-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, IGvpjmOyRvcbpwrUSxLI0xE2ygcL6Gx6K6JNpYDiouYZuZT6ndpAwjB8Vr7TzhsS idHFQokSBHjQs/h9dvESKQ== 0001012704-01-500021.txt : 20010815 0001012704-01-500021.hdr.sgml : 20010815 ACCESSION NUMBER: 0001012704-01-500021 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010814 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UGLY DUCKLING CORP CENTRAL INDEX KEY: 0001012704 STANDARD INDUSTRIAL CLASSIFICATION: PERSONAL CREDIT INSTITUTIONS [6141] IRS NUMBER: 860721358 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-14759 FILM NUMBER: 1712892 BUSINESS ADDRESS: STREET 1: 2525 E CAMELBACK ROAD STREET 2: STE 500 CITY: PHOENIX STATE: AZ ZIP: 85016 BUSINESS PHONE: 6028526600 MAIL ADDRESS: STREET 1: 2525 E CAMELBACK RD STREET 2: STE 1150 CITY: PHOENIX STATE: AZ ZIP: 85016 10-Q 1 f10qtxt.txt ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 --------------- FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: June 30, 2001 Commission File Number 000-20841 UGLY DUCKLING CORPORATION (Exact name of registrant as specified in its charter) Delaware 86-0721358 (State or other jurisdiction of (I.R.S. employer incorporation or organization) Identification no.) 2525 E. Camelback Road, Suite 500, Phoenix, Arizona 85016 (Address of principal executive offices) (Zip Code) (602) 852-6600 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes [ ] No --------------- INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE: At August 13, 2001, there were approximately 12,302,000 shares of Common Stock, $0.001 par value, outstanding. This document serves both as a resource for analysts, shareholders, and other interested persons, and as the quarterly report on Form 10-Q of Ugly Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission, which has taken no action to approve or disapprove the report or pass upon its accuracy or adequacy. Additionally, this document is to be read in conjunction with the consolidated financial statements and notes thereto included in Ugly Duckling's Annual Report on Form 10-K, for the year ended December 31, 2000. ================================================================================ UGLY DUCKLING CORPORATION FORM 10-Q TABLE OF CONTENTS
Page Part I - FINANCIAL STATEMENTS Item 1. FINANCIAL STATEMENTS Condensed Consolidated Balance Sheets-- June 30, 2001 and December 31, 2000..........................1 Condensed Consolidated Statements of Operations-- Three and Six Months Ended June 30, 2001 and 2000.........................................................................2 Condensed Consolidated Statements of Cash Flows-- Six Months Ended June 30, 2001 and 2000...........................................................................3 Notes to Condensed Consolidated Financial Statements.................................................4 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...............10 Item 3. MARKET RISK.........................................................................................24 Part II.-- OTHER INFORMATION Item 1. LEGAL PROCEEDINGS...................................................................................25 Item 2. CHANGES IN SECURITIES...............................................................................25 Item 3. DEFAULTS UPON SENIOR SECURITIES.....................................................................25 Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.................................................25 Item 5. OTHER INFORMATION...................................................................................25 Item 6. EXHIBITS AND REPORTS ON FORM 8-K....................................................................26 SIGNATURES..........................................................................................27
ITEM 1. UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
June 30, 2001 December 31, (unaudited) 2000 ----------------- ------------------- ----------------- ------------------- ASSETS Cash and Cash Equivalents $ 7,059 $ 8,805 Finance Receivables, Net 544,585 500,469 Note Receivable from Related Party 12,000 12,000 Inventory 40,772 63,742 Property and Equipment, Net 40,278 38,679 Intangible Assets, Net 12,048 12,527 Other Assets 18,474 11,724 Net Assets of Discontinued Operations 3,734 4,175 ----------------- ------------------- $ 678,950 $ 652,121 ================= =================== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Accounts Payable $ 1,498 $ 2,239 Accrued Expenses and Other Liabilities 25,525 36,830 Notes Payable - Portfolio 415,877 406,551 Other Notes Payable 42,495 16,579 Subordinated Notes Payable 34,951 34,522 ----------------- ------------------- Total Liabilities 520,346 496,721 ----------------- ------------------- Stockholders' Equity: Preferred Stock $.001 par value, 10,000 shares authorized none issued and outstanding - - Common Stock $.001 par value, 100,000 shares authorized, 18,764 issued and 12,302 and 12,292 outstanding 19 19 Additional Paid-in Capital 173,741 173,723 Retained Earnings 24,958 21,772 Treasury Stock, at cost (40,114) (40,114) ----------------- ------------------- Total Stockholders' Equity 158,604 155,400 Commitments and Contingencies - - ----------------- ------------------- $ 678,950 $ 652,121 ================= ===================
See accompanying notes to Condensed Consolidated Financial Statements. 1 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS Three and Six Months Ended June 30, 2001 and 2000 (In thousands, except earnings per share amounts) (unaudited)
Three Months Ended Six Months Ended June 30, June 30, ------------------------------------------------------ 2001 2000 2001 2000 ------------------------------------------------------ Cars Sold 11,607 14,369 26,458 30,171 ====================================================== Total Revenues $ 140,819 $ 151,398 $ 304,849 $ 309,715 ====================================================== Sales of Used Cars $ 105,919 $ 121,527 $ 236,105 $ 254,313 Less: Cost of Used Cars Sold 60,639 68,417 133,480 141,359 Provision for Credit Losses 32,210 32,212 71,230 66,785 ------------------------------------------------------ 13,070 20,898 31,395 46,169 ------------------------------------------------------ Other Income (Expense): Interest Income 34,900 29,871 68,744 55,402 Portfolio Interest Expense (7,492) (5,997) (16,011) (11,026) ------------------------------------------------------ Net Interest Income 27,408 23,874 52,733 44,376 ------------------------------------------------------ Income before Operating Expenses 40,478 44,772 84,128 90,545 Operating Expenses: Selling and Marketing 6,235 7,426 13,861 15,561 General and Administrative 27,217 25,192 54,655 50,730 Depreciation and Amortization 2,435 2,231 4,842 4,439 ------------------------------------------------------ Operating Expenses 35,887 34,849 73,358 70,730 ------------------------------------------------------ Operating Income 4,591 9,923 10,770 19,815 Other Interest Expense 2,862 2,585 5,953 4,877 ------------------------------------------------------ Earnings before Income Taxes 1,729 7,338 4,817 14,938 Income Taxes 709 2,990 1,975 6,107 ------------------------------------------------------ Earnings before Extraordinary Item 1,020 4,348 2,842 8,831 Extraordinary Item - Gain on Early Extinguishment of Debt, net 344 - 344 - ------------------------------------------------------ Net Earnings $ 1,364 $ 4,348 $ 3,186 $ 8,831 ====================================================== Earnings per Common Share before Extraordinary Item: Basic $ 0.08 $ 0.31 $ 0.23 $ 0.61 ====================================================== Diluted $ 0.08 $ 0.31 $ 0.23 $ 0.60 ====================================================== Net Earnings per Common Share: Basic $ 0.11 $ 0.31 $ 0.26 $ 0.61 ====================================================== Diluted $ 0.11 $ 0.31 $ 0.26 $ 0.60 ====================================================== Shares Used in Computation: Basic Weighted Average Shares Outstanding 12,299 14,052 12,296 14,479 ====================================================== Diluted Weighted Average Shares Outstanding 12,330 14,248 12,328 14,700 ======================================================
See accompanying notes to Condensed Consolidated Financial Statements. 2 UGLY DUCKLING CORPORATION AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS Six Months ended June 30, 2001 and 2000 (In thousands) (unaudited)
Six Months Ended June 30, ----------------------------------- 2001 2000 ---------------- ---------------- Cash Flows from Operating Activities: Net Earnings $ 3,186 $ 8,831 Adjustments to Reconcile Net Earnings to Net Cash Provided by Operating Activities: Provision for Credit Losses 71,230 66,785 Depreciation and Amortization 6,912 6,459 Loss from Disposal of Property and Equipment 399 3 Collections from Residuals in Finance Receivables Sold 1,136 8,743 Decrease in Inventory 22,970 17,000 Increase in Other Assets 250 316 Increase (Decrease) in Accounts Payable, Accrued Expenses and Other liabilities (10,033) 1,860 Decrease in Income Taxes Payable (2,013) (2,300) ---------------- ---------------- Net Cash Provided by Operating Activities 94,037 107,697 ---------------- ---------------- Cash Flows Used in Investing Activities: Increase in Finance Receivables (213,732) (261,882) Collections on Finance Receivables 124,646 102,059 Decrease in Investments Held in Trust on Finance Receivables Sold 1,398 5,937 Proceeds from Sale of Property and Equipment 1,760 1,766 Purchase of Property and Equipment (8,122) (6,511) ---------------- ---------------- Net Cash Used in Investing Activities (94,050) (158,631) ---------------- ---------------- Cash Flows from Financing Activities: Initial Deposits at Securitization into Investments Held in Trust (6,407) (14,619) Additional Deposits into Investments Held in Trust (69,358) (3,767) Release of Investments Held in Trust 46,972 11,526 Additions to Notes Payable Portfolio 349,350 314,456 Repayment of Notes Payable Portfolio (341,464) (275,483) Additions to Other Notes Payable 37,168 881 Repayment of Other Notes Payable (11,720) (9,854) Repayment/Extinguishment of Subordinated Notes Payable (6,733) - Proceeds from Issuance of Common Stock 18 432 Acquisition of Treasury Stock - (114) ---------------- ---------------- Net Cash Provided (Used) by Financing Activities (2,174) 23,458 ---------------- ---------------- Net Cash Provided by Discontinued Operations 441 27,920 ---------------- ---------------- Net Increase (Decrease) in Cash and Cash Equivalents (1,746) 444 Cash and Cash Equivalents at Beginning of Period 8,805 3,683 ---------------- ---------------- Cash and Cash Equivalents at End of Period $ 7,059 $ 4,127 ================ ================ Supplemental Statement of Cash Flows Information: Interest Paid $ 20,130 $ 15,678 ================ ================ Income Taxes Paid $ 12,071 $ 8,405 ================ ================ Acquisition of Treasury Stock with Subordinated Debt $ - $ 8,005 ================ ================
See accompanying notes to Condensed Consolidated Financial Statements. 3 UGLY DUCKLING CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Note 1. Basis of Presentation Our accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by such accounting principles generally accepted in the United States of America for a complete financial statement presentation. In our opinion, such unaudited interim information reflects all adjustments, consisting only of normal recurring adjustments, necessary to present our financial position and results of operations for the periods presented. Our results of operations for interim periods are not necessarily indicative of the results to be expected for a full fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 2000 was derived from our audited consolidated financial statements as of that date but does not include all the information and footnotes required by accounting principles generally accepted in the United States of America. For a complete financial statement presentation, we suggest that these condensed consolidated financial statements be read in conjunction with the audited consolidated financial statements included in our Annual Report on Form 10-K, for the year ended December 31, 2000. All amounts are in thousands with the exception of per share, per unit and per car data, unless otherwise noted. Note 2. Summary of Finance Receivables A summary of Finance Receivables, net, follows:
June 30, December 31, 2001 2000 ----------------- ----------------- Contractually Scheduled Payments $ 723,882 $ 696,220 Unearned Finance Charges (189,116) (181,274) ----------------- ----------------- Principal Balances 534,766 514,946 Accrued Interest 5,463 5,655 Loan Origination Costs 7,411 7,293 ----------------- ----------------- Principal Balances, net 547,640 527,894 Investments Held in Trust 98,534 71,139 Residuals in Finance Receivables Sold - 1,136 ----------------- ----------------- Finance Receivables 646,174 600,169 Allowance for Credit Losses (101,589) (99,700) ----------------- ----------------- Finance Receivables, net $ 544,585 $ 500,469 ================= ================= Allowance as a % of Ending Principal Balances 19.0% 19.4% ================= =================
Investments Held in Trust represent funds held by trustees on behalf of our securitization bond holders. The balance of Investments Held in Trust increased from December 31, 2000 due to deposits into the trust accounts arising from an additional securitization completed during the first and second quarters of 2001, including a pre-funded amount of approximately $25.2 million related to the securitization completed in the second quarter of 2001. The increase was partially offset by the distribution of funds associated with portfolios securitized during prior periods. Note 3. Related Party Transactions The Note Receivable - Related Party originated from the Company's December 1999 sale of its Cygnet Dealer Finance subsidiary to Cygnet Capital Corporation, an entity controlled by Ernest C. Garcia II, Chairman and principal shareholder of the Company. The $12.0 million note from Cygnet Capital Corporation has a 10-year term, with interest payable quarterly at 9%, due December 2009. The note is secured by the capital stock of Cygnet Capital Corporation and guaranteed by Verde Investments, Inc. ("Verde"), an affiliate of Mr. Garcia. Under the terms of the agreement, Mr. Garcia will be allowed to reduce the principal balance up to a maximum of $8.0 million by surrendering to the Company shares of Ugly Duckling common stock (valued at 98% of the average of the closing prices of the stock on NASDAQ for the ten trading days prior to the surrender) as long as Mr. Garcia's ownership interest of the Company voting stock does not fall below 15% and the acceptance of such stock by the Company does not result in a breach of a covenant. 4 In May 2001, Verde purchased one of the Company properties at its approximate book value of $1,650,000. Verde has leased the property back to the Company under a 20-year lease, which expires May 2021. The lease is a triple net lease with an increase of approximately 2% in year two and annual CPI adjustments thereafter. Verde is expected to purchase another property, with a scheduled close date of August 2001. The purchase price is $800,000 which approximates book value. The Company currently sublets this property thus there will not be a subsequent leaseback with Verde. Note 4. Notes Payable Notes Payable, Portfolio A summary of Notes Payable, Portfolio at June 30, 2001 and December 31, 2000:
