================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 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
---------------
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.
================================================================================
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page
Part I - FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets-- June 30, 2002 and December 31, 2001 1
Condensed Consolidated Statements of Operations-- Three and Six Months Ended
June 30, 2002 and 2001 2
Condensed Consolidated Statements of Cash Flows-- Six Months Ended
June 30, 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 12
Item 3. MARKET RISK 33
Part II -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 34
Item 2. CHANGES IN SECURITIES 35
Item 3. DEFAULTS UPON SENIOR SECURITIES 35
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 35
Item 5. OTHER INFORMATION 35
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 35
SIGNATURES 36
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)
June 30, December 31,
2002 2001
----------------- ----------------
ASSETS
Cash and Cash Equivalents $ 10,003 $ 8,572
Finance Receivables, Net 531,928 495,254
Note Receivable from Related Party 12,000 12,000
Inventory 38,148 58,618
Property and Equipment, Net 30,331 37,739
Goodwill 11,569 11,569
Other Assets 10,972 20,006
Net Assets of Discontinued Operations - 3,899
----------------- ----------------
$ 644,951 $ 647,657
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 3,955 $ 2,850
Accrued Expenses and Other Liabilities 41,863 38,250
Notes Payable - Portfolio 398,640 377,305
Other Notes Payable 25,690 52,510
Subordinated Notes Payable 25,813 31,259
----------------- ----------------
Total Liabilities 495,961 502,174
----------------- ----------------
Stockholders' Equity:
Preferred Stock $.001 par value, 10,000,000 shares
authorized, 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 133,418 173,741
Retained Earnings 15,572 12,074
Treasury Stock, at cost - (40,351)
----------------- ----------------
Total Stockholders' Equity 148,990 145,483
----------------- ----------------
$ 644,951 $ 647,657
================= ================
See accompanying notes to Condensed Consolidated Financial Statements.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Six Months Ended June 30, 2002 and 2001
(In thousands, except cars sold amounts)
(Unaudited)
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
2002 2001 2002 2001
----------------------------- -----------------------------
Cars Sold 12,068 11,607 27,368 26,458
============================= =============================
Total Revenues $ 155,986 $ 140,819 $ 331,050 $ 304,849
============================= =============================
Sales of Used Cars $ 120,247 $ 105,919 $ 262,481 $ 236,105
Less:
Cost of Used Cars Sold 71,337 60,639 154,354 133,480
Provision for Credit Losses 38,395 32,210 83,762 71,230
----------------------------- -----------------------------
10,515 13,070 24,365 31,395
----------------------------- -----------------------------
Other Income (Expense):
Interest Income 35,739 34,900 68,569 68,744
Portfolio Interest Expense (6,251) (7,492) (12,394) (16,011)
----------------------------- -----------------------------
Net Interest Income 29,488 27,408 56,175 52,733
----------------------------- -----------------------------
Income before Operating Expenses 40,003 40,478 80,540 84,128
Operating Expenses:
Selling and Marketing 6,137 6,235 13,750 13,861
General and Administrative 25,561 27,217 51,343 54,655
Depreciation and Amortization 2,058 2,435 4,166 4,842
----------------------------- -----------------------------
Operating Expenses 33,756 35,887 69,259 73,358
----------------------------- -----------------------------
Income before Other Interest Expense 6,247 4,591 11,281 10,770
Other Interest Expense 2,328 2,862 4,634 5,953
----------------------------- -----------------------------
Earnings before Income Taxes 3,919 1,729 6,647 4,817
Income Taxes 1,791 709 3,149 1,975
----------------------------- -----------------------------
Earnings before Extraordinary Item 2,128 1,020 3,498 2,842
Extraordinary Item - Gain on early extinguishment of debt, net - 344 - 344
----------------------------- -----------------------------
Net Earnings $ 2,128 1,364 3,498 3,186
============================= =============================
See accompanying notes to Condensed Consolidated Financial Statements.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2002 and 2001
(In thousands)
(unaudited)
Six Months Ended
June 30,
-----------------------------
2002 2001
-----------------------------
Cash Flows from Operating Activities:
Net Earnings $ 3,498 $ 3,186
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 83,762 71,230
Depreciation and Amortization 6,698 6,912
Loss from Disposal of Property and Equipment 107 399
Deferred Income Taxes 291 -
Collections from Residuals in Finance Receivables Sold - 1,136
Decrease in Inventory 21,425 22,970
(Decrease) of Inventory Allowance (955) -
(Increase) Decrease in Other Assets 7,400 250
Increase (Decrease) in Accounts Payable, Accrued Expenses and Other Liabilities 3,060 (10,033)
Increase (Decrease) in Income Taxes Payable 3,001 (2,013)
-----------------------------
Net Cash Provided by Operating Activities 128,287 94,037
-----------------------------
Cash Flows from Investing Activities:
Increase in Finance Receivables (247,202) (213,732)
Collections on Finance Receivables 126,299 124,646
Decrease in Investments Held in Trust on Finance Receivables Sold - 1,398
Proceeds from Disposal of Property and Equipment 2,952 1,760
Purchase of Property and Equipment (3,768) (8,122)
-----------------------------
Net Cash Used in Investing Activities (121,719) (94,050)
-----------------------------
Cash Flows from Financing Activities:
Initial Deposits at Securitization into Investments Held in Trust (8,846) (6,407)
Additional Deposits into Investments Held in Trust (38,623) (69,358)
Collections from Investments Held in Trust 47,936 46,972
Additions to Notes Payable Portfolio 334,245 349,350
Repayment of Notes Payable Portfolio (314,478) (341,464)
Additions to Other Notes Payable 73,627 37,168
Repayment of Other Notes Payable (96,906) (11,720)
Repayment of Subordinated Notes Payable (6,000) (6,733)
Proceeds from Additional Paid in Capital 3 -
Proceeds from Issuance of Common Stock 6 18
-----------------------------
Net Cash Used in Financing Activities (9,036) (2,174)
-----------------------------
Net Cash Provided by Discontinued Operations 3,899 441
-----------------------------
Net Increase (Decrease) in Cash and Cash Equivalents 1,431 (1,746)
Cash and Cash Equivalents at Beginning of Period 8,572 8,805
-----------------------------
Cash and Cash Equivalents at End of Period $ 10,003 $ 7,059
=============================
Supplemental Statement of Cash Flows Information:
Interest Paid $ 15,324 $ 20,130
=============================
Income Taxes Paid (Received) $ (212) $ 12,071
=============================
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 AND SUBSIDIARIES
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
financial 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:
June 30, December 31,
2002 2001
----------------------------------
Contractually Scheduled Payments $ 774,680 $ 694,572
Unearned Finance Charges (209,298) (179,873)
----------------------------------
Principal Balances, net 565,382 514,699
Accrued Interest 5,857 5,824
Loan Origination Costs 7,360 6,635
----------------------------------
Loan Receivables 578,599 527,158
Investments Held in Trust 69,529 69,996
----------------------------------
Finance Receivables 648,128 597,154
Allowance for Credit Losses (116,200) (101,900)
----------------------------------
Finance Receivables, net $ 531,928 $ 495,254
==================================
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, historically ranging from 2.3% to 7.3% 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,
currently ranging from 8.0% to 11.5%, of the underlying finance receivables
principal balances.
The Company previously reported in its Annual Report on Form 10-K for the
year ended December 31, 2001 and in its Quarterly Report on Form 10-Q for the
three month period ended March 31, 2002 that four of its securitizations had
reached Termination Events (as defined in the securitizations) triggering an
acceleration of rights for the insurer under the Insurance Agreements for the
respective securitizations. As reported, the Termination Events occurred on the
charge-off triggers for 2000B, 2000C, and 2001A in December 2001 and on the
delinquency trigger for 1999C in January 2002. As a result, all cash flow from
these trusts otherwise distributable to the Company was deposited into a reserve
account for these securitizations. In June 2002, as reported on Form 8-K,
revised calculations indicated that no Termination Events in fact had been
triggered on the net charge-off trigger for 2000B, 2000C, and 2001A in December
2001. However, the revised calculations did confirm the Termination Event
occurred on the delinquency trigger for 1999C in January, an additional
Termination Event occurred on the delinquency trigger for 1999C in February
2002, and a Termination Event occurred on the delinquency trigger for 2000A, in
February, March and April 2002. Both the 1999C and 2000A trusts have been
repurchased by the Company in April and July, respectively, and are no longer
required to be tested by the performance targets set by the trust insurer and
all cash has been released. In addition, upon review of these revised
calculations for the 2000B, 2000C and 2001A trusts, trapped cash related to
these trusts was released and distributed to the Company in June of 2002. As of
August 1, 2002, no cash is being held above the required reserve 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. ("Verde"), an affiliate of Ernest C. Garcia II, Chairman and
the then 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 exercised 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 one-month 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. As a result of
the going private transaction, the warrants have been terminated. 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. As of June 30, 2002, the balance of the note due
to CCC was $1.4 million.
