Risk Factors
There are various risks in purchasing our debt securities, including those
described below. You should carefully consider these risk factors together with
all other information included in this Form 10-Q.
We make forward-looking statements. This Report includes statements that
constitute forward-looking statements within the meaning of the safe harbor
provisions of the Private and Securities Litigation Reform Act of 1995. We claim
the protection of the safe-harbor for our forward-looking statements.
Forward-looking statements are often characterized by the words "may,"
"anticipates," "believes," "estimates," "projects," "expects" or similar
expressions and do not reflect historical facts. Forward-looking statements in
this report relate, among other matters, to: 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 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; 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-K and specifically those found below. We are not obligated to
publicly update or revise any forward looking statements, whether as a result of
new information, future events, or for any other reason. References to Ugly
Duckling Corporation as the largest chain of buy-here pay-here used car
dealerships in the United States is management's belief based upon the knowledge
of the industry and not on any current independent third party study.
Our majority stockholder can control substantially all matters. As a result
of the closing of the going private transaction on March 4, 2002, Ernest C.
Garcia II, our Chairman, and Gregory B. Sullivan, our Chief Executive Officer
and President, are the beneficial owners of all our outstanding common stock.
They control the election of our directors or the approval of any merger,
reorganization or other business combination transaction. They could vote to
approve such a transaction on terms, which might be considered more favorable to
them than to unaffiliated and/or subordinated debtholders.
Our public debtholders are subordinated to almost all other classes of debt
we have and, as a result, they are particularly vulnerable to material adverse
financial changes, including material adverse changes in our liquidity.
Future losses could impair our ability to raise capital or borrow money and
consequently affect our future profitability and liquidity. While we have been
profitable in the past, we were not profitable in 2001 and we cannot assure you
that we will be profitable in future periods. Losses in future periods could
impair our ability to raise additional capital or borrow money as needed.
We may not be able to continue to obtain the financing we need to fund our
operations and, as a result, our business, profitability and liquidity could be
materially adversely affected. Our operations require large amounts of capital.
We have borrowed, and will continue to borrow, substantial amounts to fund our
operations. If we cannot obtain the financing we need on a timely basis and on
favorable terms, our business, profitability and liquidity could be materially
adversely affected. We have recently experienced a less favorable borrowing
environment than in the past. We currently obtain financing through four primary
sources:
o a warehouse facility with Greenwich Capital Financial Products, Inc.
("Greenwich");
o an inventory facility with Automotive Finance Corporation ("AFC")
o securitization transactions; and
o loans from other sources.
Warehouse Facility with Greenwich. When our prior warehouse lender, GE
Capital Corporation, announced that it was exiting the automobile finance
market, we had to replace our GE credit facility with a new facility. Our new
warehouse facility with Greenwich is now our primary source of operating
capital. We have pledged substantially all of our assets to Greenwich to secure
the borrowings we make under this facility. The warehouse facility recently was
renewed until March 2003. Under our securitizations, we are required to have a
credit facility reasonably acceptable to the insurer on April 30th of each year.
Failure to maintain such a facility would constitute an event of default under
our securitizations and, if that occurred, our liquidity would be materially
adversely affected.
Inventory Line of Credit with Automotive Finance Corporation. We entered
into a $36 million inventory line of credit with AFC in August of 2001, which
matures in June of 2003. If we are unable to maintain an inventory line of
credit, our liquidity would be materially adversely affected.
Securitization Transactions. We restore capacity under the warehouse
facility from time to time by securitizing portfolios of finance receivables.
Our ability to successfully and efficiently complete securitizations may be
affected by several factors, including:
o the condition of securities markets generally;
o conditions in the asset-backed securities markets specifically;
o the credit quality of our loan portfolio; and
o the performance of our servicing operations.
In past periods, we experienced a tightening of the restrictive covenants
in our securitization transactions as well as increases in the credit
enhancements required to close our securitizations. High delinquency levels and
charge offs or other events, such as our failure to have a warehouse facility
acceptable to the insurer of our securitization transactions in place on April
30 of each year, can also cause a "termination event" under our securitization
transactions. Four of our securitizations experienced termination events as
previously discussed in our 2001 form 10-K "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Securitizations". The
occurrence of termination events could result in the trapping of cash in the
Reserve Account up to the amount of the A bond for those securitizations, and/or
our being replaced as servicer under those securitizations or in a liquidation
and sale of the securitized portfolios. In addition, these types of occurrences
could also cause a "portfolio performance event," which could result in all cash
flow from the securitized receivables otherwise distributable on the junior
obligations held by us being retained in the trust as additional security for
senior securities until the event has been cured. One of our securitizations,
2000A, is currently experiencing such an event, although we expect that to be
remedied in 2002. The continuance of termination events or the occurrence of
additional termination or portfolio events could have a material adverse effect
on our ability to access the securitization market and/or our business,
liquidity and financial condition.
