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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 1999
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.)
2525 E. Camelback Road, Suite 500,
Phoenix, Arizona 85016
(Address of principal executive (Zip Code)
offices)
(602) 852-6600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
---------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At November 4, 1999, there were approximately 14,880,000 shares of Common
Stock, $0.001 par value, outstanding.
This document serves both as a resource for analysts, shareholders, and
other interested persons, and as the quarterly report on Form 10-Q of Ugly
Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission,
which has taken no action to approve or disapprove the report or pass upon its
accuracy or adequacy. Additionally, this document is to be read in conjunction
with the consolidated financial statements and notes thereto included in Ugly
Duckling's Annual Report on Form 10-K, for the year ended December 31, 1998.
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UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Page
Part I - FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets -- September 30, 1999 and December 31, 1998...................... 1
Condensed Consolidated Statements of Operations -- Three and Nine Months Ended September 30, 1999
and September 30, 1998............................................................................. 2
Condensed Consolidated Statements of Cash Flows -- Nine Months Ended September 30, 1999 and
September 30, 1998................................................................................. 3
Notes to Condensed Consolidated Financial Statements................................................... 4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................. 10
Item 3. MARKET RISK............................................................................................ 31
Part II. -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS...................................................................................... 33
Item 2. CHANGES IN SECURITIES.................................................................................. 33
Item 3. DEFAULTS UPON SENIOR SECURITIES........................................................................ 33
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................... 33
Item 5. OTHER INFORMATION ..................................................................................... 33
Item 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................................... 33
SIGNATURES............................................................................................. 35
Exhibit 10.1 Amendment No. 5 to the Amended and Restated Motor Vehicle and Installment Contract Loan and
Security Agreement between General Electric Capital Corporation and Registrant dated August
16, 1999
Exhibit 10.1(a) Amendment No. 6 to the Amended and Restated Motor Vehicle and Installment Contract Loan and
Security Agreement between General Electric Capital Corporation and Registrant dated August
27, 1999
Exhibit 10.2 Third Amendment to Credit and Security Agreement between Registrant and First Merchants, dated as of
August 2, 1999
Exhibit 10.3 Amendment to Loan Agreement between Registrant and each of the Kayne Anderson related Lenders named
therein, dated September 30, 1999
Exhibit 11 Statement regarding computation of per share earnings (see note 5 of Notes to
Condensed Consolidated Financial Statements)
Exhibit 27 Financial Data Schedule
Exhibit 99 Statement Regarding Forward Looking Statements and Risk Factors
Page 1
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
September 30, December 31,
1999 1998
----------------- ------------------
ASSETS
Cash and Cash Equivalents............................................. $ 4,165 $ 2,751
Finance Receivables, Net.............................................. 356,370 163,209
Notes Receivable, Net................................................. 21,347 28,257
Inventory............................................................. 46,322 44,167
Property and Equipment, Net........................................... 34,881 32,970
Intangible Assets, Net................................................ 15,327 15,530
Other Assets.......................................................... 23,279 20,575
Net Assets of Discontinued Operations................................. 20,939 38,516
----------------- ------------------
$ 522,630 $ 345,975
================= ==================
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable.................................................. $ 3,795 $ 2,479
Accrued Expenses and Other Liabilities............................ 38,710 19,694
Notes Payable..................................................... 280,571 117,294
Subordinated Notes Payable........................................ 37,077 43,741
----------------- ------------------
Total Liabilities..................................................... 360,153 183,208
----------------- ------------------
Stockholders' Equity:
Common Stock...................................................... 19 19
Additional Paid in Capital........................................ 173,257 173,809
Retained Earnings................................................. 9,522 3,449
Treasury Stock.................................................... (20,321) (14,510)
----------------- ------------------
Total Stockholders' Equity............................................ 162,477 162,767
----------------- ------------------
$ 522,630 $ 345,975
================= ==================
See accompanying notes to Condensed Consolidated Financial Statements.
Page 2
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Nine Months Ended September 30, 1999 and
1998 (In thousands, except earnings per share
amounts)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------- ----------------------------
1999 1998 1999 1998
------------ -------------- ------------- -------------
Sales of Used Cars......................................... $ 103,315 $ 73,580 $ 307,633 $ 216,075
Less:
Cost of Used Cars Sold................................. 57,773 42,763 173,429 125,085
Provision for Credit Losses............................ 29,315 16,298 84,510 46,648
------------ -------------- ------------- -------------
16,227 14,519 49,694 44,342
------------ -------------- ------------- -------------
Other Income:
Interest Income........................................ 25,044 7,187 59,311 19,415
Gain on Sale of Finance Receivables.................... -- 3,820 -- 12,093
Servicing and Other Income............................. 6,963 12,127 24,259 25,726
------------ -------------- ------------- -------------
32,007 23,134 83,570 57,234
------------ -------------- ------------- -------------
Income before Operating Expenses........................... 48,234 37,653 133,264 101,576
Operating Expenses:
Selling and Marketing.................................. 6,160 5,316 18,655 15,754
General and Administrative............................. 26,112 26,781 81,524 63,690
Depreciation and Amortization.......................... 2,458 1,445 6,917 3,970
------------ -------------- ------------- -------------
34,730 33,542 107,096 83,414
------------ -------------- ------------- -------------
Operating Income........................................... 13,504 4,111 26,168 18,162
Interest Expense........................................... 6,422 1,482 15,895 4,355
------------ -------------- ------------- -------------
Earnings before Income Taxes............................... 7,082 2,629 10,273 13,807
Income Taxes............................................... 2,900 1,102 4,200 5,609
------------ -------------- ------------- -------------
Income from Continuing Operations.......................... 4,182 1,527 6,073 8,198
Discontinued Operations:
Loss from Operations of Discontinued Operations, net of
income tax benefit of $492............................. -- -- -- (768)
Loss on Disposal of Discontinued Operations, net of
income tax benefit of $2,372 and $5,396................ -- (3,628) -- (8,455)
============ ============== ============= =============
Net Earnings (Loss)......................................... $ 4,182 $ (2,101) $ 6,073 $ (1,025)
============ ============== ============= =============
Earnings per Common Share from Continuing
Operations:
Basic.................................................. $ 0.28 $ 0.08 $ 0.40 $ 0.44
============ ============== ============= =============
Diluted................................................ $ 0.28 $ 0.08 $ 0.39 $ 0.44
============ ============== ============= =============
Net Earnings (Loss) per Common Share:
Basic.................................................. $ 0.28 $ (0.11) $ 0.40 $ (0.06)
============ ============== ============= =============
Diluted................................................ $ 0.28 $ (0.11) $ 0.39 $ (0.05)
============ ============== ============= =============
Shares Used in Computation:
Basic.................................................. 14,903 18,560 15,161 18,600
============ ============== ============= =============
Diluted................................................ 15,167 18,800 15,384 18,800
============ ============== ============= =============
See accompanying notes to Condensed Consolidated Financial Statements.
Page 3
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 1999 and 1998
(In thousands)
1999 1998
-------------- --------------
Cash Flows from Operating Activities:
Net Earnings................................................................ $ 6,073 $ (1,025)
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses............................................... 84,510 46,648
Gain on Sale of Finance Receivables....................................... -- (12,093)
Depreciation and Amortization ............................................ 6,917 3,970
Loss from Discontinued Operations......................................... -- 9,223
Purchase of Finance Receivables Held for Sale............................. -- (246,431)
Increase in Deferred Income Taxes......................................... (3,769) (1,260)
Proceeds from Sale of Finance Receivables................................. -- 159,498
Collections of Finance Receivables........................................ -- 41,527
Increase in Inventory..................................................... (1,280) (3,833)
Increase in Other Assets.................................................. (1,862) (6,293)
Increase in Accounts Payable, Accrued Expenses and Other Liabilities...... 20,595 11,005
Increase in Income Taxes Payable.......................................... 2,926 1,521
-------------- --------------
Net Cash Provided by Operating Activities................................... 114,110 2,457
-------------- --------------
Cash Flows from Investing Activities:
Purchase of Finance Receivables Held for Investment....................... (377,547) --
Collections of Finance Receivables Held for Investment.................... 121,551 --
Increase in Investments Held in Trust..................................... (10,914) (9,719)
Advances under Notes Receivable........................................... (6,577) (38,788)
Repayments of Notes Receivable............................................ 13,487 39,062
Proceeds from Disposal of Property and Equipment.......................... -- 27,413
Purchase of Property and Equipment........................................ (8,165) (20,567)
Payment for Acquisition of Assets......................................... (12,095) --
-------------- --------------
Net Cash Used in Investing Activities....................................... (280,260) (2,599)
-------------- --------------
Cash Flows from Financing Activities:
Additions to Notes Payable................................................ 270,027 30,000
Repayment of Notes Payable................................................ (106,750) (46,222)
Net Issuance (Repayment) of Subordinated Notes Payable.................... (6,664) 18,000
Proceeds from Issuance of Common Stock.................................... 60 303
Acquisition of Treasury Stock............................................. (5,811) (535)
Repurchase of Outstanding Warrants........................................ (612) --
Other, Net................................................................ (263) (222)
-------------- --------------
Net Cash Provided by Financing Activities................................... 149,987 1,324
-------------- --------------
Cash Provided by (Used in) Discontinued Operations.......................... 17,577 (3,313)
-------------- --------------
Net Increase (Decrease) in Cash and Cash Equivalents........................ 1,414 (2,131)
Cash and Cash Equivalents at Beginning of Period............................ 2,751 3,537
-------------- --------------
Cash and Cash Equivalents at End of Period.................................. $ 4,165 $ 1,406
============== ==============
Supplemental Statement of Cash Flows Information:
Interest Paid............................................................... $ 16,110 $ 7,697
============== ==============
Income Taxes Paid........................................................... $ 5,609 $ 1,558
============== ==============
See accompanying notes to Condensed Consolidated Financial Statements.
Page 4
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Our accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles
for a complete financial statement presentation. In our opinion, such unaudited
interim information reflects all adjustments, consisting only of normal
recurring adjustments, necessary to present our financial position and results
of operations for the periods presented. Our results of operations for interim
periods are not necessarily indicative of the results to be expected for a full
fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 1998
was derived from our audited consolidated financial statements as of that date
but does not include all the information and footnotes required by generally
accepted accounting principles. 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, 1998.
Note 2. Summary of Finance Receivables
Following is a summary of our Finance Receivables, Net, as of September 30, 1999
and December 31, 1998 (in thousands):
September 30, 1999 December 31, 1998
----------------------------------------- -----------------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
------------- ------------- ------------ -------------- ------------ -----------
Gross Installment Sales Contracts........ $ 464,775 $ 131,510
Unearned Finance Charges................. (132,793) (37,574)
------------- --------------
Installment Sales Contract Principal
Balances.............................. 331,982 53,066 385,048 93,936 51,282 145,218
Add: Accrued Interest.................... 3,689 650 4,339 877 473 1,350
Loan Origination Costs............... 5,053 -- 5,053 2,237 -- 2,237
------------- ------------- ------------ -------------- ------------ -----------
Principal Balances, Net.................. 340,724 53,716 394,440 97,050 51,755 148,805
Residuals in Finance Receivables Sold.... 19,576 2,625 22,201 33,331 2,625 35,956
Investments Held in Trust................ 42,137 -- 42,137 20,564 -- 20,564
------------- ------------- ------------ -------------- ------------ -----------
402,437 56,341 458,778 150,945 54,380 205,325
Allowance for Credit Losses.............. (80,698) (3,888) (84,586) (24,777) (2,024) (26,801)
Discount on Acquired Loans............... -- (17,822) (17,822) -- (15,315) (15,315)
------------- ------------- ------------ -------------- ------------ -----------
Finance Receivables, Net................. $ 321,739 $ 34,631 $ 356,370 $ 126,168 $ 37,041 $ 163,209
============= ============= ============ ============== ============ ===========
Classification of Principal Balances:
Finance Receivables Held for Investment.. $ 86,169 $ 53,066 $ 139,235 $ 26,852 $ 51,282 $ 78,134
Finance Receivables Held as Collateral
for Securitization Notes Payable......... 245,813 -- 245,813 67,084 -- 67,084
============= ============= ============ ============== ============ ===========
Installment Sales Contract Principal
Balances................................. $ 331,982 $ 53,066 $ 385,048 $ 93,936 $ 51,282 $ 145,218
============= ============= ============ ============== ============ ===========
Page 5
As of September 30, 1999 and December 31, 1998, our Residuals in Finance
Receivables Sold from dealership operations were comprised of the following (in
thousands):
September 30, December 31,
1999 1998
----------------- ------------------
Retained interest in subordinated securities (B Certificates)................. $ 25,017 $ 51,243
Net interest spreads, less present value discount............................. 9,207 25,838
Reduction for estimated credit losses......................................... (14,648) (43,750)
----------------- ------------------
Residuals in finance receivables sold......................................... $ 19,576 $ 33,331
================= ==================
Securitized principal balances outstanding.................................... $ 95,457 $ 198,747
================= ==================
Estimated credit losses as a % of securitized principal balances outstanding. 15.3% 22.0%
================= ==================
The following table reflects a summary of activity for our Residuals in
Finance Receivables Sold from dealership operations for the periods ended
September 30, 1999 and 1998, respectively (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
1999 1998 1999 1998
------------ ------------ ------------- -------------
Balance, Beginning of Period.................................. $ 22,559 $ 28,417 $ 33,331 $ 13,277
Additions..................................................... -- 11,182 -- 35,435
Amortization.................................................. (2,983) (4,440) (13,755) (13,553)
------------ ------------ ------------- -------------
Balance, End of Period........................................ $ 19,576 $ 35,159 $ 19,576 $ 35,159
============ ============ ============= =============
Note 3. Notes Receivable
Our Cygnet dealer program has various notes receivable from used car
dealers. Under Cygnet's asset based loan program, our commitments for revolving
notes receivable totaled $9.5 million at September 30, 1999.
