===============================================================================
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, 1999
Commission File Number 000-20841
UGLY DUCKLING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification
no.)
2525 E. Camelback Road, Suite 500,
Phoenix, Arizona 85016
(Address of principal executive (Zip Code)
offices)
(602) 852-6600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
---------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At August 6, 1999, there were approximately 14,879,000 shares of Common
Stock, $0.001 par value, outstanding.
This document serves both as a resource for analysts, shareholders, and
other interested persons, and as the quarterly report on Form 10-Q of Ugly
Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission,
which has taken no action to approve or disapprove the report or pass upon its
accuracy or adequacy. Additionally, this document is to be read in conjunction
with the consolidated financial statements and notes thereto included in Ugly
Duckling's Annual Report on Form 10-K, for the year ended December 31, 1998.
================================================================================
<PAGE>
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Part I. -- FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS...........................................................................
<S> <C>
Condensed Consolidated Balance Sheets-- June 30, 1999 and December 31, 1998........................... 1
Condensed Consolidated Statements of Operations-- Three and Six Months Ended June 30, 1999 and June 30, 1998 2
Condensed Consolidated Statements of Cash Flows-- Six Months Ended June 30, 1999 and June 30, 1998.... 3
Notes to Condensed Consolidated Financial Statements.................................................. 4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 10
Item 3. MARKET RISK ................................................................................... 31
Part II. -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS..............................................................................
32
Item 2. CHANGES IN SECURITIES.......................................................................... 32
Item 3. DEFAULTS UPON SENIOR SECURITIES................................................................ 32
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 32
Item 5. OTHER INFORMATION.............................................................................. 32
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 32
SIGNATURES.............................................................................................. 34
Exhibit 10.1 Amendment No. 4 to the Amended and Restated Motor Vehicle and Installment Contract Loan and
Security Agreement between General Electric Capital Corporation and Registrant dated June
30, 1999
Exhibit 11 Statement regarding computation of per share earnings (see note 5 of Notes to Condensed Consolidated Financial
Statements)
Exhibit 27 Financial Data Schedule
Exhibit 99 Risk Factors
</TABLE>
<PAGE>
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- ----------------
ASSETS
<S> <C> <C>
Cash and Cash Equivalents $ 1,302 $ 2,751
Finance Receivables, Net 307,199 163,209
Notes Receivable, Net 21,317 28,257
Inventory 37,810 44,167
Property and Equipment, Net 34,750 32,970
Intangible Assets, Net 14,985 15,530
Other Assets 22,997 20,575
Net Assets of Discontinued Operations 24,817 38,516
------------- ----------------
$ 465,177 $ 345,975
============= ================
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
<S> <C> <C>
Accounts Payable $ 4,892 $ 2,479
Accrued Expenses and Other Liabilities 30,992 19,694
Notes Payable 232,952 117,294
Subordinated Notes Payable 36,943 43,741
------------- ----------------
Total Liabilities 305,779 183,208
------------- ----------------
Stockholders' Equity:
Common Stock 19 19
Additional Paid in Capital 173,864 173,809
Retained Earnings 5,339 3,449
Treasury Stock (19,824) (14,510)
------------- ----------------
Total Stockholders' Equity 159,398 162,767
------------- ----------------
$ 465,177 $ 345,975
============= ================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 1
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Six Months Ended June 30, 1999 and 1998
(In thousands, except earnings per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------ -------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales of Used Cars $ 97,876 $ 69,523 $ 204,319 $ 142,496
Less:
Cost of Used Cars Sold 55,559 39,237 115,656 78,968
Provision for Credit Losses 26,635 14,988 55,196 30,350
------------ -------------- ------------- -------------
15,682 15,298 33,467 33,178
------------ -------------- ------------- -------------
Other Income:
Interest Income 20,186 6,024 34,236 12,230
Gain on Sale of Finance Receivables -- 3,659 -- 8,273
Servicing and Other Income 7,670 9,531 17,295 13,442
------------ -------------- ------------- -------------
27,856 19,214 51,531 33,945
------------ -------------- ------------- -------------
Income before Operating Expenses 43,538 34,512 84,998 67,123
Operating Expenses:
Selling and Marketing 5,887 4,274 12,495 9,195
General and Administrative 27,022 22,567 55,381 41,353
Depreciation and Amortization 2,321 1,352 4,458 2,525
------------ -------------- ------------- -------------
35,230 28,193 72,334 53,073
------------ -------------- ------------- -------------
Operating Income 8,308 6,319 12,664 14,050
Interest Expense 5,817 1,369 9,473 2,871
------------ -------------- ------------- -------------
Earnings before Income Taxes 2,491 4,950 3,191 11,179
Income Taxes 1,021 2,007 1,301 4,507
------------ -------------- ------------- -------------
Income from Continuing Operations 1,470 2,943 1,890 6,672
Discontinued Operations:
Loss from Operations of Discontinued Operations, net of
income tax benefit of $492 -- -- -- (768)
Loss on Disposal of Discontinued Operations, net of
income tax benefit of $3,024 -- -- -- (4,827)
------------ -------------- ------------- -------------
Net Earnings $ 1,470 $ 2,943 $ 1,890 $ 1,077
============ ============== ============= =============
Earnings per Common Share from Continuing Operations:
Basic $ 0.10 $ 0.16 $ 0.12 $ 0.36
============ ============== ============= =============
Diluted $ 0.10 $ 0.16 $ 0.12 $ 0.35
============ ============== ============= =============
Net Earnings per Common Share:
Basic $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============== ============= =============
Diluted $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============== ============= =============
Shares Used in Computation:
Basic 14,940 18,590 5,292 18,570
============ ============== ============= =============
Diluted 15,210 18,980 15,495 18,930
============ ============== ============= =============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 2
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
------------- ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings $ 1,890 $ 1,077
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 55,196 30,350
Gain on Sale of Finance Receivables -- (8,273)
Depreciation and Amortization 4,458 2,525
Loss from Discontinued Operations -- 5,595
Purchase of Finance Receivables Held for Sale -- (161,018)
Increase in Deferred Income Taxes (5,188) (1,260)
Proceeds from Sale of Finance Receivables -- 109,711
Collections of Finance Receivables -- 26,026
(Increase) Decrease in Inventory 6,357 (2,370)
(Increase) Decrease in Other Assets 1,172 (3,143)
Increase in Accounts Payable, Accrued Expenses and Other
liabilities 13,922 7,733
Increase in Income Taxes Payable 2,926 703
------------- ------------
Net Cash Provided by Operating Activities 80,733 7,656
------------- ------------
Cash Flows Used in Investing Activities:
Purchase of Finance Receivables Held for Investment (256,684) --
Collections of Finance Receivables Held for Investment 62,148 --
Increase in Investments Held in Trust (5,983) (7,537)
Advances under Notes Receivable (5,195) (24,312)
Repayments of Notes Receivable 12,135 26,727
Proceeds from Disposal of Property and Equipment -- 21,893
Purchase of Property and Equipment (5,692) (12,759)
------------- ------------
Net Cash Provided by (Used in) Investing Activities (199,271) 4,012
------------- ------------
Cash Flows from Financing Activities:
Additions to Notes Payable 199,336 30,000
Repayment of Notes Payable (84,088) (46,631)
Net Issuance (Repayment) of Subordinated Notes Payable (6,798) 13,000
Proceeds from Issuance of Common Stock 55 40
Acquisition of Treasury Stock (5,314) --
Other, Net 199 (182)
------------- ------------
Net Cash Provided by (Used in) Financing Activities 103,390 (3,773)
------------- ------------
Cash Provided by (Used in) Discontinued Operations 13,699 (9,780)
------------- ------------
Net Decrease in Cash and Cash Equivalents (1,449) (1,885)
Cash and Cash Equivalents at Beginning of Period 2,751 3,537
------------- ------------
Cash and Cash Equivalents at End of Period $ 1,302 $ 1,652
============= ============
Supplemental Statement of Cash Flows Information:
Interest Paid $ 10,180 $ 2,706
============= ============
Income Taxes Paid $ 3,315 $ 1,106
============= ============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 3
<PAGE>
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Our accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and pursuant to rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for a complete financial statement presentation. In our opinion, such unaudited
interim information reflects all adjustments, consisting only of normal
recurring adjustments, necessary to present our financial position and results
of operations for the periods presented. Our results of operations for interim
periods are not necessarily indicative of the results to be expected for a full
fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 1998
was derived from our audited consolidated financial statements as of that date
but does not include all the information and footnotes required by generally
accepted accounting principles. We suggest that these condensed consolidated
financial statements be read in conjunction with the audited consolidated
financial statements included in our Annual Report on Form 10-K, for the year
ended December 31, 1998.