June 30, December 31, 2001 2000 ----------------- ----------------- Revolving Warehouse Facility with GE Capital, secured by substantially $ - $ 53,326 all assets of the Company, terminated April 2001 Revolving Warehouse Facility with Greenwich Capital Financial Products, Inc, secured by substantially all assets of the Company 17,620 - Class A obligations issued pursuant to the Company's Securitization Program, secured by underlying pools of finance receivables and investments held in trust totaling $592.1 million at June 30, 2001 401,854 355,972 ----------------- ----------------- Subtotal 419,474 409,298 Less: Unamortized Loan Fees 3,597 2,747 ----------------- ----------------- Total $ 415,877 $ 406,551 ================= =================
Effective April 2001, the Company replaced the warehouse receivables portion of the GE Capital facility. The new warehouse receivables revolving facility allows for maximum borrowings of $75 million during the period May 1 through November 30 and increases to $100 million during the period December 1 through April 30. The term of the facility is 364 days with a renewal option, upon mutual consent, for an additional 364-day period. The borrowing base consists of up to 65% of the principal balance of eligible loans originated from the sale of used cars. The lender maintains an option to adjust the advance rate on the principal to reflect changes in market conditions or portfolio performance. The interest rate on the facility is LIBOR plus 2.80% (6.96% at June 30, 2001). The facility is secured with substantially all Company assets. The line is subject to several covenants, including certain financial and loan portfolio related covenants. At June 30, 2001, the Company was in compliance with all required covenants. Class A obligations have interest payable monthly at rates ranging from 4.74% to 7.26%. Monthly principal reductions on Class A obligations approximate 70% of the principal reductions on the underlying pool of finance receivable loans. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Securitizations" for further information on the Class A bonds. Other Notes Payable A summary of Other Notes Payable at June 30, 2001 and December 31, 2000 follows:
June 30, December 31, 2001 2000 ----------------- ----------------- Note payable, secured by the capital stock of UDRC and UDRC II and certain other receivables $ 32,000 $ 11,141 Other notes payable bearing interest at rates ranging from 7.5% to 11% due through July 2003, secured by certain real property and certain property and equipment 6,491 5,637 Revolving Inventory Facility for $25.0 million with GE Capital, secured by substantially all Company assets 5,000 - ----------------- ----------------- Subtotal 43,491 16,778 Less: Unamortized Loan Fees 996 199 ----------------- ----------------- Total $ 42,495 $ 16,579 ================= =================
5 Effective April 2001, the Company secured an option to extend the $25 million inventory line of credit portion of the facility with GE Capital from June 30, 2001 until December 31, 2001. The extension on the inventory line of credit with GE Capital requires the payment of a fee for each quarterly extension after June 30, 2001, and, after June 30, 2001, the interest rate on the line increases by 50 basis points to LIBOR plus 3.65%. The interest rate in effect on this line was 7.31% at June 30, 2001. The facility agreement contains various reporting and performance covenants, including the maintenance of certain ratios and limitations on additional borrowings from other sources. At June 30, 2001, the Company was in compliance with these covenants with the exception of interest coverage ratios, for which the Company has obtained a waiver. As of the date of this report, the Company has signed a term sheet with a lender for a replacement to the inventory line of credit and expects to close on the final documents by August 31, 2001. Subordinated Notes Payable A summary of Subordinated Notes Payable at June 30, 2001 and December 31, 2000 follows:
June 30, December 31, 2001 2000 ----------------- ----------------- $13.5 million senior subordinated notes payable to unrelated parties, bearing $ 8,000 $ 11,500 interest at 15% per annum payable quarterly, principal due February 2003 and senior to subordinated debentures $7.0 million senior subordinated note payable to a related party, bearing interest at LIBOR plus 6% per annum payable quarterly, principal due February 2010 6,600 - $17.5 million subordinated debentures, interest at 12% per annum (approximately 18.8% effective rate) payable semi-annually, principal balance due October 23, 2003 13,839 17,479 $11.9 million subordinated debentures, interest at 11% per annum (approximately 19.7% effective rate) payable semi-annually, principal balance due April 15, 2007 11,940 11,940 ----------------- ----------------- Subtotal 40,379 40,919 Less: Unamortized Loan Fees - 31 Unamortized Discount - subordinated debentures 5,428 6,366 ----------------- ----------------- Total $ 34,951 $ 34,522 ================= =================
In June 2001, the Company repurchased in the open market and retired approximately $3.6 million of the $17.5 million in subordinated debentures for approximately $2.6 million. The after tax impact of the transaction was a gain from extinguishment of debt of $0.3 million. The gain has been classified as "Extraordinary Item - Gain on Early Extinguishment of Debt" on the Condensed Consolidated Statement of Operations. 6 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 three and six-month periods ended June 30, 2001, and 2000. Net earnings per common share are as follows:
Three Months Ended Six Months Ended June 30, June 30, ------------------------------ -------------------------- 2001 2000 2001 2000 ------------------------------ -------------------------- Earnings before Extraordinary Item $ 1,020 $ 4,348 $ 2,842 $ 8,831 Net Earnings $ 1,364 $ 4,348 $ 3,186 $ 8,831 ============================== ========================== Basic Earnings Per Share before Extraordinary Item $ 0.08 $ 0.31 $ 0.23 $ 0.61 ============================== ========================== ============================== ========================== Diluted Earnings Per Share before Extraordinary Item $ 0.08 $ 0.31 $ 0.23 $ 0.60 ============================== ========================== ============================== ========================== Basic Net Earnings Per Share $ 0.11 $ 0.31 $ 0.26 $ 0.61 ============================== ========================== Diluted Net Earnings Per Share $ 0.11 $ 0.31 $ 0.26 $ 0.60 ============================== ========================== Basic EPS-Weighted Average Shares Outstanding 12,299 14,052 12,296 14,479 Effect of Dilutive Securities: Warrants 31 12 32 13 Stock Options - 184 - 208 ------------------------------ -------------------------- Diluted EPS-Weighted Average Shares Outstanding 12,330 14,248 12,328 14,700 ============================== ========================== Warrants Not Included in Diluted EPS Since Antidilutive 795 1,124 795 1,124 ============================== ========================== Stock Options Not Included in Diluted EPS Since Antidilutive 1,423 846 1,434 864 ============================== ==========================
Note 6. Business Segments The Company has three distinct business segments. These consist of retail car sales operations (Retail Operations), the income resulting from the finance receivables generated at the Company dealerships (Portfolio Operations), and corporate and other operations (Corporate Operations). In computing operating profit by business segment, the following items were considered in the Corporate Operations category: portions of administrative expenses, interest expense and other items not considered direct operating expenses. Identifiable assets by business segment are those assets used in each segment of Company operations. 7 A summary of operating activity by business segment for the three and six-month periods ended June 30, 2001 and 2000 follows:
Retail Portfolio Corporate Total ------ --------- --------- ----- Three Months Ended June 30, 2001 Sales of Used Cars $ 105,919 $ - $ - $ 105,919 Less: Cost of Cars Sold 60,639 - - 60,639 Provision for Credit Losses 21,898 10,312 - 32,210 ------------- ------------- -------------- -------------- 23,382 (10,312) - 13,070 Net Interest Income - 27,408 - 27,408 ------------- ------------- -------------- -------------- Income before Operating Expenses 23,382 17,096 - 40,478 ------------- ------------- -------------- -------------- Operating Expenses: Selling and Marketing 6,235 - - 6,235 General and Administrative 14,855 7,359 5,003 27,217 Depreciation and Amortization 1,363 232 840 2,435 ------------- ------------- -------------- -------------- 22,453 7,591 5,843 35,887 ------------- ------------- -------------- -------------- Operating Income (Loss) $ 929 $ 9,505 $ (5,843) $ 4,591 ============= ============= ============== ============== Capital Expenditures $ 1,157 $ 358 $ 3,434 $ 4,949 ============= ============= ============== ============= Identifiable Assets $ 79,837 $ 538,393 $ 56,986 $ 675,216 ============= ============= ============== ============== Three Months Ended June 30, 2000 Retail Portfolio Corporate Total ------ --------- --------- ----- Sales of Used Cars $ 121,527 $ - $ - $ 121,527 Less: Cost of Cars Sold 68,417 - - 68,417 Provision for Credit Losses 24,738 7,474 - 32,212 ------------- ------------- -------------- -------------- 28,372 (7,474) - 20,898 Net Interest Income - 23,764 110 23,874 ------------- ------------- -------------- -------------- Income before Operating Expenses 28,372 16,290 110 44,772 ------------- ------------- -------------- -------------- Operating Expenses: Selling and Marketing 7,426 - - 7,426 General and Administrative 14,593 5,416 5,183 25,192 Depreciation and Amortization 1,133 280 818 2,231 ------------- ------------- -------------- -------------- 23,152 5,696 6,001 34,849 ------------- ------------- -------------- -------------- Operating Income (Loss) $ 5,220 $ 10,594 $ (5,891) $ 9,923 ============= ============= ============== ============== Capital Expenditures $ 2,220 $ 195 $ 1,818 $ 4,233 ============= ============= ============== ============== Six Months Ended June 30, 2001 Retail Portfolio Corporate Total ------ --------- --------- ----- Sales of Used Cars $ 236,105 $ - $ - $ 236,105 Less: Cost of Cars Sold 133,480 - - 133,480 Provision for Credit Losses 48,550 22,680 - 71,230 ------------- ------------- -------------- -------------- 54,075 (22,680) - 31,395 Net Interest Income - 52,603 130 52,733 ------------- ------------- -------------- -------------- Income before Operating Expenses 54,075 29,923 130 84,128 ------------- ------------- -------------- -------------- Operating Expenses: Selling and Marketing 13,861 - - 13,861 General and Administrative 29,513 15,367 9,775 54,655 Depreciation and Amortization 2,689 496 1,657 4,842 ------------- ------------- -------------- -------------- 46,063 15,863 11,432 73,358 ------------- ------------- -------------- -------------- Operating Income (Loss) $ 8,012 $ 14,060 $ (11,302) $ 10,770 ============= ============= ============== ============== Capital Expenditures $ 3,244 $ 587 $ 4,291 $ 8,122 ============= ============= ============== ============== Identifiable Assets $ 79,837 $ 538,393 $ 56,986 $ 675,216 ============= ============= ============== ============== 8 Six Months Ended June 30, 2000 Retail Portfolio Corporate Total ------ --------- --------- ----- Sales of Used Cars $ 254,313 $ - $ - $ 254,313 Less: Cost of Cars Sold 141,359 - - 141,359 Provision for Credit Losses 51,832 14,953 - 66,785 ------------- ------------- -------------- -------------- 61,122 (14,953) - 46,169 Net Interest Income - 44,156 220 44,376 ------------- ------------- -------------- -------------- Income before Operating Expenses 61,122 29,203 220 90,545 ------------- ------------- -------------- -------------- Operating Expenses: Selling and Marketing 15,561 - - 15,561 General and Administrative 28,783 11,493 10,454 50,730 Depreciation and Amortization 2,204 580 1,655 4,439 ------------- ------------- -------------- -------------- 46,548 12,073 12,109 70,730 ------------- ------------- -------------- -------------- Operating Income (Loss) $ 14,574 $ 17,130 $ (11,889) $ 19,815 ============= ============= ============== ============== Capital Expenditures $ 3,493 $ 294 $ 2,724 $ 6,511 ============= ============= ============== ==============
Note 7. Use of Estimates The preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from our estimates. Note 8. Reclassifications We have made certain reclassifications to previously reported information to conform to the current presentation. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction We operate the largest chain of buy here-pay here used car dealerships in the United States. At June 30, 2001, we operated 77 dealerships located in eleven metropolitan areas in eight states. We have one primary line of business: to sell and finance quality used vehicles to customers within what is referred to as the sub-prime segment of the used car market. The sub-prime market is comprised of customers who typically have limited credit histories, low incomes or past credit problems. References to Ugly Duckling Corporation as the largest chain of buy-here pay-here used car dealerships in the United States is management's belief based upon the knowledge of the industry and not on any current independent third party study. As a buy here-pay here dealer, we offer the customer certain advantages over more traditional financing sources including: o expanded credit opportunities, o flexible payment terms, including structuring loan payment due dates as weekly or biweekly, often coinciding with the customer's payday, o the ability to make payments in person at the dealerships. This is an important feature to many sub-prime borrowers who may not have checking accounts or are otherwise unable to make payments by the due date through use of the mail due to the timing of paydays. We distinguish our retail operations from those of typical buy here-pay here dealers through our:
o dedication to customer service, o advertising and marketing programs, o larger inventories of used cars, o upgraded facilities, and o network of multiple locations, o centralized purchasing.
