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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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: March 31, 2002
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 offices) (Zip Code)
(602) 852-6600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
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This document serves both as a resource for analysts, bond holders, 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 included in Ugly Duckling's
Annual Report on Form 10-K, for the year ended December 31, 2001.
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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-- March 31, 2002 and December 31, 2001 1
Condensed Consolidated Statements of Operations-- Three Months Ended
March 31, 2002 and 2001 2
Condensed Consolidated Statements of Cash Flows-- Three Months Ended
March 31, 2002 and 2001 3
Notes to Condensed Consolidated Financial Statements 4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
Item 3. MARKET RISK 29
Part II -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 30
Item 2. CHANGES IN SECURITIES 32
Item 3. DEFAULTS UPON SENIOR SECURITIES 32
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 32
Item 5. OTHER INFORMATION 32
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 32
SIGNATURES 33
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(unaudited)
March 31, December 31,
2002 2001
-------------------- ------------------
ASSETS
Cash and Cash Equivalents $ 8,858 $ 8,572
Finance Receivables, net 514,329 495,254
Note Receivable from Related Party 12,000 12,000
Inventory 39,471 58,618
Property and Equipment, net 30,137 37,739
Goodwill 11,569 11,569
Other Assets 21,032 20,006
Net Assets of Discontinued Operations - 3,899
-------------------- ------------------
$ 637,396 $ 647,657
==================== ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 4,110 $ 2,850
Accrued Expenses and Other Liabilities 47,336 38,250
Notes Payable - Portfolio 381,208 377,305
Other Notes Payable 29,753 52,510
Subordinated Notes Payable 28,130 31,259
-------------------- ------------------
Total Liabilities 490,537 502,174
-------------------- ------------------
Stockholders' Equity:
Preferred Stock $.001 par value, 10,000,000 shares
authorized, and none issued and outstanding - -
Common Stock $.001 par value, 100,000,000 shares
authorized, 100 and 18,774,000 issued, respectively,
and 100 and 12,275,000 outstanding, respectively - 19
Additional Paid-in Capital 133,415 173,741
Retained Earnings 13,444 12,074
Treasury Stock, at cost - (40,351)
-------------------- ------------------
Total Stockholders' Equity 146,859 145,483
-------------------- ------------------
$ 637,396 $ 647,657
==================== ==================
See accompanying notes to Condensed Consolidated Financial Statements.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 2002 and 2001
(In thousands, except cars sold amounts)
(unaudited)
Three Months Ended
March 31,
-----------------------------
2002 2001
-----------------------------
Cars Sold 15,300 14,851
=============================
Total Revenues $ 175,064 $ 164,030
=============================
Sales of Used Cars $ 142,234 $ 130,186
Less:
Cost of Used Cars Sold 83,017 72,841
Provision for Credit Losses 45,367 39,020
-----------------------------
13,850 18,325
-----------------------------
Other Income (Expense):
Interest Income 32,830 33,844
Portfolio Interest Expense (6,143) (8,519)
-----------------------------
Net Interest Income 26,687 25,325
-----------------------------
Income before Operating Expenses 40,537 43,650
Operating Expenses:
Selling and Marketing 7,613 7,626
General and Administrative 25,782 27,438
Depreciation and Amortization 2,108 2,407
-----------------------------
Operating Expenses 35,503 37,471
-----------------------------
Income before Other Interest Expense 5,034 6,179
Other Interest Expense 2,306 3,091
-----------------------------
Earnings before Income Taxes 2,728 3,088
Income Taxes 1,358 1,266
-----------------------------
Net Earnings $ 1,370 $ 1,822
=============================
See accompanying notes to Condensed Consolidated Financial Statements.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2002 and 2001
(In thousands)
(unaudited)
Three Months Ended
March 31,
2002 2001
----------------------------------
Cash Flows from Operating Activities:
Net Earnings $ 1,370 $ 1,822
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 45,367 39,020
Depreciation and Amortization 3,415 3,564
Loss from Disposal of Property and Equipment 65 423
Deferred Income Taxes (160) -
Collections from Residuals in Finance Receivables Sold - 1,136
Decrease in Inventory 20,066 20,443
(Decrease) of Inventory Allowance (919) (135)
(Increase) Decrease in Other Assets (2,660) 945
Increase (Decrease) in Accounts Payable, Accrued Expenses and Other Liabilities 8,233 (7,866)
Increase in Income Taxes Payable 3,907 179
----------------------------------
Net Cash Provided by Operating Activities 78,684 59,531
----------------------------------
Cash Flows Used in Investing Activities:
Increase in Finance Receivables (133,554) (119,405)
Collections on Finance Receivables 64,443 62,726
Proceeds from Disposal of Property and Equipment 2,887 46
Purchase of Property and Equipment (1,409) (3,173)
----------------------------------
Net Cash Used in Investing Activities (67,633) (59,806)
----------------------------------
Cash Flows from Financing Activities:
Initial Deposits at Securitization into Investments Held in Trust - (3,532)
Additional Deposits into Investments Held in Trust (10,054) (12,918)
Collections from Investments Held in Trust 14,723 9,151
Decrease in Investments Held in Trust on Finance Receivables Sold - 1,398
Additions to Notes Payable Portfolio 111,650 161,691
Repayment of Notes Payable Portfolio (108,578) (178,288)
Additions to Other Notes Payable 17,600 22,792
Repayment of Other Notes Payable (36,611) (138)
Repayment of Subordinated Notes Payable (3,400) (1,000)
Proceeds from Issuance of Common Stock 6 -
----------------------------------
Net Cash Used in Financing Activities (14,664) (844)
----------------------------------
Net Cash Provided by Discontinued Operations 3,899 893
----------------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 286 (226)
Cash and Cash Equivalents at Beginning of Period 8,572 8,805
----------------------------------
Cash and Cash Equivalents at End of Period $ 8,858 $ 8,579
==================================
Supplemental Statement of Cash Flows Information:
Interest Paid $ 5,912 $ 9,795
==================================
Income Taxes Paid (Received) $ (2,784) $ 1,445
==================================
Supplemental Statement of Non-Cash Investing and Financing Activities:
Other Notes Payable Assumed by Leasor in Sale Leaseback Transaction $ 4,070 $ -
==================================
See accompanying notes to Condensed Consolidated Financial Statements.
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, 2001
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, 2001. All amounts are in thousands with the exception of per
unit and per car data, unless otherwise noted.
Note 2. Summary of Finance Receivables
A summary of Finance Receivables, net, follows:
March 31, December 31,
2002 2001
------------------- ------------------
Contractually Scheduled Payments $ 740,879 $ 694,572
Unearned Finance Charges (197,037) (179,873)
------------------- ------------------
Principal Balances, net 543,842 514,699
Accrued Interest 5,479 5,824
Loan Origination Costs 7,281 6,635
------------------- ------------------
Loan Receivables 556,602 527,158
Investments Held in Trust 65,327 69,996
------------------- ------------------
Finance Receivables 621,929 597,154
Allowance for Credit Losses (107,600) (101,900)
------------------- ------------------
Finance Receivables, net $ 514,329 $ 495,254
=================== ==================
Allowance as % of Principal Balances, net 19.8% 19.8%
=================== ==================
Investments Held in Trust represent funds held by trustees on behalf of our
securitization bondholders and consists of reserve accounts, as further
described, plus collections in transit. In connection with its securitization
transactions, the Company provides a credit enhancement to the investor. The
Company makes an initial cash deposit, ranging from 3% to 6% of the initial
underlying finance receivables principal balance, into an account held by the
trustee (reserve account) and pledges this cash to the trust to which the
finance receivables were transferred. Additional deposits from the residual cash
flow (through the trustee) are made to the reserve account as necessary to
attain and maintain the reserve account at a specified percentage, ranging from
8.0% to 11.0%, of the underlying finance receivables principal balances.
Due to the impact of the recession, the events of September 11th and the
poor auction recovery market at year end 2001, three of our trusts, 2000B, 2000C
and 2001A, reached charge-off levels for the month of December 2001 that
triggered an acceleration of rights for MBIA under the Insurance Agreements of
the respective trusts. These rights include, among other things, the ability to
transition servicing on the trusts to a third party and accelerate the cash flow
to the A bondholders until they have been paid in full. These trusts reached
these levels only for the month indicated and remained below these levels to
date. These trusts continue to trap cash in the reserve accounts related to
these breaches in charge-off levels.
Note 3. Related Party Transactions
In January 2001, the Company entered into a $35 million senior secured loan
facility as a renewal for a $38 million senior loan facility originated in May
1999. As a condition to the $35 million senior secured loan agreement, Verde
Investments, Inc., an affiliate of Ernest C. Garcia II, Chairman and principal
shareholder of the Company, was required to invest $7 million in the Company
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% of the $35 million facility. The Company did not meet
this pre-tax income requirement for the first six months of 2001. Per the loan
agreement, Mr. Garcia was 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. 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. The Company 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 a portion of the finance
receivables 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 and its shareholders. The balance of the note
with Verde was $2.0 million at March 31, 2002.
Pursuant to the option discussed above, in December 2001 Verde exercised
its right to purchase from, and lease back to the Company, six properties having
a net book value of approximately $6.7 million. This purchase and lease back
transaction closed in January 2002. Verde assumed all of the obligations of the
notes payable secured by the six properties. The Company has notified the
lenders on these six properties and the Company has not yet been released as the
borrower under the notes payable. The six properties were leased back to the
Company on terms consistent with other sale-leasebacks, 15 year triple net
leases, expiring December 2015.
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 Mr. Garcia. 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. The balance of this loan at March 31, 2002 was $12.0 million.
On November 26, 2001, Mr. Garcia initiated a Tender Offer to purchase all
of the outstanding shares of the Company's common stock not owned by him for
$2.51 per share. On December 10, 2001, the Company entered into an Agreement and
Plan of Merger with Mr. Garcia, Mr. Sullivan, UDC Acquisition Corp.
("Acquisition"), an entity controlled by Mr. Garcia and Mr. Sullivan, and UDC
Holdings Corp. The Merger Agreement provided for Acquisition to amend the
pending Tender Offer to purchase all of the outstanding shares of the Company by
increasing the offer from $2.51 per share to $3.53 per share (the "Amended
Tender Offer"). The Merger Agreement also provided for a second step merger (the
"Merger") at the same price of $3.53 per share (the Amended Tender Offer and the
Merger together are the "Transaction"). The Merger Agreement further provided
that the Transaction could be consummated only if a majority of the minority
shareholders of the Company, in the aggregate, tendered in the Amended Tender
Offer or (if Acquisition did not own 90% or more of the shares after the Amended
Tender Offer) voted in favor of the Merger. At that time, there were 4,771,749
shares of the Company's stock not held by the buyout group. The Transaction was
entered into after review by a special transaction committee comprised of
independent members of the board of directors; the committee and the board
consulted with and obtained a fairness opinion from an investment banking firm,
U.S. Bancorp Piper Jaffray. The special committee recommended the Transaction to
the full board and the board recommended the Transaction to the shareholders of
the Company. On December 14, 2001, the Company commenced the Amended Tender
Offer. The Company's shareholders overwhelmingly supported the Amended Tender
Offer, which closed on January 16, 2002. Shareholders tendered 3,806,800 shares
of the Company's common stock representing approximately 79% of the minority
shares. Upon completion of the Amended Tender Offer and Acquisition paying the
tendering shareholders, Acquisition owned approximately 92% of the Company.
Acquisition received its funding for these payments from UDC Holdings, Inc. On
March 4, 2002 Acquisition completed a short form merger with and into the
Company. The Company was the surviving corporation under the short form merger.
As of March 31, 2002, the Company has a receivable from UDC Holdings, Inc. of
approximately $1.7 million which is classifed in Other Assets.