In July 1997, First Merchants Acceptance Corporation (First Merchants) filed
for bankruptcy. Immediately subsequent to the bankruptcy filing, we executed a
loan agreement to provide First Merchants with debtor in possession financing
(DIP facility). Additionally, in August 1999, we increased our funding
obligation to First Merchants by $2.0 million bringing the maximum commitment
under the DIP facility to $13.5 million at September 30, 1999. The outstanding
balance on the DIP facility totaled $12.5 million and $12.2 million at September
30, 1999 and December 31, 1998, respectively.
Following is a summary of Notes Receivable at September 30, 1999 and
December 31, 1998 (in thousands):
September 30, December 31,
1999 1998
------------------ -----------------
Notes Receivable under the asset based loan program, net of
allowance for doubtful accounts of $103, and $500, respectively...... $ 7,080 $ 8,311
First Merchants Debtor in Possession Note Receivable..................... 12,492 12,228
First Merchants Bank Group Participation................................. 721 6,856
Other Notes Receivable................................................... 1,054 862
------------------ -----------------
Notes Receivable, Net.................................................... $ 21,347 $ 28,257
================== =================
Page 6
Note 4. Notes Payable
The following is a summary of Notes Payable at September 30, 1999 and
December 31, 1998 (in thousands):
September 30, December 31,
1999 1998
------------------ ---------------
Revolving Facility with GE Capital........................................ $ 60,031 $ 51,765
Securitization Notes Payable.............................................. 184,905 50,607
Note Payable Collateralized by Securitization Subsidiaries' Common Stock.. 36,000 12,234
Mortgage Loan with Finance Company........................................ -- 3,386
Others.................................................................... 726 967
------------------ ---------------
Subtotal.................................................................. 281,662 118,959
Less: Unamortized Loan Fees.............................................. 1,091 1,665
------------------ ---------------
Notes Payable............................................................. $ 280,571 $ 117,294
================== ===============
Note 5. Common Stock Equivalents
Net Earnings per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding for the periods
ended September 30, 1999, and 1998 as follows (in thousands, except for per
share amounts):
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
1999 1998 1999 1998
-------------------------------------------------------
Income from Continuing Operations...................................... $ 4,182 $ 1,527 $ 6,073 $ 8,198
============ ============ ============ ============
Net Earnings (Loss).................................................... $ 4,182 $ (2,101) $ 6,073 $ (1,025)
============ ============ ============ ============
Basic EPS-Weighted Average Shares Outstanding.......................... 14,903 18,560 15,161 18,600
============ ============ ============ ============
Basic Earnings (Loss) Per Share from:
Continuing Operations.............................................. $ 0.28 $ 0.08 $ 0.40 $ 0.44
============ ============ ============ ============
Net Earnings (Loss)................................................ $ 0.28 $ (0.11) $ 0.40 $ (0.06)
------------ ------------ ------------ ------------
Basic EPS-Weighted Average Shares Outstanding.......................... 14,903 18,560 15,161 18,600
Effect of Diluted Securities:
Warrants .......................................................... 11 29 -- 25
Stock Options...................................................... 253 211 223 175
------------ ------------ ------------ ------------
Dilutive EPS-Weighted Average Shares Outstanding....................... 15,167 18,800 15,384 18,800
============ ============ ============ ============
Diluted Earnings (Loss) Per Share from:
Continuing Operations.............................................. $ 0.28 $ 0.08 $ 0.39 $ 0.44
============ ============ ============ ============
Net Earnings (Loss)................................................ $ 0.28 $ (0.11) $ 0.39 $ (0.05)
============ ============ ============ ============
Warrants Not Included in Diluted EPS Since Antidilutive................ 1,158 1,439 1,120 1,439
============ ============ ============ ============
Stock Options Not Included in Diluted EPS since Antidilutive........... 979 1,562 1,054 716
============ ============ ============ ============
Note 6. Business Segments
We have two divisions: dealership operations and non-dealership operations.
Within our divisions, we have six distinct business segments. Within the
dealership operations division, the segments consist of retail car sales
operations (company dealerships), the income generated from the finance
receivables generated at the Ugly Duckling dealerships and corporate and other
operations. Under the non-dealership operations division, the segments consist
of the Cygnet dealer program, bulk purchasing and loan servicing, and corporate
and other operations.
Page 7
A summary of operating activity by business segment for the periods ended
September 30, 1999 and 1998 follows (in thousands):
Dealership Operations Non Dealership Operations
-------------------------------------- --------------------------------------
Company Cygnet
Company Dealership Corporate Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
------------ ------------ ------------ ------------ ------------ ------------ ------------
Three months ended September 30, 1999:
Sales of Used Cars................... $ 103,315 $ -- $ -- $ -- $ -- $ -- $ 103,315
Less: Cost of Used Cars Sold........ 57,773 -- -- -- -- -- 57,773
Provision for Credit Losses...... 21,527 6,033 -- 1,755 -- -- 29,315
------------ ------------ ------------- ------------ ------------ ------------ ------------
24,015 (6,033) -- (1,755) -- -- 16,227
Interest Income...................... -- 19,597 178 3,923 1,344 2 25,044
Servicing and Other Income........... 72 1,793 56 -- 5,042 -- 6,963
------------ ------------ ------------- ------------ ------------ ------------ ------------
Income before Operating Expenses..... 24,087 15,357 234 2,168 6,386 2 48,234
------------ ------------ ------------- ------------ ------------ ------------ ------------
Operating Expenses:
Selling and Marketing............ 6,144 -- -- 16 -- -- 6,160
General and Administrative....... 11,111 4,794 4,390 1,055 4,063 699 26,112
Depreciation and Amortization.... 919 279 565 112 373 210 2,458
------------ ------------ ------------- ------------ ------------ ------------ ------------
18,174 5,073 4,955 1,183 4,436 909 34,730
------------ ------------ ------------- ------------ ------------ ------------ ------------
Operating Income (Loss).............. $ 5,913 $ 10,284 $ (4,721) $ 985 $ 1,950 $ (907) $ 13,504
============ ============ ============= ============ ============ ============ ============
Three months ended September 30, 1998:
Sales of Used Cars................... $ 73,580 $ -- $ -- $ -- $ -- $ -- $ 73,580
Less: Cost of Used Cars Sold........ 42,763 -- -- -- -- -- 42,763
Provision for Credit Losses...... 15,709 37 -- 552 -- -- 16,298
------------ ------------ ------------- ------------ ------------ ------------ ------------
15,108 (37) -- (552) -- -- 14,519
Interest Income...................... -- 4,537 54 2,299 297 -- 7,187
Gain on Sale of Loans................ -- 3,820 -- -- -- -- 3,820
Servicing and Other Income........... 70 3,972 44 -- 8,041 -- 12,127
------------ ------------ ------------- ------------ ------------ ------------ ------------
Income before Operating Expenses..... 15,178 12,292 98 1,747 8,338 -- 37,653
------------ ------------ ------------- ------------ ------------ ------------ ------------
Operating Expenses:
Selling and Marketing............ 5,242 -- -- 59 8 7 5,316
General and Administrative....... 8,133 4,380 4,334 575 6,585 2,774 26,781
Depreciation and Amortization.... 628 323 256 24 183 31 1,445
------------ ------------ ------------- ------------ ------------ ------------ ------------
14,003 4,703 4,590 658 6,776 2,812 33,542
------------ ------------ ------------- ------------ ------------ ------------ ------------
Operating Income (Loss).............. $ 1,175 $ 7,589 $ (4,492) $ 1,089 $ 1,562 $ (2,812) $ 4,111
============ ============ ============= ============ ============ ============ ============
Page 8
Dealership Operations Non Dealership Operations
-------------------------------------- --------------------------------------
Company Cygnet
Company Dealership Corporate Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
------------ ------------ ------------ ------------ ------------ ------------ ------------
Nine months ended September 30, 1999:
Sales of Used Cars................... $ 307,633 $ -- $ -- $ -- $ -- $ -- $ 307,633
Less: Cost of Used Cars Sold........ 173,429 -- -- -- -- -- 173,429
Provision for Credit Losses...... 63,551 17,562 -- 3,397 -- -- 84,510
------------ ------------ ------------ ------------ ------------ ------------ ------------
70,653 (17,562) -- (3,397) -- -- 49,694
Interest Income...................... -- 45,556 348 11,432 1,971 4 59,311
Servicing and Other Income........... 84 6,972 234 -- 16,969 -- 24,259
------------ ------------ ------------- ------------ ------------ ------------ ------------
Income before Operating Expenses..... 70,737 34,966 582 8,035 18,940 4 133,264
------------ ------------ ------------ ------------ ------------ ------------ ------------
Operating Expenses:
Selling and Marketing............ 18,577 -- -- 75 3 -- 18,655
General and Administrative....... 33,120 13,944 14,348 3,024 14,872 2,216 81,524
Depreciation and Amortization.... 2,572 842 1,623 297 1,064 519 6,917
------------ ------------ ------------ ------------ ------------ ------------ ------------
54,269 14,786 15,971 3,396 15,939 2,735 107,096
------------ ------------ ------------ ------------ ------------ ------------ ------------
Operating Income (Loss).............. $ 16,468 $ 20,180 $ (15,389) $ 4,639 $ 3,001 $ (2,731) $ 26,168
============ ============ ============ ============ ============ ============ ============
Nine months ended September 30, 1998:
Sales of Used Cars................... $ 216,075 $ -- $ -- $ -- $ -- $ -- $ 216,075
Less: Cost of Used Cars Sold........ 125,085 -- -- -- -- -- 125,085
Provision for Credit Losses...... 45,006 47 -- 1,595 -- -- 46,648
------------ ------------ ------------ ------------ ------------ ------------ ------------
45,984 (47) -- (1,595) -- -- 44,342
Interest Income...................... -- 11,860 171 5,909 1,475 -- 19,415
Gain on Sale of Loans................ -- 12,093 -- -- -- -- 12,093
Servicing and Other Income........... 270 11,825 143 1 13,487 -- 25,726
------------ ------------ ------------- ------------ ------------ ------------ ------------
Income before Operating Expenses..... 46,254 35,731 314 4,315 14,962 -- 101,576
------------ ------------ ------------ ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing............ 15,545 -- -- 178 20 11 15,754
General and Administrative....... 23,559 13,215 10,412 1,651 10,785 4,068 63,690
Depreciation and Amortization.... 1,856 972 706 69 336 31 3,970
------------ ------------ ------------ ------------ ------------ ------------ ------------
40,960 14,187 11,118 1,898 11,141 4,110 83,414
------------ ------------ ------------ ------------ ------------ ------------ ------------
Operating Income (Loss).............. $ 5,294 $ 21,544 $ (10,804) $ 2,417 $ 3,821 $ (4,110) $ 18,162
============ ============ ============ ============ ============ ============ ============
Note 7. Discontinued Operations
In February 1998, we announced our intention to close our branch office
network, through which we purchased retail installment contracts from third
party dealers, and exit this line of business. We completed the branch office
closure as of March 31, 1998. As a result of the branch office network closure,
we reclassified the results of operations of the branch office network in the
accompanying condensed consolidated balance sheets and condensed consolidated
statements of operations to discontinued operations.