Note 2. Summary of Finance Receivables
Following is a summary of our Finance Receivables, Net, as of June 30, 1999
and December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
---------------------------------------- ---------------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
------------- ------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Installment Sales Contract Principal Balances $ 256,645 $ 77,366 $ 334,011 $ 93,936 $ 51,282 $ 145,218
Add: Accrued Interest 2,755 868 3,623 877 473 1,350
Loan Origination Costs 4,450 -- 4,450 2,237 -- 2,237
------------- ------------- ------------- ------------ ------------ ------------
Principal Balances, Net 263,850 78,234 342,084 97,050 51,755 148,805
Residuals in Finance Receivables Sold 22,559 2,625 25,184 33,331 2,625 35,956
Investments Held in Trust 35,249 -- 35,249 20,564 -- 20,564
------------- ------------- ------------- ------------ ------------ ------------
321,658 80,859 402,517 150,945 54,380 205,325
Allowance for Credit Losses (66,905) (2,990) (69,895) (24,777) (2,024) (26,801)
Discount on Acquired Loans -- (25,423) (25,423) -- (15,315) (15,315)
------------- ------------- ------------- ------------ ------------ ------------
Finance Receivables, Net $ 254,753 $ 52,446 $ 307,199 $ 126,168 $ 37,041 $ 163,209
============= ============= ============= ============ ============ ============
Classification of Principal Balances:
Finance Receivables Held for Investment $ 99,049 $ 77,366 $ 176,415 $ 26,852 $ 51,282 $ 78,134
Finance Receivables Held as Collateral for
Securitization Notes Payable 157,596 -- 157,596 67,084 -- 67,084
============= ============= ============= ============ ============ ============
Installment Sales Contract Principal Balances $ 256,645 $ 77,366 $ 334,011 $ 93,936 $ 51,282 $ 145,218
============= ============= ============= ============ ============ ============
</TABLE>
Page 4
<PAGE>
As of June 30, 1999 and December 31, 1998, our Residuals in Finance
Receivables Sold from dealership operations were comprised of the following (in
thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
Retained interest in subordinated securities (B
Certificates) $ 33,080 $ 51,243
Net interest spreads, less present value discount 14,596 25,838
Reduction for estimated credit losses (25,117) (43,750)
----------------- -----------------
Residuals in finance receivables sold $ 22,559 $ 33,331
================= =================
Securitized principal balances outstanding $ 126,945 $ 198,747
================= =================
Estimated credit losses as a % of securitized principal
balances outstanding 19.8% 22.0%
================= =================
</TABLE>
The following table reflects a summary of activity for our Residuals in
Finance Receivables Sold from dealership operations for the periods ended June
30, 1999 and 1998, respectively (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Balance, Beginning of Period $ 28,480 $ 24,741 $ 33,331 $ 13,277
Additions -- 10,396 -- 24,254
Amortization (5,921) (6,719) (10,772) (9,113)
------------ ------------ ----------- ------------
Balance, End of Period $ 22,559 $ 28,418 $ 22,559 $ 28,418
============ ============ =========== ============
</TABLE>
Note 3. Notes Receivable
Our Cygnet dealer program has various notes receivable from used car
dealers. Under Cygnet's asset based loan program, our commitments for revolving
notes receivable totaled $9.6 million at June 30, 1999.
In July 1997, First Merchants Acceptance Corporation (First Merchants) filed
for bankruptcy. Immediately subsequent to the bankruptcy filing, we executed a
loan agreement to provide First Merchants with debtor in possession financing
(DIP facility). The maximum commitment under the DIP facility was $11.5 million
at June 30, 1999. The outstanding balance on the DIP facility totaled $11.5
million and $12.2 million at June 30, 1999 and December 31, 1998, respectively.