In March and April of 2002 Cygnet Capital Corporation, a company affiliated
with our chairman, Mr. Garcia, purchased on the open market $0.3 million face
value of the Company's 2003 debentures and $1.7 million face value of the
Company's 2007 debentures. As of May 1, 2002, Mr. Garcia, or entities affiliated
with Mr. Garcia, own approximately $2.6 million face value of the Company's 2003
debentures and approximately $4.9 million face value of the Company's 2007
debentures.
Note 4. Notes Payable
Notes Payable, Portfolio
A summary of Notes Payable, Portfolio at March 31, 2002 and December 31,
2001 follows ($ in thousands):
March 31, December 31,
2002 2001
------------------- -------------------
Revolving Facility for $100.0 million with Greenwich Capital Financial
Products, Inc, secured by substantially all assets of the Company not
otherwise pledged $ 113,230 $ 38,249
Class A obligations issued pursuant to the Company's securitization program,
secured by underlying pools of finance receivables and investments held in
trust totaling $547.9 million and $515.2 million at March 31, 2002 and
December 31, 2001, respectively 270,183 341,812
------------------- -------------------
Subtotal 383,413 380,061
Less: Unamortized Loan Fees 2,205 2,756
------------------- -------------------
Total $ 381,208 $ 377,305
=================== ===================
In March 2002, the Company renewed its revolving warehouse facility with
Greenwich Capital Financial Products, Inc. for an additional 364-day term
through March 2003. The facility allows for maximum borrowings of $100 million
during the entire renewed term, as compared to $75 million during the period May
1, 2001 through November 30, 2001, increasing to $100 million during the period
December 1, 2001 through April 30, 2002, under the initial term. In addition,
the 65% cap on the advance rate was removed and the calculation of the warehouse
advance relative to the net securitization advance was improved by 2%. The
lender maintains an option to adjust the advance rate to reflect changes in
market conditions or portfolio performance. The interest rate on the facility is
LIBOR plus 2.80% (4.70% as of March 31, 2002, and 4.72% as of December 31,
2001). The facility is secured with substantially all Company assets. At March
31, 2002, due to the timing of the first securitization of 2002, the Company was
not in compliance with the debt to EBITDA ratio covenant of this facility and
received a waiver from the lender. The Company was in compliance with all other
required covenants.
Class A obligations have interest payable monthly at rates ranging from
3.4% to 5.1%. Monthly principal reductions on the Class A obligations
approximate 70% of the principal reductions on the underlying pool of finance
receivable loans.
Other Notes Payable
A summary of Other Notes Payable at March 31, 2002 and December 31, 2001
follows ($ in thousands):
March 31, December 31,
2002 2001
-------------------- -------------------
Senior note payable with certain lenders, secured by the capital stock of
UDRC II, UDRC III, UDRC IV, and certain other receivables $ 23,000 $ 26,000
Revolving Facility for $36.0 million with Automotive Finance Corporation,
secured by the Company's automobile inventory 5,062 20,963
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 1,941 6,133
-------------------- -------------------
Subtotal 30,003 53,096
Less: Unamortized Loan Fees 250 586
-------------------- -------------------
Total $ 29,753 $ 52,510
==================== ===================
The Company entered into a $35 million senior secured loan facility with
certain lenders in January 2001. The facility has a term of 25 months. Pursuant
to the credit agreement, the Company must make principal payments of $1.0
million per month during the period from April 2001 through September 2002.
Thereafter through maturity, the credit 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 (7.90% as of March
31, 2002, and 7.90% as of December 31, 2001). The loan is secured by certain
Finance Receivables. At March 31, 2002, due to the timing of the first
securitization of 2002, the Company was not in compliance with the senior debt
to total capitalization covenant of this facility, and received a waiver from
the lender. The Company was in compliance with all other required covenants.
On August 31, 2001, the Company entered into a $36 million revolving
inventory facility with Automotive Finance Corporation that expires in June of
2003. The borrowing base is calculated on advance rates on inventory purchased,
ranging from 80% to 100% of the purchase price. The interest rate on the
facility is Prime plus 6.0% (10.75% as of March 31, 2002, and 10.75% as of
December 31, 2001). The facility is secured with the Company's automobile
inventory. At March 31, 2002, the Company was in compliance with all required
covenants.
Subordinated Notes Payable
A summary of Subordinated Notes Payable at March 31, 2002 and December 31,
2001 follows ($ in thousands):
March 31, December 31,
2002 2001
-------------------- -------------------
$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 $ 5,000 $ 5,000
$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 13,839
$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 December 2003 2,000 5,400
-------------------- -------------------
Subtotal 32,779 36,179
Less: Unamortized Discount - subordinated debentures 4,649 4,920
-------------------- -------------------
Total $ 28,130 $ 31,259
==================== ===================
Note 5. Stockholders' Equity
On November 16, 2001, Mr. Ernest Garcia II, the Company's Chairman and
majority shareholder, announced his intention to initiate a tender offer to
purchase all of the outstanding common stock of the Company not owned by him for
$2.51 per share. On December 10, 2001, the Company entered into an Agreement and
Plan of Merger (the "Merger Agreement") with Mr. Garcia, Mr. Gregory B.
Sullivan, the President and CEO of the Company, UDC Holdings Corp. ("UDC
Holdings"), an entity controlled by Mr. Garcia and Mr. Sullivan, and UDC
Acquisition Corp. ("UDC Acquisition"), an entity wholly owned by UDC Holdings
(collectively, the "Buyout Group"). The Merger Agreement provided that the
pending tender offer would be amended to, among other things, increase the offer
price from $2.51 per share to $3.53 per share (the "Amended Tender Offer"). The
Merger Agreement also provided for a second step merger at the same price of
$3.53 per share (the "Merger," and together with the Amended Tender Offer, the
"Transaction"). The Merger Agreement further provided that the Transaction could
be consummated only if a majority of the minority shareholders of the Company
either tendered their shares in the Amended Tender Offer or voted in favor of
the Merger. At that time, there were 4,771,749 shares of the Company's stock not
held by the Buyout Group.
On December 14, 2001, the Buyout Group commenced the Amended Tender Offer.
In the Amended Tender Offer materials, the Buyout Group disclosed that it
intended to cause the Merger to become effective without a meeting of
shareholders, pursuant to Delaware law, if the Amended Tender Offer resulted in
UDC Acquisition holding at least 90% of the Company's outstanding shares. The
Company and the board also sent materials to its shareholders at the same time
recommending that shareholders tender their shares pursuant to the Amended
Tender Offer.
The Company's shareholders overwhelmingly supported the Amended Tender
Offer, which expired on January 16, 2002. Shareholders tendered 3,806,800 shares
of the Company's common stock representing approximately 79% of the minority
shares. Upon completion of the Amended Tender Offer, UDC Acquisition owned
approximately 92% of the Company.
On March 4, 2002, the Merger was consummated. In the Merger, which was
consummated without a shareholder vote in accordance with Delaware law, UDC
Acquisition was merged with and into the Company, with the Company surviving.
Upon consummation of the Merger and pursuant to the terms of the Merger
Agreement and Delaware law:
o All shares of outstanding common stock not held in treasury or owned by the
Buyout Group were cancelled, retired and converted into the right to
receive either (a) $3.53 per share in cash, without interest or (b) if the
holder properly exercised appraisal rights under Delaware law, the fair
value of the shares as determined by the Court in appraisal proceedings;
o All treasury shares and shares held by the Buyout Group were cancelled and
retired without any consideration; and
o All shares of UDC Acquisition common stock outstanding immediately prior to
the effective date of the Merger were converted into shares of common stock
of the Company.
As a result of the Merger, the only remaining outstanding shares of common
stock of the Company are the 100 shares of common stock issued upon conversion
of the shares UDC Acquisition common stock. All of these shares are held by UDC
Holdings.
Shortly after the expiration of the Amended Tender Offer, the Company
mailed to the shareholders who did not tender their shares a notice outlining
the procedures they were required to follow if they wished to dissent from the
Merger and seek appraisal of their shares. Under Delaware law, these
shareholders had 20 days from the date of the mailing of the notice to notify
the Company of their intention to assert appraisal rights. If such notice is
timely made, dissenting shareholders must file a petition for appraisal in the
Delaware Court of Chancery within 120 days of the effective date of the Merger,
or all appraisal rights will be lost and dissenters will only be entitled to the
merger consideration of $3.53 per share. In the event a petition for appraisal
is filed, the court then determines which shareholders are entitled to appraisal
rights and appraises the shares of such shareholders.
Although several shareholders provided the Company with timely notice of
their intention to assert appraisal rights, to the Company's knowledge, no
petition for appraisal has been filed in the Delaware Court of Chancery as of
the date of filing of this quarterly report. The deadline for filing such a
petition is on or about July 2, 2002. In the event such a petition is filed, UDC
Holdings has agreed to fund the payment to the dissenting shareholders.
Note 6. Business Segments
The Company has three distinct business segments. These consist of retail
car sales operations (Retail Operations), the income resulting from the finance
receivables generated at the Company dealerships (Portfolio Operations), and
corporate and other operations (Corporate Operations). In computing operating
profit by business segment, the following items were considered in the Corporate
Operations category: portions of administrative expenses, interest expense and
other items not considered direct operating expenses. Identifiable assets by
business segment are those assets used in each segment of Company operations.
A summary of operating activity by business segment for the three months
ended March 31, 2002 and 2001 follows:
Three months ended March 31, 2002: Retail Portfolio Corporate Total
------ --------- --------- -----
Sales of Used Cars $ 142,234 $ - $ - $ 142,234
Less: Cost of Cars Sold 83,017 - - 83,017
Provision for Credit Losses 30,057 15,310 - 45,367
--------------- -------------- -------------- ---------------
29,160 (15,310) - 13,850
Net Interest Income - 26,687 - 26,687
--------------- -------------- -------------- ---------------
Income before Operating Expenses 29,160 11,377 - 40,537
--------------- -------------- -------------- ---------------
Operating Expenses:
Selling and Marketing 7,613 - - 7,613
General and Administrative 13,449 6,542 5,791 25,782
Depreciation and Amortization 1,111 252 745 2,108
--------------- -------------- -------------- ---------------
22,173 6,794 6,536 35,503
--------------- -------------- -------------- ---------------
Income (Loss) before Other Interest Expense $ 6,987 $ 4,583 $ (6,536) $ 5,034
=============== ============== ============== ===============
Capital Expenditures $ 447 $ 95 $ 867 $ 1,409
=============== ============== ============== ===============
Identifiable Assets $ 68,203 $ 538,619 $ 30,574 $ 637,396
=============== ============== ============== ===============
Three months ended March 31, 2001: Retail Portfolio Corporate Total
------ --------- --------- -----
Sales of Used Cars $ 130,186 $ - $ - $ 130,186
Less: Cost of Cars Sold 72,841 - - 72,841
Provision for Credit Losses 26,652 12,368 - 39,020
--------------- -------------- -------------- ---------------
30,693 (12,368) - 18,325
Net Interest Income - 25,195 130 25,325
--------------- -------------- -------------- ---------------
Income before Operating Expenses 30,693 12,827 130 43,650
--------------- -------------- -------------- ---------------
Operating Expenses:
Selling and Marketing 7,626 - - 7,626
General and Administrative 14,658 8,008 4,772 27,438
Depreciation and Amortization 1,326 264 817 2,407
--------------- -------------- -------------- ---------------
23,610 8,272 5,589 37,471
--------------- -------------- -------------- ---------------
Income (loss) before Other Interest Expense $ 7,083 $ 4,555 $ (5,459) $ 6,179
=============== ============== ============== ===============
Capital Expenditures $ 2,087 $ 229 $ 857 $ 3,173
=============== ============== ============== ===============
Identifiable Assets, Excluding
Net Assets of Discontinued Operations $ 85,204 $ 549,682 $ 21,302 $ 656,188
=============== ============== ============== ===============
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. Recent Accounting Pronouncements
The Company adopted the provisions of Statement No. 141 as of July 1, 2001,
and Statement 142 effective January 1, 2002. Statement No. 141 required upon
adoption of Statement No. 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 No. 141 for recognition apart from goodwill. In
conjunction with the adoption fo the Statement No. 142, the Company has
allocated the entire goodwill balance to the Retail Operations Segment. During
the second quarter of 2002, the Company expects to finalize the first step of
the required impairment tests of goodwill as of January 1, 2002. The Company
does not expect the effect of these tests to be material to the earnings or the
financial position of the Company. In addition, upon adoption we discontinued
amortizing goodwill. For the three months ended March 31, 2001, the Company had
approximately $0.2 million in amortization expense. As of March 31, 2002, the
Company has unamortized goodwill of approximately $11.6 million within the
retail segment and no unamortized identifiable intangible assets. (For further
discussion on SFAS No. 141 and 142, see Management's Discussion and Analysis of
Financial Condition- Recent Accounting Pronouncements.)