Page 9
The components of Net Assets of Discontinued Operations as of September 30,
1999 and December 31, 1998 follow (in thousands):
September 30, December 31,
1999 1998
---------------- ---------------
Finance Receivables, Net........................... $ 17,042 $ 30,649
Residuals in Finance Receivables Sold.............. 2,956 7,875
Investments Held in Trust.......................... 2,135 3,665
Other Assets, Net of Accounts Payable and
Accrued Liabilities............................ 331 2,351
Disposal Liability................................. (1,525) (6,024)
================ ===============
Net Assets of Discontinued Operations.............. $ 20,939 $ 38,516
================ ===============
Note 8. Use of Estimates
The preparation of our 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 9. Certain Bankruptcy Remote Entities
Ugly Duckling Receivables Corporation (UDRC) and Ugly Duckling Receivables
Corporation II (UDRC II) (collectively referred to as Securitization
Subsidiaries), are our wholly-owned special purpose "bankruptcy remote
entities." Their assets, including assets classified as Discontinued Operations,
include Residuals in Finance Receivables Sold and Investments Held In Trust.
Total assets for UDRC and UDRC II are approximately $2.6 million and $258.6
million, respectively, at September 30, 1999. These amounts would not be
available to satisfy claims of our creditors on a consolidated basis.
Note 10. Reclassifications
We have made certain reclassifications to previously reported information to
conform to the current presentation.
Page 10
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND
RESULTS OF OPERATIONS
Our Quarterly Report on Form 10-Q contains forward looking statements. We
may make additional written or oral forward looking statements from time to time
in filings with the Securities and Exchange Commission or otherwise. Such
forward looking statements are within the meaning of that term in Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Such statements may include, but are not
limited to, projections of revenues, income, or loss, capital expenditures,
plans for future operations, financing needs or plans, Year 2000 readiness, and
plans relating to our products or services, as well as assumptions relating to
the foregoing. The words "believe," "expect," "intend," "anticipate,"
"estimate," "project," and similar expressions identify forward looking
statements, which speak only as of the date the statement was made. Forward
looking statements are inherently subject to risks and uncertainties, some of
which cannot be predicted or quantified. Future events and actual results could
differ materially from those set forth in, contemplated by, or underlying the
forward looking statements. We undertake no obligation to publicly update or
revise any forward looking statements, whether as a result of new information,
future events, or otherwise. Statements in this Quarterly Report, including the
Notes to the Condensed Consolidated Financial Statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
describe factors, among others, that could contribute to or cause such
differences. Additional risk factors that could cause actual results to differ
materially from those expressed in such forward looking statements are set forth
in Exhibit 99 which is attached hereto and incorporated by reference into this
Quarterly Report on Form 10-Q.
Introduction
Dealership Operations. We operate the largest chain of buy here-pay here
used car dealerships in the United States. We sell and finance our used vehicles
to customers within the sub-prime segment of the used car market. Our customers
typically have limited credit histories, low incomes or past credit problems. At
September 30, 1999, we operated 67 dealerships located in Los Angeles, Atlanta,
Tampa, Orlando, San Antonio, Phoenix, Las Vegas, Albuquerque, Tucson, and
Dallas. In the third quarter of 1999, we acquired four dealerships in the
Orlando market and a loan portfolio of approximately $15.0 million from DCT of
Ocala Corporation. We also opened one dealership in Las Vegas, and three in
California. In the fourth quarter of 1999, we completed negotiations with
Virginia Auto Mart to acquire five dealerships and a loan portfolio of
approximately $8.0 million.
Non-Dealership Operations. In addition to our dealership and financing
operations, we also o provide financing to other independent used car dealers
through our Cygnet dealer program, o service and collect large portfolios of
finance receivables owned by others, and o manage selected financial assets that
we acquire from financially distressed third parties.
We have entered into several large servicing and/or bulk purchasing
transactions involving third party dealer contract portfolios. Under these
transactions, we have acquired loan portfolios or participation interests in
loan portfolios that we also service. During the second quarter of 1999, we
closed our loan servicing facility in Nashville, Tennessee, and consolidated our
non-dealership loan servicing operations into our two remaining facilities,
which are located in Aurora, Colorado and Plano, Texas.
We have reduced our bulk purchase and third party loan servicing operations.
We have recently transferred our rights to service the loan portfolios of Auto
Marketing Network (AMN) to Loan Servicing Enterprise in exchange for $140,000.
The AMN portfolio totaled $85.5 million as of September 30, 1999. We also intend
to close our Aurora, Colorado collection facility in the near future and move
remaining portfolios to our Plano, Texas collection facility.
In 1998, we classified the Cygnet dealer program and bulk purchase and third
party loan servicing operations as discontinued operations and attempted to
split off these operations through a rights offering to our stockholders. Due to
a lack of stockholder interest, however, we cancelled the rights offering. We
recorded a charge of $2.0 million ($1.2 million, net of income taxes) during the
third quarter of 1998 to write off costs associated with the cancelled rights
offering. In the first quarter of 1999, we reclassified the Cygnet dealer
program and bulk purchase and loan servicing operations into continuing
operations for all periods presented in this quarterly report.
Discontinued Operations. From 1994 through the first quarter of 1998, we
maintained a national branch office network that acquired and serviced retail
installment contracts from numerous independent third party dealers. We
Page 11
discontinued these operations in 1998.
Below is a summary of our businesses by division and their related segments:
[Organizational Chart of Business Segments]
The chart above shows Ugly Duckling with two operating divisions. Dealership
operations is the first division. Dealership operations has three distinct
segments. Retail sales is its first segment. This is the segment that operates
our chain of Ugly Duckling Car Sales dealerships. Portfolio and loan servicing
is the second segment of dealership operations. This segment holds and services
the loan portfolios originated or acquired by our dealership operations.
Finally, dealership operations has an administration segment that provides
corporate administration to the division. Our non-dealership operations division
also contains three segments. The first non-dealership operations segment is the
bulk purchasing/loan servicing segment. In this segment, we acquire loan
portfolios in bulk from third parties and provide loan servicing for third
parties. The second segment of non-dealership operations is the Cygnet dealer
program under which we provide various credit facilities to independent used car
dealers. Finally, the non-dealership operations also have an administration
segment that provides corporate administration to the non-dealership operations.
Last, the chart shows our discontinued operations, which contains our branch
office network that we closed in February 1998 and the loans we acquired through
that network.
In the following discussion and analysis, we explain the general financial
condition and the results of operations of Ugly Duckling and its subsidiaries.
In particular, we analyze and explain the changes in the results of operations
of our various business segments for the quarter and nine month periods ended
September 30, 1999 compared to the quarter and nine month periods ended
September 30, 1998.
Results of Operations for the Three Months Ended September 30, 1999 and 1998
Income items in our Statement of Operations consist of:
o Sales of Used Cars, less Cost of Used Cars Sold, less Provision for
Credit Losses
o Interest Income
o Gain on Sale of Loans
o Servicing and Other Income
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended: September 30,
(Dollars in Thousands)
---------------------------
1999 1998
------------ -----------
Used Cars Sold (Units).................. 12,219 9,128
============ ===========
Sales of Used Cars...................... $ 103,315 $ 73,580
Cost of Used Cars Sold.................. 57,773 42,763
------------ -----------
Gross Margin............................ $ 45,542 $ 30,817
============ ===========
Gross Margin %.......................... 44.1% 41.9%
============ ===========
Per Unit Sold:
Sales of Used Cars...................... $ 8,455 $ 8,061
Cost of Used Cars Sold.................. 4,728 4,685
------------ -----------
Gross Margin............................ $ 3,727 $ 3,376
============ ===========
Page 12
The number of cars we sold (units) increased by 33.9% for the three months
ended September 30, 1999 over the same period in 1998. The increase in units
sold is primarily the result of an increase in the number of dealerships in
operation and an increase in same store sales. Same store unit sales for the
three months ended September 30, 1999 increased 11.0% compared to the three
month period ended September 30, 1998. The increase in our same store unit sales
was primarily a result of the maturation of stores purchased or opened in late
1997, changes in marketing and promotions, and more efficient management
resulting from separating our non-dealership operations. We anticipate future
revenue growth will come from increasing the number of our dealerships and not
from higher sales volumes at existing dealerships.
Our Used Car Sales revenues increased by 40.4% for the three months ended
September 30, 1999 over the same period ended September 30, 1998. The growth for
this period reflects increases in the number of dealerships, increases in same
store sales, and an increase in the average unit sales price. The Cost of Used
Cars Sold increased by 35.1% for the three months ended September 30, 1999 over
the same period ended September 30, 1998. The increase in The Cost of Used Cars
Sold is attributed to the increase in the number of dealerships in operation and
an increase in same store sales. The gross margin on used car sales (Sales of
Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses)
increased by 47.8% for the three months ended September 30, 1999 over the same
period ended September 30, 1998. The gross margin per car sold for the three
months ended September 30, 1999 increased 10.4% over the three months ended
September 30, 1998 primarily as a result of a management decision to increase
the gross margin on each unit sold.
Our average sales price per car increased by 4.9% for the three months ended
September 30, 1999 over the three months ended September 30, 1998. The increase
in the average sales price per car is a result of a small increase in the direct
cost of the cars we sell and a management decision to increase the gross margin
on each unit sold.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Three Months Ended: September 30,
--------------------------
1999 1998
------------ ------------
Provision for Credit Losses (in thousands)........ $ 27,560 $ 15,746
============ ============
Provision per contract originated................. $ 2,271 $ 1,738
============ ============
Provision as % of Principal balances originated... 26.9% 22.2%
============ ============
The Provision for Credit Losses in our dealership operations increased by
75.0% in the three months ended September 30, 1999 over the three months ended
September 30, 1998. The Provision for Credit Losses per unit originated at our
dealerships increased by $533 or 30.7% in the three months ended September 30,
1999 over the three months ended September 30, 1998. When we changed how we
structure securitizations for accounting purposes in the fourth quarter of 1998,
we also changed the timing of providing for credit losses. For periods prior to
the fourth quarter of 1998, we generally provided a Provision for Credit Losses
of approximately 21% of the loan principal balance at the time of origination to
record the loan at the lower of cost or market. However, as a consequence of our
revised securitization structure, we will now be retaining securitized loans on
our balance sheet for accounting purposes and recognizing income over the life
of the contracts. We record a provision for credit losses of approximately 27%
of the principal balance at the time of origination.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 226.1% to $1.8 million in the three
months ended September 30, 1999 from $552,000 in the three months ended
September 30, 1998. The increase was primarily due to the significant increase
in loans under the Cygnet dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Page 13
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our securitization transactions that were
structured as sale transactions for accounting purposes (Securitized Contract
Sales). Interest Income increased by 330.4% to $19.8 million for the three
months ended September 30, 1999 from $4.6 million for the three months ended
September 30, 1998. The increase was primarily due to the increase in the
average finance receivables retained on our balance sheet. Because prior to 1999
we structured most of our securitizations to recognize income as sales for
accounting purposes, there were fewer receivables retained on our balance sheet
and Interest Income was lower in these periods. See "Securitizations-Dealership
Operations" below for additional discussion of our securitization transactions
and our on balance sheet portfolio.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Three Months ended: September 30,
---------------------
1999 1998
--------- ---------
Percentage of sales revenue financed.............. 99.3% 96.5%
========= =========
Percentage of sales units financed................ 99.3% 99.2%
========= =========
The average effective yield on finance receivables from our dealerships was
approximately 25.9% for the three months ended September 30, 1999 and 25.8% for
the three months ended September 30, 1998. Our policy is to charge 29.9% per
year on our dealership contracts. However, in those states that impose interest
rate limits, such as Texas and Florida, we charge the maximum interest rate
permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from our Cygnet dealer program and from a loan we made
to First Merchants as part of its bankruptcy proceedings. Interest Income from
the First Merchants transaction increased by 25.4% to $370,000 for the three
months ended September 30, 1999 from $295,000 for the three months ended
September 30, 1998. The increase in interest income from the First Merchants
transaction is primarily the result of a higher average balance on the First
Merchants debtor in possession loan (DIP loan) for the three months period ended
September 30, 1999 compared to the three months period ended September 30, 1998.