We finance substantially all of the used cars that we sell at our dealerships through retail installment loan contracts. Subject to certain underwriting standards and the discretion of our dealership or sales managers, potential customers must meet our formal underwriting guidelines before we will agree to finance the purchase of a vehicle. Our employees analyze and verify the customer credit application information and subsequently make a determination whether to provide financing to the customer. Our business is divided into three operating segments; retail, portfolio and corporate. Information regarding our operating segments can be found in Note (6) of the Notes to Condensed Consolidated Financial Statements contained herein. Operating segment information is also included in "Management's Discussion and Analysis of Financial Condition and Results of Operations - Business Segment Information" found below. In December 1999, we sold the Cygnet Dealer Finance (CDF) subsidiary and also decided to abandon any efforts to acquire third party loans or servicing rights to additional third party portfolios. As a result, CDF, Cygnet Servicing and the associated Cygnet Corporate segment assets and liabilities are classified as net assets from discontinued operations. We plan to complete the servicing of the portfolios that we currently service. In the following discussion and analysis, we explain the results of operations and general financial condition of Ugly Duckling and its subsidiaries. In particular, we analyze and explain the changes in the results of operations of our business segments for the three and six-month periods ended June 30, 2001 and 2000. All amounts are presented in thousands except per share, per unit and per car data, unless otherwise noted. 10 UGLY DUCKLING CORPORATION SELECTED CONSOLIDATED FINANCIAL DATA (Amounts in millions, except per share, per unit data, share and number of loans data)
(Unaudited) At or For the Three Months Ended -------------------------------------------------------------------------------- Operating Data: June 2001 Mar 2001 Dec 2000 Sept 2000 June 2000 Mar 2000 --------- -------- -------- --------- ---------- -------- Total Revenues $ 140.8 $ 164.0 $ 135.2 $ 158.1 $ 151.4 $ 158.3 Sales of Used Cars $ 105.9 $ 130.2 $ 102.3 $ 126.6 $ 121.5 $ 132.8 Net Earnings per Share $ 0.11 $ 0.15 $ (0.20) $ 0.21 $ 0.31 $ 0.30 EBITDA $ 14.5 $ 17.1 $ 8.7 $ 16.5 $ 18.2 $ 17.1 E-Commerce Revenue as Percent of Sales of Used Cars 14.4% 11.6% 13.6% 9.5% 5.3% 4.3% Number Dealerships in Operation 77 77 77 77 77 75 Average Sales per Dealership per Month 50 64 51 64 62 70 Number of Used Cars Sold 11,607 14,851 11,874 14,825 14,369 15,802 Sales Price - Per Car Sold $ 9,125 $ 8,766 $ 8,618 $ 8,542 $ 8,458 $ 8,403 Cost of Sales - Per Car Sold $ 5,224 $ 4,905 $ 4,727 $ 4,773 $ 4,761 $ 4,616 Gross Margin - Per Car Sold $ 3,901 $ 3,861 $ 3,891 $ 3,769 $ 3,696 $ 3,787 Provision - Per Car Sold $ 2,775 $ 2,627 $ 3,292 $ 2,435 $ 2,242 $ 2,188 Total Operating Expense - Per Car Sold $ 3,092 $ 2,523 $ 2,832 $ 2,495 $ 2,425 $ 2,271 Total Operating Income - Per Car Sold $ 396 $ 416 $ (168) $ 466 $ 691 $ 626 Total Operating Income $ 4.6 $ 6.2 $ (2.0) $ 6.9 $ 9.9 $ 9.9 Earnings before Income Taxes $ 1.7 $ 3.1 $ (4.2) $ 4.5 $ 7.3 $ 7.6 Cost of Used Cars as Percent of Sales 57.3% 56.0% 54.8% 55.9% 56.3% 54.9% Gross Margin as Percent of Sales 42.7% 44.0% 45.2% 44.1% 43.7% 45.1% Provision - % of Originations 31.1% 31.0% 38.8% 29.0% 27.1% 27.0% Total Operating Expense - % of Total Revenues 25.5% 22.8% 24.9% 23.4% 23.0% 22.7% Segment Operating Expense Data: Retail Operating Expense - Per Car Sold $ 1,934 $ 1,590 $ 1,710 $ 1,549 $ 1,611 $ 1,481 Retail Operating Expense-% of Used Car Sales 21.2% 18.1% 19.8% 18.1% 19.1% 17.6% Corporate/Other Expense - Per Car Sold $ 503 $ 376 $ 417 $ 428 $ 418 $ 387 Corporate/Other Expense - % of Total Revenue 4.1% 3.4% 3.7% 4.0% 4.0% 3.9% Portfolio Exp. Annualized - % of End of Period Managed Principal 5.8% 6.2% 6.7% 6.1% 5.0% 5.5% Balance Sheet Data: Finance Receivables, net $ 544.6 $ 522.9 $ 500.5 $ 491.9 $ 451.2 $ 407.3 Inventory $ 40.8 $ 43.4 $ 63.7 $ 43.7 $ 45.9 $ 49.1 Total Assets $ 679.0 $ 659.5 $ 652.1 $ 618.5 $ 577.5 $ 548.0 Portfolio Notes Payable $ 415.9 $ 390.6 $ 406.6 $ 362.3 $ 316.0 $ 282.9 Subordinated Notes Payable $ 35.0 $ 40.8 $ 34.5 $ 36.1 $ 37.3 $ 28.9 Total Debt $ 493.3 $ 470.9 $ 457.7 $ 416.3 $ 381.0 $ 345.2 Total Stockholder's Equity $ 158.6 $ 157.2 $ 155.4 $ 158.5 $ 166.8 $ 170.6 Common Shares Outstanding - End of Period 12,302 12,292 12,292 12,378 13,899 14,980 Book Value per Share $ 12.89 $ 12.79 $ 12.64 $ 12.81 $ 12.00 $ 11.39 Tangible Book Value per Share $ 11.91 $ 11.79 $ 11.62 $ 11.78 $ 11.02 $ 10.43 Total Debt to Equity 3.1 3.0 2.9 2.6 2.3 2.0 Loan Portfolio Data: Interest Income $ 34.9 $ 33.8 $ 32.9 $ 31.4 $ 29.9 $ 25.5 Average Yield on Portfolio 26.7% 26.3% 26.1% 26.1% 26.8% 26.2% Portfolio Interest Expense 7,492 8,519 8,354 7,318 5,997 5,029 Average Borrowing Cost 8.3% 8.9% 8.7% 10.7% 8.6% 8.0% Principal Balances Originated $ 103.6 $ 126.0 $ 100.8 $ 124.4 $ 118.8 $ 128.1 Principal Balances Originated as % of Sales 97.8% 96.8% 98.5% 98.2% 97.7% 96.5% Number of Loans Originated 11,558 14,776 11,906 14,748 14,291 15,721 Average Original Amount Financed $ 8,965 $ 8,528 $ 8,468 $ 8,433 $ 8,311 $ 8,150 Number of Loans Originated as % of Units Sold 99.6% 99.5% 100.3% 99.5% 99.5% 99.5% Portfolio Delinquencies: Current 76.4% 78.6% 66.1% 72.4% 71.9% 74.8% 1 to 30 days 16.8% 15.7% 26.1% 19.3% 20.9% 19.9% 31 to 60 days 4.1% 3.3% 4.7% 4.9% 4.5% 3.4% Over 60 days 2.7% 2.4% 3.1% 3.4% 2.7% 1.9% Principal Outstanding - Retained $ 534.8 $ 535.0 $ 514.9 $ 512.8 $ 472.3 $ 418.9 Number of Loans Outstanding - Retained 86,446 87,033 82,598 79,848 71,518 62,459
11 Second Quarter highlights include: o Total revenues were $140.8 million o E-Commerce generated $15.2 million in revenues and 1,686 cars sold during the second quarter of 2001 as compared to $15.1 million in revenues and 1,725 cars sold during the first quarter of 2001 o Loan portfolio principal balance was $534.8 million, representing a 13% increase over the year-ago quarter o New loan originations were $103.6 million, a 13% decrease from the year ago quarter o Closed 20th Securitization with loan principal balances of approximately $142.3 million and Class A bonds issued of $100.8 million o Our Chairman of the Board and largest shareholder, Ernest C. Garcia II, made an offer to purchase all of our outstanding stock Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended Six Months Ended June 30, June 30, ----------------------------- Percentage ------------------------------ Percentage 2001 2000 Change 2001 2000 Change ----------------------------- -------------- ------------------------------ -------------- Number of Used Cars Sold 11,607 14,369 (19.2%) 26,458 30,171 (12.3%) ============================= ============================== Sales of Used Cars $ 105,919 $ 121,527 (12.8%) $ 236,105 $ 254,313 (7.2%) Cost of Used Cars Sold 60,639 68,417 (11.4%) 133,480 141,359 (5.6%) ----------------------------- ------------------------------ Gross Margin $ 45,280 $ 53,110 (14.7%) $ 102,625 $ 112,954 (9.1%) ============================= ============================== Gross Margin % 42.7% 43.7% 43.5% 44.4% Per Car Sold: Sales $ 9,125 $ 8,458 7.9% $ 8,924 $ 8,429 $ 5.9% Cost of Used Cars Sold 5,224 4,761 9.7% 5,045 4,684 7.7% ----------------------------- ------------------------------ Gross Margin 3,901 3,696 5.5% 3,879 3,744 3.6% ============================= ==============================
For the three and six-month periods ended June 30, 2001, the number of cars sold decreased by 19.2% and 12.3%, respectively, over the same periods of the prior year and Used Car Sales revenues decreased 12.8% and 7.2%, respectively, over the same periods in 2000. During the latter half of 2000, we developed a risk management department, which is currently focusing on credit risk modeling techniques. We believe the decrease in both units sold and revenues is primarily the result of initiatives which have put more stringent guidelines in place regarding income qualifications and down payment requirements in an effort to improve the quality of loans generated from used car sales. To a lesser extent, we believe a general softening of the economy has led to reduced retail activity in the sub-prime market. Our Internet site continues to be a valuable tool generating a steady flow of credit applications and sales. We accept credit applications from potential customers via our website, located at http://www.uglyduckling.com. Credit inquiries received over the web are reviewed by our employees, who then contact the customers and schedule appointments. Internet applications continue to provide an increasing amount of Used Cars Sold revenues. During the second quarter of 2001, through our internet site, we sold 1,686 cars generating $15.2 million in revenue versus 1,725 cars totaling $15.1 million in revenue during the first quarter of 2001 and up from 1,553 cars sold and $13.7 million in revenue during the fourth quarter of 2000. We continue to find that the E-commerce customer group generally outperforms other customers in terms of loan performance. Accordingly, we continue to monitor and enhance our Internet application levels. The Cost of Used Cars Sold for the three and six-month periods ended June 30, 2001 decreased 11.4% and 5.6%, respectively, over the comparable periods of the previous year. The decrease is due to a decline in the number of used cars sold, partially offset by an increase in the Cost of Used Cars Sold. The Cost of Used Cars Sold on a per car basis increased 9.7% and 7.7% for the three and six-month periods ended June 30, 2001, respectively, over the same periods of the prior year. The increase is due to an effort to purchase higher quality vehicles as a result of research completed by our risk management department, which indicated better loan performance on the loans associated with the higher cost inventory. This increase was offset by an increase in the sales price 12 earned per car. The gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses) as a percentage of related revenue decreased to 42.7% and 43.5% for the three and six-months ended June 30, 2001 versus 43.7% and 44.4% for the three and six-month periods ended June 30, 2000. The decrease is due to the cost of used cars sold rising at a higher pace than the related revenues. For the three months ended June 30, 2001 as compared with the three months ended June 30, 2000, gross margin on a per car sold basis increased $205 to $3,901 per car and increased $135 to $3,879 for the six month period ended June 30, 2001 from $3,744 during the same period of the previous year. This increase is due to an increase in the overall revenue earned per car, partially offset by the increase in the per unit cost of used cars sold. We finance substantially all of our used car sales. The percentage of cars sold financed and the percentage of sales revenue financed has remained relatively constant for both the three and six-month periods ended June 30, 2001 versus the comparable periods of 2000. The following table indicates the percentage of sales units and revenue financed:
Three Months Ended Six Months Ended June 30, June 30, ------------------------ ----------------------- 2001 2000 2001 2000 ------------------------ ----------------------- Percentage of used cars sold financed 99.6% 99.5% 99.5% 99.5% ======================== ======================= Percentage of sales revenue financed 97.8% 97.7% 97.3% 97.1% ======================== =======================
