ 2,959 $3,092 $2,523 $2,832 $2,495 $2,425 $2,271
Total Operating Income - Per Car Sold $ (744) $ 396 $ 416 $(168) $ 466 $ 691 $ 626
Total Operating Income (Loss) $ (8.9) $ 4.6 $ 6.2 $ (2.0) $ 6.9 $ 9.9 $ 9.9
Earnings (Loss) before Income Taxes $ (11.6) $ 1.7 $ 3.1 $ (4.2) $ 4.5 $ 7.3 $ 7.6
Cost of Used Cars as % of Sales 56.8% 57.3% 56.0% 54.8% 55.9% 56.3% 54.9%
Gross Margin as % of Sales 43.2% 42.7% 44.0% 45.2% 44.1% 43.7% 45.1%
Provision - % of Originations 44.7% 31.1% 31.0% 38.8% 29.0% 27.1% 27.0%
Total Operating Expense - % of Total Revenues 24.3% 25.5% 22.8% 24.9% 23.4% 23.0% 22.7%
Segment Operating Expense Data:
Retail Operating Expense - Per Car Sold $ 1,795 $1,934 $1,590 $1,710 $1,549 $1,611 $1,481
Retail Operating Expense -% of Used Car Sales 19.4% 21.2% 18.1% 19.8% 18.1% 19.1% 17.6%
Corporate/Other Expense - Per Car Sold $ 532 $ 503 $ 376 $ 417 $ 428 $ 418 $ 387
Corporate/Other Expense - % of Total Revenue 4.4% 4.1% 3.4% 3.7% 4.0% 4.0% 3.9%
Portfolio Exp. Annualized - % of End of Period Managed Principal 5.6% 5.8% 6.2% 6.6% 5.9% 4.6% 5.5%
Balance Sheet Data:
Finance Receivables, net $ 501.0 $544.6 $522.9 $500.5 $491.9 $451.2 $407.3
Inventory $ 47.4 $ 40.8 $ 43.4 $ 63.7 $ 43.7 $ 45.9 $ 49.1
Total Assets $ 657.7 $679.0 $659.5 $652.1 $618.5 $577.5 $548.0
Notes Payable - Portfolio $ 386.6 $415.9 $390.6 $406.6 $362.3 $316.0 $282.9
Subordinated Notes Payable $ 32.6 $ 35.0 $ 40.8 $ 34.5 $ 36.1 $ 37.3 $ 28.9
Total Debt $ 460.8 $493.3 $470.9 $457.7 $416.3 $381.0 $345.2
Common Stock $ 173.8 $173.8 $173.7 $173.7 $173.7 $173.7 $173.7
Treasury Stock $ (40.4) $(40.1) $(40.1) $(40.1) $(39.4) $(28.4) $(20.3)
Total Stockholder's Equity $ 151.6 $158.6 $157.2 $155.4 $158.5 $166.8 $170.6
Common Shares Outstanding - End of Period 12,275 12,302 12,292 12,292 12,378 13,899 14,980
Book Value per Share $ 12.35 $12.89 $12.79 $12.64 $12.81 $12.00 $11.39
Tangible Book Value per Share $ 11.38 $11.91 $11.79 $11.62 $11.78 $11.02 $10.43
Total Debt to Equity 3.0 3.1 3.0 2.9 2.6 2.3 2.0
Loan Portfolio Data:
Interest Income $ 35.0 $ 34.9 $ 33.8 $ 32.9 $ 31.4 $ 29.9 $ 25.5
Average Yield on Portfolio 26.5% 26.7% 26.3% 26.1% 26.1% 26.8% 26.2%
Portfolio Interest Expense $ 7.5 $ 7.5 $ 8.5 $ 8.4 $ 7.3 $ 6.0 $ 5.0
Average Borrowing Cost 8.0% 8.3% 8.9% 8.7% 10.7% 8.6% 8.0%
Principal Balances Originated $ 109.1 $103.6 $126.0 $100.8 $124.4 $118.8 $128.1
Principal Balances Originated as % of Sales 99.0% 97.8% 96.8% 98.5% 98.2% 97.7% 96.5%
Number of Loans Originated 11,844 11,558 14,776 11,906 14,748 14,291 15,721
Average Original Amount Financed $ 9,215 $8,965 $8,528 $8,468 $8,433 $8,311 $8,150
Number of Loans Originated as % of Units Sold 99.5% 99.6% 99.5% 100.3% 99.5% 99.5% 99.5%
Managed Portfolio Delinquencies:
Current 67.4% 76.4% 78.6% 66.1% 72.4% 71.9% 74.8%
1 to 30 days 24.0% 16.8% 15.7% 26.1% 19.3% 20.9% 19.9%
31 to 60 days 5.3% 4.1% 3.3% 4.7% 4.9% 4.5% 3.4%
Over 60 days 3.3% 2.7% 2.4% 3.1% 3.4% 2.7% 1.9%
Principal Outstanding - Managed $ 537.9 $534.8 $535.0 $519.0 $525.5 $500.0 $461.8
Principal Outstanding - Retained $ 537.9 $534.8 $535.0 $514.9 $512.8 $472.3 $418.9
Number of Loans Outstanding - Managed 85,961 86,446 87,033 84,864 85,240 81,407 75,496