We expect interest income from the DIP loan to decline as permanent payments are
made on the principal of the loan. We anticipate receiving a permanent principal
paydown of approximately $3.5 million on November 15, 1999, and expect that all
but the most recent $2 million increase in the DIP loan may be paid in full by
the end of the first quarter 2000.
Interest from the Cygnet dealer program increased by 69.6% to $3.9 million
for the three months ended September 30, 1999 from $2.3 million for the three
months ended September 30, 1998. The increase in interest income in the Cygnet
dealer program reflects a significant increase in the amount of loans
outstanding during the three months ended September 30, 1999 compared to the
three months ended September 30, 1998.
Arbitrage Income. During September of 1999, we recognized approximately
$974,000 of arbitrage interest income from our investment in First Merchants.
The arbitrage interest represents our retained portion of interest income on
contracts that we purchased from First Merchants and sold to a third party. We
retained a residual interest in these contracts. We had deferred recording our
share of this interest income until the third quarter of this year when we
resolved certain contingencies surrounding our investment in First Merchants. We
expect that, going forward, we will record interest income on a quarterly basis
for the life of the residual interest, currently expected to be approximately
six months. Due to the rapid run-off of this residual interest, the amounts we
record will be substantially lower in future periods with interest income
estimated to be approximately $200,000 for the fourth quarter of 1999 and
$100,000 in the first quarter of 2000. Actual amounts realized will depend on a
variety of factors, including the balance of the outstanding portfolio and the
collections thereon.
Gain on Sale of Loans
Dealership Operations. The gain on sale of finance receivables we have
recorded prior to the fourth quarter of 1998 was generated from securitizations
that were structured as sale transactions. During the fourth quarter of 1998, we
began structuring our securitization transactions as financings for accounting
purposes (securitized borrowings) instead of sales transactions and, therefore,
we have not recognized gains on the sale of loans from securitization
transactions subsequent to the change. We recorded Gains on Sale of Loans
related to Securitized Contract Sales of zero for the three months ended
September 30, 1999 and $3.8 million during the three months ended September 30,
Page 14
1998. See "Securitizations-Dealership Operations" below for a summary of the
structure of our securitizations.
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the three months ended September 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
-------------- -------------- --------------
September 30, 1999........ $ 1,921 $ 5,042 $ 6,963
============== ============== ==============
September 30, 1998........ $ 4,086 $ 8,041 $ 12,127
============== ============== ==============
Dealership Operations. Servicing and Other Income decreased by 53.0% to $1.9
million in the three months ended September 30, 1999 compared to the $4.1
million recognized in the three months ended September 30, 1998. We service the
securitized contracts that were included in the Securitized Contract Sales
transactions for monthly fees ranging from .25% to .33% of the beginning of
month principal balances (3.0% to 4.0% per year). We do not, however, recognize
service fee income on the contracts included in our Securitized Borrowings. The
significant decrease in Servicing and Other Income is primarily due to the
decrease in the principal balance of (1) contracts being serviced under the
previous securitization structure and (2) a portfolio we service on behalf of a
third party. We anticipate that our future Servicing and Other Income will
continue to decline as the principal balance of the contracts serviced under the
Securitized Contract Sales agreements and the third party portfolio continues to
decrease.
Non-Dealership Operations. Our Servicing and Other Income decreased 37.3% to
$5.0 million in the three months ended September 30, 1999 compared to the $8.0
million recognized in the three months ended September 30, 1998. Our servicing
fee is generally a percentage of the serviced portfolio principal balance
(generally 3.25% to 4.0% per year) with a minimum fee per loan serviced
(generally $14 to $17 per month). The decrease in our Servicing and Other income
is due to a continued decrease in both the average principal balance and the
number of loans under service by our bulk purchasing/loan-servicing segment. We
have not entered into any loan servicing agreements thus far in 1999 and have
reduced our bulk purchase and loan servicing operations, including the scheduled
closure of our Aurora, Colorado servicing facility in December 1999. We do not
have a current estimate for the cost of closing our Aurora, Colorado servicing
facility. As our operations in this area wind down, we expect the average
principal balance and number of loans under service in our bulk purchase and
third party loan servicing operations, and consequently our servicing fee income
from this segment, to continue to decrease, subject to the incentive
compensation discussed below. However, we do not expect our costs associated
with the servicing of these portfolios to decrease as quickly as these
portfolios are declining.
Under our agreements with First Merchants, we are entitled to certain
incentive compensations in excess of our normal servicing fees once certain
creditors of First Merchants have been paid in full. As of September 30, 1999,
we had not recorded any fee income from these incentive provisions. We believe
that the underlying portfolios expected to produce the excess servicing fees now
have a performance history from which reasonable estimates of future performance
can be made. Based on this, beginning in the fourth quarter of 1999, we expect
to begin recording excess servicing fees and estimate that the total incentive
compensation from this servicing agreement will range from $6.0 million to $8.0
million. Additionally, these estimated excess servicing fees are projected to be
approximately $1.6 million in the fourth quarter of 1999. With the portfolio's
expected decline in size, we expect these excess-servicing fees to decline on a
pro-rata basis. Under current estimates, we believe that approximately 50% of
these excess-servicing fees will be realized by December 31,2000.
We also anticipate that we will receive a distribution of approximately $4.0
million in the near future from collections on charged of receivables held by
First Merchants.
In addition, our non-dealership operations have entered into a servicing
agreement with another company that filed and subsequently emerged from
bankruptcy. Under this servicing agreement, we are also entitled to incentive
compensation in excess of our normal servicing fee after certain creditors are
paid in full. However, based on this portfolio's historic performance, as of
September 30, 1999, we do not expect to receive any excess servicing fees on
this portfolio.
Page 15
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 27.9% to $48.2 million for the three months ended September 30, 1999
from $37.7 million for the three months ended September 30, 1998. Growth of
Sales of Used Cars and Interest Income were the primary contributors to the
increase.
Operating Expenses
Operating Expenses consist of:
o Selling and Marketing Expenses,
o General and Administrative Expenses, and
o Depreciation and Amortization.
A summary of operating expenses for our business segments for the three
months ended September 30, 1999 and 1998 follows (in thousands):
Dealership Operations Non-Dealership Operations
--------------------------------------- ---------------------------------------
Company Cygnet
Company Dealership Corporate Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ------------- ------------ ------------ ------------- ------------ ------------
1999:
Selling and Marketing............. $ 6,144 $ -- $ -- $ 16 $ -- $ -- $ 6,160
General and Administrative........ 11,111 4,794 4,390 1,055 4,063 699 26,112
Depreciation and Amortization..... 919 279 565 112 373 210 2,458
----------- ------------- ------------ ------------ ------------- ------------ ------------
$ 18,174 $ 5,073 $ 4,955 $ 1,183 $ 4,436 $ 909 $ 34,730
=========== ============= ============ ============ ============= ============ ============
1998:
Selling and Marketing............. $ 5,242 $ -- $ -- $ 59 $ 8 $ 7 $ 5,316
General and Administrative........ 8,133 4,380 4,334 575 6,585 2,774 26,781
Depreciation and Amortization..... 628 323 256 24 183 31 1,445
----------- ------------- ------------ ------------ ------------- ------------ ------------
$ 14,003 $ 4,703 $ 4,590 $ 658 $ 6,776 $ 2,812 $ 33,542
=========== ============= ============ ============ ============= ============ ============
A summary of Selling and Marketing, General and Administrative and
Depreciation and Amortization Expenses for the three months ended September 30,
1999 and 1998 as a percentage of Sales of Used Cars and Selling and Per Car Sold
from our company dealership segment follows:
Three Months Ended: September 30,
----------------------
1999 1998
---------- ----------
As Percent of Sales:
Selling and Marketing Expense .......................... 6.0% 7.1%
General and Administrative Expense...................... 10.8% 11.1%
Depreciation and Amortization........................... 1.0% 1.0%
Per Car Sold:
Selling and Marketing Expense........................... $ 503 $ 574
General and Administrative Expense...................... $ 909 $ 891
Depreciation and Amortization........................... $ 75 $ 69
Selling and Marketing Expenses. For the three months ended September 30,
1999 and 1998, Selling and Marketing Expenses consisted almost entirely of
advertising costs and commissions relating to our dealership operations. Total
Selling and Marketing Expenses increased by 15.9% to $6.2 million for the three
months ended September 30, 1999 from $5.3 million for the three months ended
September 30, 1998. The decrease in Selling and Marketing Expenses as a
percentage of Sales of Used Cars and on a per unit basis is primarily due to an
increase in the number of cars sold and an increase in the number of dealerships
in operation for the three months ended September 30, 1999 compared to the three
months ended September 30, 1998.
Page 16
General and Administrative Expenses. For the three months ended September
30, 1999, total General and Administrative Expenses decreased by 2.6% to $26.1
million from $26.8 million for the three months ended September 30, 1998. The
decrease in General and Administrative Expenses was primarily a result of
consolidating our non-dealership operations. General and Administrative Expenses
for our Dealership Operations increased 20.5% due to the addition of new
dealerships and the expansion of infrastructure to administer the increased
number of used car dealerships in operation.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 70.1% to
$2.5 million for the three months ended September 30, 1999 from $1.4 million for
the three months ended September 30, 1998. The increase in 1999 was primarily
due to depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 326.7% to $6.4 million for the three months
ended September 30, 1999 from $1.5 million for the three months ended September
30, 1998. The increase in the third quarter of 1999 was primarily due to
increased borrowings under our Securitization Notes Payable, Notes Payable and
Subordinated Notes Payable. The increased borrowings were used primarily to fund
the increases in Finance Receivables.
Income Taxes
Income taxes totaled $2.9 million for the three months ended September 30,
1999, and $1.1 million for the three months ended September 30, 1998. Our
effective tax rate was 41.0% for the three months ended September 30, 1999 and
41.9% for the three months ended September 30, 1998.
Results of Operations for the Nine Months Ended September 30, 1999 and 1998
Sales of Used Cars and Cost of Used Cars Sold
Nine Months Ended: September 30,
(Dollars in Thousands)
-------------------------------
1999 1998
------------- --------------
Used Cars Sold (Units)........................ 36,389 27,198
============= ==============
Sales of Used Cars............................ $ 307,633 $ 216,075
Cost of Used Cars Sold........................ 173,429 125,085
------------- --------------
Gross Margin.................................. $ 134,204 $ 90,990
============= ==============
Gross Margin %................................ 43.6% 42.1%
============= ==============
Per Unit Sold:
Sales of Used Cars............................ $ 8,454 $ 7,945
Cost of Used Cars Sold........................ 4,766 4,599
------------- --------------
Gross Margin.................................. $ 3,688 $ 3,346
============= ==============
The number of cars we sold (units) increased by 33.8% for the nine months
ended September 30, 1999 over the same period in 1998. As previously mentioned,
the increase in the number of cars sold is primarily a result of an increase in
the number of dealerships in operation and an increase in same store sales. Same
store unit sales for the nine months ended September 30, 1999 increased 6.8%
compared to the nine month period ended September 30, 1998. The increase in our
same store unit sales was primarily a result of the maturation of stores
purchased or opened in late 1997, changes in marketing and promotions, and more
efficient management resulting from separating our non-dealership operations. We
anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Page 17
Our Used Car Sales revenues increased by 42.4% for the nine months ended
September 30, 1999 over the same period ended September 30, 1998. The growth for
this period reflects increases in the number of dealerships in operation and the
average unit sales price. The Cost of Used Cars Sold increased by 38.6% for the
nine months ended September 30, 1999 over the same period ended September 30,
1998. The increase in the Cost of Used Cars Sold is primarily a result of an
increase in the number of dealerships in operation and an increase in same store
sales. The gross margin on used car sales (Sales of Used Cars less Cost of Used
Cars Sold excluding Provision for Credit Losses) increased by 47.5% for the nine
months ended September 30, 1999 over the same period ended September 30, 1998.
The gross margin per car sold for the nine months ended September 30, 1999
increased 10.2% over the nine months ended September 30, 1998, primarily as a
result of a management decision to increase the gross margin on each car sold.