Provision for Credit Losses The following is a summary of the Provision for Credit Losses: Three Months Ended Six Months Ended June 30, Percentage June 30, Percentage -------------------------- -------------------------- 2001 2000 Change 2001 2000 Change -------------------------- -------------- -------------------------- -------------- Provision for Credit Losses $ 32,210 $ 32,212 0.0% $ 71,230 $ 66,785 6.7% ========================== ========================== Provision per loan originated $ 2,787 $ 2,254 23.6% $ 2,705 $ 2,225 21.6% ========================== ========================== Provision as a percentage of principal balances originated 31.1% 27.1% 31.0% 27.0% ========================== ==========================
The Provision for Credit Losses is the amount we charge to current operations on each car sold to establish an allowance for credit losses. Measured for financial analysis purposes as a percentage of loan originations, the Provision for Credit Losses has increased for the three and six-month periods ended June 30, 2001 over the same periods of the prior year. The increase was primarily due to an increase in the overall provision charged from 27% of loans originated during the three and six-months ended June 30, 2000 to 31% of loans originated during the same periods of 2001. The increase was necessary to establish an adequate allowance for the finance receivables. The provision per loan originated increased 23.6% and 21.6% for the three and six-month periods ended June 30, 2001 over the same periods of the previous year. The rise is due to the increase in the overall provision mentioned above, coupled with an increase of $654 in the average amount financed for the three-month period ended June 30, 2001 to $8,965 per unit versus $8,311 during the same period of the previous year. For the six-month period ended June 30, 2001, the average amount financed increased $493 to $8,720 from $8,227 financed in the equivalent period of the previous year. See "Static Pool Analysis" below for further Provision for Credit Loss discussion. 13
Net Interest Income Three Months Ended Six Months Ended -------------------------- ------------------------ June 30, Percentage June 30, Percentage -------------------------- ------------------------ 2001 2000 Change 2001 2000 Change -------------------------- ------------- ------------------------ ------------- Interest Income $ 34,900 $ 29,871 16.8% $ 68,744 $ 55,402 $ 24.1% Portfolio Interest Expense (7,492) (5,997) 24.9% (16,011) (11,026) 45.2% -------------------------- ------------------------ Net Interest Income $ 27,408 $ 23,874 14.8% $ 52,733 $ 44,376 18.8% ========================== ======================== Average Effective Yield 26.7% 26.8% 26.5% 26.5% Average Borrowing Cost 8.3% 9.7% 8.6% 9.4%
Interest Income consists primarily of interest on finance receivable principal balances retained on our balance sheet. Retained principal balances, net grew to $544.6 million at June 30, 2001 from $451.2 million at June 30, 2000. The growth in retained principal balances is primarily due to the change in the way we structure our securitizations to the collateralized borrowing method during the fourth quarter of 1998. Since that time, all securitized loans are retained on our balance sheet and the income is recognized over the life of the loan. Portfolio interest expense increased to $7.5 million and $16.0 million for the three and six-month periods ending June 30, 2001, respectively, versus $6.0 million and $11.0 million, respectively, for the same periods of the previous year. The increase is due to the increase in Portfolio Notes Payable, which consist of our Class A obligations related to our securitization program, along with our revolving warehouse facility. This increase in interest expense is offset by the additional interest income earned from the growth in finance receivables retained on our balance sheet. Income before Operating Expenses Income before Operating Expenses decreased 9.6% to $40.5 million for the three-month period ended June 30, 2001 and decreased 7.1% to $84.1 million for the six-month period ended June 30, 2001 as compared to $44.8 million and $90.5 million for the three and six-month periods ended June 30, 2000, respectively. The decrease resulted from a decrease in Used Car Sales and an increase in the amount charged to current operations for the provision for credit losses from 27% during 2000 to 31% in the first half of 2001, and an increase in interest expense resulting from additional portfolio notes payable, partially offset by an increase in interest income due to the growth in the finance receivables portfolio. Operating Expenses
Three Months Ended Six Months Ended June 30, Percentage June 30, Percentage ------------------------- ------------------------ 2001 2000 Change 2001 2000 Change -------------------------------------- ------------------------ ------------- Operating Expenses $ 35,887 $ 34,849 3.0% $ 73,358 $ 70,730 3.7% ========================= ======================== Per Car Sold $ 3,092 $ 2,425 27.5% $ 2,773 $ 2,344 18.3% ========================= ======================== As % of Total Revenue 25.5% 23.0% 24.1% 22.8% ========================= ========================
Operating expenses, which consist of selling, marketing, general and administrative and depreciation/amortization expenses, increased slightly quarter over quarter and for the six months ended June 30, 2001 versus 2000 but remained relatively constant as a percentage of total revenues. Included in these expenses for the six-month period ended June 30, 2001, is a pre-tax charge of approximately $600,000, taken during the first quarter of 2001, for the closing of the collection and loan administration centers in Florida and Texas. During the first quarter of 2001, we initiated a plan to close our collections and loan administration operations in Clearwater, Florida, Plano, Texas and Dallas, Texas and move them to our stores or to our Gilbert, Arizona collection facility. As a result of these closings, we took an after tax charge of approximately $368,000 to cover payroll, severance and certain property related expenses. We had estimated to take additional restructuring charges in the second quarter related to costs of abandoned assets still in use with a carrying value of approximately $500,000. We have taken a charge of approximately 14 $230,000 related to the cost of abandoned assets in Plano, Texas with the remaining charge for the Clearwater facility expected to be taken during the third quarter of 2001. The impact resulting from the shut down of these operations, including the impact of future charges, is estimated to be break even over the remainder of 2001 and to decrease operating expenses by $1.5 million annually beginning in 2002. Other Interest Expense Interest expense arising from our other, non-portfolio debt totaled $2.9 million and $6.0 million for the three and six-months periods ended June 30, 2001 versus $2.6 million and $4.9 million for the comparable periods of the prior year. The increase is primarily attributable to interest expense arising from our exchange debt on the exchange offer completed in April 2000. Income Taxes Income taxes totaled $0.7 million and $2.0 million for the three and six-month periods ended June 30, 2001, respectively, versus $3.0 million and $6.1 million, respectively, for same equivalent periods in 2000. Our effective tax rate was 41% for all periods presented. Earnings before Extraordinary Item Earnings before Extraordinary Item totaled $1.0 million and $2.8 million for the three and six-month periods ended June 30, 2001, respectively, versus $4.3 million and $8.8 million, respectively, for the same periods of the previous year. The decrease is primarily a result of the increase in the Provision for Credit Loss from 27% to 31% of originations and an increase in portfolio interest expense, partially offset by an increase in interest income. Gain on Early Extinguishment of Debt During the three-months ended June 30, 2001, we repurchased in the open market and retired approximately $3.2 million of our exchange offer debt due October 2003, for approximately $2.6 million. The after tax impact of the purchase was a gain from extinguishment of debt of $0.3 million. Net Earnings Net Earnings totaled $1.4 million and $3.2 million for the three and six-months ended June 30, 2001, respectively, as compared with $4.3 million and $8.8 million for the same periods of the prior year. The decrease is primarily a result of a decrease in Used Cars Sold, an increase in the provision for credit loss from 27% to 31% of originations and an increase in portfolio interest expense, partially offset by an increase in interest income. Business Segment Information We report our operations based on three operating segments. These segments are reported as Retail, Portfolio and Corporate. These segments were previously reported as Company Dealership, Company Dealership Receivables and Corporate and Other, respectively. See Note 6 to the Condensed Consolidated Financial Statements. Operating Expenses for our business segments, along with a description of the included activities, for the three and six-month periods ended June 30, 2001 and 2000 are as follows: Retail Operations. Operating expenses for our Retail segment consist of Company marketing efforts, maintenance and development of dealership and inspection center sites, and direct management oversight of used car acquisition, reconditioning and sales activities. A summary of retail operating expenses follows: 15
Three Months Ended Six Months Ended June 30, June 30, -------------------------------------- --------------------------------------- 2001 2000 2001 2000 ------------------- ----------------- ----------------- -------------------- Retail Operations Selling and Marketing $ 6,235 $ 7,426 $ 13,861 $ 15,561 General and Administrative 14,855 14,593 29,513 28,783 Depreciation and Amortization 1,363 1,133 2,689 2,204 ------------------- ----------------- ----------------- -------------------- Retail Expense $ 22,453 $ 23,152 $ 46,063 $ 46,548 =================== ================= ================= ==================== Per Car Sold: Selling and Marketing $ 537 517 524 516 General and Administrative 1,280 1,016 1,115 954 Depreciation and Amortization 117 79 102 73 ------------------- ----------------- ----------------- -------------------- Total $ 1,934 $ 1,612 $ 1,741 $ 1,543 =================== ================= ================= ==================== As % of Used Cars Sold Revenue: Selling and Marketing 5.9% 6.1% 5.9% 6.1% General and Administrative 14.0% 12.0% 12.5% 11.3% Depreciation and Amortization 1.3% 0.9% 1.1% 0.9% ------------------- ----------------- ----------------- -------------------- Total 21.2% 19.1% 19.5% 18.3% =================== ================= ================= ====================
Selling and Marketing expenses on a per car sold basis have increased due to a decrease in the amount of cars sold without a proportionate decrease in expenses, for both the three and six-months ended June 30, 2001, versus the same period of the previous year. However, selling and marketing costs as a percentage of Used Cars Sold Revenue have remained relatively constant primarily due to an increase of $667 and $495 in the average sales price per car for the three and six months ended June 30, 2001, respectively. General and Administrative expenses increased both on a per car sold basis as well as on a percentage of related revenue basis for the three and six-month periods ended June 30, 2001, principally due to a reduction in the amount of cars sold and a high proportion of fixed general and administrative costs. We are in the process of implementing cost savings initiatives across the company in an effort to improve profitability. Portfolio Operations. Operating expenses for our Portfolio segment consist of loan servicing and collection efforts, securitization activities, and other operations pertaining directly to the administration and collection of the loan portfolio.