Number of Loans Outstanding - Retained 85,961 86,446 87,033 82,598 79,848 71,518 62,459
11
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended Nine Months Ended
September 30, Percentage September 30, Percentage
----------------------------- ----------------------------
2001 2000 Change 2001 2000 Change
-------------- ------------- ------------- -------------- ------------ -------------
Number of Used Cars Sold 11,907 14,825 (19.7%) 38,365 44,996 (14.7%)
============== ============= ============== ============
Sales of Used Cars $ 110,237 $ 126,636 (13.0%) $ 346,342 $ 380,949 (9.1%)
Cost of Used Cars Sold 62,622 70,760 (11.5%) 196,102 212,119 (7.6%)
-------------- ------------- -------------- ------------
Gross Margin $ 47,615 $ 55,876 (14.8%) $ 150,240 $ 168,830 (11.0%)
============== ============= ============== ============
Gross Margin % 43.2% 44.1% 43.4% 44.3%
Per Car Sold:
Sales $ 9,258 $ 8,542 8.4% $ 9,028 $ 8,466 6.6%
Cost of Used Cars Sold 5,259 4,773 10.2% 5,112 4,714 8.4%
-------------------------------- --------------------------------
Gross Margin $ 3,999 $ 3,769 6.1% $ 3,916 $ 3,752 4.4%
================================ ================================
For the three and nine-month periods ended September 30, 2001, the number
of cars sold decreased by 19.7% and 14.7%, respectively, over the same periods
of the prior year and Sales of Used Cars decreased 13.0% and 9.1%, respectively,
over the same periods in 2000. During the latter half of 2000, we developed a
risk management department, which is focusing on developing credit risk models.
We believe the decrease in both units sold and revenues is primarily the result
of initiatives which have put more stringent underwriting guidelines in place
including 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 Sales of Used Cars. During the third quarter of
2001, applications received via our internet site generated 1,730 cars sold and
$15.7 million in revenue, up from 1,686 cars sold and $15.2 million in revenue
during the second quarter and1,725 cars sold and $15.1 million in revenue during
the first quarter of 2001.
The Cost of Used Cars Sold for the three and nine-month periods ended
September 30, 2001 decreased 11.5% and 7.6%, 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 10.2% and 8.4% for the
three and nine-month periods ended September 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 per
unit sales price. 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 43.2% and 43.4% for the three and nine-months ended
September 30, 2001 versus 44.1% and 44.3% for the three and nine-month periods
ended September 30, 2000. The decrease is due to the per unit cost of used cars
sold rising at a higher pace than the related sales revenue. For the three
months ended September 30, 2001 as compared with the three months ended
September 30, 2000, gross margin on a per car sold basis increased $230 to
$3,999 per car from $3,769 for the same quarter of the previous year and
increased $164 to $3,916 for the nine month period ended September 30, 2001 from
$3,752 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.