Note 10. Subsequent Events
On April 1, 2002, the Company completed its 22nd securitization, consisting
of approximately $170.4 million in principal balances and the issuance of
approximately $121.0 million in Class A bonds, including a pre-funded amount of
approximately $16.3 million. The coupon rate on the Class A bonds is 4.16%, the
initial deposit into the reserve account was 6.0% and the reserve account
maximum is 10.0%. As a condition for MBIA providing insurance for this
securitization, the Company deposited an additional $2.3 million in an escrow
account to protect MBIA from any potential losses on any currently active
trusts.
On April 1, 2002, Verde Investments transferred to Cygnet Capital
Corporation ("CCC"), an affiliate of Verde and Mr. Ernest C. Garcia, the
remaining $2.0 million balance of the $7.0 million note payable. All future
principal reductions and interest payments will be made to CCC.
On February 4, 2002, the parties entered into a Stipulation and Agreement
of Compromise, Settlement and Release documenting the settlement of the
shareholder derivative complaint filed on March 20, 2001 and providing for a
final hearing for court review and approval of the settlement (see Management's
Discussion and Analysis of Financial Condition - Part II Other Information -
Item 1. Legal Proceedings). A mailing was sent to the shareholders in
mid-February and this hearing was held on April 17, 2002. On April 18th, the
court entered its final decision approving the settlement and finding it fair,
reasonable and in the best interests of the class, certifying the class for
purposes of the settlement, compromising and releasing all claims with prejudice
on the merits and awarding attorneys' fees and costs to the plaintiffs' in the
amount of $1,050,000. A notice of appeal was filed by two dissenting
shareholders, acting pro se (without legal counsel), prior to the expiration of
the appeal period. A motion to dismiss will be filed challenging the appeal and
the Company intends on vigorously defending the court order and the settlement.
The Company also has reached an agreement with its directors' and officers'
liability insurance carrier to reimburse the Company for the payment of the
plaintiffs' fees and costs (assuming the court order becomes final), and it is
in the process of documenting that agreement.
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 March 31, 2002, 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 bi-weekly, often coinciding with the customer's payday,
o the ability to make payments in person at the dealerships. This is an
important feature to many sub-prime borrowers who may not have checking
accounts or are otherwise unable to make payments by the due date through
use of the mail due to the timing of paydays.
We distinguish our retail operations from those of typical buy-here
pay-here dealers through our:
o dedication to customer service, o advertising and marketing programs,
o larger inventories of used cars, o upgraded facilities, and
o network of multiple locations, o centralized purchasing.
We finance substantially all of the used cars that we sell at our
dealerships through retail installment loan contracts. Subject to certain
underwriting standards and the discretion of our dealership or sales managers,
potential customers must meet our formal underwriting guidelines before we will
agree to finance the purchase of a vehicle. Our employees analyze and verify the
customer credit application information and subsequently make a determination
whether to provide financing to the customer.
Our business is divided into three operating segments: Retail, Portfolio
and Corporate 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 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-month periods ended March
31, 2002 and 2001. All amounts are presented in thousands except per unit and
per car data, unless otherwise noted.
During the first quarter of 2002 we:
o Became a privately held company on March 4, 2002 when UDC Acquisition
Corp., an entity controlled by Ugly Duckling's Chairman, Mr. Ernest Garcia
II, completed its short form merger with and into Ugly Duckling,
o Experienced significant improvement in delinquencies with accounts greater
than 30 days delinquent falling from 9.3% at December 31, 2001 down to 5.7%
at March 31, 2002, a 39% improvement,
o Increased revenues to $175 million in the first quarter of 2002, a 7%
increase over the first 3 months of 2001, o Took steps to further reduce
expenses through a second reduction in work force to save approximately
$1.7 million annually in salary, wages and benefits,
o Renewed our warehouse credit facility with Greenwich Capital Financial
Products, Inc., increasing the maximum borrowings and improving the
effective advance rate,
o Launched a pilot interest rate program in the Phoenix market called
RateAdvantage that offers interest rates ranging from 9.9% to 29.9%
depending upon the customer's credit grade and the size of the down
payment, and
o We continued to make improvements to our business model, respositioning the
Company to focus on providing our customers with innovative credit
solutions, quality vehicles, and outstanding customer service.
---------------------------------------------------------------------------
Selected Consolidated Financial Data For the Three Months Ending,
---------------------------------------------------------------------------
($ in thousands, except per car sold amounts) March 31, December 31, September 30, June 30, March 31,
2002 2001 2001 2001 2001
---------------------------------------------------------------------------
Operating Data:
Total Revenues $ 175,064 $ 121,292 $ 145,237 $ 140,819 $ 164,030
Sales of Used Cars $ 142,234 $ 88,018 $ 110,237 $ 105,919 $ 130,186
Earnings before Interest, Taxes, Depr. & Amort. $ 13,285 $ 5,423 $ 969 $ 14,518 $ 17,105
E-Commerce Revenue as Percent of Sales of Used Cars 13.8% 13.8% 14.2% 14.4% 11.6%
Number Dealerships in Operation 76 76 76 77 77
Average Sales per Dealership per Month 67 41 52 50 64
Number of Used Cars Sold 15,300 9,353 11,907 11,607 14,851
Sales Price - Per Car Sold $ 9,296 $ 9,411 $ 9,258 $ 9,125 $ 8,766
Cost of Sales - Per Car Sold $ 5,426 $ 5,549 $ 5,259 $ 5,224 $ 4,905
Gross Margin - Per Car Sold $ 3,870 $ 3,862 $ 3,999 $ 3,901 $ 3,861
Provision - Per Car Sold $ 2,965 $ 3,324 $ 4,095 $ 2,775 $ 2,627
Total Operating Expense - Per Car Sold $ 2,320 $ 3,765 $ 2,959 $ 3,092 $ 2,523
Total Operating Income (Loss) - Per Car Sold $ 329 $ (413) $ (744) $ 396 $ 416
Total Operating Income (Loss) $ 5,034 $ (3,865) $ (8,859) $ 4,591 $ 6,179
Earnings before Income Taxes $ 2,728 $ (6,392) $ (11,554) $ 1,729 $ 3,088
Cost of Used Cars as Percent of Sales 58.4% 59.0% 56.8% 57.3% 56.0%
Gross Margin as Percent of Sales 41.6% 41.0% 43.2% 42.7% 44.0%
Provision - % of Originations 32.3% 35.5% 44.7% 31.1% 31.0%
Total Operating Expense - % of Total Revenues 20.3% 29.0% 24.3% 25.5% 22.8%
Segment Operating Expense Data:
Retail Operating Expense - Per Car Sold $ 1,449 $ 1,932 $ 1,795 $ 1,934 $ 1,590
Retail Operating Expense-% of Used Car Sales 15.6% 20.5% 19.4% 21.2% 18.1%
Corporate/Other Expense - Per Car Sold $ 427 $ 828 $ 532 $ 503 $ 376
Corporate/Other Expense - % of Total Revenue 3.7% 6.4% 4.4% 4.1% 3.4%
Portfolio Exp. Annualized - % of End of Period
Principal 5.0% 7.3% 5.6% 5.8% 6.2%
Balance Sheet Data:
Finance Receivables, net $ 514,329 $ 495,254 $ 501,048 $ 544,585 $ 522,893
Inventory $ 39,471 $ 58,618 $ 47,414 $ 40,772 $ 43,434
Total Assets $ 637,396 $ 647,657 $ 657,740 $ 678,950 $ 659,470
Portfolio Notes Payable $ 381,208 $ 377,305 $ 386,572 $ 415,877 $ 390,615
Subordinated Notes Payable $ 28,130 $ 31,259 $ 32,600 $ 34,951 $ 40,807
Other Notes Payable $ 29,753 $ 52,510 $ 41,646 $ 42,495 $ 39,444
Total Debt $ 439,091 $ 461,074 $ 460,818 $ 493,323 $ 470,866
Total Stockholders' Equity $ 146,859 $ 145,483 $ 151,550 $ 158,604 $ 157,222
Total Debt to Equity 3.0 3.2 3.0 3.1 3.0
Loan Portfolio Data:
Interest Income $ 32,830 $ 33,274 $ 35,000 $ 34,900 $ 33,844
Average Yield on Portfolio 25.9% 25.8% 26.5% 26.7% 26.3%
Portfolio Interest Expense 6,143 6,957 7,489 7,492 8,519
Average Portfolio Borrowing Cost 7.0% 7.5% 8.0% 8.3% 8.9%
Principal Balances Originated $ 140,455 $ 87,452 $ 109,139 $ 103,615 $ 126,015
Principal Balances Originated as % of Sales 98.7% 99.4% 99.0% 97.8% 96.8%
Number of Loans Originated 15,225 9,283 11,844 11,558 14,776
Average Original Amount Financed $ 9,225 $ 9,421 $ 9,215 $ 8,965 $ 8,528
Number of Loans Originated as % of Units Sold 99.5% 99.3% 99.5% 99.6% 99.5%
Portfolio Delinquencies:
Current 72.4% 64.5% 67.4% 76.4% 78.6%
1 to 30 days 21.9% 26.2% 24.0% 16.8% 15.7%
31 to 60 days 3.3% 5.6% 5.3% 4.1% 3.3%
Over 60 days 2.4% 3.7% 3.3% 2.7% 2.4%
Principal Outstanding , net $ 543,842 $ 514,699 $ 537,946 $ 534,766 $ 535,039
Number of Loans Outstanding 84,821 82,254 85,961 86,446 87,033
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended
March 31,
----------------------------- Percentage
2002 2001 Change
----------------------------- --------------
Number of Used Cars Sold
15,300 14,851 3.0%
=============================
Sales of Used Cars $ 142,234 $ 130,186 9.3%
Cost of Used Cars Sold 83,017 72,841 14.0%
-----------------------------
Gross Margin $ 59,217 $ 57,345 3.3%
=============================
Gross Margin % 41.6% 44.0%
Per Car Sold:
Sales $ 9,296 $ 8,766 6.0%
Cost of Used Cars Sold 5,426 4,905 10.6%
-----------------------------
Gross Margin $ 3,870 $ 3,861 0.2%
=============================
For the three-month period ended March 31, 2002, the number of cars sold
increased to 15,300 units, a 3.0% over the same period of the prior year.
Through our analysis of the primary factors that influence loan performance, we
determined that a higher cost and better quality vehicle positively affects the
gross loan loss rate across all credit grades. We made a decision to upgrade the
quality of our vehicle inventory throughout 2001 and have continued to increase
the quality of our vehicles in the first quarter of 2002. As a result, the
average sales price increased 6.0% and the cost of a vehicle increased 10.6%
compared to the first quarter of 2001. The average dollar gross margin per car
remained fairly constant between periods. We calculate our vehicle sales price
using a fixed dollar margin and not as a percentage of cost; therefore, when we
increased the quality and related cost of vehicles, the margin decreased from
44.0% down to 41.6%. We foresee this trend continuing throughout 2002 as we
continue to move toward better quality inventory.