Our average sales price per car increased by 6.4% for the nine months ended
September 30, 1999 over the nine months ended September 30, 1998. The increase
in the average sales price per car is a result of an increase in the direct cost
of the cars we sell and an increase in the provision for credit losses
recognized at the time of origination. On a per unit basis, the Cost of Used
Cars Sold increased by 3.6% for the nine months ended September 30, 1999 over
the nine months ended September 30, 1998 due to a small increase in the direct
cost of the cars we sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Nine Months Ended: September 30,
---------------------------
1999 1998
------------ ------------
Provision for Credit Losses (in thousands)............... $ 81,113 $ 45,053
============ ============
Provision per contract originated........................ $ 2,240 $ 1,674
============ ============
Provision as percent of principal balances originated.... 26.9% 21.7%
============ ============
The Provision for Credit Losses in our dealership operations increased by
80.0% in the nine months ended September 30, 1999 over the nine months ended
September 30, 1998. The Provision for Credit Losses per unit originated at our
dealerships increased by $566 or 33.8% in the nine months ended September 30,
1999 over the nine months ended September 30, 1998. The increase is primarily a
result of the change in how we structure securitizations for accounting
purposes.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 112.5% to $3.4 million in the nine months
ended September 30, 1999 from $1.6 million in the nine months ended September
30, 1998. The increase was primarily due to the significant increase in loans
under the Cygnet dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our Securitized Contract Sales. Interest Income
increased by 282.5% to $45.9 million for the nine months ended September 30,
1999 from $12.0 million for the nine months ended September 30, 1998. The
increase was primarily due to the increase in the average finance receivables
retained on our balance sheet. Because we structured most of our securitizations
to recognize income as sales for accounting purposes prior to 1999, there were
fewer receivables retained on our balance sheet and Interest Income was lower in
these periods. See "Securitizations-Dealership Operations" below for additional
discussion of our securitization transactions and our on balance sheet
portfolio.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Page 18
Nine Months Ended: September 30,
------------------------------------
1999 1998
--------------- ---------------
Percentage of sales revenue financed..... 98.0% 96.1%
=============== ===============
Percentage of sales units financed....... 99.5% 99.0%
=============== ===============
The average effective yield on finance receivables from our dealerships
was approximately 26.2% for the nine months ended September 30, 1999 and 25.2%
for the nine months ended September 30, 1998.
Non-Dealership Operations. Interest Income from the First Merchants
transaction decreased by 33.5% to approximately $997,000 for the nine months
ended September 30, 1999 from $1.5 million for the nine months ended September
30, 1998. This decrease is primarily the result of a lower average loan balance
on our Note Receivable from First Merchants for the nine months ended September
30,1999 compared to the nine months ended September 30, 1998. During September
of 1999, we also recognized approximately $974,000 of arbitrage interest income
from our investment in FMAC. See "Results of Operations for the Three Months
Ended September 30, 1999 and 1998 -- Interest Income" above for a description of
this arbitrage interest income and our expectations with respect to future
interest income from the DIP loan.
Interest Income from the Cygnet dealer program increased by 93.2% to $11.4
million for the nine months ended September 30, 1999 from $5.9 million for the
nine months ended September 30, 1998. The increase in interest income in the
Cygnet dealer program reflects an increase in the amount of loans outstanding
during the nine months ended September 30, 1999 compared to the nine months
ended September 30, 1998.
Gain on Sale of Loans
Dealership Operations. Because of the change in the way we structure our
securitization transactions for accounting purposes in the fourth quarter of
1998, we no longer recognize gains on the sale of loans from securitization
transactions. We recorded Gains on Sale of Loans related to Securitized Contract
Sales of zero for the nine months ended September 30, 1999 and $12.1 million
during the nine months ended September 30, 1998. See "Securitizations-Dealership
Operations" below for a summary of the structure of our securitizations.
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the nine months ended September 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
------------- ------------------ -------------
September 30, 1999........ $ 7,290 $ 16,969 $ 24,259
============= ================== =============
September 30, 1998........ $ 12,238 $ 13,488 $ 25,726
============= ================== =============
Dealership Operations. Servicing and Other Income decreased by 40.4% to $7.3
million in the nine months ended September 30, 1999 compared to the $12.2
million recognized in the nine months ended September 30, 1998. As previously
noted, we anticipate that our future Servicing and Other Income will decline as
the principal balance of the contracts serviced under the Securitized Contract
Sales agreements and the third party portfolio will continue to decrease.
Non-Dealership Operations. Our Servicing and Other Income increased 25.8% to
$17.0 million in the nine months ended September 30, 1999 compared to the $13.5
million recognized in the nine months ended September 30, 1998. Our Servicing
and Other Income increased because our non-dealership operations did not begin
servicing loans until April 1998. As previously noted, we have not entered into
any loan servicing agreements in 1999 and expect that, except for certain
incentive fee income, our servicing fee income will continue to decline as the
principal balances of the portfolios that we are currently servicing decrease.
See "Results of Operations for the Three Months Ended September 30, 1999 and
1998 -- Servicing and Other Income" above for a description of our expectations
with respect to certain incentive fee income.
Page 19
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 31.2% to $133.3 million for the nine months ended September 30, 1999
from $101.6 million for the nine months ended September 30, 1998. Growth of
Sales of Used Cars, Interest Income, and Servicing and Other Income were the
primary contributors to the increase.
A summary of operating expenses for our business segments for the nine
months ended September 30, 1999 and 1998 follows (in thousands):
Dealership Operations Non-Dealership Operations
------------------------------------- -------------------------------------
Company Cygnet
Company Dealership Corporate Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing And Other Total
----------- ----------- ----------- ----------- ----------- ----------- ------------
1999:
Selling and Marketing........ $ 18,577 $ -- $ -- $ 75 $ 3 $ -- $ 18,655
General and Administrative... 33,120 13,944 14,348 3,024 14,872 2,216 81,524
Depreciation and Amortization 2,572 842 1,623 297 1,064 519 6,917
----------- ----------- ----------- ----------- ----------- ----------- ------------
$ 54,269 $ 14,786 $ 15,971 $ 3,396 $ 15,939 $ 2,735 $ 107,096
=========== =========== =========== =========== =========== =========== ============
1998:
Selling and Marketing........ $ 15,545 $ -- $ -- $ 178 $ 20 $ 11 $ 15,754
General and Administrative... 23,559 13,215 10,412 1,651 10,785 4,068 63,690
Depreciation and Amortization 1,856 972 706 69 336 31 3,970
----------- ----------- ----------- ----------- ----------- ----------- ------------
$ 40,960 $ 14,187 $ 11,118 $ 1,898 $ 11,141 $ 4,110 $ 83,414
=========== =========== =========== =========== =========== =========== ============
A summary of Selling and Marketing, General and Administrative and
Depreciation and Amortization Expenses for the nine months ended September 30,
1999 and 1998 as a percentage of Sales of Used Cars and Selling and Per Car Sold
from our company dealership segment follows:
Nine Months Ended: September 30,
----------------------
1999 1998
---------- ----------
As Percent of Sales:
Selling and Marketing Expense......................... 6.0% 7.2%
General and Administrative Expense.................... 10.8% 10.9%
Depreciation and Amortization......................... 1.0% 1.0%
Per Car Sold:
Selling and Marketing Expense......................... $ 511 $ 572
General and Administrative Expense.................... $ 910 $ 866
Depreciation and Amortization......................... $ 71 $ 68
Selling and Marketing Expenses. For the nine months ended September 30, 1999
and 1998, total Selling and Marketing Expenses consisted almost entirely of
advertising costs and commissions relating to our dealership operations. Total
Selling and Marketing Expenses increased by 18.4% to $18.7 million for the nine
months ended September 30, 1999 from $15.8 million for the nine months ended
September 30, 1998. The decrease in Selling and Marketing Expense as a
percentage of Sales of Used Cars and on a per unit basis is primarily due to an
increase in the number of cars sold and an increase in the number of dealerships
in operation for the nine months ended September 30, 1999 compared to the nine
months ended September 30, 1998.
General and Administrative Expenses. For the nine months ended September 30,
1999, total General and Administrative Expenses increased by 27.9% to $81.5
million from $63.7 million for the nine months ended September 30, 1998. The
increase in General and Administrative Expenses was primarily a result of an
increase in the number of dealerships in operation, the addition of our bulk
purchasing and loan servicing operations in the second quarter of 1998, the
expansion of infrastructure to administer the increased number of used car
dealerships in operation, and the growth of the Cygnet dealer program.
Page 20
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 72.5% to
$6.9 million for the nine months ended September 30, 1999 from $4.0 million for
the nine months ended September 30, 1998. The increase in 1999 was primarily due
to depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 261.4% to $15.9 million for the nine months
ended September 30, 1999 from $4.4 million for the nine months ended September
30, 1998. The increase for the nine months ended September 30, 1999 was
primarily due to increased borrowings under our Securitization Notes Payable,
Notes Payable and Subordinated Notes Payable. The increased borrowings were used
primarily to fund the increases in Finance Receivables. See "Financial Position"
below.
Income Taxes
Income taxes totaled $4.2 million for the nine months ended September 30,
1999, and $5.6 million for the nine months ended September 30, 1998. Our
effective tax rate was 40.9% for the nine months ended September 30, 1999 and
40.6% for the nine months ended September 30, 1998.
Discontinued Operations
We recorded a pre-tax charge to discontinued operations totaling
approximately $9.1 million (approximately $5.6 million, net of income taxes)
during the first quarter of 1998 related to the closure of our branch office
network. In addition, we recorded a $6.0 million charge (approximately $3.6
million, net of income taxes) during the third quarter of 1998 due primarily to
higher than anticipated loan losses and servicing expenses. The charges we
recorded to Discontinued Operations represent the total estimated net loss we
expect to realize from the branch office network closure. As a result, there was
no income or loss from Discontinued Operations for the nine months ended
September 30, 1999.
Financial Position
Total assets increased by 51.1% to $522.6 million at September 30, 1999
from $346.0 million at December 31, 1998. The increase was due primarily to an
increase in Finance Receivables of $193.2 million to $356.4 million at September
30, 1999 from $163.2 million at December 31, 1998. Our dealership operations'
Finance Receivables increased approximately $195.6 million due primarily to the
change in our securitization structure, and our non-dealership operations'
Finance Receivables decreased approximately $2.4 million primarily as a result
of the runoff of the bulk purchasing/loan servicing portfolio.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable. Notes Payable increased by $163.3
million to $280.6 million at September 30, 1999 from $117.3 million at December
31, 1998. The increase in our Notes Payable is attributable to an increase of
$8.3 million in our revolving line of credit, which totaled approximately $60.0
million at September 30, 1999, compared to $51.8 million at December 31, 1998.
Our Securitization Notes Payable increased by $134.3 million as a result of
securitization transactions we closed in April and August 1999. Our Note Payable
Collateralized by the Common Stock of our Securitization Subsidiaries increased
by $23.8 million as a result of a loan obtained from an unrelated third party in
May 1999. We also repaid $3.4 million in mortgage loans from an unrelated
finance company.
Growth in Finance Receivables. As a result of our continued expansion,
contract receivables managed by our dealership operations have continued to
increase. The following table reflects the growth in period end balances of our
dealership operations measured in terms of the principal amount and the number
of contracts outstanding.
Page 21
Total Contracts Outstanding - Dealership Operations
(In thousands, except number of contracts)
September 30, 1999 December 31, 1998
---------------------------------- ----------------------------------
Principal Number of Principal Number of
Amount Contracts Amount Contracts
----------------- --------------- ---------------- ----------------
Managed Portfolio........................... $ 427,439 68,420 $ 292,683 49,601
Less: Portfolios Securitized and Sold...... 95,457 22,546 198,747 37,186
---------------- --------------- ---------------- ----------------
Total Retained Principal.................... $ 331,982 45,874 $ 93,936 12,415
================= =============== ================ ================
In addition to the loan portfolio summarized above, we also service loan
portfolios totaling approximately $56.6 million ($19.3 million for Kars and
$37.3 million from branch office originations) as of September 30, 1999 and
$121.2 million ($47.9 million for Kars and $73.3 million from branch office
originations) as of December 31, 1998.
Total Contracts Originated/Purchased - Dealership
Operations (In thousands, except number of contracts
and average principal)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ --------------------------
1999 1998 1999 1998
------------ ---------- ------------ -------------
Principal Amount....................................... $ 102,599 $ 71,027 $ 301,430 $ 207,643
Number of Contracts.................................... 12,137 9,058 36,211 26,915
Average Principal...................................... $ 8,453 $ 7,841 $ 8,324 $ 7,715
Finance Receivable principal balances generated or acquired by our
dealership operations during the three months period ended September 30, 1999
increased by 44.5% to $102.6 million from $71.0 million for the three months
ended September 30, 1998. For the nine months ended September 30, 1999, Finance
Receivables increased by 45.2% to $301.4 million from $207.6 million for the
nine months ended September 30, 1998. The increase in average principal financed
is due to the increase in our average sales price per car sold.