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 sale and leaseback
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 that Verde assumed all of the obligations of the
notes payable on these six properties; however, the Company has not 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 2017.
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 CCC has a
10-year term, with interest payable quarterly at 9%, due December 2009. The note
is secured by the capital stock of CCC and guaranteed by Verde. The balance of
this loan at June 30, 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, and UDC Acquisition Corp.
("Acquisition"), a wholly owned subsidiary of 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, Acquisition 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 Corp. On March 4, 2002, Acquisition
completed a short form merger with and into the Company. The Company was the
surviving corporation in the short form merger. As of June 30, 2002, the Company
has a receivable from UDC Holdings Corp. of approximately $1.7 million which is
classified in Other Assets. Ray Fidel, Ugly Ducking Car Sales and Finance
Corporation's executive vice president and chief operating officer, now holds a
minority interest in UDC Holdings Corp., along with Mr. Sullivan. Mr. Garcia
holds a majority interest in UDC Holdings Corp.
In March and April of 2002, Cygnet Capital Corporation, a company
affiliated with the Company's 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.
On April 1, 2002, the Company entered into an Aircraft Lease Agreement with
Verde Investments, Inc. to lease a Raytheon Hawker 125-700A aircraft. The lease
expires on March 31, 2003 and provides for monthly lease payments of $100,000 to
Verde, plus an initial security deposit of $100,000. The Company is also
responsible to pay all costs and expenses relating to the Aircraft and its
operations. During the first six months of 2002, the Company paid $0.5 million
to Verde for the aircraft lease and reimbursement of various travel costs and
other expenses incurred by Verde on behalf of the Company.
On June 30, 2002, Cygnet Capital Corporation, a company affiliated with the
Company's Chairman and principal shareholder, Mr. Garcia, purchased from an
unrelated party the entire $3.0 million outstanding balance of the Company's
senior subordinated notes payable bearing interest at 15% per annum and with
principal due February 2003. The senior subordinated notes have been modified to
extend the principal maturity date to February 12, 2005 and to provide for
earlier payment of principal out of the retained earnings of the Company, up to
a maximum of $1.0 million per quarter, to the extent that the Company is in
compliance with the covenant requirements of its various lenders.
Note 4. Notes Payable
Notes Payable, Portfolio
A summary of Notes Payable, Portfolio at June 30, 2002 and December 31,
2001 follows ($ in thousands):
June 30, 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 $ 83,896 $ 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 $446.6 million and $515.2 million at June 30, 2002 and
December 31, 2001, respectively 317,116 341,812
-------------------- --------------------
Subtotal 401,012 380,061
Less: Unamortized Loan Fees 2,372 2,756
-------------------- --------------------
Total $ 398,640 $ 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 $100 million during the period
December 1, 2001 through April 30, 2002, under the initial term. In addition,
the 65% cap on the advance rate was removed and the calculation of the warehouse
advance relative to the net securitization advance was improved by 2%. The
lender maintains an option to adjust the advance rate to reflect changes in
market conditions or portfolio performance. The interest rate on the facility is
one-month LIBOR plus 2.80% (4.64% as of June 30, 2002, and 4.72% as of December
31, 2001). The facility is secured with substantially all Company assets. At
June 30, 2002, the Company was in compliance with all required covenants.
Class A obligations have interest payable monthly at rates ranging from
3.4% to 8.3%. Monthly principal reductions on the Class A obligations
approximate 71% of the principal reductions on the underlying pool of finance
receivable loans.
Other Notes Payable
A summary of Other Notes Payable at June 30, 2002 and December 31, 2001
follows ($ in thousands):
June 30, 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 $ 15,236 $ 26,000
Revolving Facility for $36.0 million with Automotive Finance Corporation,
secured by the Company's automobile inventory 8,681 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 1,817 6,133
-------------------- --------------------
Subtotal 25,734 53,096
Less: Unamortized Loan Fees 44 586
-------------------- --------------------
Total $ 25,690 $ 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 one-month LIBOR plus 600 basis points (7.84 % as
of June 30, 2002, and 7.90% as of December 31, 2001). The loan is secured by
certain Finance Receivables. At June 30, 2002, the Company was in compliance
with all required covenants.
On August 31, 2001, the Company entered into a $36 million revolving
inventory facility with Automotive Finance Corporation that expires in June of
2003. The borrowing base is calculated on advance rates on inventory purchased,
ranging from 80% to 100% of the purchase price. The interest rate on the
facility is Prime plus 6.0% (10.75% as of June 30, 2002, and 10.75% as of
December 31, 2001). The facility is secured with the Company's automobile
inventory. At June 30, 2002, the Company was in compliance with all required
covenants.
Subordinated Notes Payable
A summary of Subordinated Notes Payable at June 30, 2002 and December 31,
2001 follows ($ in thousands):
June 30, December 31,
2002 2001
------------------- -------------------
$13.5 million senior subordinated notes payable to related parties, bearing
interest at 15% per annum payable quarterly, principal balance due
February 12, 2005 and is senior to subordinated debentures $ 3,000 $ 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 1,400 5,400
------------------- -------------------
Subtotal 30,179 36,179
Less: Unamortized Discount - subordinated debentures 4,366 4,920
------------------- -------------------
Total $ 25,813 $ 31,259
=================== ===================
Note 5. Stockholders' Equity
On December 14, 2001, Acquisition commenced an amended tender offer to
purchase all of the Company's outstanding shares of common stock not owned by
Mr. Garcia, Mr. Sullivan or affiliated entities. As of March 4, 2002, the
Company and Acquisition effected a statutory merger under Section 253 of the
Delaware General Corporation Law. The Company was the surviving corporation in
the merger, and following the merger UDC Holding Corp. held all of the
outstanding shares of the common stock of the Company. As a result, the Company
became a privately held company and its shares were deregistered under the
Exchange Act. Therefore, no public trading market exists for its shares. The
Company expects to continue to file certain reports under the Exchange Act due
to the listing of certain debt securities listed on the American Stock Exchange.
On May 31, 2002, UDC Holding Corp. conveyed all of the stock of UDC to DT
Holdings Corp., a 100% owned subsidiary of UDC Holdings Corp.
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. Two appraisal rights actions have been
filed in Delaware requesting a valuation of the shareholders' UDC shares. The
court now determines which shareholders are entitled to appraisal rights and
appraises the shares of such shareholders. UDC Holdings has agreed to fund the
payment of the final appraisal amount to dissenting shareholders. The only
remaining outstanding shares of common stock of the Company are the 100 shares
of common stock issued upon conversion of the shares of UDC Acquisition Corp.
common stock. All of these shares are held by DT Holdings Corp., a 100% owned
subsidiary of UDC Holdings Corp.