Our Internet site continues to be a valuable tool generating a steady flow
of credit applications, which lead to the closing of sales at our dealerships.
We accept credit applications from potential customers via our website, located
at www.uglyduckling.com and www.duckloans.com. Our employees review the credit
applications received over the web and then contact the customers and schedule
appointments at our dealerships. During the first quarter of 2002, applications
received via our internet site generated 2,104 cars sold and $19.7 million in
revenue, up from 1,773 cars sold and $15.0 million in revenue during the same
period of the prior year.
We finance substantially all of our used car sales. The percentage of cars
sold financed has remained constant for the three months ended March 31, 2002
versus the comparable period of 2001. We have experienced a slight increase in
the percentage of sales revenue financed as a result of an increase in the
average sales price per car sold due to our focus on better quality cars. The
following table indicates the percentage of sales units and revenue financed:
Three Months Ended
March 31,
-----------------------
2002 2001
-----------------------
Percentage of used cars sold financed 99.5% 99.5%
=======================
Percentage of sales revenue financed 98.7% 96.8%
=======================
Provision for Credit Losses
The following is a summary of the Provision for Credit Losses:
Three Months Ended
March 31,
-------------------------- Percentage
2002 2001 Change
-------------------------- -------------
Provision for Credit Losses $45,367 $39,020 16.3%
==========================
Provision per loan originated $2,980 $2,641 12.8%
==========================
Provision as a percentage of
principal balances originated 32.3% 31.0%
==========================
The Provision for Credit Losses increased to $45.4 million or 32.3% of the
total amount financed for the quarter ended March 31, 2002, up from $39.0
million or 31.0% of the total amount financed for the quarter ended March 31,
2001. 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. The Company began to improve the underlying credit quality mix of its
originations due to improved credit standards and the introduction of loan
grading in 2001. As a result, 2001 and 2002 originations are performing better
to date than loans originated in prior periods. Offsetting these improvements
are the effects of the recession and the performance of loans originated prior
to 2001 that do not have the benefit of the new higher credit standards and are
emerging at loss levels higher than previously estimated. In addition, the net
principal balance of loans outstanding increased from $535.0 million at March
31, 2001 to $543.8 million at March 31, 2002. The net result is an increase in
the Provision for Credit Losses both in total dollars and as a percentage of the
amount financed in the first quarter of 2002. The Allowance as a percentage of
loan principal is 19.8% at December 31, 2001 and March 31, 2002, up from 19.1%
as of March 31, 2001.
See "Static Pool Analysis" below for further Provision for Credit Loss
discussion.
Net Interest Income
Three Months Ended
March 31, Percentage
-------------------------
2002 2001 Change
------------------------- -------------
Interest Income $ 32,830 $ 33,844 (3.0%)
Portfolio Interest Expense (6,143) (8,519) (27.9%)
-------------------------
Net Interest Income $ 26,687 $ 25,325 5.4%
=========================
-------------------------
Average Effective Yield 25.9% 26.3%
Average Borrowing Cost 7.0% 8.9%
Interest Income consists primarily of interest on finance receivable
principal balances retained on our balance sheet, plus interest income from
investments held in trust. The average effective yield on finance receivables
remained fairly constant at 25.9% and 26.3% for the three months ended March 31,
2002 and 2001, respectively. Offsetting the slight decrease in yield was an
increase in the average retained principal balances to $528.0 million for the
first quarter of 2002, up from $525.5 million for the first quarter of 2001. The
decrease in interest income consisted primarily of a decrease in interest earned
on investments held in trust from $1.0 million for the quarter ended March 31,
2001 to $0.3 million for the quarter ended March 31, 2002. This decrease was
primarily related to lower money market rates during the first quarter of 2002.
Portfolio interest expense consists primarily of interest on our revolving
warehouse facility and the Class A obligations issued in our securitization
transactions from the collateralized borrowings on the retained portfolio.
Portfolio interest expense decreased to $6.1 million for the three-month period
ending March 31, 2002, compared to $8.5 million for the same period of the
previous year. The decrease is due to lower borrowing costs as a result of a
decline in LIBOR, and due to borrowing less under the combination of the
warehouse line and securitizations as a result of securing the inventory line in
August of 2001, which is included in other interest expense.
Income before Operating Expenses
Income before Operating Expenses decreased 7.1% to $40.5 million for the
three-month period ended March 31, 2002, as compared to $43.7 million for the
three-month period ended March 31, 2001. The decrease resulted from an increase
in the amount charged to current operations for the provision for credit losses,
partially offset by an increase in gross margin on used cars sold due to an
increase in the number of units sold, and an increase in net interest income
primarily due to a decrease in portfolio interest expense.
Operating Expenses
Three Months Ended
March 31,
-------------------------------- Percentage
2002 2001 Change
-------------------------------- --------------
Operating Expenses $ 35,503 $ 37,471 (5.3%)
================================
Per Car Sold $ 2,320 $ 2,523 (8.0%)
================================
As % of Total Revenue 20.3% 22.8%
================================
Operating expenses, which consist of selling, marketing, general and
administrative and depreciation/amortization expenses, decreased quarter over
quarter and as a percentage of total revenues. The decrease in operating
expenses in 2002 was primarily due to numerous cost savings initiatives taken
during 2001, including consolidating collection and loan servicing centers by
closing two of our four centralized facilities and completing a reduction in
work force of primarily corporate staff in the fourth quarter of 2001. In
January of 2002 we incurred a $0.8 million charge related to a second reduction
in work force to save an additional $1.7 million per annum in salary, wages and
benefits.
Other Interest Expense
Other Interest Expense, which consists of interest on Other Notes Payable
and Subordinated Notes Payable, totaled $2.3 million for the three months ended
March 31, 2002, versus $3.1 million for the comparable period of the prior year.
The average outstanding balance for Other Notes Payable was $41.1 million and
$33.7 million for the three months ended March 31, 2002 and 2001, respectively.
The increase is primarily attributable to borrowings under the revolving
inventory facility, partially offset by scheduled principal reductions made on
the senior secured loan facility and a reduction in mortgage interest related to
the sale of certain dealerships to Verde Investments in January 2002. The
average outstanding balance of Subordinated Notes Payable decreased to $29.0
million from $41.4 million for the three months ended March 31, 2002 and 2001,
respectively. The decrease related primarily to scheduled principal reductions
on the senior subordinated note payable, the repurchase in June 2001 of $3.6
million in principal of the subordinated debentures due in 2003 and a $5.0
million reduction in the subordinated debt payable to Verde Investments. See
Note (4) of the Notes to the Condensed Consolidated Financial Statements for
further discussion.
Income Taxes
Income taxes totaled $1.4 million for the three-month period ended March
31, 2002, versus $1.3 for same equivalent period in 2001. Our effective tax rate
was 41% for the period ended March 31, 2002, and 41% for the same period in
2001. In addition, the income taxes for the three months ended March 31, 2002,
include approximately $0.2 million change for a change in estimate for tax
deficiencies.
Net Earnings
Net Earnings totaled $1.4 million for the three months ended March 31,
2002, as compared with $1.8 million for the same period of the prior year. The
decrease was due primarily to the increase in provision for loan losses,
partially offset by an increase in the number of vehicles sold, an increase in
net interest income due primarily to a reduction in portfolio interest expense,
a decrease in operating expenses due to numerous cost savings initiatives and a
decrease in other interest expense due to a reduction in borrowings.
Business Segment Information
We report our operations based on three operating segments. These segments
are reported as Retail, Portfolio and Corporate Operations. See Note (6) to the
Condensed Consolidated Financial Statements.
Operating Expenses for our business segments, along with a description of
the included activities, for the three -month period ended March 31, 2002 and
2001 are as follows:
Retail Operations. Operating expenses for our Retail segment consist of
Company marketing efforts, maintenance and development of dealership and
inspection center sites, and direct management of used car purchases,
reconditioning and sales activities. A summary of retail operating expenses
follows ($ in thousands, except per car sold amounts):
Three Months Ended
March 31,
-------------------------------
2002 2001
--------------- --------------
Retail Operations:
Selling and Marketing $ 7,613 $ 7,626
General and Administrative 13,449 14,658
Depreciation and Amortization 1,111 1,326
--------------- --------------
Retail Expense $ 22,173 $ 23,610
=============== ==============
Per Car Sold:
Selling and Marketing $ 497 $ 514
General and Administrative 879 987
Depreciation and Amortization 73 89
--------------- --------------
Total $ 1,449 $ 1,590
=============== ==============
As % of Used Cars Sold Revenue:
Selling and Marketing 5.4% 5.9%
General and Administrative 9.4% 11.3%
Depreciation and Amortization 0.8% 1.0%
--------------- --------------
Total 15.6% 18.2%
=============== ==============
Total Selling and Marketing expenses remained fairly constant quarter over
quarter; however, due to an increase in the number of cars sold, these expenses
decreased slightly on a per car sold basis. Selling and Marketing decreased as a
percentage of car sales revenues due to the increase in the number of cars sold
and combined with an increase in sales price per vehicle.
General and Administrative expenses decreased in total dollars, on a per
car sold basis and as a percentage of cars sales revenue related for the three
months ended March 31, 2002, principally due to a reduction in work force and
other general cost saving initiatives.
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. A summary of portfolio operating expenses follows ($ in thousands,
except expense per month per loan serviced):
Three Months Ended
March 31,
-------------------------------
2002 2001
-------------------------------
Portfolio Expense:
General and Administrative $ 6,542 $ 8,008
Depreciation and Amortization 252 264
-------------------------------
Portfolio Expense $ 6,794 $ 8,272
===============================
-------------------------------
Average Expense per Month per Loan Serviced $ 27.00 $ 31.68
===============================
Annualized Expense as % of EOP Managed -------------------------------
Principal Balances 5.0% 6.2%
===============================
The decrease in portfolio expenses and in the expense per month per loan
serviced for the three-month period ended March 31, 2002 compared to the same
period in 2001 for our Portfolio segment is primarily a result of efficiencies
gained with the closing of the collection and loan administration facilities in
Florida and Texas during the first quarter of 2001 and other general cost saving
initiatives. The three months ended March 31, 2001 include a $0.6 restructuring
related to the closure of those facilities.
Corporate Operations. Operating expenses for our Corporate segment consist
of costs to provide managerial oversight and reporting for the Company, develop
and implement policies and procedures, and provide expertise to the Company in
areas such as finance, legal, human resources and information technology. A
summary of corporate expenses follows ($ in thousands, except per car sold
amounts):
Three Months Ended
March 31,
---------------------------------
2002 2001
----------------- --------------
Corporate Expense:
General and Administrative $ 5,791 $ 4,772
Depreciation and Amortization 745 817
----------------- --------------
Corporate Expense $ 6,536 $ 5,589
----------------- --------------
Per Car Sold $ 427 $ 376
================= ==============
As % of Total Revenues 3.7% 3.4%
================= ==============
Corporate operating expenses as a percent of total revenue remained
relatively consistent for the three months ended March 31, 2002, versus the same
period of 2001. However, corporate expenses increased in total and on a per car
sold basis, as compared to the same period of the previous year, primarily due
to the $0.8 million restructuring charge in January 2002 as result of the second
reduction in work force.
Financial Position
The following table represents key components of our financial position ($
in thousands):
March 31, December 31, Percentage
2002 2001 Change
----------------- ---------------- ---------------
Total Assets $ 637,396 $ 647,657 (1.6%)
Finance Receivables, net 514,329 495,254 3.9%
Inventory 39,471 58,618 (32.7%)
Property and Equipment, net 30,137 37,739 (20.1%)
Net Assets of Discontinued Operations - 3,899 N/A
Total Debt 439,091 461,074 (4.8%)
Notes Payable - Portfolio 381,208 377,305 1.0%
Other Notes Payable 29,753 52,510 (43.3%)
Subordinated Notes Payable 28,130 31,259 (10.0%)
Stockholders' Equity $ 146,859 $ 145,483 0.9%
Total Assets. Total assets have remained relatively constant as the
decrease in Inventory and in Net Property and Equipment was partially offset by
the increase in Finance Receivables, net.