12
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 nine-month periods ended September
30, 2001 versus the comparable periods of 2000. The following table indicates
the percentage of sales units and revenue financed:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2001 2000 2001 2000
------------ ------------ ------------ ------------
Percentage of used cars sold financed 99.5% 99.5% 99.5% 99.5%
============ ============ ============ ============
Percentage of sales revenue financed 99.0% 98.2% 97.8% 97.5%
============ ============ ============ ============
Provision for Credit Losses
The following is a summary of the Provision for Credit Losses:
Three Months Ended Nine Months
September 30, Percentage September 30, Percentage
--------------------------------- -------------------------------
2001 2000 Change 2001 2000 Change
---------------- ---------------- ------------ -------------- --------------- -------------
Provision for Credit Losses $48,755 $36,092 35.1% $119,985 $102,877 16.6%
================ ================ ============== ===============
Provision per loan originated $4,116 $2,447 68.2% $3,143 $2,298 36.8%
================ ================ ============== ===============
Provision as a percentage of
principal balances originated 44.7% 29.0% 35.4% 27.7%
================ ================ ============== ===============
The Company's results for third quarter of 2001 reflect a significant
increase in the Provision for Loan Losses (Provision) to 44.7% of the total
amount financed versus 31% in the prior quarters of 2001, and versus 29% in the
third quarter of 2000. While early indications reflect actual improvements in
loan loss experience on 2001 originations due to improvement in underwriting, it
was necessary to increase the quarter's Provision as a percent of the quarter's
loan originations due to resulting lower loan origination volume. Company policy
is to maintain an Allowance for Credit Losses (Allowance) for all loans in its
portfolio to cover estimated net charge offs for the next 12 months. Our loans
have experienced lifetime losses in the 31% to 34% range for the past few years.
With origination growth over this time we have been able to maintain an adequate
Allowance in accordance with Company policy and with GAAP by providing between
27% to 31% of the quarter's amount financed. As the speed of portfolio growth
has slowed due to the reduced loan originations, an increase to the Provision as
a percentage of lower originations is necessary unless there is a significant
decrease in loss rates.
The increase in the Provision was also due to loss levels for prior years'
originations emerging at levels higher than previously estimated as well as the
economic environment and its likely effect on our portfolio performance. More
specifically, with the economic and political events occurring in the third
quarter of 2001, management intensified its review of general trends in the
economy, specific economic events in many of its markets and the impact of such
factors on the market segments in which its customers are employed. As a result
of this evaluation, management concluded that these factors offset other
evidence that supported that its 2001 originations will ultimately perform
better than loans originated in fiscal year 1999 and 2000. While the Company
believes loans originated in 2001 were underwritten to higher credit standards
and its transition to a dealership centered collection methodology will produce
more effective collection results, uncertainties in the economy and our
customers' ongoing employment opportunities could offset these positive factors.
Accordingly, the Company adjusted upward its estimate of loan losses for its
2001 originations to a level generally equal to that actually being experienced
on its fiscal year 2000 originations.
We will continue to monitor the adequacy of our Allowance and depending
upon our Allowance evaluations, the rate of Provision charged may need to be
increased in future quarters. While we believe the Allowance balance as of
September 30, 2001 remains at a level we estimate to be adequate to cover net
charge-offs over the next 12 months, we currently expect to need a Provision in
excess of 31% again in the fourth quarter of 2001 because of expected net
charge-offs beyond this 12 month period.
See "Static Pool Analysis" below for further Provision for Credit Loss
discussion.
13
Net Interest Income
Three Months Ended Nine Months Ended
-------------------------- -------------------------
September 30, Percentage September 30, Percentage
-------------------------- -------------------------
2001 2000 Change 2001 2000 Change
------------ ------------ ------------- ------------ ------------ --------------
Interest Income $ 35,000 $ 31,436 11.3% $103,744 $ 86,838 19.5%
Portfolio Interest Expense (7,489) (7,318) 2.3% (23,500) (18,344) 28.1%
------------ ------------ ------------ ------------
Net Interest Income $ 27,511 $ 24,118 14.1% $80,244 $ 68,494 17.2%
============ ============ ============ ============
Average Effective Yield 26.5% 26.1% 26.5% 26.4%
============ ============ ============ ============
Average Borrowing Cost 8.0% 10.7% 8.1% 10.5%
============ ============ ============ =============
Interest Income consists primarily of interest on finance receivable
principal balances retained on our balance sheet. Retained principal balances,
net grew to $537.9 million at September 30, 2001 from $512.8 million at
September 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 $23.5 million for
the three and nine-month periods ending September 30, 2001, respectively, versus
$7.3 million and $18.3 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. Lower borrowing costs help offset
the growth in the portfolio. 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 39.9% to $26.4 million for the
three-month period ended September 30, 2001 and decreased 17.8% to $110.5
million for the nine-month period ended September 30, 2001 as compared to $43.9
million and $134.4 million for the three and nine-month periods ended September
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,
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 Nine Months Ended
September 30, Percentage September 30, Percentage
-------------------------- --------------------------
2001 2000 Change 2001 2000 Change
------------ ------------ -------------- ------------ ------------ -------------
Operating Expenses $ 35,230 $ 36,995 (4.8%) $ 108,588 $107,725 0.8%
============ ============ ============ ============
Per Car Sold $ 2,959 $ 2,495 18.6% $ 2,830 $ 2,394 18.2%
============ ============ ============ ============
As % of Total Revenue 24.3% 23.4% 24.1% 23.0%
============ ============ ============ ============
Operating expenses, which consist of selling, marketing, general and
administrative and depreciation/amortization expenses, decreased slightly
quarter over quarter, and increased slightly for the nine months ended September
30, 2001 versus 2000 but remained relatively constant as a percentage of total
revenues. Included in these expenses for the nine-month period ended September
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
14
move them to our dealerships 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
have taken a charge of approximately $230,000 related to the cost of abandoned
assets in Plano, Texas. For the Clearwater Facility we estimate an additional
restructuring charge in the fourth quarter related to costs of abandoned assets
with a carrying value of approximately $500,000. 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.