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 and six
months ended June 30, 2002 and 2001 follows:
Retail Portfolio Corporate Total
-------------- --------------- -------------- ----------------
Three months ended June 30, 2002:
Sales of Used Cars $ 120,247 $ - $ - $ 120,247
Less: Cost of Cars Sold 71,337 - - 71,337
Provision for Credit Losses 25,891 12,504 - 38,395
-------------- --------------- -------------- ----------------
23,019 (12,504) - 10,515
Net Interest Income - 29,488 - 29,488
-------------- --------------- -------------- ----------------
Income before Operating Expenses 23,019 16,984 - 40,003
-------------- --------------- -------------- ----------------
Operating Expenses:
Selling and Marketing 6,137 - - 6,137
General and Administrative 12,996 7,095 5,470 25,561
Depreciation and Amortization 1,090 240 728 2,058
-------------- --------------- -------------- ----------------
20,223 7,335 6,198 33,756
-------------- --------------- -------------- ----------------
Operating Income (Loss) before Other Interest
Expense $ 2,796 $ 9,649 $ (6,198) $ 6,247
============== =============== ============== ================
Capital Expenditures $ 757 $ 199 $ 1,403 $ 2,359
============== =============== ============== ================
Identifiable Assets, Excluding Net Assets
of Discontinued Operations $ 66,545 $ 551,064 $ 27,342 $ 644,951
============== =============== ============== ================
Retail Portfolio Corporate Total
-------------- --------------- -------------- ----------------
Three months ended June 30, 2001:
Sales of Used Cars $ 105,919 $ - $ - $ 105,919
Less: Cost of Cars Sold 60,639 - - 60,639
Provision for Credit Losses 21,898 10,312 - 32,210
-------------- --------------- -------------- ----------------
23,382 (10,312) - 13,070
Net Interest Income - 27,408 - 27,408
-------------- --------------- -------------- ----------------
Income before Operating Expenses 23,382 17,096 - 40,478
-------------- --------------- -------------- ----------------
Operating Expenses:
Selling and Marketing 6,235 - - 6,235
General and Administrative 14,855 7,359 5,003 27,217
Depreciation and Amortization 1,363 232 840 2,435
-------------- --------------- -------------- ----------------
22,453 7,591 5,843 35,887
-------------- --------------- -------------- ----------------
Income (loss) before Other Interest Expense $ 929 $ 9,505 $ (5,843) $ 4,591
============== =============== ============== ================
Capital Expenditures $ 1,157 $ 358 $ 3,434 $ 4,949
============== =============== ============== ================
Identifiable Assets, Excluding Net Assets
of Discontinued Operations $ 79,837 $ 538,393 $ 56,986 $ 675,216
============== =============== ============== ================
Retail Portfolio Corporate Total
-------------- --------------- -------------- ----------------
Six Months Ended June 30, 2002:
Sales of Used Cars $ 262,481 $ - $ - $ 262,481
Less: Cost of Cars Sold 154,354 - - 154,354
Provision for Credit Losses 55,948 27,814 - 83,762
-------------- --------------- -------------- ----------------
52,179 (27,814) - 24,365
Net Interest Income - 56,175 - 56,175
-------------- --------------- -------------- ----------------
Income before Operating Expenses 52,179 28,361 - 80,540
-------------- ------------------------------ ----------------
Operating Expenses:
Selling and Marketing 13,750 - - 13,750
General and Administrative 26,445 13,637 11,261 51,343
Depreciation and Amortization 2,201 492 1,473 4,166
-------------- --------------- -------------- ----------------
42,396 14,129 12,734 69,259
-------------- --------------- -------------- ----------------
Income (loss) before Other Interest Expense $ 9,783 $ 14,232 $ (12,734) $ 11,281
============== =============== ============== ================
Capital Expenditures $ 1,204 $ 294 $ 2,270 $ 3,768
============== =============== ============== ================
Identifiable Assets, Excluding Net Assets
of Discontinued Operations $ 66,545 $ 551,064 $ 27,342 $ 644,951
============== =============== ============== ================
Retail Portfolio Corporate Total
-------------- --------------- -------------- ----------------
Six Months Ended June 30, 2001:
Sales of Used Cars $ 236,105 $ - $ - $ 236,105
Less: Cost of Cars Sold 133,480 - - 133,480
Provision for Credit Losses 48,550 22,680 - 71,230
-------------- --------------- -------------- ----------------
54,075 (22,680) - 31,395
Net Interest Income - 52,603 130 52,733
-------------- --------------- -------------- ----------------
Income before Operating Expenses 54,075 29,923 130 84,128
-------------- --------------- -------------- ----------------
Operating Expenses:
Selling and Marketing 13,861 - - 13,861
General and Administrative 29,513 15,367 9,775 54,655
Depreciation and Amortization 2,689 496 1,657 4,842
-------------- --------------- -------------- ----------------
46,063 15,863 11,432 73,358
-------------- --------------- -------------- ----------------
Income (loss) before Other Interest Expense $ 8,012 $ 14,060 $ (11,302) $ 10,770
============== =============== ============== ================
Capital Expenditures $ 3,244 $ 587 $ 4,291 $ 8,122
============== =============== ============== ================
Identifiable Assets, Excluding Net Assets
of Discontinued Operations $ 79,837 $ 538,393 $ 56,986 $ 675,216
============== =============== ============== ================
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 of Statement No. 142, the Company has allocated
the entire goodwill balance to the Retail Operations Segment. During the second
quarter of 2002, the Company finalized the required impairment tests of goodwill
as of January 1, 2002. The Company does not have an impairment of goodwill as of
the date of adoption. In addition, upon adoption, the Company discontinued
amortizing goodwill. For the three and six months ended June 30, 2001, the
Company had approximately $0.2 million and $0.5 million, respectively, in
amortization expense. As of June 30, 2002, the Company has unamortized goodwill
of approximately $11.6 million within the retail segment. (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 July 16, 2002, the Company made a principal reduction payment of $0.2
million on the Subordinated Note Payable to Cygnet Capital Corp. reducing the
outstanding balance to $1.2 million. On July 26, 2002, the Company paid off the
remaining $1.2 million balance. For further discussion of this note payable, see
Note (3) to Notes of Condensed Consolidated Financial Statements.
On July 19, 2002, the Company renewed its senior secured loan facility with
certain lenders. The loan facility was increased from a $35 million loan
facility to $45 million. Interest is payable at one-month LIBOR plus 500 basis
points, with a minimum LIBOR of 2.125%, and has a term of approximately 30
months. The loan discount at funding was 5% or $2.25 million and there are no
prepayment penalties. The facility is secured by the Company's retained
interests in the residuals from its securitization transactions.
On July 30, 2002, the Company priced its 23rd securitization, 2002B, which
is scheduled to close on August 15, 2002. If this securitization closes as
expected it will consist of approximately $211.3 million in principal balances
and the issuance of approximately $150.0 million in Class A bonds, including a
pre-funded amount of approximately $27.5 million. The coupon rate on the Class A
bonds is 2.99%, the initial deposit into the reserve account is 7.25% and the
reserve account maximum is 11.5%, subject to adjustment upon the occurrence of
specified Termination Events or Portfolio Performance Events. The Class A bonds
will be insured by XL Capital Assurance, resulting in AAA by Standard and Poor's
and Aaa by Moody's ratings.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
Introduction
We operate the largest chain of buy-here pay-here used car dealerships in
the United States. At June 30, 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.
On September 1, 2002, we intend to change the Company name from Ugly
Duckling to DriveTime. The goal of the name change is to attract a higher volume
of our better customers, reduce loan losses and improve profitability. After
extensive name and brand development research, the name DriveTime was selected
because it represented the new image and direction of the Company. Our vision
for the Company is to be the auto dealership and finance company of choice for
people with credit issues, large and small. DriveTime means Innovative Credit
Solutions, Quality Vehicles, and Outstanding Customer Service.
Consistent with our new name and the vision for the Company, we are making
improvements to the way we do business and the product we provide to our
customers. Some of the changes include:
o Inventory - a wider variety of higher quality, late model vehicles,
o DriveCare - a standard 90-day, 3,000 mile limited warranty covering
major mechanical items and air conditioning,
o RateAdvantage - a new interest rate program offering lower rates
depending on the customer's credit history and size of the down
payment,
o VIP Program - existing customers with good payment histories are
eligible to finance their next vehicle with lower interest rates and
down payments,
o Customer Service - we are committed to provide a straight-forward,
professional and friendly experience for our customers,
o Advertising - a new aspirational advertising campaign is scheduled for
launch on September 1st that targets customers with small and large
credit problems, and
o Facilities - all of our 76 dealerships are receiving a new facelift,
including new signage, flooring, furniture, paint, wallpaper and
awnings, totaling approximately $6.3 million.
Our overall target customer population and our business model have not
significantly changed. However, through risk management and analysis we have
been able to credit grade our customer base and as part of DriveTime, we intend
to shift the mix of our loans within our sub-prime target market toward those
grades with lower loss rates. In addition, we have improved our inventory
because we determined that historically our credit losses are lower for better
vehicles across all our credit grades. The goals for DriveCare and RateAdvantage
are to increase volume while at the same time reducing loan losses through lower
vehicle repair costs and lower loan payment amounts for our customers.
We believe the changes we are making in conjunction with the change to
DriveTime will have long-term benefits to the Company, including enhancing
volume, lowering credit losses and improving profitability. However, launching
DriveTime may negatively impact earnings during the remainder of 2002 due to the
write-off of certain property and equipment and other launch related expenses of
approximately $0.5 million, plus depreciation on the estimated $6.3 million of
dealership improvements. We estimate the overall impact on interest income
related to lower rates offered under RateAdvantage and the VIP Program will be
to lower the portfolio's weighted average contract APR by approximately 100
basis points.
As a buy-here pay-here dealer, we offer the customer certain advantages over
more traditional financing sources including:
o expanded credit solutions,
o standard limited warranty on virtually every vehicle,
o flexible payment terms, including structuring loan payment due dates
as weekly or bi-weekly, often coinciding with the customer's payday,
and
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 larger and newer inventories of used cars,
o advertising and marketing programs,
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 Corporation and its
subsidiaries. In particular, we analyze and explain the changes in the results
of operations of our business segments for the three and six months ended June
30, 2002 and 2001. All amounts are presented in thousands except per unit and
per car data, unless otherwise noted.
During the second quarter of 2002 we:
o Increased revenues to $156.0 million, an 11% increase over the second
quarter of 2001,
o Closed our 22nd Securitization with loan principal balances of
approximately $170.4 million and Class A bonds issued of $121.0
million,
o Obtained a commitment from XL Capital Assurance to replace MBIA as the
insurer for future securitizations,
o Determined that an error was made in the calculation of triggers
related to the 2000B, 2000C and 2001A securitization trusts and that
no Termination Events had in fact been triggered for these trusts in
prior periods, resulting in the release of $13.0 million of trapped
cash to the Company in June 2002,
o Launched the RateAdvantage interest rate program in our Phoenix, Los
Angeles, Richmond, and Atlanta markets - that offers lower rates
depending on the customer's credit history and size of the down
payment,
o Launched the DriveCare limited warranty program, in our Phoenix
market, that offers a 90-day, 3,000 mile, limited warranty on major
mechanical items and air conditioning,
o Continued to make improvements to our business model, repositioning
the Company to focus on providing our customers with innovative credit
solutions, quality vehicles, and outstanding customer service,
o Began preparations for changing the Company's name and logo from Ugly
Duckling Corporation to DriveTime effective on September 1, 2002, and
o Formulated a $6.3 million plan for refurbishing all 76 existing
dealerships prior to the official launch of DriveTime on September 1,
2002.