Inventory. Inventory represents the acquisition and reconditioning costs of
used cars located at our dealerships and our inspection centers. The change in
inventory from December 31, 2001 to March 31, 2002 is due to management's
decision to increase inventory levels at the end of the year in preparation for
the strong seasonal sale periods during the first and second quarters of the
year. We generally acquired our used car inventory from three sources:
approximately 55% from auctions, 40% from wholesalers and 5% from new car
dealerships for the first quarter of 2002. In future periods the percentage of
vehicles acquired from auctions is anticipated to increase dramatically as we
are implementing changes to our inventory acquisition strategy to focus on
auctions and to limit purchases from wholesalers. We believe this will help
enable us to achieve our goal of purchasing higher quality inventory at better
prices.
Property and Equipment, net. Net Property and Equipment decreased by $7.6
million during the quarter ended March 31, 2002. The decrease was primarily
related to the January 2002 sale and leaseback of six dealerships, with a net
book value of $6.7 million, to Verde Investments, Inc. pursuant to the option
agreement granted in 2001 as partial consideration for the $7.0 million
subordinated loan made by Verde Investments, Inc. See Note (3) to the Condensed
Consolidated Financial Statements.
Finance Receivables, net. Net Finance Receivables grew by $19.1 million or
3.9% during the quarter ended March 31, 2002. New originations in the quarter
exceeded the portfolio runoff, consisting of regular principal payments, payoffs
and charge-offs, by $29.1 million. Partially offsetting the growth in loan
principal balances was a $4.7 million decrease in Investments Held in Trust and
the $5.7 million increase in the Allowance for Credit Losses. The decrease in
Investments Held in Trust was primarily due to the Company purchasing back the
remaining balance on the 1999C securitization, resulting in a release of
approximately $4.4 million in cash to the Company. See Note (2) to the Condensed
Consolidated Financial Statements for the detail components of Finance
Receivables, net.
The following table reflects activity in the Allowance for Credit Losses,
as well as information regarding charge-off activity, for the three months ended
March 31, 2002 and 2001 ($ in thousands):
Three Months Ended March 31,
Allowance Activity: 2002 2001
--------------------------------------
Balance, Beginning of Period $ 101,900 $ 99,700
Provision for Credit Losses 45,367 39,020
Other Allowance Activity - 42
Net Charge Offs (39,667) (36,762)
--------------------------------------
Balance, End of Period $ 107,600 $ 102,000
======================================
Charge off Activity:
Principal Balances $ (47,031) $ (47,156)
Recoveries, Net 7,364 10,394
--------------------------------------
Net Charge Offs $ (39,667) $ (36,762)
======================================
The Allowance as a percentage of loan principal is 19.8% at December 31,
2001 and March 31, 2002, up from 19.1% as of March 31, 2001. The Allowance for
Credit Losses was $102.0 million as of March 31, 2001 and $107.6 million as of
March 31, 2002. Of the $5.6 million increase in the allowance for credit losses,
$1.7 million related to the increase in loan principal balance from $535.0
million as of March 31, 2001 to $543.8 million as of March 31, 2002. The
remainder of the increase related primarily to originations prior to 2001 that
are emerging at higher loss levels than previously estimated and due to the
effects of the recession. Offsetting these higher loss rates on older
originations are new originations since the 1st quarter of 2001 that are
performing better than prior years due to the implementation of higher credit
standards.
The Allowance for Credit Losses is maintained at a level that in
management's judgment is adequate to provide for estimated probable credit
losses inherent in our retail portfolio over the next twelve months and is
reviewed on an ongoing basis. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Static Pool Analysis" below.
Net Assets of Discontinued Operations. In December 1999, we sold the Cygnet
Dealer Finance ("CDF") subsidiary and also decided to abandon any efforts to
acquire third party loans or servicing rights to additional third party
portfolios. As a result, CDF, Cygnet Servicing and the associated Cygnet
Corporate segment assets and liabilities were classified as net assets from
discontinued operations. We plan to complete the servicing of the portfolios
that we currently service.
Total Debt. Total Debt is comprised of Notes Payable - Portfolio, Other
Notes Payable and Subordinated Notes Payable. We finance the increases in our
loan portfolio and other assets primarily through additional borrowings on our
warehouse line, additional securitizations and our inventory line of credit. See
"Management's Discussion and Analysis of Financial Conditions and Operation -
Financing Resources" below.
Notes Payable - Portfolio. Notes Payable - Portfolio consists of our
warehouse line and securitizations. The amount outstanding under the warehouse
line increased by $75.0 million during the quarter ended March 31, 2002. The
increase was used to fund new originations during the quarter, pending the
securitization of these loans which was completed in April 2002 upon the
issuance of $121.0 million in Class A bonds. The amount of obligations
outstanding pursuant to the Company's securitization program decreased $71.6
million in the first quarter of 2002 primarily due to no new securitizations
during the quarter combined with normal runoff of the portfolio and the
repurchase of the 1999C trust by the Company.
Other Notes Payable - The decrease in Other Notes Payable was primarily due
to a decrease in the inventory line of $15.9 million related to seasonal
reductions in our vehicle inventory. In addition, on January 4, 2002, Verde
Investments, Inc. ("Verde"), an affiliate of Mr. Ernest Garcia II, the Company's
chairman, purchased six properties located in Texas, Virginia, and California,
and simultaneously leased the properties to the Company on terms similar to the
Company's current leases, 15 year triple net leases, expiring December 2017.
In conjunction with this sale, Verde assumed responsibility for payments on
approximately $4.1 million of principal mortgage balances. For further
discussion, see Notes (3) and (4) of Notes to the Condensed Consolidated
Financial Statements.
Subordinated Notes Payable - The decrease in Subordinated Notes Payable was
primarily due to the pay down on the subordinated note payable to Verde
Investments, Inc., an affiliate of Mr. Garcia, entered into in January 2001,
which was reduced from $5.4 million outstanding at December 31, 2001 to $2.0
million outstanding at March 31, 2002. Other decreases are due to the
amortization of capitalized loan fees. See Notes (3) and (4) of the Notes to the
Condensed Consolidated Financial Statements.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for loans we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge-offs for each pool
separately. We calculate the cumulative net charge-offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge-off. The table below
displays the cumulative net charge-offs of each pool as a percentage of original
loan cumulative balances, based on the quarter the loans were originated. The
table is further stratified by the number of payments made by our customers
prior to charge-off. For periods denoted by "x", the pools have not seasoned
sufficiently to allow us to compute cumulative losses. For periods denoted by
"-", the pools have not yet reached the indicated cumulative age. While we
monitor static pools on a monthly basis, for presentation purposes we are
presenting the information in the table below on a quarterly basis.
Currently reported cumulative losses may vary from those previously
reported due to ongoing collection efforts on charged-off accounts, and the
difference between final proceeds on the sale of repossessed collateral versus
our estimates of the sale proceeds. Management, however, believes that such
variation will not be material.
The following table sets forth as of April 30, 2002, the cumulative net
charge-offs as a percentage of original loan cumulative (pool) balances, based
on the quarter of origination and segmented by the number of monthly payments
completed by customers before charge-off. The table also shows the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
Pool's Cumulative Net Losses as Percentage of Pool's Original
Aggregate Principal Balance
($ in thousands)
Monthly Payments Completed by Customer Before Charge-Off
--------------------------------------------------------
Orig. 0 3 6 12 18 24 TLI Reduced
------ - - - -- -- -- ----- -------
1993 $ 12,984 8.8% 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% 20.8% 26.3% 28.7% 29.9% 100.0%
2nd Quarter $ 66,908 1.1% 8.0% 14.2% 21.7% 27.2% 29.1% 30.1% 100.0%
3rd Quarter $ 71,027 1.0% 7.9% 13.2% 22.9% 27.6% 30.1% 30.9% 100.0%
4th Quarter $ 69,583 0.9% 6.6% 13.0% 24.2% 28.9% 31.2% 32.2% 99.9%
1999
1st Quarter $103,068 0.8% 7.4% 15.0% 23.4% 29.3% 31.5% 32.8% 99.6%
2nd Quarter $ 95,768 1.1% 9.8% 16.6% 25.2% 31.3% 33.6% 34.7% 98.7%
3rd Quarter $102,585 1.0% 8.2% 14.1% 25.2% 30.7% 33.5% 34.6% 96.5%
4th Quarter $80,641 0.7% 5.9% 12.6% 23.5% 28.9% 32.0% 32.7% 93.2%
2000
1st Quarter $128,123 0.3% 6.5% 14.5% 24.1% 30.3% x 32.7% 88.6%
2nd Quarter $118,778 0.6% 8.5% 15.9% 25.9% 32.6% - 33.8% 82.7%
3rd Quarter $124,367 0.7% 7.7% 14.3% 25.8% x - 31.8% 75.4%
4th Quarter $100,823 0.6% 6.6% 13.6% 25.8% - - 28.3% 66.7%
2001
1st Quarter $126,013 0.4% 6.4% 14.1% x - - 23.6% 57.2%
2nd Quarter $103,521 0.5% 6.3% 13.0% - - - 16.4% 43.9%
3rd Quarter $109,037 0.7% 5.4% x - - - 9.1% 28.0%
4th Quarter $ 87,355 0.7% x - - - - 4.2% 12.4%
2002
1st Quarter $140,178 x - - - - - 0.5% 6.3%
The following table sets forth the principal balances' delinquency status
as a percentage of total outstanding contract principal balances from dealership
operations:
March 31, December 31,
Days Delinquent: 2002 2001
----------------- -----------------
Current 72.4% 64.5%
1-30 Days 21.9% 26.2%
31-60 Days 3.3% 5.6%
61-90 Days 2.4% 3.7%
----------------- -----------------
Total Portfolio 100.0% 100.0%
================= =================
In accordance with our charge-off policy, there are no accounts more than
90 days delinquent as of March 31, 2002.
Current accounts increased from 64.5% as of December 31, 2001 to 72.4% as
of March 31, 2002 and accounts greater than 30 days delinquent decreased from
9.3% to 5.7% during the same period, a 39% improvement. The improvement in
delinquencies is a combination of (i) the positive effect of higher credit
standards and the improved credit quality mix of originations since the first
quarter of 2001, (ii) the transition of 1-60 day collectors into our
dealerships, (iii) the easing of the effects of the recession, and (iv)
seasonality and the positive impact of income tax refunds.
Although delinquencies have improved dramatically in the first quarter of
2002 and loan losses on recently originated loan pools indicate improved loan
performance compared to those loans originated prior to 2001, the Provision for
Credit Losses increased to $45.4 million or 32.3% of the total amount financed
for the quarter ended March 31, 2002, up from $39.0 million or 31.0% of the
total amount financed for the quarter ended March 31, 2001. 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. The Company
began to improve the underlying credit quality mix of its originations due to
improved credit standards and the introduction of loan grading in 2001. As a
result, 2001 and 2002 originations are performing better to date than loans
originated in prior periods. Offsetting these improvements are the effects of
the recession and the performance of loans originated prior to 2001 that do not
have the benefit of the new higher credit standards and are emerging at loss
levels higher than previously estimated. The Allowance as a percentage of loan
principal is 19.8% at December 31, 2001 and March 31, 2002, up from 19.1% as of
March 31, 2001.
Securitizations
Under the current legal structure of our securitization program, we sell
loans to our 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
notes or certificates (Class A obligations or Notes Payable) to investors. The
subordinate classes are retained by us or our subsidiaries. We continue to
service the securitized loans.
The Class A obligations have historically received investment grade
ratings. To secure the payment of the Class A obligations, the securitization
subsidiaries have obtained 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 reserve accounts are classified in our
consolidated financial statements as Investments Held in Trust and are a
component of Finance Receivables, net.