In August of 2001 the lease on the Company's corporate headquarters expired
and the Company relocated to another location in Phoenix. Third quarter 2001
operating expenses include approximately $500,000 in non-recurring costs
associated with the corporate relocation. Beginning in the third quarter of
2001, the Company also began the process of implementing numerous cost savings
initiatives to reduce operating expenses including the relocation of its
corporate headquarters. Further, in early October of 2001 the Company continued
this process by implementing a reduction in force of primarily corporate staff.
Beginning in 2002, this reduction in staff, the relocation of its corporate
headquarters and other cost saving initiatives are expected to decrease annual
operating expenses by approximately $6.0 million.
Also included in Operating Expenses in the third quarter is $350,000
related to legal and other expenses associated with the offer from Mr. Ernest C.
Garcia II, the Company's Chairman of the Board and largest shareholder, to the
Board of Directors to purchase all of the outstanding stock of the Company not
owned by him.
Other Interest Expense
Interest expense arising from our other, non-portfolio debt totaled $2.7
million and $8.6 million for the three and nine-month periods ended September
30, 2001, versus $2.4 million and $7.2 million for the comparable periods of the
prior year. The increase is primarily attributable to interest expense arising
from our senior secured loan facility, which was renewed during the first
quarter of 2001.
Income Taxes
Income tax benefit totaled ($4.7) million and ($2.8) million for the three
and nine month periods ended September 30, 2001, respectively, versus $1.9
million and $8.0 million in income taxes, respectively, for same equivalent
periods in 2000. Our effective tax rate was 41% for all periods presented.
Earnings (Loss) before Extraordinary Item
Earnings (Loss) before Extraordinary Item totaled ($6.8) million and ($4.0)
million for the three and nine month periods ended September 30, 2001,
respectively, versus $2.7 million and $11.5 million, respectively, for the same
periods of the previous year. The decrease resulted from a decrease in Used Car
Sales and an increase in the amount charged to current operations for the
Provision, 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.
Gain on Early Extinguishment of Debt
During the nine months ended September 30, 2001, we repurchased in the open
market and retired approximately $3.2 million, net of unamortized discount, 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 (Loss)
Net Earnings (Loss) totaled ($6.8) million and ($3.6) million for the three
and nine months ended September 30, 2001, respectively, as compared with $2.7
million and $11.5 million for the same periods of the prior year. The decrease
resulted from a decrease in Used Car Sales and an increase in the amount charged
to current operations for the Provision, 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.
15
Business Segment Information
We report our operations based on three operating segments. These segments
are reported as Retail, Portfolio and Corporate Operations. 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 nine-month periods ended September
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:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
2001 2000 2001 2000
--------------- -------------- -------------- ----------------
Retail Operations:
Selling and Marketing $ 6,084 $ 7,187 $ 19,945 $ 22,748
General and Administrative 13,867 14,570 43,380 43,353
Depreciation and Amortization 1,419 1,201 4,108 3,405
--------------- -------------- -------------- ----------------
Retail Expense $ 21,370 $ 22,958 $ 67,433 $ 69,506
=============== ============== ============== ================
Per Car Sold:
Selling and Marketing $ 511 485 520 506
General and Administrative 1,165 983 1,131 963
Depreciation and Amortization 119 81 107 76
--------------- -------------- -------------- ----------------
Total $ 1,795 $ 1,549 $ 1,758 $ 1,545
=============== ============== ============== ================
As % of Used Cars Sold Revenue:
Selling and Marketing 5.5% 5.7% 5.8% 6.0%
General and Administrative 12.6% 11.5% 12.5% 11.4%
Depreciation and Amortization 1.3% 1.0% 1.2% 0.9%
--------------- -------------- -------------- ----------------
Total 19.4% 18.2% 19.5% 18.3%
=============== ============== ============== ================
Selling and Marketing expenses on a per car sold basis have increased due
to a decrease in the number of cars sold without a proportionate decrease in
expenses, for both the three and nine months ended September 30, 2001, versus
the same period of the previous year. However, selling and marketing costs as a
percentage of Sales of Used Cars have remained relatively constant primarily due
to an increase of $716 and $562 in the average sales price per car for the three
and nine months ended September 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 nine-month
periods ended September 30, 2001, principally due to a reduction in the amount
of cars sold and the resulting high proportion of fixed general and
administrative costs.