Our non-dealership operations began servicing loans on behalf of First
Merchants in April 1998, and began servicing additional loan portfolios on
behalf of other third parties throughout 1998. At September 30, 1999, our
non-dealership bulk purchasing/loan servicing operations were servicing a total
of approximately $273.9 million in finance receivables (approximately 47,000
contracts) compared to $587.3 million in finance receivables (approximately
80,000 contracts) at December 31, 1998.
Cygnet dealer's net investment in finance receivables purchased from two
third party dealers totaled approximately $9.0 million representing
approximately 21.2% of Cygnet dealer's net finance receivables portfolio as of
September 30, 1999. We did not have any other third party dealer loans that
exceeded 10% of our Cygnet dealer finance receivable portfolio as of September
30, 1999.
Allowance for Credit Losses
We have established an Allowance for Credit Losses (Allowance) to cover
anticipated credit losses on the contracts currently in our portfolio. We
established the Allowance by recording an expense through the Provision for
Credit Losses.
For Finance Receivables generated at our dealerships, our policy is to
charge off a contract the earlier of:
o when we believe it is uncollectible, or o when it is delinquent for more
than 90 days.
The following table reflects activity in the Allowance for our dealership
operations, as well as information regarding charge off activity for the three
and nine months ended September 30, 1999 and 1998, in thousands.
Page 22
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -------------------------------
1999 1998 1999 1998
--------------- -------------- -------------- ---------------
Allowance Activity:
Balance, Beginning of Period......................... $ 66,905 $ 5,950 $ 24,777 $ 10,356
Provision for Credit Losses.......................... 27,560 15,746 81,113 45,053
Allowance on Acquired Loans.......................... 3,835 -- 3,835 --
Reduction Attributable to Loans Sold................. -- (14,068) -- (44,785)
Net Charge Offs...................................... (17,602) (2,056) (29,027) (5,052)
--------------- -------------- -------------- ---------------
Balance, End of Period............................... $ 80,698 $ 5,572 $ 80,698 $ 5,572
=============== ============== ============== ===============
Allowance as a Percent of Period End Balances........ 24.3% 18.5% 24.3% 18.5%
=============== ============== ============== ===============
Charge off Activity:
Principal Balances................................... $ (22,030) $ (2,665) $ (36,610) $ (7,001)
Recoveries, Net...................................... 4,428 609 7,583 1,949
--------------- -------------- -------------- ---------------
Net Charge Offs...................................... $ (17,602) $ (2,056) $ (29,027) $ (5,052)
=============== ============== ============== ===============
Net Charge Offs as a Percent of Average Principal
Outstanding....................................... 6.0% 4.2% 13.4% 8.6%
=============== ============== ============== ===============
Average Principal Balance Outstanding................ $ 292,452 $ 48,872 $ 216,447 $ 58,503
=============== ============== ============== ===============
The Allowance on contracts from dealership operations was 24.3% of the
outstanding principal balances as of September 30, 1999 and 26.4% of outstanding
principal balances as of December 31, 1998. We changed the structure of our
securitization transactions for accounting purposes in the fourth quarter of
1998, which resulted in us retaining the securitized loans from securitization
transactions closed subsequent to the third quarter of 1998. We increased the
provision for credit losses to approximately 27% of the principal balance for
loans originated beginning in the fourth quarter of 1998 as we intend to hold
the balance sheet portfolio for investment and not for sale.
A Summary of the Allowance on contracts from non-dealership operations
follows:
Non-Dealership Operations
-----------------------------------------------------------------
September 30, December 31,
-------------------------------- -------------------------------
1999 1998 1998 1997
--------------- --------------- --------------- --------------
As Percent of Period End Balances:
Allowance........................................ 7.3% 3.5% 3.9% 3.8%
Non-refundable discount and security deposits.... 33.6% 28.6% 29.9% 26.0%
=============== =============== =============== ==============
Total Allowance, discount and security deposits.. 40.9% 32.1% 33.8% 29.8%
=============== =============== =============== ==============
Even though a contract is charged off, we continue to attempt to collect the
contract. Recoveries as a percentage of principal balances charged off from
dealership operations averaged 20.1% for the three months ended September 30,
1999 compared to 22.9% for the three months ended September 30, 1998. Such
recoveries for the nine month periods ended September 30, 1999 and 1998 averaged
20.7% and 27.8%, respectively. Recoveries as a percentage of principal balances
charged off from non-dealership operations averaged 33.4% for the three months
ended September 30, 1999 compared to 35.7% for the three months ended September
30, 1998. Such recoveries for the nine month periods ended September 30, 1999
and 1998 averaged 33.0% and 30.7%, respectively.
For Finance Receivables acquired by our non-dealership operations with
recourse to the seller, our general policy is to exercise the recourse
provisions in our agreements under the Cygnet dealer program when a contract is
delinquent for 45 days. For contracts not purchased with recourse, our policy is
similar to that for our dealership operations.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for contracts 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
Page 23
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
contract 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
for the reasons listed below, however, management believes that such variation
will not be material:
o ongoing collection efforts on charged off accounts, and
o the difference between final proceeds on the sale of repossessed
collateral versus our estimates of the sale proceeds.
The following table sets forth as of October 31, 1999, the cumulative net
charge offs as a percentage of original contract 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
Monthly Payments Completed by Customer Before Charge Off
-------------------------------------------------------------------------
Orig. 0 3 6 12 18 24 TLI Reduced
------------- ------ -------- -------- -------- ------- ------- ------- ----------
1994:
1st Quarter $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter $ 8,191 1.6% 9.1% 14.7% 20.4% 22.7% 23.6% 23.8% 100.0%
2nd Quarter $ 9,846 2.0% 8.5% 13.3% 18.1% 20.7% 22.1% 22.5% 100.0%
3rd Quarter $ 10,106 2.5% 7.9% 12.2% 18.8% 22.1% 23.5% 24.1% 99.9%
4th Quarter $ 8,426 1.5% 6.6% 11.7% 18.1% 22.4% 24.0% 24.5% 99.8%
1996:
1st Quarter $ 13,635 1.6% 8.0% 13.7% 20.6% 24.7% 26.0% 27.0% 99.6%
2nd Quarter $ 13,462 2.2% 9.2% 13.4% 21.9% 25.8% 27.5% 28.8% 98.6%
3rd Quarter $ 11,082 1.6% 6.8% 12.4% 21.2% 25.3% 27.5% 28.5% 97.1%
4th Quarter $ 10,817 0.6% 8.4% 15.8% 24.7% 29.0% 30.8% 31.8% 95.4%
1997:
1st Quarter $ 16,279 2.1% 10.5% 17.7% 24.3% 29.3% 31.6% 32.5% 92.6%
2nd Quarter $ 25,875 1.5% 9.9% 15.8% 22.7% 27.4% 29.6% 29.9% 87.0%
3rd Quarter $ 32,147 1.4% 8.4% 13.2% 22.4% 26.9% x 28.9% 82.0%
4th Quarter $ 42,529 1.4% 6.8% 12.5% 21.8% 26.2% x 27.3% 77.2%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.4% 20.9% x -- 25.6% 70.9%
2nd Quarter $ 66,908 1.1% 8.0% 14.2% 22.0% x -- 24.3% 61.4%
3rd Quarter $ 71,027 1.0% 8.0% 13.4% x -- -- 21.9% 52.7%
4th Quarter $ 69,583 0.9% 6.7% 13.4% x -- -- 18.4% 40.3%
1999:
1st Quarter $ 102,733 0.8% 7.7% x -- -- -- 12.6% 27.4%
2nd Quarter $ 96,098 1.2% x -- -- -- -- 7.0% 12.0%
3rd Quarter $ 102,599 x -- -- -- -- -- 0.6% 1.2%
Page 24
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
contract principal balances from dealership operations.
Retained Securitized Managed
---------- ----------- ------------
September 30, 1999:
31 to 60 days.......... 6.0% 9.4% 6.8%
61 to 90 days.......... 3.1% 4.7% 3.5%
December 31, 1998:
31 to 60 days.......... 2.3% 5.2% 4.6%
61 to 90 days.......... 0.5% 2.2% 1.9%
In accordance with our charge off policy, there are no accounts more than 90
days delinquent as of September 30, 1999 and December 31, 1998.
Delinquencies increased primarily because of turnover at our collection
centers and a new repossession practice implemented in the second quarter of
1999. Because of our initiatives and the return of staffing to prior levels,
delinquencies after September 30, 1999 have been improved by over 1% and we
expect that trend to continue. However, there can be no assurance that
delinquencies will continue to decline.
Securitizations--Dealership Operations
Structure of Securitizations. In the fourth quarter of 1998 we announced
that we were changing the way we structure transactions for accounting purposes
under our securitization program. Through September 30, 1998, we had structured
these transactions as sales for accounting purposes (Securitized Contract
Sales). However, beginning in the fourth quarter of 1998, we began structuring
securitizations for accounting purposes to retain the contract, and the related
Securitization Note Payable on our balance sheet and recognize the income over
the life of the contracts (Securitized Borrowings). We continue to service the
securitized contracts.
Residuals in Finance Receivables Sold. The residuals are a component of
Finance Receivables and represent our retained interest in the Finance
Receivables included in our Securitized Contract Sales. We utilize a number of
assumptions to determine the initial value of the Residuals in Finance
Receivables Sold. The Residuals in Finance Receivables Sold represent the
present value of the expected net cash flows of the trusts formed to hold the
securitized receivables using the out of the trust method. The net cash flows
out of the trusts are the collections on the loans in the trusts in excess of
the principal and interest payments due on the senior certificates issued by the
trusts and certain other trust expenses. The assumptions used to compute the
Residuals in Finance Receivables Sold include, but are not limited to:
o charge off rates,
o repossession recovery rates,
o portfolio delinquency,
o prepayment rates, and
o trust expenses.
The Residuals in Finance Receivables Sold are adjusted monthly to
approximate the present value of the expected remaining net cash flows out of
the trusts. If actual cash flows on a securitization are below our original
estimates, and those differences appear to be other than temporary in nature, we
are required to revalue Residuals in Finance Receivables Sold and record a
charge to earnings based upon the reduction. The cumulative net loss at
origination assumption inherent in the securitization transactions we entered
into in 1996 and 1997 is approximately 27.5%. For the securitizations that we
completed during the nine month period ended September 30, 1998, net losses were
estimated using total expected cumulative net losses at loan origination of
approximately 29.0%. The remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts was approximately 15.3% as of September 30, 1999, compared
to 22.0% as of December 31, 1998. Because we now structure our securitization
transactions to retain the Finance Receivables securitized, we will no longer be
adding to our Residuals in Finance Receivables Sold. Further, the remaining
Residuals in Finance Receivables Sold that were originated under our prior
method will continue to decline as the underlying loan portfolios mature.
Consequently, the remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts will continue to decline as the related loan portfolios
mature. The balance of the Residuals in Finance Receivables sold was $19.6
Page 25
million at September 30, 1999 and $33.3 million as of December 31, 1998. We
classify the residuals as "held-to-maturity" securities in accordance with SFAS
No. 115.
Spread Account Requirements. We maintain a spread account under our
securitization agreements. The spread account is a reserve account that would be
used to repay the senior certificates on notes issued by the trusts (Class A
securities) in the event collections on a particular pool of finance receivables
was insufficient to make the required payments. At the time a securitization
transaction is entered into, our securitization subsidiary makes an initial cash
deposit into the spread account, generally equivalent to 4% to 6% of the initial
underlying Finance Receivables principal balance, and pledges this cash to the
spread account. The trustee then makes additional deposits to the spread account
out of collections on the securitized receivables as necessary to maintain the
spread account at a specified percentage, ranging from 6.0% to 10.5%, of the
underlying Finance Receivables' principal balance. The trustee will not make
distributions to the securitization subsidiaries on the subordinate interests
unless:
o the spread account has the required balance,
o the required periodic payments to the Class A security holders are
current, and
o the trustee, servicer and other administrative costs are current.