Contractual Restrictions. The warehouse facility, the inventory line of
credit, the securitization program, and our other credit facilities contain
various restrictive covenants, including financial tests. Failure to satisfy the
covenants in our credit facilities or our securitization program could result in
a default (and could preclude us from further borrowing under the defaulted
facility), could cause cross defaults to our other debt, and could prevent us
from securing alternate sources of funds necessary to operate our business. Any
of these events would have a material adverse effect on our business, liquidity
and financial condition. From time to time, we incur technical or other breaches
under our material credit facilities, and we have obtained waivers from the
applicable lenders. There can be no assurance we will continue to receive
waivers and our inability to obtain these waivers may cause cross defaults to
our other debt and have a material impact on our liquidity and our ability to
obtain or retain operating capital.
We have a high risk of credit losses because of the poor creditworthiness
of our borrowers. Substantially all of the sales financing we extend and the
loans that we service are with "sub-prime" borrowers. Sub-prime borrowers
generally cannot borrow money from traditional lending institutions, such as
banks, savings and loans, credit unions, and captive finance companies owned by
automobile manufacturers, because of their poor credit histories and/or low
incomes. Loans to sub-prime borrowers are difficult to collect and are subject
to a high risk of loss. We have established an allowance for credit losses to
cover our anticipated credit losses over a twelve-month period. We periodically
review and may make upward or downward adjustments to the allowance based upon
whether we believe the allowance is adequate to cover our anticipated credit
losses. However, our allowance may not be sufficient to cover our credit losses
and we may need to increase our provision or allowance if certain adverse
factors arise, including adverse economic events or material increases in
delinquencies or charge-offs. A significant variation in the timing of or
increase in credit losses in our portfolio or a substantial increase in our
allowance or provision for credit losses would have, and in 2001 did have, a
material adverse effect on our net earnings.
We could have a system failure if our current contingency plan is not
adequate, which could adversely affect our ability to collect on loans and
comply with statutory requirements. We depend on our loan servicing and
collection facilities and on long-distance and local telecommunications access
to transmit and process information among our various facilities. We use a
standard program to prepare and store off-site backup tapes of our main system
applications and data files on a routine basis. We regularly revise our
contingency plan. However, the plan as revised may not prevent a systems failure
or allow us to timely resolve any systems failures. Also, a natural disaster,
calamity, or other significant event that causes long-term damage to any of
these facilities or that interrupts our telecommunications networks could have a
material adverse effect on our operations, profitability and liquidity.
We have slowed our growth, which negatively affects our earnings and
profitability. Since 1999, we have slowed our growth. Our ability to continue
our growth is limited by our access to capital. We are also committed to slowing
our growth until we improve our loan loss experience, which appears to be
occurring. As additional capital is secured, we will consider whether to resume
or accelerate our expansion plans or use the capital for other purposes such as
repurchasing our debt.
Even if we make acquisitions, such acquisitions may be unsuccessful or
strain or divert our resources from more profitable operations. Although we have
decided to slow our growth during the foreseeable future, we intend to consider
additional acquisitions, alliances, and transactions involving other companies
that could complement our existing business if we can do so with little or no
capital or if we can raise capital sufficient for any such transaction. However,
we may not be able to identify suitable acquisition parties, joint venture
candidates, or transaction counter parties. Even if we can identify suitable
parties, we may not be able to consummate these transactions on terms that we
find favorable or obtain required consents or approvals.
We may also not be able to successfully integrate any businesses that we
acquire into our existing operations. If we cannot successfully integrate any
future acquisitions, our operating expenses may increase, which would affect our
net earnings and/or liquidity. Moreover, these types of transactions may result
in the incurrence of additional debt and amortization of expenses related to
goodwill and intangible assets, all of which could adversely affect our
profitability and/or liquidity. These transactions also involve numerous other
risks, including the diversion of management attention from other business
concerns, entry into markets in which we have had no or only limited experience,
and the potential loss of key employees of acquired companies. Occurrence of any
of these risks could have a material adverse effect on us.