16
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 Nine Months Ended
September 30, September 30,
----------------------------------- ---------------------------------
2001 2000 2001 2000
---------------- ----------------- ---------------- ---------------
Portfolio Expense:
General and Administrative $ 7,286 $ 7,411 $ 22,653 $ 18,904
Depreciation and Amortization 236 278 732 858
---------------- ----------------- ---------------- ---------------
Portfolio Expense $ 7,522 $ 7,689 $ 23,385 $ 19,762
================ ================= ================ ===============
Average Expense per Month per Loan Serviced $ 28.99 $ 28.73 $ 29.60 $ 25.38
================ ================= ================ ===============
Annualized Expense as % of End of Period
Managed Principal Balances 5.6% 5.8% 5.8% 5.0%
================ ================= ================ ===============
Portfolio expenses slightly decreased for the three months ended September
30, 2001, versus the same period of 2000. For the nine-month period, the
increase in both Portfolio expenses and the Average Expense per Month per Loan
serviced is partly attributed to $600,000 of cost incurred in relation to the
closing of the collections and loan administration centers in Florida and Texas
during the first quarter of 2001.
Corporate Operations. Operating expenses for our Corporate segment consist
of costs to provide managerial oversight, provide 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 Nine Months Ended
September 30, September 30,
----------------------------------- -----------------------------------
2001 2000 2001 2000
---------------- ---------------- ---------------- -----------------
Corporate Expense:
General and Administrative $ 5,654 $ 5,542 $ 15,429 $ 15,996
Depreciation and Amortization 684 806 2,341 2,461
----------------- ---------------- ---------------- -----------------
Corporate Expense $ 6,338 $ 6,348 $ 17,770 $ 18,457
----------------- ---------------- ---------------- -----------------
Per Car Sold $ 532 $ 428 $ 463 $ 410
================= ================ ================ =================
As % of Total Revenues 4.4% 4.0% 3.9% 3.9%
================= ================ ================ ==================
Operating expenses related to our Corporate segment as a percent of total
revenue remained relatively consistent for the three and nine-months ended
September 30, 2001, versus the same period of 2000. However, on a per car sold
basis corporate expenses increased $104 and $53 per car for the three and nine
months ended September 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 nine months ended September 30, 2001
without a proportionate reduction in expenses. We are implementing a cost
savings plan in an effort to reduce overall operating expenses.
Financial Position
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
------------------------------------- -------------------------------------------
September 30, December 31, September 30, December 31,
2001 2000 2001 2000
------------------ ---------------- ---------------------- ------------------
Principal - Managed $ 537,946 $ 519,005 $ 85,961 $ 84,864
Less: Principal - Securitized and Sold - 4,059 - 2,266
------------------ ---------------- ---------------------- ------------------
Principal - Retained on Balance Sheet $ 537,946 $ 514,946 $ 85,961 $ 82,598
================== ================ ====================== ==================
17
At September 30, 2001, the entire loan portfolio is on balance sheet.
Principal - Retained on Balance Sheet has increased 4.5% from December 31, 2000.