Under our existing securitizations, we are required to maintain certain
cash balances in the spread accounts. Generally, our securitization trusts
operate independently. These balances vary by trust and may change based on the
level of delinquencies and charge offs of the loans in the respective trust. At
September 30, 1999, primarily due to an increase in delinquencies, the targeted
spread account balance for one trust was increased and the actual balance was
$2.4 million under the increased specified levels. After September 30, 1999, the
targeted spread account balance for four other trusts were also increased and
actual balances in the spread accounts for these trusts cumulatively were $13.6
million under the increased specified levels. While these increased targeted
spread account requirements continue, collections on receivables in these trusts
in excess of amounts required to pay the senior certificates, our servicing
fees, and certain other amounts will be used to satisfy the increased spread
account amount and will not be distributed to us. Because of the normal
reduction of the portfolios in these trusts, and our expectation that
delinquency levels will decrease, we expect the targeted spread account balances
for these trusts to return to their prior levels within the first quarter of
2000, and at that time any accumulated excess cash will be released.
Based on its historical performance and its current delinquency levels, a
termination event is expected to occur on one trust in December 1999. When a
termination event occurs, the party controlling the trust has the right to
remove us as servicer although we do not currently expect that this will occur.
Further, as this trust has paid down to less that 10% of its original balance it
is subject to a "clean-up" call, meaning, we can buy the remaining interest. We
expect to repurchase the remaining interest (contracts) in the trust in the
fourth quarter of 1999 or in the first quarter of 2000. While this trust will
pay a scheduled distribution on November 15, 1999, should the termination event
occur or it not be immediately repurchased, we will not receive any further cash
distributions related to our residual interests in this trust until repurchase
does occur.
We also maintain spread accounts for the securitization transactions that
were consummated by our discontinued operations. For the same reason noted
above, we have been required to increase the spread account balance by $200,000
on one trust and since then a termination event has occurred on this trust. We
expect to repurchase this trust by the end of the first quarter of 2000. Another
trust is currently subject to termination but is expected to be repurchased on
November 15, 1999. We will not receive any further cash distributions from these
trusts until repurchase.
All our trusts are administered independently and only certain trusts are
affected by these events. For those affected, it is estimated that the amount of
cash distributions postponed to future periods will approximate $2 to $3 million
per month over the next three to five months. We believe that the increased
payments expected from the First Merchants transaction as described above will
exceed the estimated amount of cash payments that will be postponed. Therefore,
we do not believe that the delay in receiving these cash distributions and our
purchase of certain trusts will have a material adverse effect on our financial
status.
However, while our delinquency levels are currently improving and we expect
to purchase certain trusts, there can be no assurance that delinquencies will
continue to improve, that spread account balances will be able to return to
prior levels, that cash distributions will begin from these trusts, or that
financial conditions will not change and make the absence of these cash
distribution's material to us.
Certain financial information regarding securitizations. During August 1999
we closed a Securitized Borrowing transaction in which we securitized
Page 26
approximately $123.3 million of contracts and issued approximately $87.5 million
of Class A securities. In the second quarter of 1999 we closed a Securitized
Borrowing transaction in which we securitized $119.7 million of contracts,
issuing $87.4 million in Class A securities. During the first three quarters of
1998, we securitized $222.8 million in contracts, issuing $161.1 million in
Class A securities, and $61.7 million in residual interests. We recorded the
carrying value of the related Residuals in Finance Receivables Sold at $36.5
million for the first three quarters of 1998. Due to the change in the structure
of our securitization transactions, we did not record any Residuals in Finance
Receivables for the securitization transaction we closed in April or August of
1999.
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have increased
in connection with the growth of our business. We require capital for:
o increases in our contract portfolio,
o expansion of our dealership network,
o our commitments under the First Merchants transaction,
o expansion of the Cygnet dealer program,
o common stock repurchases,
o the purchase of inventories,
o the purchase of property and equipment, and
o working capital and general corporate purposes.
We fund our capital requirements primarily through:
o operating cash flow,
o our revolving facility with General Electric Capital Corporation (GE
Capital),
o securitization transactions,
o supplemental borrowings, and
o occasionally, equity offerings.
While to date we have met our liquidity requirements as needed, there can be
no assurance that we will be able to continue to do so in the future. See
"Securitizations -- Dealership Operations" for a discussion of potential
liquidity concerns arising because of an increase in delinquencies in our
securitization transactions.
Operating Cash Flow
Net Cash Provided by Operating Activities increased by $111.7 million in the
nine months ended September 30, 1999 to $114.1 million compared to the nine
months ended September 30, 1998 of $2.5 million. The change in inventory and
accounts payable and accrued expenses contributed to the increase in operating
cash flow for the quarter. The changes in the Net Cash Provided by Operating
activities and Net Cash Used in Investing Activities is largely due to a change
in classification of portfolio activity related to the change in the structure
of our securitization transactions. Under our old structure contracts were held
for sale and, consequently, Finance Receivable purchases and related sales
proceeds were considered operating activities. Under our revised structure,
contracts are held for investment and such purchases are considered investing
activities.
Net Cash Used in Investing Activities increased by $277.7 million to $280.3
million in the nine months ended September 30, 1999 compared to $2.6 million of
Net Cash Provided by Investing Activities in the nine months ended September 30,
1998. The increase in Cash Used in Investing Activities is primarily due to
increases in purchases of Finance Receivables, net decreases in Cash advanced
under our Notes Receivable, which were offset by increased collections of
Finance Receivables and Notes Receivable.
Net Cash Provided by Financing Activities increased by $148.7 million to
$150.0 million in the nine months ended September 30, 1999 compared to $1.3
million of Net Cash Used in Financing Activities in the nine months ended
September 30, 1998. The increase is due to increases in Notes Payable, net of
increases in repayments of Notes Payable and the acquisition of Treasury Stock.
Page 27
Financing Resources
Revolving Facility. The maximum commitment under our revolving credit
facility with GE Capital is $125.0 million. Under the revolving facility, we may
borrow:
o up to 65.0% of the principal balance of eligible contracts originated from
the sale of used cars,
o up to 86.0% of the principal balance of eligible contracts previously
originated by our branch office network,
o the lesser of $20 million or 58% of the direct vehicle costs for eligible
vehicle inventory, and
o the lesser of $15 million or 50% of eligible contracts or loans originated
under the Cygnet dealer program.
However, an amount up to $3.0 million of the borrowing capacity under the
revolving facility is not available at any time while our guarantee to the
purchaser of contracts acquired from First Merchants is outstanding. The
revolving facility expires in September 2000 and contains a provision that
requires us to pay GE Capital a termination fee of $200,000 if we terminate the
revolving facility prior to the expiration date. We secure the facility with
substantially all of our assets.
As of September 30, 1999, our borrowing capacity under the revolving
facility was $89.8 million, the aggregate principal amount outstanding under the
revolving facility was approximately $60.0 million, and the amount available to
be borrowed under the facility was $29.8 million. The revolving facility bears
interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.44% as
of September 30, 1999).
The revolving facility contains covenants that, among other things, limit
our ability to do the following without GE Capital's consent:
o incur additional indebtedness,
o make any change in our capital structure,
o declare or pay dividends, except in accordance with all applicable laws
and not in excess of fifteen percent (15%) of each year's net earnings
available for distribution, and
o make certain investments and capital expenditures.
The revolving facility also provides that an event of default will occur if
Mr. Ernest C. Garcia II owns less than 15.0% of our voting stock. Mr. Garcia
owned approximately 32.1% of our common stock at September 30, 1999.
We were also required to be Year 2000 compliant no later than June 30, 1999
(see discussion below under the Year 2000 Readiness Disclosure), and we are also
required to maintain specified financial ratios, including a debt to equity
ratio of 2.2 to 1 and a net worth of at least $150 million.
Securitizations. Our securitization program is a primary source of our
working capital. Since September 30, 1997, we have closed all of our
securitizations with private investors through Greenwich Capital Markets, Inc.
(Greenwich Capital). In March 1999, we executed a commitment letter with
Greenwich Capital to act as our exclusive agent in placing up to $300 million of
surety wrapped securities under our securitization program.
Securitizations generate cash flow for us from:
o the sale of Class A securities,
o ongoing servicing fees, and
o excess cash flow distributions from collections on the contracts
securitized after:
o payments on the Class A securities sold to third party investors,
o payment of fees, expenses, and insurance premiums, and
o required deposits to the spread account.
In August 1999, we closed a securitization transaction through Greenwich
Capital. Under this transaction, we securitized approximately $123.3 million of
contracts and issued approximately $87.5 million of Class A securities with an
annual interest rate of 6.45%.
Page 28
In April 1999, we closed a securitization transaction through Greenwich
Capital. Under this transaction, we securitized approximately $119.7 million of
contracts and issued approximately $87.4 million of Class A securities with an
annual interest rate of 5.7%.
Securitization also allows us to fix our cost of funds for a given contract
portfolio. Failure to regularly engage in securitization transactions will
adversely affect us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Securitizations--Dealership operations" for
a more complete description of our securitization program.
Supplemental Borrowings
Verde Debt. Prior to our public offering in September 1996, we historically
borrowed substantial amounts from Verde Investments, Inc. (Verde), which is
owned by our Chairman, Ernest C. Garcia II. The Subordinated Notes Payable
balances outstanding to Verde totaled $8.0 and $10.0 million as of September 30,
1999 and as of December 31, 1998. Under the terms of this note, we are required
to make monthly payments of interest and annual payments of principal in the
amount of $2.0 million. These borrowings accrue interest at an annual rate of
10.0%. Except for the debt incurred related to our exchange offer, this debt is
junior to all of our other indebtedness and we may suspend interest and
principal payments if we are in default on obligations to any other creditors.
In July 1997, our Board of Directors approved the prepayment of the total
balance of the Verde subordinated debt after the earlier of the following:
o the completion of a debt offering,
o the First Merchants transactions have been completed or the cash
requirements for completion of the transaction are known, or
o we either have cash in excess of our current needs or have funds
available under our financing sources in excess of our current needs.
No such prepayment has been made as of the date of filing of this Form 10-Q.
Any prepayment would require the consent of certain of our lenders.
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. The debentures are unsecured and are subordinate to
all of our existing and future indebtedness. We must pay interest on the
debentures twice a year at 12% per year. We are required to pay the principal
amount of the debentures on October 23, 2003.
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%. We can redeem all
or part of the debentures at any time, subject to the subordination provision of
the debentures. The balance of the subordinated debentures was $14.1 million at
September 30, 1999.
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 pay interest on this debt quarterly at 12% per annum. This debt is:
o senior to the Verde subordinated note (described above) and the
subordinated debentures issued in our exchange offer (also described
above), and
o subordinate to our other indebtedness.
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.
In July 1998, we borrowed a total of $5.0 million in subordinated debt from
unrelated third parties for a three-year term. In the first quarter of 1999, we
prepaid $3.0 million of the loans. We repaid the remaining $2.0 million in June
1999.
Additional Financing. On November 12, 1998, we borrowed $15.0 million for a
term of 364 days from Greenwich Capital. We pay interest on this loan at an
interest rate equal to LIBOR plus 400 basis points. We secured the loan with the
common stock of our securitization subsidiaries. In March 1999, we borrowed
Page 29
$20.0 million for a term of 278 days from Greenwich Capital. $1.5 million was
used to repay the remaining balance of the $15 million Greenwich Capital loan.
The new loan was secured by the common stock of our securitization subsidiaries.
The interest rate is at LIBOR plus 500 basis points and we paid an origination
fee of 100 basis points. We repaid this loan in the second quarter of 1999.
On March 26, 1999, we borrowed approximately $28.9 million from Greenwich
Capital under a repurchase facility with a 62% advance rate, bearing interest at
8.5%, and maturing May 31, 1999. This repurchase facility was repaid in April
1999.
In March 1999, we executed a commitment letter with Greenwich Capital in
which, subject to satisfaction of certain conditions, Greenwich Capital agreed
to provide us with a $100 million surety-wrapped warehouse line of credit at a
rate equal to LIBOR plus 110 basis points.
On May 14, 1999, we borrowed approximately $38.0 million from an unrelated
party for a term of three years maturing on May 1, 2001 (Residual Loan).The note
calls for monthly principal payments of generally not less than $500,000 plus
interest at a rate equal to LIBOR plus 550 basis points. The loan is secured by
our Residuals in Finance Receivables Sold and certain Finance Receivables.
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
During the three months ended September 30, 1999, we opened four new
dealerships and acquired four dealerships and one reconditioning center from DCT
of Ocala. In the second quarter of 1999, we opened one new dealership. In the
fourth quarter of 1999 we completed negotiations with Virginia Auto Mart to
obtain five dealerships and a loan portfolio of approximately $8.0 million. We
also have an additional three dealerships under development. The direct cost of
opening a dealership is primarily a function of whether we lease a facility or
construct a facility. A leased facility costs approximately $650,000 to develop,
while a facility we construct costs approximately $1.7 million. In addition, we
require capital to finance the portfolio that we carry on our balance sheet for
each store. It takes approximately $2.2 million in cash to support a typical
stabilized store portfolio with our existing 65% advance rate under our GE
facility. Additionally, it takes approximately 30 months for a store portfolio
to reach a stabilized level.