Three Months Ended Six Months Ended June 30, June 30, ------------------------------------ -------------------------------------- 2001 2000 2001 2000 ------------------ ---------------- ------------------ ------------------ Portfolio Expense: General and Administrative $ 7,359 $ 5,416 $ 15,367 $ 11,493 Depreciation and Amortization 232 280 496 580 ------------------ ---------------- ------------------ ------------------ Portfolio Expense $ 7,591 $ 5,696 $ 15,863 $ 12,073 ================== ================ ================== ================== Expense per Month per Loan Serviced $ 29.25 $ 24.06 $ 30.37 $ 26.36 ================== ================ ================== ================== Annualized Expense as % of EOP Managed Principal Balances 5.8% 5.0% 6.0% 5.3% ================== ================ ================== ==================
The increase in portfolio expenses as well as the expense per month per loan serviced for the three and six-month periods ended June 30, 2001 for our Portfolio segment is primarily a result of the increased number of loans in our portfolio. Also attributing to the increase was approximately $600,000 for the six-month period ended June 30, 2001, respectively, for costs incurred in relation to the closing of the collection and loan administration facilities in Florida and Texas during the first quarter of 2001. 16 Corporate Operations. Operating expenses for our Corporate segment consist of costs to provide managerial oversight, financings and reporting for the Company, develop and implement policies and procedures, and provide expertise to the Company in areas such as finance, legal, human resources and information technology.
Three Months Ended Six Months Ended June 30, June 30, ------------------------------------ --------------------------------------- 2001 2000 2001 2000 ------------------ ---------------- ----------------- -------------------- Corporate Expense: General and Administrative $ 5,003 $ 5,183 $ 9,775 $ 10,454 Depreciation and Amortization 840 818 1,657 1,655 ------------------ ---------------- ----------------- -------------------- Corporate Expense $ 5,843 $ 6,001 $ 11,432 $ 12,109 ------------------ ---------------- ----------------- -------------------- Per Car Sold $ 503 $ 418 $ 432 $ 401 ================== ================ ================= ==================== As % of Total Revenues 4.1% 4.0% 3.8% 3.9% ================== ================ ================= ====================
Operating expenses related to our Corporate segment as a percent of total revenue remained relatively consistent for the three and six-months ended June 30, 2001, versus the same period of 2000. However, on a per car sold basis corporate expenses increased $85 and $31 per car for the three and six-months ended June 30, 2001, respectively, as compared to the same periods of the previous year. The increase on a per car sold basis is due to a decline in used cars sold for both the three and six-months ended June 30, 2001 without a proportionate reduction in expenses. As mentioned previously, we are taking steps to implement a cost savings plan in an effort to reduce overall company expenses. Financial Position The following table represents key components of our financial position:
June 30, December 31, Percentage 2001 2000 Change -------------------------------------------------- Total Assets $ 678,950 $ 652,121 4.1% Inventory 40,772 63,742 (36.0%) Finance Receivables, Net 544,585 500,469 8.8% Net Assets of Discontinued Operations 3,734 4,175 (10.6%) Total Debt 493,323 457,652 7.8% Notes Payable - Portfolio 415,877 406,551 2.3% Other Notes Payable 42,495 16,579 156.3% Subordinated Notes Payable 34,951 34,522 1.2% Stockholders' Equity $ 158,604 $ 155,400 2.1%
Total Assets. Total assets has increased slightly due to an increase in Finance Receivables, Net, partially offset by the decrease in Inventory. Inventory. Inventory represents the acquisition and reconditioning costs of used cars located at our dealerships and our inspection centers. Our strong sales periods are typically the first and second quarters of the year. Consequently, management increases inventory levels at year-end in preparation for the upcoming increase in demand. As the increase in demand diminishes, inventory levels return to normal operating levels, thus the lower inventory amount as of June 30, 2001. Growth in Finance Receivables, net. Due to the lack of growth in the volume of cars sold, Finance Receivables, net as of June 30, 2001 increased only 8.8% from December 31, 2000. See Note (2) to the Condensed Consolidated Financial Statements for the details of the components of Finance Receivables, net. 17 The following table reflects the growth in principal balances retained on our balance sheet measured in terms of the principal balances and the number of loans outstanding.
Managed Loans Outstanding ----------------------------------------------------------------------- ----------------------------------------------------------------------- Principal Balances Number of Loans ----------------------------------------------------------------------- June 30, December 31, June 30, December 31, 2001 2000 2001 2000 ----------------------------------------------------------------------- Principal - Managed $ 534,766 $ 519,005 86,446 84,864 Less: Principal - Securitized and Sold - 4,059 - 2,266 ----------------------------------------------------------------------- Principal - Retained on Balance Sheet $ 534,766 $ 514,946 $ 86,446 $ 82,598 =======================================================================
At June 30, 2001, the entire loan portfolio is on balance sheet. Principal Balances - Retained on Balance Sheet has increased 3.8%. As we continue to focus on enhanced underwriting guidelines, we do not expect the portfolio balance to grow as significantly as in past quarters. The number of loans originated were 11,558 for the quarter ended June 30, 2001, versus 14,291 during the same quarter of the prior year. For the six-months ended June 30, the number of loans originated totaled 26,334 in 2001 versus 30,012 in 2000. Although the volume of loans originated is declining and the number of loans outstanding is leveling, we believe the quality of the loans written is improving, with the ultimate goal of reducing loan losses. The following table reflects activity in the Allowance for Credit Losses, as well as information regarding charge off activity, for the three and six months ended June 30, 2001 and 2000:
Three Months Ended Six Months Ended June 30, June 30, ---------------------------------------------------------------------------- 2001 2000 2001 2000 ------------------ ------------------------------------ ----------------- Allowance Activity: Balance, Beginning of Period $ 102,000 $ 87,585 $ 99,700 $ 76,150 Provision for Credit Losses 32,210 32,212 71,230 66,785 Other Allowance Activity (48) (1,104) (6) (1,000) Net Charge Offs (32,573) (20,160) (69,335) (43,402) ------------------ ------------------------------------ ------------------- Balance, End of Period $ 101,589 $ 98,533 $ 101,589 $ 98,533 ================== ==================================== ================= Allowance as % Ending Principal Balances 19.0% 20.9% 19.0% 20.9% ================== ==================================== =================
The Allowance for Credit Losses is maintained at a level that in management's judgment is adequate to provide for estimated probable credit losses inherent in our retail portfolio for the next 12 months. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Static Pool Analysis" below. Charge offs, net of recoveries, for the three months ended June 30, 2001 and 2000 were $32.6 million and $20.2 million, respectively. As a percentage of average principal balances, net charge offs for the same periods were 6.1% and 4.1%, respectively. For the six-month periods ended June 30, 2001 and 2000, net charge offs were $69.4 million and $43.4 million, respectively. Net charge offs as a percentage of average principal balances for the same periods were 13.0% and 9.3%, respectively. During the second quarter of 2001, we inserted 31-60 day collectors into the majority of the dealerships. Upon initial deployment of the 31-60 day collectors, we experienced some negative performance as the collectors and collection managers adapted to collecting and managing the mid-range delinquencies and a decentralized environment. Adjustments were subsequently made in an attempt to address the negative performance issues and we ultimately expect to improve collection performance as a result of the relocation of these collectors. While we continue to monitor the adequacy of our allowance for finance receivables, there can be no assurance that our provision rate, currently 31% of originations, will be adequate to maintain an allowance balance that will cover net charge offs for the next twelve months. In particular, the current level of the allowance is premised in part on projected improvements in collections and improved underwriting on more recent originations, which, if they don't materialize, may result in the need for a higher level for the allowance as early as the third quarter. Consequently, dependent upon our allowance evaluations in the future, the rate of provision charged may need to be increased in future quarters. 18 Static Pool Analysis We use a "static pool" analysis to monitor performance for loans we have originated at our dealerships. In a static pool analysis, we assign each month's originations to a unique pool and track the charge offs for each pool separately. We calculate the cumulative net charge offs for each pool as a percentage of that pool's original principal balances, based on the number of complete payments made by the customer before charge off. The table below displays the cumulative net charge offs of each pool as a percentage of original loan cumulative balances, based on the quarter the loans were originated. The table is further stratified by the number of payments made by our customers prior to charge off. For periods denoted by "x", the pools have not seasoned sufficiently to allow us to compute cumulative losses. For periods denoted by "-", the pools have not yet reached the indicated cumulative age. While we monitor static pools on a monthly basis, for presentation purposes we are presenting the information in the table below on a quarterly basis. Currently reported cumulative losses may vary from those previously reported due to ongoing collection efforts on charged off accounts, and the difference between final proceeds on the sale of repossessed collateral versus our estimates of the sale proceeds. Management, however, believes that such variation will not be material. The following table sets forth as of July 31, 2001, the cumulative net charge offs as a percentage of original loan cumulative (pool) balances, based on the quarter of origination and segmented by the number of monthly payments completed by customers before charge off. The table also shows the percent of principal reduction for each pool since inception and cumulative total net losses incurred (TLI).
Pool's Cumulative Net Losses as Percentage of Pool's Original Aggregate Principal Balance ($ in thousands) Monthly Payments Completed by Customer Before Charge Off ---------------------------------------------------------------------------------- Orig. 0 3 6 12 18 24 TLI Reduced ---------- -------- -------- -------- -------- -------- -------- -------- -------- 1993 $ 12,984 8.8% 22.1% 28.5% 33.8% 35.9% 36.5% 36.8% 100.0% 1994 $ 23,589 5.3% 14.8% 19.9% 25.6% 28.0% 28.7% 28.8% 100.0% 1995 $ 36,569 1.9% 8.1% 13.1% 19.0% 22.2% 23.5% 24.1% 100.0% 1996: $ 48,996 1.5% 8.1% 13.9% 22.1% 26.2% 27.9% 28.9% 100.0% 1997: 1st Quarter $ 16,279 2.1% 10.7% 18.2% 24.8% 29.8% 32.0% 33.5% 100.0% 2nd Quarter $ 25,875 1.5% 9.9% 15.8% 22.7% 27.4% 29.4% 30.6% 100.0% 3rd Quarter $ 32,147 1.4% 8.3% 13.2% 22.4% 26.9% 29.1% 30.6% 99.9% 4th Quarter $ 42,529 1.4% 6.8% 12.6% 21.8% 26.0% 28.7% 29.9% 99.9% 1998: 1st Quarter $ 69,708 0.9% 6.9% 13.4% 20.9% 26.3% 28.7% 29.9% 99.8% 2nd Quarter $ 66,908 1.1% 8.1% 14.2% 21.7% 27.2% 29.2% 30.2% 98.4% 3rd Quarter $ 71,027 1.0% 7.9% 13.3% 23.0% 27.7% 30.2% 30.9% 99.1% 4th Quarter $ 69,583 0.9% 6.6% 13.1% 24.2% 29.0% 31.4% 31.9% 97.2% 1999: 1st Quarter $ 103,068 0.8% 7.4% 15.0% 23.5% 29.4% 31.6% 31.9% 93.5% 2nd Quarter $ 95,768 1.1% 9.9% 16.7% 25.3% 31.4% x 33.4% 88.2% 3rd Quarter $ 102,585 1.0% 8.3% 14.2% 25.2% 30.8% -- 31.8% 82.4% 4th Quarter $ 80,641 0.7% 5.9% 12.6% 23.6% x -- 28.3% 74.6% 2000: 1st Quarter $ 128,123 0.3% 6.5% 14.6% 24.2% -- -- 26.3% 66.1% 2nd Quarter $ 118,778 0.6% 8.6% 15.9% x -- -- 24.2% 56.1% 3rd Quarter $ 124,367 0.7% 7.8% 14.4% -- -- -- 18.1% 43.7% 4th Quarter $ 100,823 0.6% 6.7% x -- -- -- 11.1% 29.9% 2001: 1st Quarter $ 126,015 0.4% x -- -- -- -- 4.2% 18.1% 2nd Quarter $ 103,615 x -- -- -- -- -- 0.3% 5.5%
19 The following table sets forth the principal balances delinquency status as a percentage of total outstanding contract principal balances from dealership operations.