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 11,844 for the quarter ended September 30, 2001, versus
14,748 during the same quarter of the prior year. For the nine months ended
September 30, the number of loans originated totaled 38,178 in 2001 versus
44,760 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 nine
months ended September 30, 2001 and 2000:
Three Months Ended Nine Months Ended
September 30, September 30,
Allowance Activity: 2001 2000 2001 2000
---------------- ---------------- ---------------- ----------------
Balance, Beginning of Period $ 101,589 $ 98,533 $ 99,700 $ 76,150
Provision for Credit Losses 48,755 36,092 119,985 102,877
Other Allowance Activity (127) (1,250) (133) (2,250)
Net Charge Offs (35,717) (33,332) (105,052) (76,734)
---------------- ---------------- ---------------- ---------------
Balance, End of Period $ 114,500 $ 100,043 $ 114,500 $ 100,043
================ ================ ================ ===============
Allowance as % Ending Principal Balances 21.3% 19.5% 21.3% 19.5%
================ ================ ================ ===============
Charge off Activity:
Principal Balances $ (45,655) $ (41,934) $ (134,416) $ (99,076)
Recoveries, Net 9,938 8,602 29,364 22,342
----------------- ---------------- ----------------- ---------------
Net Charge Offs $ 35,717) $ (33,332) $ (105,052) $ (76,734)
====================== ================ ================ ===============
The Allowance for Credit Losses is maintained at a level that in
management's judgment is adequate to provide for estimated probable net credit
losses inherent in our portfolio for the next 12 months. See - Static Pool
Analysis section and the Provision for Credit Losses section of "Management's
Discussion and Analysis of Financial Condition and Results of Operations. "
Charge offs, net of recoveries, for the three months ended September 30,
2001 and 2000 were $35.7 million and $33.3 million, respectively. As a
percentage of average principal balances, net charge offs for the same periods
were 6.6% and 6.7%, respectively. For the nine-month periods ended September 30,
2001 and 2000, net charge offs were $105.1 million and $76.7 million,
respectively. Net charge offs as a percentage of average principal balances for
the same periods were 19.7% and 17.0%, respectively.
During the second quarter of 2001, we placed 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 to address the negative performance issues and we expect to improve
collection performance as a result of the relocation of these collectors.
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 customer's
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.
18
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 October 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).
Pools' Cumulative Net Losses as Percentage of Pools' 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% 21.4% 27.6% 32.8% 34.8% 35.3% 36.8% 100.0%
1994 $23,589 5.3% 14.6% 19.6% 25.2% 27.5% 28.2% 28.8% 100.0%
1995 $36,569 1.9% 8.1% 13.1% 19.0% 22.1% 23.4% 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% 27.3% 29.4% 30.6% 100.0%
3rd Quarter $32,147 1.4% 8.3% 13.2% 22.4% 26.9% 29.1% 30.6% 100.0%
4th Quarter $42,529 1.4% 6.8% 12.6% 21.8% 26.0% 28.7% 29.9% 100.0%
1998
1st Quarter $69,708 0.9% 6.9% 13.4% 20.9% 26.3% 28.7% 29.9% 100.0%
2nd Quarter $66,908 1.1% 8.1% 14.2% 21.7% 27.2% 29.1% 30.2% 99.8%
3rd Quarter $71,027 1.0% 7.9% 13.2% 22.9% 27.7% 30.2% 30.9% 99.7%
4th Quarter $69,583 0.9% 6.6% 13.1% 24.2% 28.9% 31.3% 32.1% 98.9%
1999
1st Quarter $103,068 0.8% 7.4% 15.0% 23.5% 29.3% 31.5% 32.3% 96.9%
2nd Quarter $95,768 1.1% 9.9% 16.7% 25.3% 31.3% 33.7% 34.1% 93.0%
3rd Quarter $102,585 1.0% 8.3% 14.1% 25.2% 30.8% x 33.2% 88.4%
4th Quarter $80,641 0.7% 5.9% 12.6% 23.6% 29.0% -- 30.2% 81.8%
2000
1st Quarter $128,123 0.3% 6.5% 14.6% 24.1% x -- 29.1% 74.6%
2nd Quarter $118,778 0.6% 8.6% 15.9% 25.9% -- -- 28.4% 66.3%
3rd Quarter $124,367 0.7% 7.7% 14.3% x -- -- 23.8% 55.5%
4th Quarter $100,823 0.6% 6.6% 13.6% -- -- -- 18.0% 43.4%
2001
1st Quarter $126,015 0.4% 6.4% x -- -- -- 11.4% 31.9%
2nd Quarter $103,615 5.7% x -- -- -- -- 4.5% 18.4%
3rd Quarter $109,037 x -- -- -- -- -- 0.4% 3.9%
19
The following table sets forth the principal balances delinquency status as
a percentage of total outstanding loan principal balances.
September 30, September 30, December 31,
Days Delinquent: 2001 2000 2000
---------------- ---------------- -----------------
Current 67.4% 72.4% 66.1%
1-30 Days 24.0% 19.3% 26.1%
31-60 Days 5.3% 4.9% 4.7%
61-90 Days 3.3% 3.4% 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 September 30, 2001.