We intend to finance the construction of new dealerships and the DIP
facility financing through operating cash flows and supplemental borrowings,
including amounts available under the revolving facility and the securitization
program.
Matters Relating to First Merchants. On July 11, 1997, we entered into an
agreement to provide debtor in possession financing to First Merchants (DIP
Facility). As of September 30, 1999, the maximum commitment on the DIP facility
was $11.5 million and the outstanding balance on the DIP facility totaled $11.9
million. When First Merchants defaulted on the DIP facility, we negotiated a
settlement agreement with them that has increased our funding obligation by $2.0
million, subject to satisfaction of certain conditions, and in exchange for
other concessions. These conditions were satisfied in August 1999 and the loan
is no longer in default. The total amount outstanding on the additional $2.0
million is approximately $600,000. We anticipate paydowns on the DIP financing
to begin in the near future and expect that FMAC will pay all but the most
recent $2.0 million increase by the end of the first quarter of 2000. We believe
that we will begin to record certain incentive fee income from the First
Merchants transaction in the fourth quarter of 1999. We also anticipate that we
will receive a distribution of approximately $4.0 million on November 15, 1999
from collections on charged off receivables held by First Merchants. These
payments should be sufficient to offset the reduction in cash distributions from
our securitization transactions over the next 3 to 5 months. See
"Securitizations - Dealership Operations" above.
In the past, we reported that we entered into agreements with certain of the
banks from which we purchased First Merchants' senior bank debt to pay them
additional consideration, up to the amount of the discount we received on the
purchase of the bank debt, if First Merchants makes cash payments or issues
notes at market rates to its unsecured creditors and equity holders in excess of
10% of their allowed claims in First Merchants' bankruptcy proceedings. In the
third quarter of 1999, we repurchased the warrants that were previously issued
to this group of banks and these contingent claims for consideration of
approximately $612,000.
Common Stock Repurchase Program. During the first quarter of 1999, we
repurchased approximately 928,000 shares of our common stock for $5.2 million
under our first stock repurchase program. We have repurchased a total of one
million shares of our common stock under the program, which is the total number
Page 30
of shares the Board of Directors authorized under that program. In April 1999,
our Board of Directors authorized, subject to certain conditions and lender
approval, a second stock repurchase program that would allow us to repurchase up
to 2.5 million additional shares of our common stock. Purchases may be made
depending on market conditions, share price, and other factors. During the third
quarter of 1999 we repurchased an additional 66,325 shares for $497,000.
Year 2000 Readiness Disclosure
Many older computer programs refer to years only in terms of their final two
digits. Such programs may interpret the year 2000 to mean the year 1900 instead.
The problem affects not only computer software, but also computer hardware and
other systems containing processors and embedded chips. Business systems
affected by this problem may not be able to accurately process date related
information before, during or after January 1, 2000. This is commonly referred
to as the Year 2000 issue. Failures of our own business systems due to Year 2000
issues as well as those of our suppliers and business partners could materially
adversely affect our business. We are in the process of addressing these issues.
Our Year 2000 compliance program consists of:
o identification and assessment of critical computer programs, hardware and
and other business equipment and systems,
o remediation and testing,
o assessment of the Year 2000 readiness of our critical suppliers, vendors
and business partners, and
o contingency planning.
Identification and Assessment
The first component of our Year 2000 compliance program is complete. We have
identified our critical computer programs, hardware, and other equipment to
determine which systems are compliant, or must be replaced or remediated.
Remediation and Testing
Dealership Operations. We have finished remediating the program code and
underlying data, testing the remediated code modifications and have implemented
these changes into operation for our integrated car sales and loan servicing
system (CLASS System). We placed the modified program code into production in
April 1999 and have completed performing date testing on the modified code.
Non-Dealership Operations. Our non-dealership loan servicing operations
currently utilize several loan processing and collections programs provided
through third party service bureaus. Based upon certifications we have received
from the software vendors, and independent testing we have performed, we believe
that our loan processing and collections programs are Year 2000 compliant.
Our Cygnet dealer program utilizes one of the same loan processing and
collections programs used by our loan servicing operations. The service bureau
that provides the program has written a custom module for us and has stated the
custom module is Year 2000 compliant. In addition, we have performed independent
Year 2000 compliance testing on the Cygnet dealer program's custom module, and
believe it is Year 2000 compliant.
The remediation and testing of the critical business systems used by our
dealership and non-dealership operations was completed during the second quarter
of 1999.
Assessment of Business Partners
We have also identified critical suppliers, vendors, and other business
partners and have taken steps to determine their Year 2000 readiness. These
steps include interviews, questionnaires, and other types of inquiries. Because
of the large number of business systems that our business partners use and their
varying levels of Year 2000 readiness, it is difficult to determine how any Year
2000 issues of our business partners will affect us. We are not currently aware
of any business relationships with third parties that we believe will likely
result in a significant disruption of our businesses. We believe that our
greatest risk is with our utility suppliers, banking and financial institution
partners, and suppliers of telecommunications services, all of which are
operating within the United States. Potential consequences if we, or our
business partners, are not Year 2000 compliant include:
Page 31
o failure to operate from a lack of power,
o shortage of cash flow,
o disruption or errors in loan collection and processing efforts, and
o delays in receiving inventory, supplies, and services.
If any of these events occurred, the results could have a material adverse
impact on us and our operations.
Contingency Plans
We are also developing contingency plans to mitigate the risks that could
occur in the event of a Year 2000 business disruption. Contingency plans may
include:
o increasing inventory levels,
o securing additional financing,
o relocating operations to unaffected sites,
o vendor/supplier replacement,
o utilizing temporary manual or spreadsheet-based processes, or
o other prudent actions,
We are currently working on updating our disaster recovery plan and
formulating our Year 2000 contingency plans. We will continue to develop our
contingency plans throughout the rest of the year and expect to complete them by
December 31, 1999.
Costs
We currently estimate that remediation and testing of our business systems
will cost between $2.4 million and $2.7 million. Most of these costs will be
expensed and funded by our operating line of credit. Costs incurred as of
September 30, 1999 approximate $2.4 million, including approximately $231,000 of
internal payroll costs, substantially all of which have been charged to general
and administrative expense. Costs incurred in the nine month period ended
September 30, 1999 approximate $970,000. We incurred costs of approximately
$265,000 in the comparable period in 1998. We believe costs associated with
developing and implementing contingency measures will not be material to our
operating results. The scheduled completion dates and costs associated with the
various components of our Year 2000 compliance program described above are
estimates and are subject to change.
Accounting Matters
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132) which became
effective for us January 1, 1999. SFAS No. 132 establishes standards for the
information that public enterprises report in annual financial statements. The
adoption of SFAS No. 132 did not have a material impact on us.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133) which becomes effective for us January 1,
2001. We believe the adoption of SFAS No. 133 will not have a material impact on
us.
ITEM 3.
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use instruments for trading purposes or to manage
interest rate risk. Our earnings are substantially affected by our net interest
income, which is the difference between the income earned on interest-bearing
assets and the interest paid on interest bearing notes payable. Increases in
market interest rates could have an adverse effect on profitability.
Our financial instruments consist primarily of fixed rate finance
receivables, residual interests in pools of fixed rate finance receivables,
short term variable rate revolving Notes Receivable, and variable and fixed rate
Notes Payable. Our finance receivables are classified as subprime loans and
generally bear interest at the lower of 29.9% or the maximum interest rate
Page 32
allowed in states that impose interest rate limits. At September 30, 1999, the
scheduled maturities on our finance receivables range from one to 52 months with
a weighted average maturity of 31.3 months. The interest rates we charge our
customers on finance receivables has not changed as a result of fluctuations in
market interest rates, although we may increase the interest rates we charge in
the future if market interest rates increase. A large component of our debt at
September 30, 1999 is the Collateralized Notes Payable (senior and junior
securities) 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 higher than the
interest rates on our existing Notes Payable.
We believe that our market risk information has not changed materially from
December 31, 1998.
Page 33
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We sell our cars on an "as is" basis. We require all customers to
acknowledge in writing on the date of sale that we disclaim any obligation for
vehicle-related problems that subsequently occur. Although we believe that these
disclaimers are enforceable under applicable laws, there can be no assurance
that they will be upheld in every instance. Despite obtaining these disclaimers,
in the ordinary course of business, we receive complaints from customers
relating to vehicle condition problems as well as alleged violations of federal
and state consumer lending or other similar laws and regulations. Most of these
complaints are made directly to us or to various consumer protection
organizations and are subsequently resolved. However, customers occasionally
name us as a defendant in civil suits filed in state, local, or small claims
courts. Additionally, in the ordinary course of business, we are a defendant in
various other types of legal proceedings, and are the subject of regulatory or
governmental investigations. Although we cannot determine at this time the
amount of the ultimate exposure from such matters, if any, we, based on the
advice of counsel, do not expect the final outcome to have a material adverse
effect on our financial position.
Item 2. Changes in Securities and Use of Proceeds.
(a) None
(b) None
(c) None
(d) Not Applicable
Item 3. Defaults Upon Senior Securities.
As a result of an increase in delinquencies, we recently obtained a waiver
to a technical covenant breach under our Residual Loan. In addition, we obtained
a waiver to a technical breach of a financial ratio covenant resulting from the
change in structures of our securitizations transactions under another loan.
Item 4. Submission of Matters to a Vote of Security Holders.
None
Item 5. Other Information.
On July 26, 1999, Gregory B. Sullivan, President, Chief Operating Officer
and a director of Ugly Duckling, was appointed Chief Executive Officer by our
Board of Directors. Mr. Sullivan replaced Ernest C. Garcia II, who remains as
Chairman of the Board and our largest stockholder with over 32% of Ugly
Duckling's stock.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.1 -- Amendment No. 5 to the Amended and Restated Motor
Vehicle and Installment Contract Loan and Security Agreement between
General Electric Capital Corporation and Registrant dated August 16,
1999
Exhibit 10.1(a) -- Amendment No. 6 to the Amended and Restated Motor
Vehicle and Installment Contract Loan and Security Agreement between
General Electric Capital Corporation and Registrant dated August 27,
1999
Exhibit 10.2 -- Third Amendment to Credit and Security Agreement between
Registrant and First Merchants, dated as of August 2, 1999
Exhibit 10.3 -- Amendment to Loan Agreement between Registrant and each
of the Kayne Anderson related Lenders named therein, dated September
30, 1999
Exhibit 11 -- Statement regarding computation of per share earnings (see
note 5 of Notes to condensed consolidated Financial Statements)
Exhibit 27 -- Financial Data Schedule
Page 34
Exhibit 99 --Statement Regarding Forward Looking Statements and Risk
Factors
(b) Reports on Form 8-K.
During the third quarter of 1999, the Company filed one report on Form 8-K
dated August 26, 1999 to report the acquisition of four dealerships in Orlando,
Florida and a loan portfolio of approximately $15.0 million. In addition, after
the third quarter of 1999, the Company has filed one report on Form 8-K, dated
November 8, 1999, to report the acquisition of five dealerships in Richmond,
Virginia and a loan portfolio of approximately $8.0 million.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UGLY DUCKLING CORPORATION
/s/ STEVEN T. DARAK
--------------------------------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 15, 1999
EXHIBIT INDEX
Exhibit
Number Description
10.1 Amendment No. 5 to the Amended and Restated Motor Vehicle and Installment
Contract Loan and Security Agreement between General Electric Capital
Corporation and Registrant dated August 16, 1999
10.1(a)Amendment No. 6 to the Amended and Restated Motor Vehicle and Installment
Contract Loan and Security Agreement between General Electric Capital
Corporation and Registrant dated August 27, 1999
10.2 Third Amendment to Credit and Security Agreement between Registrant and
First Merchants, dated as of August 2, 1999
10.3 Amendment to Loan Agreement between Registrant and each of the Kayne
Anderson related Lenders named therein, dated September 30, 1999
11 Statement regarding computation of per share earnings (see note 5 of
Notes to Condensed Consolidated Financial Statements)
27 Financial Data Schedule
99 Statement Regarding Forward Looking Statements and Risk Factors