June 30, 2001 June 30, 2000 December 31, 2000 ----------------- ----------------- ---------------------- Days Delinquent: Current 76.4% 71.9% 66.1% 1-30 Days 16.8% 20.9% 26.1% 31-60 Days 4.1% 4.5% 4.7% 61-90 Days 2.7% 2.7% 3.1% ----------------- ----------------- ---------------------- Total Portfolio 100.0% 100.0% 100.0% ================= ================= ======================
In accordance with our charge off policy, there are no accounts more than 90 days delinquent as of June 30, 2001. Delinquencies rose during the second quarter of 2001 versus the first quarter of this year, primarily due to seasonality. However, current and 1-30 day delinquencies have improved over the same quarter of the prior year. The current accounts, those not one day late, have improved to 76.4% as compared to 71.9% for the second quarter of 2000. Current accounts at March 31, 2001 were 78.6% and were 72.4% and 66.1% at the end of the third and fourth quarters of 2000, respectively. The improvements in 2001 over the prior year quarters are attributable to the success of the Company's in store collectors which service the 1-30 day accounts. During the second quarter of 2001, the Company also inserted 31-60 day collectors into the majority of the dealerships in order to achieve the same successes as the roll out of the 1-30 day collectors and continue to make improvements in the loans losses of this category. Based upon our continued review of the adequacy of the Allowance for Credit Losses, we have recorded a provision for loan losses for the three and six months ended June 30, 2001 at 31% of originations. The 31% provision is 1% higher than the effective 30% provision for 2000 and 4% greater than the 27% recorded during the first and second quarters of 2000, as losses on our existing, older portfolio continue to emerge at higher than expected levels. With the provision recorded during this quarter, we believe the allowance balance as of June 30, 2001 remains at a level that we estimate to be adequate to cover net charge offs for the next 12 months. Securitizations Under the current legal structure of our securitization program, we sell loans to our bankruptcy remote subsidiaries that then securitize the loans by transferring them to separate trusts that issue several classes of notes and certificates collateralized by the loans. The securitization subsidiaries then sell Class A bonds or certificates (Class A obligations or Notes Payable) representing approximately 71% of the total finance receivable balance for the most recent securitizations to investors and subordinate classes are retained by us. We continue to service the securitized loans. The Class A obligations have historically been structured so as to receive investment grade ratings. To secure the payment of the Class A obligations, the securitization subsidiaries obtain an insurance policy from MBIA Insurance Corporation that guarantees payment of amounts to the holders of the Class A obligations. Additionally, we also establish a cash "reserve" account for the benefit of the Class A obligation holders. The cash reserve accounts are classified in our condensed consolidated financial statements as Investments Held in Trust and are a component of Finance Receivables, net. Reserve Account Requirements. Under our current securitization structure, we make an initial cash deposit into a reserve account, generally equivalent to 3.0%-6.0% of the initial underlying Finance Receivables principal balance, and pledge this cash to the reserve account agent. The trustee then makes additional deposits to the reserve account out of collections on the securitized receivables as necessary to fund the reserve account to a specified percentage, ranging from 8.0% to 11.0%, of the underlying Finance Receivables' principal balance. The trustee makes distributions to us when: o the reserve account balance exceeds the specified percentage, o the required periodic payments to the Class A certificate holders are current, and o the trustee, servicer and other administrative costs are current. Certain Financial Information Regarding Our Securitizations 20 During June 2001, we closed our 20th securitization in which we securitized $142.3 million of loans, $35.5 million of which was pre-funded, and issued $100.8 million in Class A certificates with an annual interest rate of 4.74%, a significant rate improvement from our securitizations closed during 2000. Liquidity and Capital Resources
We require capital for: o increases in our loan portfolio, o the seasonal purchase of inventories, and o working capital and general corporate purposes, o the purchase or lease of property and equipment. o equity or debt repurchases, We fund our capital requirements primarily through: o operating cash flow, o our revolving warehouse and inventory credit lines, and o securitization transactions, o supplemental borrowings.
While to date we have met our liquidity requirements as needed, there can be no assurance that we will be able to continue to do so in the future. Cash Flow Net cash provided by operating activities decreased $13.7 million to $94.0 million in the six months ended June 30, 2001. The decrease is primarily due to a significant decrease in accrued liabilities at June 30, 2001 and a decrease in collections of residuals in finance receivables sold, offset by a decrease in inventory levels. Net cash used in investing activities decreased $64.5 million to $94.1 million during the six months ended June 30, 2001 as compared to $158.6 million used during the same period of 2000. The decrease is due to increased collections on finance receivables and a decline in the increase of finance receivables. Financing activities used $2.2 million for the six months ended June 30, 2001, versus generating $23.5 million during the six months ended June 30, 2000. The change is primarily due to net payments made on Notes Payable and an increase in additional deposits into investments held in trust. Financing Resources Revolving Facility. In April 2001, we replaced our warehouse receivables facility, previously with GE Capital, and have extended the $25 million inventory line of credit portion of the prior facility from June 30, 2001 until December 31, 2001. The extension on the inventory line of credit requires us to pay a fee for each quarterly extension after June 30, 2001, and after June 30, 2001, the interest rate on the line increases by 50 basis points to LIBOR plus 3.65% and is secured by substantially all company assets. The interest rate in effect on this line was 7.31% at June 30, 2001. Currently, we have signed a term sheet with a lender to replace the inventory line of credit and expect to close on this facility by August 31, 2001. Our new revolving facility is with Greenwich Capital Financial Products, Inc. and allows for maximum borrowings of $75 million during the period May 1 through November 30 increasing to $100 million during the period December 1 through April 30. The term of the facility is 364 days with a renewal option, upon mutual consent, for an additional 364-day period. The borrowing base consists of up to 65% of the principal balance of eligible loans originated from the sale of used cars. The lender maintains an option to adjust the advance rate to reflect changes in market conditions or portfolio performance. The interest rate on the facility is LIBOR plus 2.80% (6.96% at June 30, 2001). The facility is secured with substantially all Company assets. The line is subject to several covenants, including certain financial and loan portfolio related covenants. At June 30, 2001, we were in compliance with all of the covenants. 21 Securitizations. Our securitization program is a primary source of our working capital. Securitizations generate cash flow for us from the sale of Class A obligations, ongoing servicing fees, and excess cash flow distributions from collections on the loans securitized after payments on the Class A obligations, payment of fees, expenses, and insurance premiums, and required deposits to the reserve accounts. Securitization also allows us to fix our cost of funds for a given loan portfolio. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Securitizations" for a more complete description of our securitization program. Supplemental Borrowings. In January 2001, we entered into a $35 million senior secured loan facility as a renewal for our $38 million senior loan facility originated in May 1999. The new facility has a term of 25 months. Per the agreement we must make principal payments of $1.0 million per month during months 4 through 22. Thereafter through maturity, the agreement requires minimum payments of the greater of $3.0 million per month or 50% of the cash flows from classes of notes issued through securitization that are subordinate to the A notes.Interest is payable monthly at LIBOR plus 600 basis points (10.16% at June 30, 2001). The balance on this note was $32.0 million at June 30, 2001. As a condition to the $35 million senior secured loan agreement, Verde Investments, Inc., an affiliate of Mr. Garcia, was required to invest $7 million in us through a subordinated loan. The funds were placed in escrow as additional collateral for the $35 million senior secured loan. The funds were to be released in July 2001 if, among other conditions, we had at least $7 million in pre-tax income through June of 2001 and, at that time, Mr. Garcia would have guaranteed 33.3% of the $35 million facility. If the loan with Verde and the guarantee of the $35 million senior secured loan were not removed by July 25, 2001, Mr. Garcia was entitled to receive warrants from us for 1.5 million shares of stock, vesting over a one-year period, at an exercise price of $4.50 subject to certain conditions. Under the terms of the senior secured loan agreement, any necessary shareholder approval is a condition of the issuance of the warrants. We have been advised by NASDAQ that shareholder approval is required. We, with Mr. Garcia's consent, have delayed obtaining shareholder approval until after the resolution of Mr. Garcia's offer to purchase our outstanding common stock. See item 5 under "Part II -Other Information" for further information on Mr. Garcia's offer. Also as consideration for the loan, we released all options to purchase real estate that were then owned by Verde and leased to us. We also granted Verde the option to purchase, at book value, any or all properties currently owned by us, or acquired by us prior to the earlier of December 31, 2001, or the date the loan is repaid. Verde agreed to lease the properties back to us, on terms similar to our current leases, if it exercises its option to purchase any of the properties. The loan is secured by residual interests in our securitization transactions but is subordinate to the senior secured loan facility. The loan requires quarterly interest payments at LIBOR plus 600 basis points (10.16% at June 30, 2001) and is subject to pro rata reductions if certain conditions are met. An independent committee of our board reviewed and negotiated the terms of this subordinated loan and we also received an opinion from an investment banker, which deemed the loan fair from a financial point of view both to our shareholders and us. The balance of the note with Verde was $6.6 million at June 30, 2001. Capital Expenditures and Commitments In November 2000, Verde Investments, Inc. ("Verde"), an affiliate of Mr. Garcia, purchased a certain property located in Phoenix, Arizona and simultaneously leased the property to us pursuant to among other terms the following: 20 year term which expires December 31, 2020; rent payable monthly with 5% annual rent adjustments; triple net lease; four five-year options to renew; and an option to purchase the property upon prior notice and at Verde's cost. Subsequently, we surrendered this option as part of the $7 million subordinated loan with Verde. We are in the process of building a new headquarters at this location and anticipate an occupancy date of August 2001. Accounting Matters In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 as well as all purchase method business combinations completed after June 30, 2001. Statement 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill. Statement 142 will require that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 will also require that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. 22 The Company is required to adopt the provisions of Statement 141 immediately and Statement 142 effective January 1, 2002. Furthermore, any goodwill and any intangible asset determined to have an indefinite useful life that are acquired in a purchase business combination completed after June 30, 2001 will not be amortized, but will continue to be evaluated for impairment in accordance with the appropriate pre-Statement 142 accounting literature. Goodwill and intangible assets acquired in business combinations completed before July 1, 2001 will continue to be amortized prior to the adoption of Statement 142. Statement 141 will require upon adoption of Statement 142, that the Company evaluate its existing intangible assets and goodwill that were acquired in a prior purchase business combination, and make any necessary reclassifications in order to conform with the new criteria in Statement 141 for recognition apart from goodwill. Upon adoption of Statement 142, the Company will be required to reassess the useful lives and residual values of all intangible assets acquired in purchase business combinations, and make any necessary amortization period adjustments by the end of the first interim period after adoption. In addition, to the extent an intangible asset is identified as having an indefinite useful life, the Company will be required to test the intangible asset for impairment in accordance with the provisions of Statement 142 within the first interim period. Any impairment loss will be measured as of the date of adoption and recognized as the cumulative effect of a change in accounting principle in the first interim period. As of January 1, 2002, the Company expects to have unamortized goodwill of approximately $11.6 million and no unamortized identifiable intangible assets. The goodwill will be subject to the transition provisions of Statements 141 and 142. Amortization expense related to goodwill was approximately $1.0 million, $0.2 million and $0.5 million for the year ended December 31, 2000 and for the three and six months ended June 30, 2001, respectively. Because of the extensive effort needed to comply with adopting Statements 141 and 142, it is not practicable to reasonably estimate the impact of adopting these Statements on the Company's financial statements at the date of this report, including whether any transitional impairment losses will be required to be recognized as the cumulative effect of a change in accounting principle. In September 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (SFAS No. 140). SFAS No. 140 replaces SFAS No. 125 and revises the standards for accounting for securitizations and other transfers of financial assets and collateral. This statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The adoption of SFAS No. 140 did not have a material impact on us. In June 2000, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" (SFAS No. 138). SFAS No. 138 amends a limited number of issues causing implementation difficulties for entities that apply SFAS No. 133. SFAS No. 138 is effective for fiscal years beginning after June 15, 2000. Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133) required all derivatives to be recorded on the balance sheet at fair value and establishes new accounting rules for hedging instruments. The adoption of SFAS No. 138 or No. 133 did not have a material effect on us. We Make Forward Looking Statements This report includes statements that constitute forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We claim the protection of the safe-harbor for our forward looking statements. Forward-looking statements are often characterized by the words "may," "anticipates," "believes," "estimates," "projects," "expects" or similar expressions and do not reflect historical facts. Forward-looking statements in this report relate, among other matters, to: anticipated financial results, such as sales, other revenues and loan portfolios, improvements in underwriting, adequacy of the allowance for credit losses, and improvements in recoveries and loan performance, including delinquencies and charge offs; the closing of the replacement inventory line of credit; roll-out of collectors to our dealerships; the success of cost control related initiatives; improvements in inventory and inventory mix; and e-commerce related growth and loan performance. Forward looking statements include risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward looking statements, some of which we cannot predict or quantify. Factors that could affect our results and cause or contribute to differences from these forward-looking statements include, but are not limited to: any decline in consumer acceptance of our car sales strategies or marketing campaigns; any inability to finance our operations in light of a tight credit market for the sub-prime industry and our current financial circumstances; any deterioration in the used car finance industry or increased competition in the used car sales and finance industry; any inability to monitor and improve our underwriting and collection processes; any changes in estimates and assumptions in, and the ongoing adequacy of, our allowance for credit losses; any inability to continue to reduce operating expenses as a percentage of sales; increases in interest rates; adverse economic conditions; any material litigation against us or material, unexpected developments in existing litigation; any new or revised accounting, tax or legal guidance that adversely affect used car sales or financing; and developments with respect to Mr. Garcia's offer to take us private. Future events and actual results could differ materially from the forward-looking statements. 