Delinquencies rose during the third quarter of 2001 versus the second
quarter of this year, primarily due to seasonality. In addition, the Company is
also seeing an increase in delinquencies versus the prior year as a result of
the economic environment. The Company believes the transition of the 31-60 day
collectors into the dealerships has had a positive impact on collections.
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
2.25%-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.
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.
20
Cash Flow
Net cash provided by operating activities decreased $35.7 million to $135.4
million in the nine months ended September 30, 2001. The decrease is primarily
due to an increase in other assets, a decrease in net earnings (loss) and a
decrease in other liabilities at September 30, 2001.
Net cash used in investing activities decreased $101.1 million to $135.1
million during the nine months ended September 30, 2001 as compared to $236.2
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 $1.9 million for the nine months ended September
30, 2001, versus generating $39.6 million during the nine months ended September
30 , 2000. The change is primarily due to a decrease in Additions to Notes
Payable Portfolio, an increase in Additional Deposits into Investments Held in
Trust, an increase in Collections from Investments Held in Trust, and an
increase in Additions to Other Notes Payable.
Financing Resources
Revolving Facility. In April 2001, the Company replaced their warehouse
receivables facility and in August 2001, the Company replaced their inventory
facility. Both lines of credit were previously with GE Capital.
Our new revolving warehouse 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%. The facility is secured with
substantially all Company assets. At September 30, 2001, the Company was not in
compliance with the interest coverage ratio covenant of this facility and
received a waiver from the lender. The Company was in compliance with all other
required covenants.
The new revolving inventory facility is for $36 million, an $11 million
increase from the prior facility, and expires in June of 2003. Advance rates on
inventory purchased range from 80% to 100% of the purchase price. The interest
rate on the facility is PRIME plus 6.00%. The facility is secured with the
Company's automobile inventory. At September 30, 2001, the Company was not in
compliance with the interest coverage ratio covenant of this facility and
received a waiver from the lender. The Company was in compliance with all other
required covenants.
Securitizations. The Company's 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, the Company 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, the Company 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 Class A bonds. Interest is payable monthly at LIBOR plus 600
basis points. The balance on this note was $29.0 million at September 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, the Company 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. The Company did not
meet this pre-tax income requirement for the first six months of 2001.
Therefore, per the loan agreement, Mr. Garcia is now entitled to receive
warrants from the Company 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. NASDAQ has advised the
21
Company that they believe that shareholder approval is required. We are
requesting approval of the warrants at our December 2001 annual meeting. Also as
consideration for the loan, the Company released all options to purchase real
estate that were then owned by Verde and leased to the Company. We also granted
Verde the option to purchase, at book value, any or all properties currently
owned by the Company, or acquired by the Company prior to the earlier of
December 31, 2001, or the date the loan is repaid. Verde agreed to lease the
properties back to the Company, 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 the Company's securitization transactions but is
subordinate to the senior secured loan facility. The loan requires quarterly
interest payments at LIBOR plus 600 basis points and is subject to pro rata
reductions if certain conditions are met. An independent committee of the
Company's board reviewed and negotiated the terms of this subordinated loan and
the Company also received an opinion from an investment banker, which deemed the
loan fair from a financial point of view both to the Company's stockholders and
the Company. The balance of the note with Verde was $6.0 million at September
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.
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 approximately 2% in year two and an annual CPI
adjustments thereafter.
Accounting Matters
In August 2001, the Financial Accounting Standards Board issued FASB
Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets (Statement 144), which supersedes both FASB Statement No. 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of (Statement 121) and the accounting and reporting provisions of APB Opinion
No. 30, Reporting the Results of Operations--Reporting the Effects of Disposal
of a Segment of a Business, and Extraordinary, Unusual and Infrequently
Occurring Events and Transactions (Opinion 30), for the disposal of a segment of
a business (as previously defined in that Opinion). Statement 144 retains the
fundamental provisions in Statement 121 for recognizing and measuring impairment
losses on long-lived assets held for use and long-lived assets to be disposed of
by sale, while also resolving significant implementation issues associated with
Statement 121. For example, Statement 144 provides guidance on how a long-lived
asset that is used as part of a group should be evaluated for impairment,
establishes criteria for when a long-lived asset is held for sale, and
prescribes the accounting for a long-lived asset that will be disposed of other
than by sale. Statement 144 retains the basic provisions of Opinion 30 on how to
present discontinued operations in the income statement but broadens that
presentation to include a component of an entity (rather than a segment of a
business). Unlike Statement 121, an impairment assessment under Statement 144
will never result in a write-down of goodwill. Rather, goodwill is evaluated for
impairment under Statement No. 142, Goodwill and Other Intangible Assets.