Selected Consolidated Financial Data At or For the Three Months Ended,
-----------------------------------------------------------------------------
($ in thousands, except per car sold amounts) June 30, March 31, Dec 31, Sept 30, June 30, March 31,
Operating Data: 2002 2002 2001 2001 2001 2001
---------- ----------- ---------- ---------- ---------- -----------
Total Revenues $ 155,986 $ 175,064 $ 121,292 $ 145,237 $ 140,819 $ 164,030
Sales of Used Cars $ 120,247 $ 142,234 $ 88,018 $ 110,237 $ 105,919 $ 130,186
Earnings before Interest, Taxes, Depr. & Amort. $ 14,556 $ 13,285 $ 5,423 $ 969 $ 14,518 $ 17,105
E-Commerce Revenue as Percent of Sales of Used Cars 14.1% 13.8% 13.8% 14.2% 14.4% 11.6%
Number Dealerships in Operation 76 76 76 76 77 77
Average Sales per Dealership per Month 53 67 41 52 50 64
Number of Used Cars Sold 12,068 15,300 9,353 11,907 11,607 14,851
Sales Price - Per Car Sold $ 9,964 $ 9,296 $ 9,411 $ 9,258 $ 9,125 $ 8,766
Cost of Sales - Per Car Sold $ 5,911 $ 5,426 $ 5,549 $ 5,259 $ 5,224 $ 4,905
Gross Margin - Per Car Sold $ 4,053 $ 3,870 $ 3,862 $ 3,999 $ 3,901 $ 3,861
Provision - Per Car Sold $ 3,182 $ 2,965 $ 3,324 $ 4,095 $ 2,775 $ 2,627
Total Operating Expense - Per Car Sold $ 2,797 $ 2,320 $ 3,765 $ 2,959 $ 3,092 $ 2,523
Total Operating Income (Loss) - Per Car Sold $ 518 $ 329 $ (413) $ (744) $ 396 $ 416
Total Operating Income (Loss) $ 6,247 $ 5,034 $ (3,865) $ (8,859) $ 4,591 $ 6,179
Earnings before Income Taxes $ 3,919 $ 2,728 $ (6,392) $ (11,554) $ 1,729 $ 3,088
Cost of Used Cars as Percent of Sales 59.3% 58.4% 59.0% 56.8% 57.3% 56.0%
Gross Margin as Percent of Sales 40.7% 41.6% 41.0% 43.2% 42.7% 44.0%
Provision - % of Originations 32.2% 32.3% 35.5% 44.7% 31.1% 31.0%
Total Operating Expense - % of Total Revenues 21.6% 20.3% 29.0% 24.3% 25.5% 22.8%
Segment Operating Expense Data:
Retail Operating Expense - Per Car Sold $ 1,676 $ 1,449 $ 1,932 $ 1,795 $ 1,934 $ 1,590
Retail Operating Expense-% of Used Car Sales 16.8% 15.6% 20.5% 19.4% 21.2% 18.1%
Corporate/Other Expense - Per Car Sold $ 514 $ 427 $ 828 $ 532 $ 503 $ 376
Corporate/Other Expense - % of Total Revenue 4.0% 3.7% 6.4% 4.4% 4.1% 3.4%
Portfolio Exp. Annualized -
% of End of Period Principal Balance 5.2% 5.0% 7.3% 5.6% 5.8% 6.2%
Balance Sheet Data:
Finance Receivables, net $ 531,928 $ 514,329 $ 495,254 $ 501,048 $ 544,585 $ 522,893
Inventory $ 38,148 $ 39,471 $ 58,618 $ 47,414 $ 40,772 $ 43,434
Total Assets $ 644,951 $ 637,396 $ 647,657 $ 657,740 $ 678,950 $ 659,470
Portfolio Notes Payable $ 398,640 $ 381,208 $ 377,305 $ 386,572 $ 415,877 $ 390,615
Other Notes Payable $ 25,690 $ 29,753 $ 52,510 $ 41,646 $ 42,495 $ 39,444
Subordinated Notes Payable $ 25,813 $ 28,130 $ 31,259 $ 32,600 $ 34,951 $ 40,807
Total Debt $ 450,143 $ 439,091 $ 461,074 $ 460,818 $ 493,323 $ 470,866
Total Stockholders' Equity $ 148,990 $ 146,859 $ 145,483 $ 151,550 $ 158,604 $ 157,222
Total Debt to Equity 3.0 3.0 3.2 3.0 3.1 3.0
Loan Portfolio Data:
Interest Income $ 35,739 $ 32,830 $ 33,274 $ 35,000 $ 34,900 $ 33,844
Average Yield on Portfolio 26.6% 25.9% 25.8% 26.5% 26.7% 26.3%
Portfolio Interest Expense 6,251 6,143 6,957 7,489 7,492 8,519
Average Borrowing Cost 7.1% 7.0% 7.5% 8.0% 8.3% 8.9%
Principal Balances Originated $ 119,389 $ 140,455 $ 87,452 $ 109,139 $ 103,615 $ 126,015
Principal Balances Originated as % of Sales 99.3% 98.7% 99.4% 99.0% 97.8% 96.8%
Number of Loans Originated 12,016 15,225 9,283 11,844 11,558 14,776
Average Original Amount Financed $ 9,936 $ 9,225 $ 9,421 $ 9,215 $ 8,965 $ 8,528
Number of Loans Originated as % of Units Sold 99.6% 99.5% 99.3% 99.5% 99.6% 99.5%
Portfolio Delinquencies:
Current 70.3% 72.4% 64.5% 67.4% 70.2% 73.0%
1 to 30 days 23.1% 21.9% 26.2% 24.0% 23.0% 21.2%
31 to 60 days 3.9% 3.3% 5.6% 5.3% 4.1% 3.3%
Over 60 days 2.7% 2.4% 3.7% 3.3% 2.7% 2.5%
Principal Outstanding $ 565,382 $ 543,842 $ 514,699 $ 537,946 $ 534,766 $ 535,039
Number of Loans Outstanding 86,037 84,821 82,254 85,961 86,446 87,033
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended Six Month Ended
June 30, June 30,
------------------------------ Percentage ------------------------------ Percentage
2002 2001 Change 2002 2001 Change
------------------------------ --------------- ------------------------------ ---------------
Number of Used Cars Sold 12,068 11,607 4.0% 27,368 26,458 3.4%
============================== ==============================
Sales of Used Cars $ 120,247 $ 105,919 13.5% $ 262,481 $ 236,105 11.2%
Cost of Used Cars Sold 71,337 60,639 17.6% 154,354 133,480 15.6%
------------------------------ ------------------------------
Gross Margin $ 48,910 $ 45,280 8.0% $ 108,127 $ 102,625 5.4%
============================== ==============================
Gross Margin % 40.7% 42.7% 41.2% 43.5%
Per Car Sold:
Sales $ 9,964 $ 9,125 9.2% $ 9,591 $ 8,924 7.5%
Cost of Used Cars Sold 5,911 5,224 13.2% 5,640 5,045 11.8%
------------------------------ ------------------------------
Gross Margin $ 4,053 $ 3,901 3.9% $ 3,951 $ 3,879 1.9%
============================== ==============================
For the three and six months ended June 30, 2002, the number of cars sold
increased 4.0% and 3.4%, respectively, over the same periods of the prior year.
Revenues from Sales of Used Cars increased 13.5% and 11.2% for the three and six
months ended June 30, 2002, respectively, compared to the same periods of 2001.
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 six months ended June 30, 2002. As a result,
the total Sales of Used Cars, total Cost of Used Cars Sold, the average sales
price, and the average cost of used cars sold increased. The average sales price
increased 9.2% and the cost of a vehicle increased 13.2% compared to the second
quarter of 2001. The average dollar gross margin per car had a 3.9% increase
between periods. We calculate our vehicle sales price using a gross 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 42.7% to 40.7%.
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 second quarter of 2002, applications
received via our internet site generated 1,712 cars sold and $16.9 million in
revenue, up from 1,686 cars sold and $15.2 million in revenue during the same
period of the prior year. For the six months ended June 30, 2002, Internet
applications generated 3,816 cars sold and $36.6 million in revenue, up from
3,459 cars sold and $30.2 million in revenue for the same period 2001.