23 When considering each forward-looking statement, you should keep in mind the risk factors and cautionary statements found in the sections entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Risk Factors," in our most recent report on Form 10-K, in Exhibit 99 attached to this Quarterly Report on Form 10-Q and elsewhere in our Securities and Exchange Commission filings. In addition, the foregoing factors may affect generally our business, results of operations and financial position. There may also be other factors that we are currently unable to identify or quantify, but may arise or become known in the future. Forward looking statements speak only as of the dated the statement was made. We are not obligated to publicly update or revise any forward looking statements, whether as a result of new information, future events, or for any other reason. ITEM 3. Market Risk We are exposed to market risk on our financial instruments from changes in interest rates. We do not use financial instruments for trading purposes or to manage interest rate risk. Our earnings are substantially affected by our net interest income, which is the difference between the income earned on interest-bearing assets and the interest paid on interest bearing notes payable. Increases in market interest rates could have an adverse effect on profitability. Our financial instruments consist primarily of fixed rate finance receivables, residual interests in pools of fixed rate finance receivables, short-term variable rate revolving Notes Receivable, and variable and fixed rate Notes Payable. Our finance receivables are classified as subprime loans and generally bear interest at the lower of 29.9% or the maximum interest rate allowed in states that impose interest rate limits. At June 30, 2001, the scheduled maturities on our finance receivables ranged from one to 48 months, with a weighted average maturity of 23.6 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 June 30, 2001 is the Collateralized Notes Payable (Class A obligations) issued under our securitization program. Issuing debt through our securitization program allows us to mitigate our interest rate risk by reducing the balance of the variable revolving line of credit and replacing it with a lower fixed rate note payable. We are subject to interest rate risk on fixed rate Notes Payable to the extent that future interest rates are lower than the interest rates on our existing Notes Payable. We believe that our market risk information has not changed materially from December 31, 2000. 24 PART II. OTHER INFORMATION Item 1. Legal Proceedings. We sell our cars on an "as is" basis. We require all customers to acknowledge in writing on the date of sale that we disclaim any obligation for vehicle-related problems that subsequently occur. Although we believe that these disclaimers are enforceable under applicable laws, there can be no assurance that they will be upheld in every instance. Despite obtaining these disclaimers, in the ordinary course of business, we receive complaints from customers relating to vehicle condition problems as well as alleged violations of federal and state consumer lending or other similar laws and regulations. Most of these complaints are made directly to us or to various consumer protection organizations and are subsequently resolved. However, customers occasionally name us as a defendant in civil suits filed in state, local, or small claims courts. Additionally, in the ordinary course of business, we are a defendant in various other types of legal proceedings, and are the subject of regulatory or governmental investigations. Although we cannot determine at this time the amount of the ultimate exposure from such matters, if any, we do not expect the final outcome to have a material adverse effect on us. There has also been litigation filed in connection with or related to the intent and/or offer of our chairman, Mr. Garcia, to purchase all of our outstanding common stock not owned by him (See Item 5 below). On March 20, 2001, a shareholder derivative complaint was filed, purportedly on behalf of Ugly Duckling Corporation, in the Court of Chancery for the State of Delaware in New Castle County, captioned Berger v. Garcia, et al., No. 18746NC. The complaint alleges that our current directors breached fiduciary duties owed to us in connection with certain transactions between us and Mr. Garcia and various entities controlled by Mr. Garcia. The complaint was amended on April 17, 2001 to add a second cause of action, on behalf of all persons who own our common stock, and their successors in interest, which alleges that our current directors breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of Ugly Duckling common stock. Ugly Duckling is named as a nominal defendant in the action. The original cause of action seeks to void all transactions deemed to have been approved in breach of fiduciary duty and recovery by Ugly Duckling of alleged compensatory damages sustained as a result of the transactions. The second cause of action seeks to enjoin us from proceeding with the proposed acquisition by Mr. Garcia, or, in the alternative, awarding compensatory damages to the class. Following Mr. Garcia's offer in early April 2001, five additional and separate purported shareholder class action complaints were filed between April 17 and April 25, 2001 in the Court of Chancery for the State of Delaware in New Castle County. They are captioned Turberg v. Ugly Duckling Corp., et al., No. 18828NC, Brecher v. Ugly Duckling Corp., et al., No. 18829NC, Suprina v. Ugly Duckling Corporation, et al., No. 18830NC, Benton v. Ugly Duckling Corp., et al., No. 18838NC, and Don Hankey Living Trust v. Ugly Duckling Corporation, et al., No. 18843NC. Each complaint alleges that Ugly Duckling, and its directors, breached fiduciary duties in connection with the proposed acquisition by Mr. Garcia of all of the outstanding shares of the Ugly Duckling common stock. The complaints seek to enjoin the proposed acquisition by Mr. Garcia and to recover compensatory damages caused by the proposed acquisition and the alleged breach of fiduciary duties. These cases were consolidated in June 2001. We intend to vigorously defend against the plaintiff's allegations and believe that the actions are without merit. Item 2. Changes in Securities and Use of Proceeds. (a) None (b) None (c) None (d) Not Applicable Item 3. Defaults Upon Senior Securities. We recently obtained waiver letters for financial ratio covenant breaches under our revolving credit facility and our senior secured loan facility. Item 4. Submission of Matters to a Vote of Security Holders. None Item 5. Other Information. On April 16, 2001, as previously announced, Mr. Ernest Garcia, II, made an offer to the board of directors to purchase all of the outstanding shares of our common stock not already held by him. Under the terms of the offer, the holders of the outstanding shares of common stock would receive $7.00 per share, $2.00 in cash and $5.00 in subordinated debentures from the acquiring company. The 25 subordinated debentures would have interest payable at 10%, interest only payments semiannually until maturity and a ten-year term. Mr. Garcia's offer also states that Greg Sullivan, our chief executive officer and president, would receive an option to purchase a 20% interest in the acquiring company. The board of directors established a special transaction committee, composed of disinterested directors, which is in the process of evaluating the proposal. There can be no assurance that the proposed transaction regarding Mr. Garcia's offer to take us private referenced in this Form 10-Q will be consummated on the proposed terms or any revised terms. In the event that we accept the proposed transaction, we, and the acquiring company, will likely be required to file a joint proxy statement/prospectus and to make certain other filings regarding the proposed transaction with the Securities and Exchange Commission. Investors and security holders are advised to read all such filings regarding the proposed transaction, when and if the transaction proceeds and such filings are made, because they will contain important information. Investors and security holders may obtain free copies of any such filings (when and if they become available) and other documents filed by us with the Commission at the Commission's website at www.sec.gov. Information concerning any participants in any solicitation of Ugly Duckling stockholders that is made in connection with the proposed transaction will be disclosed when available. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits Exhibit 99 - Statement Regarding Forward Looking Statements and Risk Factors (b) Reports on Form 8-K. During the second quarter of 2001, the Company filed four reports on Form 8-K. The first report on Form 8-K, dated April 19, 2001 and filed April 20, 2001, reported Ugly Duckling's closing of a warehouse receivables loan facility, the closing of its 19th securitization and the extension of its inventory line of credit, and filed as an exhibit to the Form 8-K, was a press release dated April 16, 2001, entitled "Ugly Duckling Announces Closing of Warehouse Receivables Facility and 19th Securitization, and Extension of Inventory Line of Credit." The second report on Form 8-K dated April 19, 2001 and filed April 20, 2001, reported the receipt of an offer to purchase the Company, and filed as an exhibit to the Form 8-K was a press release dated April 16, 2001 entitled "Ugly Duckling Confirms Receipt of Offer to Purchase Company from Chairman/Largest Shareholder." The third report on Form 8-K, dated April 27, 2001 and filed April 30, 2001, reported Ugly Duckling's first quarter 2000 earnings, and filed as an exhibit to the Form 8-K was a press release dated April 25, 2001 entitled "Ugly Duckling Reports First Quarter 2001 Results." The fourth report filed on Form 8-K, dated May 16, 2001 and filed May 17, 2001, reported the hiring of an investment banker to evaluate the offer to purchase the Ugly Duckling by our chairman and litigation issues in connection with the offer. 26 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. UGLY DUCKLING CORPORATION /s/ STEVEN T. DARAK ----------------------------------------------------------------------- Steven T. Darak Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) Date: August 14, 2001 EXHIBIT INDEX
Exhibit Number Description 99 Statement Regarding Forward Looking Statements and Risk Factors
EX-99 3 exhibit99txt.txt RISK FACTORS Risk Factors There are various risks in purchasing our securities and investing in our business, including those described below. You should carefully consider these risk factors together with all other information included in this Form 10-Q. We make forward looking statements. This Report includes statements that constitute forward-looking statements within the meaning of the safe harbor provisions of the Private and Securities Litigation Reform Act of 1995. We claim the protection of the safe-harbor for our forward looking statements. Forward-looking statements are often characterized by the words "may," "anticipates," "believes," "estimates," "projects," "expects" or similar expressions and do not reflect historical facts. Forward-looking statements in this report relate, among other matters, to: anticipated financial results, such as sales, other revenues and loan portfolios, improvements in underwriting, adequacy of the allowance for credit losses, and improvements in recoveries and loan performance, including delinquencies and charge offs; the closing of the replacement inventory line of credit; roll-out of collectors to our dealerships; the success of cost control initiatives; improvements in inventory and inventory mix; and e-commerce related growth and loan performance. Forward looking statements include risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward looking statements, some of which we cannot predict or quantify. Factors that could affect our results and cause or contribute to differences from these forward-looking statements include, but are not limited to: any decline in consumer acceptance of our car sales strategies or marketing campaigns; any inability to finance our operations in light of a tight credit market for the sub-prime industry and our current financial circumstances; any deterioration in the used car finance industry or increased competition in the used car sales and finance industry; any inability to monitor and improve our underwriting and collection processes; any changes in estimates and assumptions in, and the ongoing adequacy of, our allowance for credit losses; any inability to continue to reduce operating expenses as a percentage of sales; increases in interest rates; adverse economic conditions; any material litigation against us or material, unexpected developments in existing litigation; and any new or revised accounting, tax or legal guidance that adversely affect used car sales or financing and developments with respect to Mr. Garcia's offer to take us private. Forward-looking statements speak only as of the date the statement was made. Future events and actual results could differ materially from the forward-looking statements. When considering each forward-looking statement, you should keep in mind the risk factors and cautionary statements found throughout this Form 10-Q and specifically those found below. We are not obligated to publicly update or revise any forward looking statements, whether as a result of new information, future events, or for any other reason. References to Ugly Duckling Corporation as the largest chain of buy-here pay-here used car dealerships in the United States is management's belief based upon the knowledge of the industry and not on any current independent third party study. Our majority stockholder can control substantially all matters put to a vote of stockholders. Ernest C. Garcia II, our Chairman, is the beneficial owner of a majority of our outstanding common stock. Mr. Garcia is now in a position to control the election of our directors or the approval of any merger, reorganization or other business combination transaction submitted to a vote of our shareholders or other extraordinary transaction. Mr. Garcia could vote to approve such a transaction on terms, which might be considered more favorable to Mr. Garcia than to unaffiliated stockholders. The terms of any such transaction could require stockholders other than Mr. Garcia to dispose of their shares of common stock for cash or other consideration even if the stockholders would prefer to continue to hold their shares of our common stock for investment. Any such transaction could also result in Ugly Duckling's common stock being delisted from the Nasdaq National Market or being held of record by fewer than 300 persons and, therefore, eligible for termination of registration pursuant to Section 12(g)(4) of the Securities Exchange Act of 1934. In filings with the Securities and Exchange Commission, Mr. Garcia has expressed a continuing interest in taking us private. For a description of his most recent offer to purchase our outstanding common stock, see Item 5 of "Part II - Other Information" included herein. Future losses could impair our ability to raise capital or borrow money and consequently affect our stock price. Although we recorded earnings from continuing operations of $3.2 million for the six months ended June 30, 2001 and $8.8 million for the six months ended June 30, 2000, we cannot assure you that we will be profitable in future periods. Losses in future periods could impair our ability to raise additional capital or borrow money as needed and could affect our stock price. We may not be able to continue to obtain the financing we need to fund our operations and, as a result, our business and profitability could be