Reserve Account Requirements. Under our current securitization structure,
we make an initial cash deposit into a reserve account, generally equivalent to
3.0%-6.0% of the initial underlying Finance Receivables' principal balance, and
pledge this cash to the reserve account agent. The trustee then makes additional
deposits to the reserve account out of collections on the securitized
receivables as necessary to fund the reserve account to a specified percentage,
historically ranging from 8.0% to 11.0%, of the underlying Finance Receivables'
principal balance. The trustee makes distributions to us when:
o reserve account balance exceeds the specified percentage,
o required periodic payments to the Class A certificate holders are current,
o portfolio charge-off and delinquency triggers are not exceeded, and
o trustee, servicer and other administrative costs are current.
Due to the impact of the recession, the events of September 11th and the
poor auction recovery market at year end 2001, three of our trusts, 2000B, 2000C
and 2001A, reached termination event charge-off levels for the month of December
2001, and one trust, 1999C, reached a termination event delinquency level in
January 2002, that triggered an acceleration of rights for MBIA under the
Insurance Agreements of the respective trusts. These rights include, among other
things, the ability to transition servicing on these trusts to a third party and
accelerate the cash flow to the A bondholders until they have been paid in full.
These trusts reached these levels only for the month indicated and have been
under these levels since then. In March 2002, we repurchased the 1999C trust
resulting in a release of $4.4 million in cash held in the reserve account to
the Company. We continue to trap cash in the reserve accounts of the 2000B,
2000C and 2001A trusts related to these December breaches in charge-off levels.
MBIA has reserved their rights with respect to these breaches, but based on
discussions with MBIA, we believe the Company will continue to function as the
servicer for these trusts. Further, based on our discussions with MBIA, we
believe that when these trusts are below the performance triggers for two
consecutive months, MBIA will allow us to begin releasing cash in excess of the
greater of a reserve account level of 20% of the outstanding Finance
Receivables' principal balance or 4% of the original Finance Receivables'
principal balance. The 2000B, 2000C and 2001A trusts were all below the
portfolio triggers in April 2002 and based on current performance we believe
they will begin to release cash in the 2nd quarter of 2002.
In addition, the impact of the recession and the events of September 11th,
also caused us to reach a portfolio event delinquency level in 2000A that has
triggered the right of MBIA to trap cash until higher reserve account levels are
met or the delinquencies fall below the required levels. As a result, trust
2000A is required to trap cash to the greater of 16% of the outstanding Finance
Receivable principal balance or 3% of the original Finance Receivable principal
balance. As of December 31, 2001, the 2000A reserve account totaled 15.1% of the
then outstanding Finance Receivable balance, and in January 2002 began releasing
cash in excess of the reserve account levels. This breach is self-curing and
once the trust delinquency and charge-off levels are below the performance
tests, the reserve balance requirement will return to the normal specified level
and release all cash to the Company to that level. No additional waiver or
approval is required for this process.
In April 2002, we completed our first securitization of this year, 2002A,
with MBIA providing the insurance in the transaction. This was the 22nd
securitization in our history, consisting of approximately $170.4 million in
principal balances and the issuance of approximately $121.0 million in Class A
bonds. The coupon rate on the Class A bonds is 4.16%, the initial deposit into
the reserve account was 6.0% and the reserve account maximum is 10.0%. As a
condition for MBIA providing insurance for this securitization, the Company
deposited an additional $2.3 million in an escrow account to protect MBIA from
any potential losses on any currently active trusts.
We have mutually agreed with MBIA to further diversify our lending sources,
a process that we initiated in 2001 with our inventory and warehouse lending
facilities, and as a result we expect that our next securitization, 2002B, will
not be insured or we will engage a different insurer for that transaction. We
are currently undergoing due diligence by potential insurers and are in the
process of negotiating terms for future securitizations. We believe that our
next securitization will be in the third quarter of this year.
For discussion of certain risks related to our securitization transactions,
see "Securitization Transactions" set forth in Exhibit 99 to this Form 10-Q.
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have leveled
as we slowed the growth of our business. We require capital for:
o investment in our loan portfolio, o the purchase of inventories, and
o working capital and general corporate purposes, o the purchase of property and equipment.
We fund our capital requirements primarily through:
o operating cash flow, o our inventory line, and
o securitization transactions, o supplemental borrowings.
o our revolving warehouse facility,
For 2002, we believe we will have adequate liquidity for our operations,
notwithstanding the termination events under the four securitizations discussed
above. We closed our first securitization transaction of 2002, insured by MBIA,
in April and believe we will continue to be able to securitize our loan pools
throughout the year. We expect that our second securitization in 2002 either
will not be insured or we will engage an insurer other than MBIA for that
transaction. We are currently undergoing due diligence by potential insurers and
are in the process of negotiating terms for future securitizations. In March of
2002, we renewed our $100 million warehouse credit facility for an additional
364 day period. In addition, we have negotiated a term sheet and have begun the
process of documenting the renewal of our $35 million senior secured loan
facility. We believe the facility will be renewed during the second quarter of
2002; however, we do not have a binding commitment from the lender. This $35
million facility, which has been reduced to $23.0 million outstanding as of
March 31, 2002, matures in February 2003. If it is not renewed, then starting in
October 2002, the regular principal reductions increase from the current $1.0
million per month up to the greater of $3.0 million per month or 50% of the cash
flows from classes of notes issued through securitizations that are subordinate
to Class A bonds. Our inventory facility does not expire until June of 2003.
As a result of the termination events and portfolio event described above,
residual cash otherwise available to us is being trapped for four of our six
securitization trusts. In March 2002 we repurchased the 1999C trust, which was
one of the four trusts that hit a termination event, resulting in a release of
$4.4 million in cash held in the reserve account to the Company. The cash
reserve levels for the remaining three trusts that hit termination events
(2000B, 2000C and 2001A) are expected to increase $4.7 million, from $10.8
million at March 31, 2002, to approximately $15.5 million in the second quarter
of 2002, and then begin releasing cash. In addition, we expect that the reserve
accounts for 2000B, 2000C and 2001A will either return to normal levels in the
3rd and 4th quarters of 2002 or the trusts will be bought back by us, resulting
in the release of these cash reserves and generating additional cash flow.
Furthermore, the portfolio event trust, 2000A, had trapped sufficient cash so
that it began releasing excess cash in January 2002. As a result of these
events, and as previously discussed, as a condition for MBIA providing insurance
for the 2002A securitization that closed in April 2002, we funded an additional
$2.3 million deposit into an escrow account as additional collateral for any
current securitizations insured by MBIA. We do not expect the cumulative effect
of these events and the trapping of cash to materially impact our ability to
adequately fund our operations in 2002. However, if we experience adverse trends
in delinquencies or charge-offs, or we are unable to renew our senior secured
term facility or are unable to securitize our loan pools, it could have a
material adverse impact on our liquidity.
For a discussion of certain risks that could affect our liquidity and
capital resources, see Exhibit 99 to this form 10-Q.
Cash Flow
Net cash provided by operating activities increased $19.2 million to $78.7
million in the three months ended March 31, 2002, up from $59.5 million net cash
provided by operating activities in the first three months of 2001. This
increase is primarily due to an increase in provision for credit losses, an
increase in accounts payable, accrued expenses and other liabilities, and an
increase in income taxes payable. Partially offsetting these increases to cash
flow from operations were a decrease in inventory allowance and an increase in
other assets.
Net cash used in investing activities increased $7.8 million to $67.6
million during the three months ended March 31, 2002 as compared to $59.8
million used during the same period of 2001. The increase in cash used in
investing activities is the result of an increase in finance receivables
originated due to increased sales price and volume, partially offset by an
increase in collections on finance receivables, proceeds from disposal of
property and equipment related to the sale of six dealership properties to Verde
Investments and a reduction in purchases of property and equipment.
Net cash used in financing activities increased $13.9 million to $14.7
million for the three months ended March 31, 2002, as compared to $0.8 million
net cash used during the same period of 2001. The increase in cash used is
primarily due to a decrease in additions to notes payable portfolio because
there were no new securitizations during the quarter, a decrease to additions to
other notes payable, an increase in repayments of other notes payable related to
the pay down of the inventory line and an increase in repayment of subordinated
notes payable. Partially offsetting these increases in cash used were decreases
in initial deposits at securitization, additional deposits into investments held
in trust and repayment of notes payable-portfolio, all primarily because there
were no new securitizations during the quarter, plus an increase in collections
from investments held in trust due to the buyback of the 1999C trust and the
related release of cash held in the reserve account.
Financing Resources
Revolving Warehouse Facility. In March 2002, the Company renewed its
revolving warehouse facility with Greenwich Capital Financial Products, Inc. for
an additional 364-day term through March 2003. The facility allows for maximum
borrowings of $100 million during the entire renewed term, as compared to $75
million during the period May 1 through November 30 increasing to $100 million
during the period December 1 through April 30 under the initial term. In
addition, the 65% cap on the advance rate was removed and the calculation of the
warehouse advance relative to the net securitization advance was improved by 2%.
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% (4.70% and 4.72% at March 31, 2002, and December 31, 2001,
respectively). The facility is secured with substantially all Company assets. At
March 31, 2002, the Company was not in compliance with the debt to EBITDA ratio
covenant of this facility and received a waiver from the lender. The Company was
in compliance with all other required covenants.
Revolving Inventory Facility. On August 31, 2001, the Company entered into
a $36 million revolving inventory facility with Automotive Finance Corporation
that 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% (10.75% at March 31, 2002, and
at December 31, 2001). The facility is secured with the Company's automobile
inventory. At March 31, 2002, the Company was in compliance with all required
covenants.
Securitizations. Our securitization program is a primary source of our
working capital. Securitizations generate cash flow for us from the sale of
Class A obligations, ongoing servicing fees, and excess cash flow distributions
from collections on the loans securitized after payments on the Class A
obligations, payment of fees, expenses, and insurance premiums, and required
deposits to the reserve accounts. Securitizations 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
Senior Secured Note Payable. In January 2001 we entered into a $35 million
senior secured loan facility with certain lenders that has a term of 25 months.
Per the agreement, the Company must make principal payments of $1.0 million per
month during months from April 2001 through September 2002. 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 (7.90 % at March 31, 2002, and at
December 31, 2001). The balance of the note was $23.0 million at March 31, 2002.
The loan is secured by certain Finance Receivables. At March 31, 2002, the
Company was not in compliance with the senior debt to total capitalization
covenant of this facility, and received a waiver from the lender. The Company
was in compliance with all other required covenants. We believe the facility
will be renewed during the second quarter of 2002; however, we do not have a
binding commitment from the lender.
Senior Subordinated Secured Note. In January 2001, we borrowed $7.0 million
in a subordinated loan from Verde Investments, Inc. ("Verde"), an affiliate of
Mr. Garcia, that is secured by residual interests in the Company's
securitization transactions but is subordinate to the senior secured note
payable. The loan requires quarterly interest payments at LIBOR plus 600 basis
points and is subject to pro rata reductions if certain conditions are met. The
balance of the note with Verde was $2.0 million at March 31, 2002. As a
condition to the $35 million senior secured note payable, Verde, an affiliate of
Mr. Garcia, was required to invest the $7.0 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% of
the $35 million facility. The Company did not meet this pre-tax income
requirement for the first six months of 2001. 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 exercised its option to purchase any of the
properties. In December 2001, Verde exercised its right to purchase from, and
lease back to the Company, six properties having a net book value of
approximately $6.7 million. This purchase and leaseback transaction closed in
January 2002, for six properties located in Texas, Virginia and California.
Senior Subordinated Notes. In February 1998, we borrowed a total of $15.0
million of subordinated debt from unrelated third parties for a three-year term.