We finance substantially all of our used car sales. The percentage of used
cars sold financed has remained constant for the three and six months ended June
30, 2002 versus the comparable periods of 2001. We have experienced an increase
in the percentage of sales revenue financed because of a slight decrease in the
average down payment as a percentage of the sales price. We determine down
payment based upon credit grade of customer, and not based on the sales price of
the car sold; therefore, as the average sales price of cars increase due to our
focus on better quality cars, the amount financed as a percentage of revenue has
correspondingly increased. The following table indicates the percentage of sales
units and revenue financed:
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -------------------------------
2002 2001 2002 2001
----------------------------- -------------------------------
Percentage of used cars sold financed 99.6% 99.6% 99.5% 99.5%
============================= ===============================
Percentage of sales revenue financed 99.3% 97.8% 99.0% 97.3%
============================= ===============================
Provision for Credit Losses
The following is a summary of the Provision for Credit Losses:
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------ Percentage ------------------------------ Percentage
2002 2001 Change 2002 2001 Change
------------------------------ --------------- ------------------------------ ---------------
Provision for Credit Losses $ 38,395 $ 32,210 19.2% $ 83,762 $ 71,230 17.6%
============================== ==============================
Provision per loan originated $ 3,195 $ 2,787 14.6% $ 3,075 $ 2,705 13.7%
============================== ==============================
Provision as a percentage of
principal balances originated 32.2% 31.1% 32.2% 31.0%
============================== ==============================
The Provision for Credit Losses increased for the three and six months
ended June 30, 2002 over the same periods of the prior year. 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 amount financed per
loan originated increased from $8,965 to $9,936 for the three months ended June
30, 2001 and 2002, respectively. 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 three and six months ended June 30, 2002.
See "Static Pool Analysis" below for further Provision for Credit Loss
discussion.
Net Interest Income
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- Percentage --------------------------- Percentage
2002 2001 Change 2002 2001 Change
----------------------------- --------------- --------------------------- -------------
Interest Income $ 35,739 $ 34,900 2.4% $ 68,569 $ 68,744 (0.3%)
Portfolio Interest Expense (6,251) (7,492) (16.6%) (12,394) (16,011) (22.6%)
----------------------------- ---------------------------
Net Interest Income $ 29,488 $ 27,408 7.6% $ 56,175 $ 52,733 6.5%
============================= ===========================
Average Effective Yield 26.6% 26.7% 26.3% 26.5%
============================= ===========================
Average Borrowing Cost 7.1% 8.3% 7.0% 8.6%
============================= ===========================
Interest Income consists primarily of interest on finance receivable
principal balances, plus interest income from investments held in trust. The
increase in Net Interest Income is mostly attributable to an increase in the
average principal balances to $554.1 million and $540.7 million for the three
and six months ended June 30, 2002, respectively, versus $535.2 million and
$531.0 million for the same periods of 2001. The average effective yield on
finance receivables remained fairly constant at 26.6% and 26.7% for the three
months ended June 30, 2002 and 2001, respectively, and 26.3% and 26.5% for the
six months ended June 30, 2002 and 2001, respectively. We experienced a decrease
in interest earned on investments held in trust from $0.8 million and $1.8
million for the three and six months ended June 30, 2001, respectively, to $0.4
million and $0.7 million for the three and six months ended June 30, 2002,
respectively. This decrease was primarily related to lower money market rates
during the six months 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 portfolio. Portfolio
interest expense was $6.3 million and $12.4 million for the three and six months
ended June 30, 2002, respectively, a decrease from $7.5 million and $16.0
million for the same periods of the previous year. The decrease is due to lower
borrowing costs as a result of a decline in our benchmark interest rates, 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 remained relatively constant with a slight
decrease to $40.0 million for the three months ended June 30, 2002, as compared
to $40.5 million for the three months ended June 30, 2001. Income before
Operating Expenses decreased 4.3% to $80.5 million for the six months ended June
30, 2002 versus $84.1 million for the same period 2001. The decreases in Income
before Operating Expenses resulted from an increase in the amount charged to
current operations for the provision for credit losses, partially offset by an
increase in used cars sold and an increase in net interest income primarily due
to an increase in the average principal balances and a decrease in portfolio
interest expense.
Operating Expenses
Three Months Six Months Ended
June 30, June 30,
----------------------------- Percentage ----------------------------- Percentage
2002 2001 Change 2002 2001 Change
----------------------------- -------------- ----------------------------- --------------
Operating Expenses $ 33,756 $ 35,887 (5.9%) $ 69,259 $ 73,358 (5.6%)
============================= =============================
Per Car Sold 2,797 3,092 (9.5%) $ 2,531 $ 2,773 (8.7%)
============================= =============================
As % of Total Revenue 21.6% 25.5% 20.9% 24.1%
============================= =============================
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 and $4.6 million for the
three and six months ended June 30, 2002, respectively, versus $2.9 million and
$6.0 million for the comparable periods of the prior year. The average
outstanding balance for Other Notes Payable was $35.4 million and $40.2 million
for the three and six months ended June 30, 2002, respectively, and $42.2
million and $37.8 million for the comparable periods of 2001. The changes to
Other Notes Payable 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
monthly average outstanding balance of Subordinated Notes Payable was $27.0
million and $28.0 million for the three and six months ended June 30, 2002,
respectively, and $38.5 million and $39.9 million for the comparable periods of
2001. 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 $5.6 million
reduction in the subordinated debt payable to affiliated companies. See Note (4)
of the Notes to the Condensed Consolidated Financial Statements for further
discussion.
Income Taxes
Income taxes totaled $1.8 million and $3.1 million for the three and six
months ended June 30, 2002, versus $0.7 million and $2.0 million for the same
periods in 2001. Our effective tax rate was 41% for the three and six months
ended June 30, 2002 and 2001. In addition, the income taxes for the three and
six months ended June 30, 2002, include approximately $0.2 and $0.4 million
charge for a change in estimate for tax deficiencies.
Net Earnings
Net Earnings totaled $2.1 million and $3.5 million or the three and six
months ended June 30, 2002, respectively, as compared with $1.4 million and $3.2
million for the three and six months ended June 30, 2001, respectively. The
increase was due primarily to an increase in the number of vehicles sold, an
increase in net interest income due primarily to a reduction in portfolio
interest expense, and a decrease in operating expenses due to numerous cost
savings initiatives, partially offset by the increase in provision for loan
losses.
Business Segment Information
We report our operations based on three operating segments. These segments
are reported as Retail, Portfolio and Corporate Operations. See Note (6) to the
Condensed Consolidated Financial Statements.
Operating Expenses for our business segments, along with a description of
the included activities, for the three and six months ended June 30, 2002 and
2001 are as follows:
Retail Operations. Operating expenses for our Retail segment consist of
Company marketing efforts, maintenance and development of dealership and
inspection center sites, and direct management of used car purchases,
reconditioning and sales activities. A summary of retail operating expenses
follows ($ in thousands, except per car sold amounts):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- % ------------------------------- %
2002 2001 Change 2002 2001 Change
------------------------------- ------------- --------------- -------------- -------------
Retail Operations:
Selling and Marketing $ 6,137 $ 6,235 (1.6%) $ 13,750 $ 13,861 (0.8%)
General and Administrative 12,996 14,855 (12.5%) 26,445 29,513 (10.4%)
Depreciation and Amortization 1,090 1,363 (20.0%) 2,201 2,689 (18.1%)
------------------------------- --------------- --------------
Retail Expense $ 20,223 $ 22,453 (9.9%) $ 42,396 $ 46,063 (8.0%)
=============================== =============== ==============
Per Car Sold:
Selling and Marketing $ 509 $ 537 (5.3%) $ 502 $ 524 (4.1%)
General and Administrative 1,077 1,280 (5.9%) 966 1,115 (13.4%)
Depreciation and Amortization 90 117 (23.1%) 80 102 (21.6%)
------------------------------- --------------- --------------
Total $ 1,676 $ 1,934 (13.3%) $ 1,548 $ 1,741 (11.1%)
=============================== =============== ==============
As % of Sales of Used Cars:
Selling and Marketing 5.1% 5.9% 5.2% 5.9%
General and Administrative 10.8% 14.0% 10.1% 12.5%
Depreciation and Amortization 0.9% 1.3% 0.8% 1.1%
------------------------------- --------------- --------------
Total 16.8% 21.2% 16.1% 19.5%
=============================== =============== ==============
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 sales of used cars due to the increase in the number of cars sold
combined with an increase in sales price per vehicle. Based on current
estimates, we believe that with the launch of the new DriveTime advertising
campaign in the 3rd quarter of 2002, Selling and Marketing Expenses will remain
fairly consistent with the first six months of 2002.
General and Administrative expenses decreased in total dollars, on a per
car sold basis and as a percentage of sales of used cars for the three and six
months ended June 30, 2002, principally due to a reduction in work force and
other general cost saving initiatives.
Depreciation and Amortization expenses decreased in total dollars, on a per
car sold basis and as a percentage of cars revenue for the three and six months
ended June 30, 2002, primarily due to discontinuation of depreciation on $3.8
million original cost of buildings as a result of the sale of the six properties
to Verde investments and the discontinuation of goodwill amortization in 2002
upon the adoption of SFAS No. 142. See Note (3) of the Notes to Condensed
Consolidated Financial Statements for further discussion.