We are considering opening a new car dealership or dealerships. If we do
so, it will also require additional capital and would entail the same types of
risks noted above for acquisitions.
Interest rates affect our profitability and cash flows. Much of our
financing income results from the difference between the rate of interest that
we pay on the funds we borrow and the rate of interest that we earn on the loans
in our portfolio. While we earn interest on the loans that we own at a fixed
rate, we pay interest on our borrowings under our warehouse facility and certain
other debt at a floating rate. When interest rates increase, our interest
expense increases and our net interest margins decrease. Increases in our
interest expense that we cannot offset by increases in interest income will
lower our profitability and liquidity.
Laws that limit the interest rates that we can charge can adversely affect
our profitability and liquidity. We operate in many states that impose limits on
the interest rate that a lender may charge. When a state limits the amount of
interest that we can charge on our installment sales loans, we may not be able
to offset any increased interest expense caused by rising interest rates or
greater levels of borrowings under our credit facilities. Therefore, these
interest rate limitations can adversely affect our profitability and liquidity.
Government regulations may limit our ability to recover and enforce
receivables or to repossess and sell collateral. We are subject to ongoing
regulation, supervision, and licensing under various federal, state, and local
statutes, ordinances, and regulations. If we do not comply with these laws, we
could be fined or certain of our operations could be interrupted or shut down.
Failure to comply could, therefore, have a material adverse effect on our
operations.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. We may not,
however, be able to remain in compliance with such laws. In addition, the
adoption of additional statutes and regulations, changes in the interpretation
of existing statutes and regulations, or our entry into jurisdictions with more
stringent regulatory requirements could also have a material adverse effect on
our operations.
We are subject to pending actions and investigations relating to our
compliance with various laws and regulations. While we do not believe that
ultimate resolution of these matters will result in a material adverse effect on
our business or financial condition (such as material fines, injunctions or
damages), there can be no assurance in this regard.
Increased competition could adversely affect our operations, profitability
and liquidity. Our primary competitors are the numerous small buy-here/pay-here
used car dealers that operate in the sub-prime segment of the used car sales
industry and the banks and/or finance companies that purchase their loans. We
attempt to distinguish ourselves from our competitors through name recognition
and other factors. However, the advertising and infrastructure required by these
efforts increase our operating expenses. There is no assurance that we can
successfully distinguish ourselves and compete in this industry. In addition, in
recent years, a number of larger companies with significant financial and other
resources have entered or announced plans to enter the used car sales and/or
finance industry. There has also been an increase in dealerships guaranteeing
financing or loan approvals. Although these companies may not currently compete
with us in our portion of the sub-prime segment of the market, they compete with
us in the segment of sub-prime we would like to target for a larger portion of
our sales and loans. They compete with us indirectly as well, such as in the
purchase of inventory, which can result in increased wholesale costs for used
cars and lower margins. They could also enter into direct competition with us at
any time at the lower end of the sub-prime market.
Increased competition may cause downward pressure on the interest rates
that we charge on loans originated by our dealerships. Either change could have
a material effect on our earnings and liquidity.
The success of our operations depends on certain key personnel. We believe
that our ability to successfully implement our business strategy and to operate
profitably depends on the continued employment of our senior management team.
The unexpected loss of the services of any of our key management personnel or
our inability to attract new management when necessary could have a material
adverse effect on our operations. We do not currently maintain key person life
insurance on any member of our executive management team other than Gregory B.
Sullivan, our President and Chief Executive Officer.
We continue to make what we believe are improvements to our business model.
Our goal is to be the auto dealership and finance company of choice for people
with credit issues, large and small. As a result, we are repositioning ourselves
to focus on providing our customers with innovative credit solutions, quality
vehicles, and outstanding customer service. We believe this will have a positive
effect on future sales volume and the credit mix of our customer base. However,
we may not successfully assess, develop, implement and/or execute one or more of
these strategies, which could have an adverse impact on our revenues,
profitability, servicing and collections, and/or liquidity.
We have undergone layoffs and restructurings over the past several months.
While we believe we have done so in a manner that should not adversely impact
our operating performance or internal controls, there can be no assurance that
did not occur. If it did occur, problems may not arise until some indeterminate
time in the future and they may or may not be material.