We issued warrants to the lenders of this debt to purchase up to 500,000 shares
of our common stock at an exercise price of $10.00 per share, exercisable at any
time until the later of February 2001, or when the debt is paid in full. On
September 30, 2000, the Loan Agreement, Warrants and Warrant Agreements between
us and certain Lenders under this Loan Agreement, were amended to: reduce the
outstanding principal balance under the Loan Agreement from $15 million to $13.5
million; require us to take out one of the lenders in the facility by paying off
that lender's $1.5 million share of the loan (which occurred), and cancel the
number of outstanding warrants attributable to that portion of the loan;
increase the interest rate under the Loan Agreement to 15%; extend the term of
the Loan Agreement to February 12, 2003; and provide for the repayment of
principal and the corresponding reduction of warrants under certain terms and
conditions. This debt is senior to the subordinated debentures issued in our
exchange offers (described below), subordinate to our other indebtedness, and
had a $5.0 million balance at March 31, 2002. With the closing of the going
private transaction, the warrants were terminated.
1998 Exchange Offer. In the fourth quarter of 1998, we acquired
approximately 2.7 million shares of our common stock in exchange for
approximately $17.5 million of subordinated debentures. We issued the debentures
at a premium of approximately $3.9 million over the market value of the shares
of our common stock that were exchanged for the debentures. Accordingly, the
debt was recorded at $13.6 million on our balance sheet. The premium will be
amortized over the life of the debentures and results in an effective annual
interest rate of approximately 18.8%. The debentures are unsecured and are
subordinate to all of our existing and future indebtedness. We must pay interest
on the debentures semi-annually at 12% per year. We are required to pay the
principal amount of the debentures on October 23, 2003. We can redeem all or
part of the debentures at any time. In June 2001, we repurchased $3.6 million of
principal of the debentures.
2000 Exchange Offer. In April 2000, we completed an exchange offer in which
we acquired approximately 1.1 million shares of our common stock in exchange for
$11.9 million of subordinated debentures. We issued the debentures at a premium
of approximately $3.9 million over the market value of the exchanged shares of
our common stock. Accordingly, the debt was recorded at $8.0 million. The
premium will be amortized over the life of the debentures and results in an
effective annual interest rate of approximately 19.9%. The debentures are
unsecured and are subordinate to all of our existing and future indebtedness. We
must pay interest on the debentures semi-annually at 11% per year. We are
required to pay the principal amount of the debentures on April 15, 2007. We can
redeem all or part of the debentures at any time.
Debt Shelf Registration. In 1997, we registered up to $200 million of our
debt securities under the Securities Act of 1933. There can be no assurance that
we will be able to use this registration statement to sell debt securities, or
successfully register and sell other debt securities in the future.
Capital Expenditures and Commitments
On March 4, 2002, UDC Acquisition Corp. ("UDC Acquisition"), an entity
wholly owned by UDC Holdings Corp., controlled by Ernest Garcia II and Greg
Sullivan, completed a short form merger with and into the Company. The Company
was the surviving corporation under the short form merger. UDC Holdings
capitalized UDC Acquisition with a combination of cash, common stock of the
Company and a receivable from UDC Holdings representing a commitment to fund the
final payment to dissenting shareholders. See Management's Discussion and
Analysis of Financial Condition - Part II Other Information - Item 1. Legal
Proceedings).
Accounting Matters
Critical Accounting Policies
The discussion and analysis of our financial condition and results of
operations are based upon our condensed consolidated financial statements, which
have been prepared in accordance with accounting principles generally accepted
in the United States of America. The preparation of these financial statements
require management to make estimates and judgments that affect the reported
amounts of assets and liabilities, revenues and expenses, and related
disclosures of contingent assets and liabilities at the date of our financial
statements. Actual results may differ from these estimates under difference
assumptions or conditions.
Certain accounting policies involve significant judgments and assumptions
by management, which have a material impact on the carrying value of assets and
liabilities and the recognition of income and expenses; management considers
these accounting policies to be a critical accounting policies. The judgments
and assumptions used by management are based on historical experience and other
factors, which are believed to be reasonable under the circumstances. The
following are the Company's critical accounting policies.
Revenue Recognition - Revenue from the sales of used cars is recognized
upon delivery, when the sales contract is signed and the agreed-upon down
payment has been received. Interest income is recognized using the interest
method. Direct loan origination costs related to loans originated at
Company dealerships are deferred and charged against finance income over
the life of the related installment sales loan using the interest method.
The accrual of interest for accounting purposes is suspended if collection
becomes doubtful, generally 90 days past due, and is resumed when the loan
becomes current.
Allowance for Loan Losses - An allowance for credit losses is established
by charging the provision for credit losses and the allocation of acquired
allowances. The evaluation of the adequacy of the allowance considers such
factors as the performance of each dealership's loan portfolio, the
Company's historical credit losses, the overall portfolio quality and
delinquency status, the value of underlying collateral, and current
economic conditions that may affect the borrowers' ability to pay. Based on
these factors, management provides for the estimated net credit losses
anticipated to be charged-off on existing receivables over the twelve
months following the balance sheet date. This estimate of existing probable
and estimatable losses is primarily based on static pool analyses prepared
for various segments of the portfolio utilizing historical loss experience,
adjusted for the estimated impact of the current environmental factors
outlined above.
Valuation of Inventory - Inventory consists of used vehicles held for sale,
which is valued at the lower of cost or market, and repossessed vehicles,
which are valued at market value. Vehicle reconditioning costs are
capitalized as a component of inventory cost. The cost of used vehicles
sold is determined on a specific identification basis.
Accounting for Securitizations - Under the current legal structure of the
securitization program, the Company sells loans to Company 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 notes or
certificates (Class A obligations) to investors, and subordinate classes
are retained by the Company. The Company continues to service the
securitized loans. The Class A obligations have historically received
investment grade ratings and are recorded as Notes Payable - Portfolio by
the Company. Additionally, a cash "reserve" account is established for the
benefit of the Class A obligations holders. The reserve accounts are
classified in the financial statements as Investments Held in Trust and are
a component of Finance Receivables, Net. For securitization transactions
closed during the third quarter of 1998 and prior years, gains on sale were
computed based upon the difference between the sales proceeds for the
portion of finance receivables sold and the Company's recorded investment
in the finance receivables sold. The Company allocated the recorded
investment in the finance receivables between the portion of the finance
receivables sold and the portion retained based on the relative fair values
on the date of sale. The retained portion is reported as Residuals in
Finance Receivables Sold and is a component of Finance Receivables, Net.
Accounting for Income Taxes - The provision for income taxes is based on
income reported for financial statement purposes and differs from the
amount of taxes currently payable, since certain income and expense items
are reported for financial statement purposes in different periods than
those for tax reporting purposes. The Company accounts for income taxes
using the asset and liability approach, the objective of which is to
establish deferred tax assets and liabilities for the temporary differences
between the financial reporting basis and the tax basis of the Company's
assets and liabilities at enacted tax rates expected to be in effect when
such amounts are realized or settled. A valuation allowance is established
for deferred tax assets if, based on the weight of available evidence, it
is more likely than not that some portion or all of the deferred tax assets
will not be realized. A valuation allowance is established, when necessary,
to reduce the deferred tax assets to the amount that is more likely than
not to be realized.
Recent Accounting Pronouncements
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 No. 144 retains
the fundamental provisions in Statement No. 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 No. 121. For example, Statement No. 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 No. 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 No. 121, an impairment assessment
under Statement No. 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 adopted the provisions of Statement No. 144 for the quarter
ending March 31, 2002. The adoption of Statement No. 144 for long-lived assets
held for use did not have a material impact on the Company's financial
statements because the impairment assessment under Statement 144 is largely
unchanged from Statement No. 121.
In June 2001, the FASB issued Statement 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 a 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 Statement
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 Statement 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 No. 142
requires 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 No. 142. Statement No. 142 also
requires that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment. The Company adopted the provisions of Statement No. 141
as of July 1, 2001, and Statement 142 effective January 1, 2002.
Statement No. 141 required upon adoption of Statement No. 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 No. 141
for recognition apart from goodwill. Upon adoption of Statement No. 142, the
Company was 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 is required to test the intangible
asset for impairment in accordance with the provisions of Statement No. 142. Any
impairment loss must 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.
The Company adopted the provisions of Statement No. 141 as of July 1, 2002,
and Statement No. 142 effective January 1, 2002. Statement No. 141 required upon
adoption of Statement No. 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 No. 141 for recognition apart from goodwill. In
conjunction with the adoption of the Statement No. 142, the Company has
allocated the entire goodwill balance to the Retail Operations Segment. During
the second quarter of 2002, the company expects to finalize the first step of
the required impairment tests of goodwill as of January 1, 2002. The Company
does not expect the effect of these tests to be material to the earnings or the
financial position of the Company. In addition, upon adoption we discontinued
amortizing goodwill. For the three months ended March 31, 2001, the Company had
approximately $0.2 million in amortization expense. As of March 31, 2002 the
Company has unamortized goodwill of approximately $11.6 million within the
retail segment and no unamortized identifiable intangible assets. (For further
discussion on SFAS No. 141 and 142, see Management's Discussion and Analysis of
Financial Condition - Recent Accounting Pronouncements.)
We Make Forward Looking Statements
This Report includes statements that constitute forward-looking statements
within the meaning of the safe harbor provisions of the Private and Securities
Litigation Reform Act of 1995. We claim the protection of the safe-harbor for
our forward-looking statements. Forward-looking statements are often
characterized by the words "may," "anticipates," "believes," "estimates,"
"projects," "expects" or similar expressions and do not reflect historical
facts. Forward-looking statements in this report relate, among other matters,
to: economic conditions; anticipated financial results, such as sales,
profitability, other revenues and loan portfolios, improvements in underwriting
including credit scoring, adequacy of the allowance for credit losses, and
improvements in recoveries and loan performance, including delinquencies and
charge offs; retaining the warehouse and inventory lines of credit; the success
of cost savings initiatives and restructurings; improvements in inventory and
inventory mix; release of trapped cash; repurchase of securitization trusts;
continued servicing in connection with securitization trusts which hit
termination events; continuing to complete securitization transactions; renewing
the term credit facility; and internet generated sales growth and loan
performance. Forward looking statements include risks, uncertainties and other
factors which may cause our actual results, performance or achievements to be
materially different from those expressed or implied by such forward looking
statements, some of which we cannot predict or quantify. Factors that could
affect our results and cause or contribute to differences from these
forward-looking statements include, but are not limited to: any decline in
consumer acceptance of our car sales strategies or marketing campaigns; any
inability to finance our operations in light of a tight credit market for the
sub-prime industry and our current financial circumstances; any deterioration in
the used car finance industry or increased competition in the used car sales and
finance industry; any inability to monitor and improve our underwriting and
collection processes; any changes in estimates and assumptions in, and the
ongoing adequacy of, our allowance for credit losses; any inability to continue
to reduce operating expenses as a percentage of sales; increases in interest
rates; generally maintaining liquidity levels and cash flows sufficient to fund
our ongoing operations; the failure to efficiently and profitably manage
acquisitions and/or new car dealerships; adverse economic conditions; any
material litigation against us or material, unexpected developments in existing
litigation; and any new or revised accounting, tax or legal guidance that
adversely affect used car sales or financing and developments with respect to
the going private transaction. Forward-looking statements speak only as of the
date the statement was made. Future events and actual results could differ
materially from the forward-looking statements. When considering each
forward-looking statement, you should keep in mind the risk factors and
cautionary statements found throughout this Form 10-Q and (including those set
forth in Exhibit 99 hereto), in addition to those risks discussed above. We are
not obligated to publicly update or revise any forward looking statements,
whether as a result of new information, future events, or for any other reason.
References to Ugly Duckling Corporation as the largest chain of buy-here
pay-here used car dealerships in the United States is management's belief based
upon the knowledge of the industry and not on any current independent third
party study.