Portfolio Operations. Operating expenses for our Portfolio segment consist
of loan servicing and collection efforts, securitization activities, and other
operations pertaining directly to the administration and collection of the loan
portfolio. A summary of portfolio operating expenses follows ($ in thousands,
except expense per month per loan serviced):
Three Months Ended Six Months Ended
June 30, June 30,
---------------------------- % -------------------------- %
2002 2001 Change 2002 2001 Change
---------------------------- ------------ -------------------------------------
Portfolio Expense:
General and Administrative $ 7,095 $ 7,359 (3.6%) $ 13,637 $ 15,367 (11.3%)
Depreciation and Amortization 240 232 3.4% 492 496 (0.8%)
---------------------------- --------------------------
Portfolio Expense $ 7,335 $ 7,591 (3.4%) $ 14,129 $ 15,863 (10.9%)
============================ ==========================
Average Expense per Month per Loan Serviced $ 28.55 $ 29.25 $ 27.79 $ 30.37
============================ ==========================
Annualized Expense as % of End of Period
Principal Balances 5.2% 5.8% 5.0% 6.0%
============================ ==========================
The decrease in portfolio expenses and in the expense per month per loan
serviced for the three and six months ended June 30, 2002, compared to the same
periods in 2001, 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 six
months ended June 30, 2001, include a $0.6 million restructuring charge related
to the closure of those facilities.
Corporate Operations. Operating expenses for our Corporate segment consist
of costs to provide managerial oversight and reporting for the Company, develop
and implement policies and procedures, and provide expertise to the Company in
areas such as finance, legal, human resources and information technology. A
summary of corporate expenses follows ($ in thousands, except per car sold
amounts):
Three Months Ended Six Months Ended
June 30, June 30,
-------------------------------- % -------------------------------- %
2002 2001 Change 2002 2001 Change
--------------- --------------- ----------- ---------------- --------------- -------------
Corporate Expense:
General and Administrative $ 5,470 $ 5,003 9.3% $ 11,261 $ 9,775 15.2%
Depreciation and Amortization 728 840 (13.3%) 1,473 1,657 (11.1%)
--------------- --------------- ---------------- ---------------
Corporate Expense $ 6,198 $ 5,843 6.1% $ 12,734 $ 11,432 11.4%
--------------- --------------- ---------------- ---------------
Per Car Sold $ 514 $ 503 $ 465 $ 432
=============== =============== ================ ===============
As % of Total Revenues 4.0% 4.1% 3.8% 3.8%
=============== =============== ================ ===============
Corporate operating expenses as a percent of total revenue remained
relatively consistent for the three and six months ended June 30, 2002, versus
the same periods of 2001. However, corporate expenses increased in total and on
a per car sold basis, as compared to the same periods 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, plus during the first six months of 2002,
the Company paid $.5 million to Verde for the aircraft lease and reimbursement
of various travel costs and other expenses incurred by Verde on behalf of the
Company. See Note (3) to the Condensed Consolidated Financial Statements.
Financial Position
The following table represents key components of our financial position ($
in thousands):
June 30, December 31, %
2002 2001 Change
----------------- --------------- --------------
Total Assets $ 644,951 $ 647,657 (0.4%)
Finance Receivables, Net 531,928 495,254 7.4%
Inventory 38,148 58,618 (34.9%)
Property and Equipment, Net 30,331 37,739 (19.6%)
Net Assets of Discontinued Operations - 3,899 (100.0%)
Total Debt 450,143 461,074 (2.4%)
Notes Payable - Portfolio 398,640 377,305 5.7%
Other Notes Payable 25,690 52,510 (51.1%)
Subordinated Notes Payable 25,813 31,259 (17.4%)
Stockholders' Equity $ 148,990 $ 145,483 2.4%
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 June 30, 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 have implemented 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. For the three months ended June 30, 2002, we acquired our used car
inventory from three sources: 80% from auctions, 15% from wholesalers and 5%
from new car dealerships.
Property and Equipment, Net. Net Property and Equipment decreased from
December 31, 2001, to June 30, 2002, by $7.4 million. 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 $36.7 million or
7.4% during the six months ended June 30, 2002. New originations for this period
exceeded the portfolio runoff, consisting of regular principal payments, payoffs
and charge-offs, by $50.7 million. Partially offsetting the growth in loan
principal balances was the $14.3 million increase in the Allowance for Credit
Losses. See Note (2) to the Condensed Consolidated Financial Statements for the
detail components of Finance Receivables, net.
The following table reflects activity in the Allowance for Credit Losses,
as well as information regarding charge-off activity, for the three and six
months ended June 30, 2002 and 2001 ($ in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------------ -------------------------------------
2002 2001 2002 2001
------------------ ----------------- ------------------ ------------------
Allowance Activity:
Balance, Beginning of Period $ 107,600 $ 102,000 $ 101,900 $ 99,700
Provision for Credit Losses 38,395 32,210 83,762 71,230
Other Allowance Activity - (48) - (6)
Net Charge Offs (29,795) (32,573) (69,462) (69,335)
------------------ ----------------- ------------------ -----------------
Balance, End of Period $ 116,200 $ 101,589 $ 116,200 $ 101,589
================== ================= ================== =================
Charge off Activity:
Principal Balances $ (36,029) (41,605) $ (83,060) $ (88,761)
Recoveries, Net 6,234 9,032 13,598 19,426
------------------ ----------------- ------------------ -----------------
Net Charge Offs $ (29,795) $ (32,573) $ (69,462) $ (69,335)
================== ================= ================== =================
The Allowance for Credit Losses was $116.2 million as of June 30, 2002,
compared to $101.6 million as of June 30, 2001. Of the $14.6 million increase in
the allowance for credit losses, $5.8 million related to the increase in loan
principal balance from $534.8 million as of June 30, 2001, to $565.4 million as
of June 30, 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 as a percentage of loan
principal is 20.6% as of June 30, 2002, up from 19.8% as of December 31, 2001,
and 19.0% as of June 30, 2001.
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.
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 $45.6 million during the six months ended June 30, 2002. The
increase was used to fund new originations during the second quarter of 2002,
pending the 2002B securitization of these loans, which is scheduled to close on
August 15, 2002. The amount of obligations outstanding pursuant to the Company's
securitization program decreased $24.7 million in the six months ended June 30,
2002, primarily due to the timing of the securitizations. Only one new
securitization, 2002A, was completed during the six months ended June 30, 2002,
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 pay down on the senior note payable of $10.8 million and a decrease in the
inventory line of $12.3 million. 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. However, the Company
guarantees these loans with the lenders. 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 scheduled $2.0 million pay down of the senior subordinated
notes payable during the second quarter of 2002 and a $4 million pay down on the
$7.0 million subordinated note payable, which was reduced from $5.4 million
outstanding at December 31, 2001, to $1.4 million outstanding at June 30, 2002.
On April 1, 2002, Verde Investments transferred to Cygnet Capital Corporation
("CCC"), an affiliate of Verde and Mr. Ernest C. Garcia, the remaining balance
of the $7.0 million note payable. On May 31, 2002, CCC purchased from an
unrelated party the entire outstanding balance of the Company's senior
subordinated notes payable. The outstanding balance of the senior subordinated
notes payable is $3.0 million at June 30, 2002. 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 July 31, 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% 6.5% 13.0% 24.1% 28.8% 31.2% 32.0% 100.0%
1999
1st Quarter $ 103,068 0.8% 7.4% 15.0% 23.4% 29.2% 31.4% 32.5% 99.9%
2nd Quarter $ 95,768 1.1% 9.8% 16.6% 25.2% 31.2% 33.5% 34.6% 99.6%
3rd Quarter $ 102,585 1.0% 8.2% 14.1% 25.1% 30.6% 33.4% 34.5% 98.6%
4th Quarter $ 80,641 0.7% 5.9% 12.6% 23.5% 28.9% 31.9% 32.7% 96.6%
2000
1st Quarter $ 128,123 0.3% 6.5% 14.5% 24.0% 30.2% 33.0% 33.3% 93.1%
2nd Quarter $ 118,778 0.6% 8.5% 15.8% 25.8% 32.5% x 34.6% 88.2%
3rd Quarter $ 124,367 0.7% 7.7% 14.3% 25.7% 32.2% - 33.3% 82.2%
4th Quarter $ 100,823 0.6% 6.6% 13.5% 25.8% x - 30.8% 74.8%
2001
1st Quarter $ 126,013 0.4% 6.3% 14.1% 24.3% - - 26.3% 66.3%
2nd Quarter $ 103,521 0.5% 6.2% 12.9% x - - 19.9% 53.9%
3rd Quarter $ 109,037 0.7% 5.3% 10.6% - - - 13.7% 39.2%
4th Quarter $ 87,355 0.7% 5.1% x - - - 8.9% 24.1%
2002
1st Quarter $ 140,178 0.5% x - - - - 3.2% 16.2%
2nd Quarter $ 119,196 x - - - - - 0.0% 3.8%
The following table sets forth the principal balances' delinquency status
as a percentage of total outstanding contract principal balances from dealership
operations:
June 30, June 30, December 31,
Days Delinquent: 2002 2001 2001
------------------ ------------------ ------------------
Current 70.3% 70.2% 64.5%
1-30 Days 23.1% 23.0% 26.2%
31-60 Days 3.9% 4.1% 5.6%
61-90 Days 2.7% 2.7% 3.7%
------------------ ------------------ ------------------
Total Portfolio 100.0% 100.0% 100.0%
================== ================== ==================
In accordance with our charge-off policy, there are no accounts more than
90 days delinquent as of June 30, 2002.