The Company is required to adopt Statement 144 no later than the year
beginning after December 15, 2001, and plans to adopt its provisions for the
quarter ending March 31, 2002. Management does not expect the adoption of
Statement 144 for long-lived assets held for use to have a material impact on
the Company's financial statements because the impairment assessment under
Statement 144 is largely unchanged from Statement 121. The provisions of the
Statement for assets held for sale or other disposal generally are required to
be applied prospectively after the adoption date to newly initiated disposal
activities. Therefore, management cannot determine the potential effects that
adoption of Statement 144 will have on the Company's financial statements.
In June 2001, the FASB issued SFAS No. 143, Accounting for Asset Retirement
Obligations, which requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred if
reasonable estimate of fair value can be made. The associated asset retirement
costs would be capitalized as part of the carrying amount of the long-lived
asset and depreciated over the life of the asset. The liability is accreted at
the end of each period through charges to operating expense. If the obligation
is settled for other than the carrying amount of the liability, the Company will
recognize a gain or loss on settlement. The provisions of SFAS No. 143 are
effective for fiscal years beginning after June 15, 2002. The Company has not
yet determined the impact, if any, of adoption of SFAS No. 143.
In June 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
22
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.
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 $0.7 million for the year ended December 31, 2000 and for the
three and nine months ended September 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
a result of the cumulative effect of this 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: adverse economic conditions; 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; our ability to retain our
inventory and warehouse lines of credit; roll-out of collectors to our
dealerships; the success of cost savings initiatives; improvements in inventory
and inventory mix; favorable interest rate environment; 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.
23
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. 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 September 30, 2001, the
scheduled maturities on our finance receivables ranged from one to 48 months,
with a weighted average maturity of 23.8 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 September 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.
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. 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
24
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. In September 2001 Mr. Garcia
withdrew his offer. If plaintiffs continue to pursue their claims 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.
None
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.1 - Loan and Security Agreement dated as of August 24,
2001between the Registrant and Automotive Finance Corporation
Exhibit 10.2 - Covenant Waiver Letter dated November 1, 2001 between the
Registrant and Automotive Finance Corporation
Exhibit 10.3 - Covenant Waiver Letter dated November 9, 2001 between the
Registrant and Greenwich Capital Financial Products, Incorporated
Exhibit 10.4 - Covenant Waiver Letter dated November 9, 2001 between the
Registrant and Sun America Life Insurance Company
Exhibit 99 - Statement Regarding Forward Looking Statements and Risk
Factors
25
(b) Reports on Form 8-K.
During the third quarter of 2001, the Company filed three reports on Form
8-K. The first report on Form 8-K, dated September 14, 2001 and filed September
14, 2001, reported Ugly Duckling's closing of an Inventory Line of Credit, filed
as an exhibit to the Form 8-K, was a press release dated September 6, 2001,
entitled "Ugly Duckling Announces Closing of an Inventory Line of Credit". The
second report on Form 8-K dated September 25, 2001 and filed September 25, 2001,
reported the withdrawal of an offer made by Mr. Ernest C. Garcia II, Ugly
Duckling's Chairman and largest stockholder, to purchase all of the outstanding
shares of common stock of Ugly Duckling not already owned by Mr. Garcia, and
filed as an exhibit to the Form 8-K was a press release dated September 24, 2001
entitled "Ugly Duckling Reports Withdrawal of Chairman's April 2001 Offer to
Purchase Outstanding Common Stock." The third report on Form 8-K, dated October
25, 2001 and filed October 25, 2001, reported Ugly Duckling's third quarter 2001
earnings, and filed as an exhibit to the Form 8-K was a press release dated
October 25, 2001 entitled "Ugly Duckling Reports Third Quarter and Nine Month
Results."
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: November 14, 2001
27
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
10.1 Loan and Security Agreement dated as of August 24, 2001 between the
Registrant and Automotive Finance Corporation
10.2 Covenant Waiver Letter dated November 1, 2001 between the Registrant and
Automotive Finance Corporation
10.3 Covenant Waiver Letter dated November 9, 2001 between the Registrant and
Greenwich Capital Financial Products, Incorporated
10.4 Covenant Waiver Letter dated November 9, 2001 between the Registrant and
Sun America Life Insurance Company
99 Statement Regarding Forward Looking Statements and Risk Factors