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,
fixed rate notes receivable, and variable and fixed rate notes payable. Our
finance receivables are classified as sub-prime 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 March 31, 2002, the scheduled maturities on
our finance receivables ranged from one to 48 months, with a weighted average
maturity of 24.3 months. In March 2002 we launched a pilot interest rate program
in the Phoenix market called RateAdvantage that offers interest rates ranging
from 9.9% to 29.9% depending upon the customer's credit grade and the size of
the down payment. Depending upon the success of the program, we are anticipating
offering the RateAdvantage interest rate program at all of our dealerships in
either the 2nd or 3rd quarters of 2002. This will impact the overall average
interest rate of our finance receivable portfolio. 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 March 31, 2002, 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, 2001.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company sells their cars on an "as is" basis. It requires all customers
to acknowledge in writing on the date of sale that we disclaim any obligation
for vehicle-related problems that subsequently occur. Although management
believes 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, the Company receives
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 the Company 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, the Company is a defendant in various other types of legal
proceedings. Although the Company cannot determine at this time the amount of
the ultimate exposure from these lawsuits, if any, based on the advice of
counsel management does not expect the final outcome to have a material adverse
effect on the Company.
The Company was recently served in Texas as a defendant in a purported
class action lawsuit captioned Felix Rather III, et. al vs. Dallas Automotive
Sale and Service, et. al (including Ugly Duckling Car Sales and Ugly Duckling
Credit Corporation), 192nd Judicial District, Dallas County, Texas (state court
case). It is our understanding that a group of law firms in Texas have sued 61
Dallas county auto dealers (including Ugly Duckling) and 19 San Antonio auto
dealers alleging the auto dealers have charged customers interest on deferred
sales taxes. More lawsuits are expected to be filed in other Texas counties.
Under Texas law, a dealer who sells vehicles on credit may elect to pay sales
taxes on the installment basis (what the plaintiffs call "deferred sales
taxes"); that is, they pay the sales taxes as their installment basis and did or
are adding the entire amount of the sales tax to the amount financed and
charging interest on it. They allege this is not allowed under Texas law. Ugly
Duckling does not and has not paid sales taxes on an installment basis. The
Company has notified plaintiffs' counsel of this fact and provided to them
information intended to establish the fact. We hope to have the lawsuit
dismissed shortly, but there is no guarantee we will be successful with these
efforts. However, we believe the claims against us are without merit and intend
to vigorously defend them.
Going Private Transaction and Related Actions. On March 20, 2001, a shareholder
derivative complaint was filed, purportedly on behalf of the Company, 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 the Company's
current directors breached fiduciary duties owed to it in connection with
certain transactions between the Company and Mr. Ernest Garcia II, its Chairman
and majority stockholder, and various entities controlled by Mr. Garcia. The
complaint was amended on April 17, 2001 to add a second cause of action, on
behalf of all persons who own Company common stock, and their successors in
interest, which alleged that the Company's current directors breached fiduciary
duties in connection with the proposed acquisition by Mr. Garcia of all of the
outstanding shares of common stock not owned by him. The Company was named as a
nominal defendant in the action. The original cause of action sought to void all
transactions deemed to have been approved in breach of directors' fiduciary
duties and recovery by the Company of alleged compensatory damages sustained as
a result of the transactions. The second cause of action sought to enjoin the
Company 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 April 2001 to purchase all outstanding
shares of the Company's common stock (for $2.00 cash, $5.00 debenture per
share), 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 were 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. These lawsuits
were very similar to the lawsuits that were filed in connection with Mr.
Garcia's offer to take the Company private in early October of 2000 (offer of
$2.00 cash, $6.50 debenture per share). Mr. Garcia withdrew his offer to take
the Company private in the latter part of October 2000, and in March of 2001 all
of the outstanding lawsuits filed in connection with that offer were voluntarily
dismissed by the plaintiffs.
With respect to the lawsuits filed in April of 2001, each complaint alleged
that the Company, and its directors, breached fiduciary duties in connection
with the proposed acquisition by Mr. Garcia of all of the outstanding shares of
common stock not owned by him. The complaints sought 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. All of these
cases were consolidated June 5, 2001.
In September of 2001, Mr. Garcia withdrew his April 2001 proposal to
purchase the outstanding common stock due to the economic uncertainty resulting
from the events following the September 11th terrorist attack. On November 16,
2001, Mr. Garcia announced his intention of initiating a tender offer to
purchase all of the outstanding shares of common stock of the Company not owned
by him. That same day, the plaintiffs' amended the consolidated cases to
re-allege the derivative claims and replaced the class claims related to the
April 2001 proposal with class claims challenging and seeking to enjoin Mr.
Garcia's tender offer. The amended complaint alleged that the defendants
breached or aided and abetted in the breach of their fiduciary duties, and
sought to void the transactions challenged in the derivative claims and recover
compensatory damages on behalf of the purported class and the Company. On
November 26, 2001, Mr. Garcia initiated a tender offer to purchase all of the
outstanding shares of the Company's common stock not owned by him for $2.51 per
share.
On December 10, 2001, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Mr. Garcia, Mr. Gregory B. Sullivan, the
President and CEO of the Company, UDC Holdings Corp. ("UDC Holdings"), an entity
controlled by Mr. Garcia and Mr. Sullivan, and UDC Acquisition Corp. ("UDC
Acquisition"), an entity wholly owned by UDC Holdings (collectively, the "Buyout
Group"). The Merger Agreement provided that the pending tender offer would be
amended to, among other things, increase the offer price from $2.51 per share to
$3.53 per share (the "Amended Tender Offer"). The Merger Agreement also provided
for a second step merger at the same price of $3.53 per share (the "Merger," and
together with the Amended Tender Offer, the "Transaction"). The Merger Agreement
further provided that the Transaction could be consummated only if a majority of
the minority shareholders of the Company either tendered their shares in the
Amended Tender Offer or voted in favor of the Merger. At that time, there were
4,771,749 shares of the Company's stock not held by the Buyout Group.
The Transaction was entered into after review by a special transaction
committee comprised of independent members of the board of directors; the
committee and the board consulted with and obtained a fairness opinion from an
investment banking firm, U.S. Bancorp Piper Jaffray. The special committee
recommended the Transaction to the full board and the board recommended the
Transaction to the shareholders of the Company.
The Company also entered into a Memorandum of Understanding on December
10th with counsel for the plaintiffs' on the ultimate resolution of the Delaware
litigation related to the Transaction. Under this Memorandum of Understanding,
the plaintiffs' litigation was to be settled, subject to certain conditions,
including entering into a mutually agreeable stipulation of settlement
consistent with the memorandum of understanding, completion of certain
confirmatory discovery, certification of the class and a court order dismissing
the litigation, and the completion of the Merger.
On December 14, 2001, the Buyout Group commenced the Amended Tender Offer.
In the Amended Tender Offer materials, the Buyout Group disclosed that it
intended to cause the Merger to become effective without a meeting of
shareholders, pursuant to Delaware law, if the Amended Tender Offer resulted in
UDC Acquisition holding at least 90% of the Company's outstanding shares. The
Company and the board also sent materials to its shareholders at the same time
recommending that shareholders tender their shares pursuant to the Amended
Tender Offer.
The Company's shareholders overwhelmingly supported the Amended Tender
Offer, which expired on January 16, 2002. Shareholders tendered 3,806,800 shares
of the Company's common stock representing approximately 79% of the minority
shares. Upon completion of the Amended Tender Offer, UDC Acquisition owned
approximately 92% of the Company.
On February 4, 2002, the parties also entered into a Stipulation and
Agreement of Compromise, Settlement and Release documenting the settlement of
the Delaware litigation and providing for a final hearing for court review and
approval of the settlement. A mailing was sent to the shareholders in
mid-February and this hearing was held on April 17, 2002. On April 18th, the
court entered its final decision approving the settlement and finding it fair,
reasonable and in the best interests of the class, certifying the class for
purposes of the settlement, compromising and releasing all claims with prejudice
on the merits and awarding attorneys' fees and costs to the plaintiffs' in the
amount of $1,050,000. The settlement is final thirty days after the final court
order. However, as discussed in Note 9 to the Condensed Consolidated Financial
Statements, a notice of appeal was filed by two dissenting shareholders prior to
the expiration date. The Company also reached an agreement with its directors'
and officers' liability insurance carrier to reimburse the Company for the
payment of the plaintiffs' fees and costs (assuming final court approval of the
settlement), and it is in the process of documenting that agreement.
On March 4, 2002, the Merger was consummated. In the Merger, which was
consummated without a shareholder vote in accordance with Delaware law, UDC
Acquisition was merged with and into the Company, with the Company surviving.
Upon consummation of the Merger and pursuant to the terms of the Merger
Agreement and Delaware law:
o All shares of outstanding common stock not held in treasury or owned by the
Buyout Group were cancelled, retired and converted into the right to
receive either (a) $3.53 per share in cash, without interest or (b) if the
holder properly exercised appraisal rights under Delaware law, the fair
value of the shares as determined by the Court in appraisal proceedings;
o All treasury shares and shares held by the Buyout Group were cancelled and
retired without any consideration; and
o All shares of UDC Acquisition common stock outstanding immediately prior to
the effective date of the Merger were converted into shares of common stock
of the Company.
As a result of the Merger, the only remaining outstanding shares of common
stock of the Company are the 100 shares of common stock issued upon conversion
of the shares UDC Acquisition common stock. All of these shares are held by UDC
Holdings.
Shortly after the expiration of the Amended Tender Offer, the Company
mailed to the shareholders who did not tender their shares a notice outlining
the procedures they were required to follow if they wished to dissent from the
Merger and seek appraisal of their shares. Under Delaware law, these
shareholders had 20 days from the date of the mailing of the notice to notify
the Company of their intention to assert appraisal rights. If such notice is
timely made, dissenting shareholders must file a petition for appraisal in the
Delaware Court of Chancery within 120 days of the effective date of the Merger,
or all appraisal rights will be lost and dissenters will only be entitled to the
merger consideration of $3.53 per share. In the event a petition for appraisal
is filed, the court then determines which shareholders are entitled to appraisal
rights and appraises the shares of such shareholders.
Although several shareholders provided the Company with timely notice of
their intention to assert appraisal rights, to the Company's knowledge, no
petition for appraisal has been filed in the Delaware Court of Chancery as of
the date of filing of this quarterly report. The deadline for filing such a
petition is on or about July 2, 2002. In the event such a petition is filed, UDC
Holdings has agreed to fund the payment of the final appraisal amount to
dissenting shareholders.
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. See
Note (4) of the Notes to the Condensed Consolidated Financial Statements.
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 - Covenant Waiver dated March 31, 2002 between the Registrant and
Greenwich Capital Financial Products, Inc.
Exhibit 99 - Statement Regarding Forward Looking Statements and Risk Factors
(b) Reports on Form 8-K.
During the first quarter of 2002, the Company filed two reports on Form
8-K. The first report on Form 8-K, dated and filed February 15, 2002, reported
Ugly Duckling's announcement of Mark G. Sauder as the new Chief Financial
Officer. A press release dated February 15, 2002 and entitled "Ugly Duckling
Announces Appointment of New Chief Financial Officer" was filed as an exhibit to
this 8-K. The second report on Form 8-K, dated and filed March 4, 2002, reported
the fourth quarter and twelve months earnings of 2001, and the closing of the
transaction pursuant to which an affiliate of Mr. Ernest C. Garcia II, Ugly
Duckling's Chairman and largest stockholder, acquired all of the outstanding
shares of common stock of Ugly Duckling. A press release dated March 4, 2002 and
entitled "Ugly Duckling Reports Fourth Quarter and Twelve Month Results, and
Closing of Going Private Transaction" was filed as an exhibit to this 8-K.
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/ MARK G. SAUDER
-----------------------------------------------------------------------
Mark G. Sauder
Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: May 14, 2002
EXHIBIT INDEX
Exhibit
Number Description
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10.1 Covenant Waiver dated March 31, 2002 between the Registrant and
Greenwich Capital Financial Products, Inc.
99 Statement Regarding Forward Looking Statements and Risk Factors