Current accounts increased from 64.5% as of December 31, 2001, to 70.3% as
of June 30, 2002, and accounts greater than 30 days delinquent decreased from
9.3% to 6.6% during the same period, a 29% improvement. The improvement in
delinquencies is a combination of the positive effect of higher credit
standards, the improved credit quality mix of originations since the first
quarter of 2001 and seasonality.
Although delinquencies have improved during 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 $38.4 million or 32.2% of the total amount financed for the quarter ended
June 30, 2002, up from $32.2 million or 31.1% of the total amount financed for
the quarter ended June 30, 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 20.6%
as of June 30, 2002, up from 19.8% as of December 31, 2001, and 19.0% as of June
30, 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 our subsidiaries or us. 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 in prior periods obtained an insurance policy from MBIA
Insurance Corporation that guarantees payment of amounts to the holders of the
Class A obligations. Recently, we have entered into a commitment with XL Capital
Assurance to insure, at a minimum, our next three securitizations. XL Capital
Assurance is rated AAA by Standard and Poor's and Aaa by Moody's ratings.
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, historically ranging
from 2.3% to 7.3% 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, currently ranging from 8.0% to 11.5%, 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.
The Company previously reported in its Annual Report on Form 10-K for the
year ended December 31, 2001, and in its Quarterly Report on Form 10-Q for the
three month period ended March 31, 2002, that four of its securitizations had
reached Termination Events (as defined in the securitizations) triggering an
acceleration of rights for the insurer under the Insurance Agreements for the
respective securitizations. As reported, the Termination Events occurred on the
charge-off triggers for 2000B, 2000C, and 2001A in December 2001, and on the
delinquency trigger for 1999C in January 2002. As a result, all cash flow from
these trusts otherwise distributable to the Company was deposited into a reserve
account for these securitizations. In June 2002, as reported on Form 8-K,
revised calculations indicated that no Termination Events in fact had been
triggered on the net charge-off trigger for 2000B, 2000C, and 2001A in December
2001. However, the revised calculations did confirm the Termination Event on the
delinquency trigger for 1999C in January, an additional Termination Event on the
delinquency trigger for 1999C in February 2002, and a Termination Event on the
delinquency trigger for 2000A for the months of February, March and April in
2002. Both the 1999C and 2000A trusts have been repurchased by the Company in
April and July, respectively, and are no longer required to be tested by the
performance targets set by the trust insurer and all cash has been released. In
addition, upon review of these revised calculations for the 2000B, 2000C and
2001A trusts, trapped cash related to these trusts was released and distributed
to the Company in June of 2002.
Although the 2000B, 2000C and 2001A trusts did not breach the Termination
Tests as originally reported, they, along with other trusts, did reach Portfolio
Events (as defined in the securitizations) and would have been required to trap
cash. Since October 2001 the following Portfolio Events occurred in the
following trusts: For trust 1999C, delinquency triggers in October, November,
and December of 2001; and January and February of 2002. For trust 2000A,
delinquency triggers in October, November, and December of 2001; and January,
February, March, April and May of 2002. For 2000B, delinquency triggers in
October, November, and December of 2001; January, February and March of 2002;
and charge-off triggers in December 2001 and January 2002. For 2000C,
delinquency triggers in November and December of 2001; January, February and
March of 2002; and charge-off triggers in December 2001 and January, February
and March of 2002. For 2001A, delinquency triggers in November and December of
2001; January and February of 2002; and charge-off triggers in December 2001,
and January, February and March of 2002. As of August 1, 2002, no cash is being
held above the required reserve levels on any trust
As with a Termination Event, breaching a Portfolio Performance test in the
trust will also cause the trust to not distribute cash to any other obligor of
the trust below the A bondholder. Any excess cash is to be deposited in the
trust reserve account to be used in the event of a cash shortfall in future
distribution periods. Each trust has a required reserve account balance and cash
deposited in excess of this required balance is considered "trapped" cash. When
a Portfolio Event is reached the reserve balance increases to a predetermined
amount typically in a range of 16% to 20% (each trust has a specific level) of
the outstanding portfolio balance. If a trust has only breached a Portfolio
test, once the performance level drops below the test level in a monthly
reporting period the Portfolio Event is deemed "cured" and the cash is released
to the original required reserve level. When a Termination Event is reached, the
reserve account level builds to a level equal to the outstanding balance on the
A bonds or until waived by the insurer. If a trust has breached a Termination
test, the event can only be cured by a waiver of the trust insurer.
In April 2002, we completed our first securitization of this year, 2002A,
with MBIA providing the insurance on 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 was 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 active trusts they insure. The Company is currently
trying to negotiate the release of these funds in light of the revised
calculations indicating no Termination Events had been triggered on any active
trusts.
While completing 2002A, we mutually agreed with MBIA to further diversify
our lending sources, a process that we initiated in 2001 with our inventory and
warehouse lending facilities. As a result we engaged a different insurer, XL
Capital Assurance ("XL"), for our second securitization of this year, 2002B, and
for subsequent securitizations. On July 30, 2002, the Company priced the 2002B
securitization, which is scheduled to close on August 15, 2002. If this
securitization closes as expected it will consist of approximately $211.3
million in principal balances and the issuance of approximately $150.0 million
in Class A bonds, including a pre-funded amount of approximately $27.5 million.
The coupon rate on the Class A bonds is 2.99%, the initial deposit into the
reserve account is 7.25% and the reserve account maximum is 11.5%. The Class A
bonds will be insured by XL Capital Assurance, resulting in AAA by Standard and
Poor's and Aaa by Moody's ratings.
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. In addition to our normal recurring
capital requirements, we are currently refurbishing all of our dealerships
related to the change of our corporate name from Ugly Duckling to DriveTime. The
total additional expenditures expected to be incurred in the 3rd quarter of 2002
related to the rollout of DriveTime is approximately $6.3 million, which we
anticipate funding through our existing liquidity or lease financing. In
general, 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. We
closed our first securitization transaction of 2002, in April and believe we
will continue to be able to securitize our loan pools throughout the year. We
have engaged XL Capital Assurance to insure our second securitization in 2002,
expected to close on August 15, 2002. In March of 2002, we renewed our $100
million warehouse credit facility for an additional 364-day period. On July 19,
2002, the Company renewed its senior secured loan facility with certain lenders
and the facility was increased from $35 million to $45 million. In addition, our
$36 million dollar revolving inventory facility does not expire until June of
2003.
As previously reported, cash flow from certain securitizations during the
first half of 2002 was deposited into reserve accounts for these securitizations
because those trusts hit termination and/or portfolio events. Despite this
trapping of cash, we had sufficient liquidity to fund our ongoing operations and
repurchase the 1999C and 2000A trusts. As of August 1, 2002, no cash is being
held above the required reserve levels.
The IRS has completed its audits of the Company for 1997, 1998 and 1999 and
the IRS has also notified the Company that it intends to perform an examination
of the Company's tax year 2000. There can be no assurance as to the ultimate
outcome of the year 2000 examination and the Company could become liable for
current tax payments related to the timing of certain deductions that may
materially impact the Company's liquidity.
For a discussion of certain risks that could affect our liquidity and
capital resources, see Exhibit 99.1 to this form 10-Q.
Cash Flow
Net cash provided by operating activities increased $34.3 million to $128.3
million in the six months ended June 30, 2002, up from $94.0 million net cash
provided by operating activities in the six months ended June 30, 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 was an increase in other assets.
Net cash used in investing activities increased $27.6 million to $121.7
million during the six months ended June 30, 2002 as compared to $94.1 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 a reduction in purchases
of property and equipment.
Net cash used in financing activities increased $6.8 million to $9.0
million for the six months ended June 30, 2002, as compared to $2.2 million net
cash used during the same period of 2001. The increase in cash used is primarily
due to an increase in repayments of other notes payable related to the pay downs
of the senior secured loan facility and the inventory line, and a decrease in
additions to notes payable portfolio because there was only one new
securitization during the six months ended June 30, 2002, compared to two new
securitizations closed in the six months ended June 30, 2001. Primarily
offsetting these increases in cash used was an increase in additions to other
notes payable related to draws on the inventory line, a decrease in additional
deposits into investments held in trust and repayment of notes
payable-portfolio, all primarily because there was only one new securitization
during the six months ended June 30, 2002.
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
one-month LIBOR plus 2.80% (4.64% and 4.72% at June 30, 2002, and December 31,
2001, respectively). The facility is secured with substantially all Company
assets. At June 30, 2002, the Company was in compliance with all 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 June 30, 2002, and
at December 31, 2001). The facility is secured with the Company's automobile
inventory. At June 30, 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 had a term of 25 months.