materially adversely affected. Our operations require large amounts of capital. We have borrowed, and will continue to borrow, substantial amounts to fund our operations. If we cannot obtain the financing we need on a timely basis and on favorable terms, our business and profitability could be materially adversely affected. As a result of our primary lender, GE Capital Corporation, exiting the automobile finance business, our portfolio performance, and a general tightening in the credit markets, we have recently experienced a less favorable borrowing environment than in the past. We currently obtain financing through four primary sources: o a warehouse facility with Greenwich Capital Financial Products, Inc. ("Greenwich"); o an inventory facility with General Electric Capital Corporation ("GECC") o securitization transactions; and o loans from other sources. Warehouse Facility with Greenwich. When our prior warehouse lender, GE Capital Corporation, announced that it was exiting the automobile finance market, we had to replace our GE credit facility with a new facility. Our new warehouse facility with Greenwich is now our primary source of operating capital. We have pledged substantially all of our assets to Greenwich to secure the borrowings we make under this facility. The warehouse facility expires in April 2002. Under our securitizations, we are required to have a credit facility reasonably acceptable to the insurer on April 30th of each year. Failure to maintain such a facility would constitute a termination event under our securitizations. If we are unable to obtain a replacement facility for the warehouse facility, our liquidity would be materially adversely affected. Inventory Line of Credit with GECC. We have extended the $25 million inventory line of credit portion of our previous revolving credit facility with GECC from June 30, 2001 to December 31, 2001. If we are unable to obtain a replacement facility for the inventory line of credit, our liquidity could be materially adversely affected. Securitization Transactions. We restore capacity under the warehouse facility from time to time by securitizing portfolios of finance receivables. Our ability to successfully and efficiently complete securitizations may be affected by several factors, including: o the condition of securities markets generally; o conditions in the asset-backed securities markets specifically; o the credit quality of our loan portfolio; and o the performance of our servicing operations. In recent periods, we have experienced a tightening of the restrictive covenants in our securitization transactions as well as increases in the credit enhancements required to close our securitizations. High delinquency levels and charge offs or other events, such as our failure to have a warehouse facility acceptable to the insurer of our securitization transactions in place on April 30 of each year, can also cause a "termination event" under our securitization transactions, which could result in our being replaced as servicer under those securitizations or in a liquidation and sale of the securitized portfolios. These types of occurrences could also cause a "portfolio performance event," which could result in all cash flow from the securitized receivables otherwise distributable on the junior obligations held by us being retained in the trust as additional security for senior securities. Any of these consequences could have a material adverse effect on our business and financial condition. Contractual Restrictions. The warehouse facility, the inventory line of credit, the securitization program, and our other credit facilities contain various restrictive covenants, including financial tests. Failure to satisfy the covenants in our credit facilities or our securitization program could result in a default (and could preclude us from further borrowing under the defaulted facility), could cause cross defaults to our other debt, and could prevent us from securing alternate sources of funds necessary to operate our business. Any of these events would have a material adverse effect on our business and financial condition. From time to time, we incur technical or other breaches under our material credit facilities, and we have obtained waivers from the applicable lenders. There can be no assurance we will continue to receive waivers and our inability to obtain these waivers may cause cross defaults to our other debt and have a material impact on our ability to obtain or retain operating capital. We have a high risk of credit losses because of the poor creditworthiness of our borrowers. Substantially all the sales financing we extend and the loans that we service are with "sub-prime" borrowers. Sub-prime borrowers generally cannot borrow money from traditional lending institutions, such as banks, savings and loans, credit unions, and captive finance companies owned by automobile manufacturers, because of their poor credit histories and/or low incomes. Loans to sub-prime borrowers are difficult to collect and are subject to a high risk of loss. We have established an allowance for credit losses to cover our anticipated credit losses. We periodically review and may make upward or downward adjustments to the allowance based upon whether we believe the allowance is adequate to cover our anticipated credit losses. However, our allowance may not be sufficient to cover our credit losses and we may need to increase our provision or allowance if certain adverse factors arise, including material increases in delinquencies or charge-offs. A significant variation in the timing of or increase in credit losses in our portfolio or a substantial increase in our allowance or provision for credit losses would have a material adverse effect on our net earnings. We could have a system failure if our current contingency plan is not adequate, which could adversely affect our ability to collect on loans and comply with statutory requirements. We depend on our loan servicing and collection facilities and on long-distance and local telecommunications access to transmit and process information among our various facilities. We use a standard program to prepare and store off-site backup tapes of our main system applications and data files on a routine basis. We regularly revise our contingency plan. However, the plan as revised may not prevent a systems failure or allow us to timely resolve any systems failures. Also, a natural disaster, calamity, or other significant event that causes long-term damage to any of these facilities or that interrupts our telecommunications networks could have a material adverse effect on our operations and profitability. We have slowed our growth, which, eventually, could negatively affect our earnings and profitability. Since 1999, we have slowed our growth in favor of an accelerated stock buy back program. Our ability to continue our growth is now limited by our access to capital. We are also committed to slowing our growth until we improve our loan loss experience. As additional capital is secured, we will consider whether to resume or accelerate our expansion plans or to continue repurchasing our stock or debt. We do not expect a slowdown in growth to adversely impact revenues or earnings in 2001. Thereafter, we expect that a failure to grow could eventually affect our earnings and/or profitability. Even if we make acquisitions, such acquisitions may be unsuccessful or strain or divert our resources from more profitable operations. Although we have decided to slow our growth during the foreseeable future, we intend to consider additional acquisitions, alliances, and transactions involving other companies that could complement our existing business if we can do so with little or no capital or if we can raise capital sufficient for any such transaction. However, we may not be able to identify suitable acquisition parties, joint venture candidates, or transaction counter parties. Even if we can identify suitable parties, we may not be able to consummate these transactions on terms that we find favorable. We may also not be able to successfully integrate any businesses that we acquire into our existing operations. If we cannot successfully integrate any future acquisitions, our operating expenses may increase, which would affect our net earnings. Moreover, these types of transactions may result in the incurrence of additional debt and amortization of expenses related to goodwill and intangible assets, all of which could adversely affect our profitability. These transactions also involve numerous other risks, including the diversion of management attention from other business concerns, entry into markets in which we have had no or only limited experience, and the potential loss of key employees of acquired companies. Occurrence of any of these risks could have a material adverse effect on us. We have continuing risks relating to the First Merchants transactions. We have entered into several transactions in the bankruptcy proceedings of First Merchants Acceptance Corporation. We have the right to 17.5% of recoveries on First Merchants' residual interests in certain securitized loan pools and other loans. However, if we lose our right to service these loans, our share of these residual interests could be reduced or eliminated. This could affect our future cash flow and profitability. Interest rates affect our profitability. Much of our financing income results from the difference between the rate of interest that we pay on the funds we borrow and the rate of interest that we earn on the loans in our portfolio. While we earn interest on the loans that we own at a fixed rate, we pay interest on our borrowings under our warehouse facility and certain other debt at a floating rate. When interest rates increase, our interest expense increases and our net interest margins decrease. Increases in our interest expense that we cannot offset by increases in interest income will lower our profitability. Laws that limit the interest rates that we can charge can adversely affect our profitability. We operate in many states that impose limits on the interest rate that a lender may charge. When a state limits the amount of interest that we can charge on our installment sales loans, we may not be able to offset any increased interest expense caused by rising interest rates or greater levels of borrowings under our credit facilities. Therefore, these interest rate limitations can adversely affect our profitability. Government regulations may limit our ability to recover and enforce receivables or to repossess and sell collateral. We are subject to ongoing regulation, supervision, and licensing under various federal, state, and local statutes, ordinances, and regulations. If we do not comply with these laws, we could be fined or certain of our operations could be interrupted or shut down. Failure to comply could, therefore, have a material adverse effect on our operations. We believe that we are currently in substantial compliance with all applicable material federal, state, and local laws and regulations. We may not, however, be able to remain in compliance with such laws. In addition, the adoption of additional statutes and regulations, changes in the interpretation of existing statutes and regulations, or our entry into jurisdictions with more stringent regulatory requirements could also have a material adverse effect on our operations. We are subject to pending actions and investigations relating to our compliance with various laws and regulations. While we do not believe that ultimate resolution of these matters will result in a material adverse effect on our business or financial condition (such as fines, injunctions or damages), there can be no assurance in this regard. Increased competition could adversely affect our operations and profitability. Our primary competitors are the numerous small buy-her pay-here used car dealers that operate in the sub-prime segment of the used car sales industry. We attempt to distinguish ourselves from our competitors through name recognition and other factors. However, the advertising and infrastructure required by these efforts increase our operating expenses. There is no assurance that we can successfully distinguish ourselves and compete in this industry. In addition, in recent years, a number of larger companies with significant financial and other resources have entered or announced plans to enter the used car sales industry. Although these companies do not currently compete with us in the sub-prime segment of the market, they compete with us in the purchase of inventory, which can result in increased wholesale costs for used cars and lower margins. They could also enter the sub-prime segment of the market at any time. Increased competition may cause downward pressure on the interest rates that we charge on loans originated by our dealerships. Either change could have a material effect on the value of our securities. The success of our operations depends on certain key personnel. We believe that our ability to successfully implement our business strategy and to operate profitably depends on the continued employment of our senior management team. The unexpected loss of the services of any of our key management personnel or our inability to attract new management when necessary could have a material adverse effect on our operations. We do not currently maintain key person life insurance on any member of our senior management team other than Gregory B. Sullivan, our President and Chief Executive Officer. We may issue stock in the future that will dilute the value of our existing stock. We have the ability to issue common stock or securities exercisable for or convertible into common stock, which may dilute the securities our existing stockholders now hold. In particular, issuance of some or all of the following securities may dilute the value of the securities that our existing stockholders now hold: o we have granted warrants to purchase a total of approximately 700,000 shares of our common stock to various parties, with exercise prices ranging from $6.75 to $10.81 per share; o we may issue additional warrants in connection with future transactions; o we may issue common stock under our various stock option plans; and o we may issue common stock in the First Merchants transaction in exchange for an increased share of collections on certain loans that we service for First Merchants. o we have committed to issue 1.5 million warrants to Mr. Garcia, subject to certain conditions. There is a potential anti-takeover or dilutive effect if we issue preferred stock. Our certificate of incorporation authorizes us to issue "blank check" preferred stock. Our board of directors may fix or change from time to time the designation, number, voting powers, preferences, and rights of this stock. Such issuances could make it more difficult for a third party to acquire us by reducing the voting power or other rights of the holders of our common stock. Preferred stock can also reduce the market value of the common stock. There may be adverse consequences from issuing blank check common stock, including a potential anti-takeover or dilutive effect. Our certificate of incorporation authorizes us to issue additional series of common stock, which we refer to as "blank check" common stock. Our board of directors may create new series of common stock from time to time in addition to the existing common stock and may fix: o the designation, voting powers, liquidation rights, conversion rights, redemption rights, dividends and distributions, preferences and relative, participating, optional and other rights, if any, of each such series; o the qualifications, limitations or restrictions, if any, of each such series; and o the number of shares constituting each such series. Blank check common stock could also: o negatively affect shareholder rights and the value of existing common stock; o have rights that are preferential or superior to the existing common stock; o track the performance of certain assets, groups of assets, businesses or subsidiaries of the company; o increase the complexity and administrative costs of our capital structure, which could negatively impact our financial condition and the value of our common stock; o create potential conflicts of interest and our board of directors could make decisions that adversely affect holders of our existing common stock; and/or o give rise to occasions when the interests of holders of one series might diverge or appear to diverge from the interests of holders of another series. Blank check common stock also may be viewed as being an "anti-takeover" device. Our board could create and issue series of common stock with terms that could make a takeover attempt by a third party more difficult to complete and such stock may also be used in connection with the issuance of a stockholder rights plan, sometimes called a "poison pill." -----END PRIVACY-ENHANCED MESSAGE-----