Per the agreement, the Company was required to make principal payments of $1.0
million per month during months from April 2001 through September 2002.
Thereafter through maturity, the agreement required 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 was payable monthly at one-month LIBOR plus 600 basis points (7.84 % at
June 30, 2002, and 7.90% at December 31, 2001). The balance of the note was
$15.2 million at June 30, 2002. The loan was secured by certain Finance
Receivables. At June 30, 2002, the Company was in compliance with all required
covenants. On July 19, 2002, the Company renewed its senior secured loan
facility with certain lenders. The loan facility was increased from a $35
million loan facility to $45 million. Interest is payable at one-month LIBOR
plus 500 basis points, with a minimum LIBOR of 2.125%, and has a term of
approximately 30 months. The loan discount at funding was 5% or $2.25 million
and there are no prepayment penalties. The facility is secured by the Company's
retained interests in the residuals from its securitization transactions.
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 one-month LIBOR plus
600 basis points and is subject to pro rata reductions if certain conditions are
met. As a condition to the $35 million senior secured note payable, Verde 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 sale and leaseback transaction closed in
January 2002, for six properties located in Texas, Virginia and California. As a
result of the going private transaction, the warrants have been terminated. 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. As of June 30, 2002, the
balance of the note was $1.4 million. Subsequently, the remaining balance was
paid off in full in July 2002.
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), and subordinate to our other indebtedness.
With the closing of the going private transaction, the warrants were terminated.
On May 31, 2002, Cygnet Capital Corporation, an affiliate of Verde and Mr.
Garcia, purchased from an unrelated party the entire outstanding balance of the
Company's senior subordinated notes payable. The outstanding balance of the
senior subordinated notes payable is $3.0 million at June 30, 2002.
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. Mr. Garcia and affiliates own $2.6 million 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. Mr. Garcia and affiliates own
$4.9 million of the debentures.
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. ("Acquisition"), an entity wholly
owned by UDC Holdings Corp., completed a short form merger with and into the
Company. The Company was the surviving corporation under the short form merger.
UDC Holdings capitalized 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. Since the consummation of the
Merger, Ray Fidel, Ugly Duckling Car Sales and Finance Corp.'s executive vice
president and chief operating officer, has acquired a minority interest in UDC
Holdings Corp., along with Mr. Sullivan. Mr. Garcia has a majority interest in
UDC Holdings Corp. See Management's Discussion and Analysis of Financial
Condition - Part II Other Information - Item 1. Legal Proceedings.
In addition to our normal recurring capital expenditures, we are currently
refurbishing all of our dealerships related to the change of our corporate name
from Ugly Duckling to DriveTime. The total additional expenditures expected to
be incurred in the 3rd and 4th quarter of 2002 related to the rollout of
DriveTime is approximately $6.3 million, which we anticipate funding through our
existing liquidity and/or lease financing.
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
portfolio credit grade mix, 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 July 2002, the Financial Accounting Standards Board issued FASB
Statement No. 146, "Accounting for Costs Associated with Exit or Disposal
Activities," which revises accounting for specified employee and contract
terminations that are part of restructuring activities. Statement No. 146
applies to costs associated with an exit activity (including restructuring) or
with a disposal of long-lived assets. Those activities can include eliminating
or reducing profit lines, terminating employees and contracts, and relocating
plant facilities or personnel. Under Statement No. 146, a company will record a
liability for a cost associated with an exit or disposal activity when that
liability is incurred and can be measured at fair value. The new requirement can
shift expense recognition from one quarter or fiscal year to another. The
provisions of Statement No. 146 are effective prospectively for exit or disposal
activities initiated after December 31, 2002. Management does not expect the
adoption of Statement No. 146 will have an effect on the Company's financial
statements.
In April 2002, the Financial Accounting Standards Board issued FASB
Statement No. 145, Rescission of Statement No. 4, 44 and 64, Amendment of
Statement No. 13, and Technical Corrections (SFAS No. 145). SFAS No. 145 will
rescind SFAS No. 4 which required all gains and losses from extinguishment of
debt to be aggregated and, if material, classified as an extraordinary item, net
of related income tax effect. As a result of SFAS No. 145, the criteria in 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 will now be used to classify those gains and
losses. SFAS No. 64 amended SFAS No. 4, and is no longer necessary because SFAS
No. 4 has been rescinded. The provisions of Statement No. 145 are effective for
fiscal years beginning after May 15, 2002. The Company has determined the impact
of adoption of Statement No. 145 will result in the reclassification of an
extraordinary item resulting from the gain from the early extinguishment of debt
that occurred in the three months ended June 30, 2001.
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
ended 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 No. 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 No. 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 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. 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, 2001,
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 Statement No. 142, the Company has allocated
the entire goodwill balance to the Retail Operations Segment. During the second
quarter of 2002, the Company finalized the required impairment tests of goodwill
as of January 1, 2002. The Company does not have an impairment of goodwill as of
the date of adoption. 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 June 30, 2002, the
Company has unamortized goodwill of approximately $11.6 million within the
retail segment. (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: our name change to DriveTime and strategic operating changes, including the
impacts of new programs such as DriveCare and RateAdvantage (including the
impact on our portfolio average APR), funding for DriveTime improvements;
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; selling and marketing expenses remaining constant through year end;
retaining the warehouse and inventory lines of credit; the success of cost
savings initiatives and restructurings; improvements in inventory, inventory
acquisition, and inventory mix, including higher priced inventory and improved
loan performance on such inventory; release of deposits held in escrow;
continuing to complete securitization transactions; 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 99.1 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 June 30, 2002, the scheduled maturities on
our finance receivables ranged from one to 48 months, with a weighted average
maturity of 24.9 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. By July 2002, we began offering the RateAdvantage
interest rate program at all of our dealerships. 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 June 30, 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. See Exhibit 99.1 for further information on Forward Looking
Statements and Risk Factors.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company has historically sold our 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.
Beginning in June 2002, the Company launched a pilot limited warranty
program in the Phoenix market offering 90 day/3,000 mile major mechanical and
air conditioning coverage. In July 2002, we rolled out this program to all of
our dealerships. We disclaim any obligation for vehicle related problems outside
the scope of the warranty. However, there can be no assurance that these
disclaimers will be upheld in every instance. Also, under certain state laws,
implied or other warranties may now apply.
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). A group of law firms in Texas have sued a large number of Dallas county
auto dealers (including Ugly Duckling) alleging the auto dealers have charged
customers interest on deferred sales taxes and overcharged in the sale and
financing of customers. It is our understanding more lawsuits have been filed in
other Texas counties. We believe the claims against us are without merit and
intend to vigorously defend against 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
then 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 then 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. 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 December 4, 2001, UDC Acquisition, a wholly owned subsidiary of UDC
Holdings Corp., an entity then wholly owned by Mr. Garcia and Mr. Sullivan,
commenced a tender offer to purchase all of UDC's outstanding shares of common
stock not owned by Mr. Garcia, Mr. Sullivan, and affiliated entities. As of
March 4, 2002, UDC Acquisition and the Company effected a statutory merger under
Section 253 of the Delaware General Corporation Law.
On February 4, 2002, the parties 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. A notice of appeal was filed by two dissenting shareholders prior to
the expiration date. Plaintiffs' counsel is not entitled to their fees and costs
until the court order is final. 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.
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 were required to file a petition for
appraisal in the Delaware Court of Chancery within 120 days of the effective
date of the merger, or their appraisal rights were lost and they are only
entitled to receive the merger consideration of $3.53 per share. Two appraisal
rights actions were filed in Delaware in this 120 day period. The court will now
determine which shareholders are entitled to appraisal rights and appraises the
shares of such shareholders. 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.
None
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 3.1 - By-laws of Ugly Duckling Corporation effective March 4, 2002
Exhibit 10.1 -Third Amendment to the Loan Agreement between the Registrant and
Cygnet Capital Corporation, dated June 30, 2002
Exhibit 10.2 -Aircraft Lease Agreement between the Registrant and Verde
Investments, Inc., dated April 1, 2002
Exhibit 99.1 -Statement Regarding Forward Looking Statements and Risk Factors
Exhibit 99.2 -Certification by Greg Sullivan, CEO, and Mark Sauder, CFO
(b) Reports on Form 8-K.
During the second quarter of 2002, the Company filed two reports on Form
8-K. The first report on Form 8-K, dated and filed April 25, 2002, reported Ugly
Duckling's announcement of the approval of the Delaware litigation matter. A
press release dated April 19, 2002, and entitled "Ugly Duckling Announces Court
Approval of Settlement of Delaware Litigation" was filed as an exhibit to this
8-K. The second report on Form 8-K, dated and filed May 20, 2002, reported the
first quarter earnings of 2002. A press release dated May 15, 2002, and entitled
"Ugly Duckling Reports First Quarter 2002 Results" 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: August 13, 2002