Following is a summary of Notes Receivable at June 30, 1999 and December 31,
1998 (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------------- ----------------
<S> <C> <C>
Notes Receivable under the asset based loan program, net of
allowance for doubtful accounts of $103, and $500, respectively $ 7,433 $ 8,311
First Merchants Debtor in Possession Note Receivable 11,502 12,228
First Merchants Bank Group Participation 1,279 6,856
Other Notes Receivable 1,103 862
-------------- ----------------
Notes Receivable, Net $ 21,317 $ 28,257
============== ================
</TABLE>
Page 5
<PAGE>
Note 4. Notes Payable
The following is a summary of Notes Payable at June 30, 1999 and December
31, 1998 (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Revolving Facility with GE Capital $ 76,647 $ 51,765
Securitization Notes Payable 119,325 50,607
Note Payable Collateralized by the Common Stock of our Securitization Subsidiaries 37,500 12,234
Mortgage Loan with Finance Company -- 3,386
Others 735 967
---------------- ---------------
Subtotal 234,207 118,959
Less: Unamortized Loan Fees 1,255 1,665
---------------- ---------------
Notes Payable $ 232,952 $ 117,294
================ ===============
</TABLE>
Note 5. Common Stock Equivalents
Net Earnings per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding for the periods
ended June 30, 1999, and 1998 as follows (in thousands, except for per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ------------------------
1999 1998 1999 1998
------------ ------------- ----------- -----------
<S> <C> <C> <C> <C>
Income from Continuing Operations $ 1,470 $ 2,943 $ 1,890 $ 6,672
============ ============= =========== ===========
Net Earnings $ 1,470 $ 2,943 $ 1,890 $ 1,077
============ ============= =========== ===========
Basic EPS-Weighted Average Shares Outstanding 14,940 18,590 15,292 18,570
============ ============= =========== ===========
Basic Earnings Per Share from:
Continuing Operations $ 0.10 $ 0.16 $ 0.12 $ 0.36
============ ============= =========== ===========
Net Earnings $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============= =========== ===========
Basic EPS-Weighted Average Shares Outstanding 14,940 18,590 15,292 18,570
Effect of Diluted Securities:
Warrants -- 44 -- 35
Stock Options 270 346 203 325
------------ ------------- ----------- -----------
Dilutive EPS-Weighted Average Shares Outstanding 15,210 18,980 15,495 18,930
============ ============= =========== ===========
Diluted Earnings Per Share from:
Continuing Operations $ 0.10 $ 0.16 $ 0.12 $ 0.35
============ ============= =========== ===========
Net Earnings $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============= =========== ===========
Warrants Not Included in Diluted EPS Since Antidilutive 1,439 1,214 1,510 715
============ ============= =========== ===========
Stock Options Not Included in Diluted EPS since Antidilutive 905 571 1,035 96
============ ============= =========== ===========
</TABLE>
Note 6. Business Segments
We have two divisions: dealership operations and non-dealership operations.
Within our divisions, we have six distinct business segments. Within the
dealership operations division, the segments consist of retail car sales
operations (company dealerships), the income generated from the finance
receivables generated at the Ugly Duckling dealerships and corporate and other
operations. Under the non-dealership operations division, the segments consist
of the Cygnet dealer program, bulk purchasing and loan servicing, and corporate
and other operations.
Page 6
<PAGE>
A summary of operating activity by business segment for the periods ended
June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non Dealership Operations
------------------------------------- -------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ------------- ----------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Three months ended June 30, 1999:
Sales of Used Cars $ 97,876 $ -- $ -- $ -- $ -- $ -- $ 97,876
Less: Cost of Used Cars Sold 55,559 -- -- -- -- -- 55,559
Provision for Credit Losses 20,131 5,658 -- 846 -- -- 26,635
----------- ------------- ----------- ------------ ------------ ----------- ------------
22,186 (5,658) -- (846) -- -- 15,682
----------- ------------- ----------- ------------ ------------ ----------- ------------
Interest Income -- 15,647 109 4,114 315 1 20,186
Servicing and Other Income 6 2,296 133 -- 5,235 -- 7,670
----------- ------------- ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 22,192 12,285 242 3,268 5,550 1 43,538
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 5,864 -- -- 23 -- -- 5,887
General and Administrative 11,101 4,567 4,621 974 4,986 773 27,022
Depreciation and Amortization 859 280 537 107 370 168 2,321
----------- ------------- ----------- ------------ ------------ ----------- ------------
17,824 4,847 5,158 1,104 5,356 941 35,230
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 4,368 $ 7,438 $ (4,916) $ 2,164 $ 194 $ (940) $ 8,308
=========== ============= =========== ============ ============ =========== ============
Three months ended June 30, 1998:
Sales of Used Cars $ 69,523 $ -- $ -- $ -- $ -- $ -- $ 69,523
Less: Cost of Used Cars Sold 39,237 -- -- -- -- -- 39,237
Provision for Credit Losses 14,263 10 -- 715 -- -- 14,988
----------- ------------- ----------- ------------ ------------ ----------- ------------
16,023 (10) -- (715) -- -- 15,298
----------- ------------- ----------- ------------ ------------ ----------- ------------
Interest Income -- 3,506 54 2,012 452 -- 6,024
Gain on Sale of Loans -- 3,659 -- -- -- -- 3,659
Servicing and Other Income 17 4,015 56 -- 5,443 -- 9,531
----------- ------------- ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 16,040 11,170 110 1,297 5,895 -- 34,512
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 4,218 -- -- 44 12 -- 4,274
General and Administrative 9,329 4,279 3,456 593 4,203 707 22,567
Depreciation and Amortization 615 311 249 23 154 -- 1,352
----------- ------------- ----------- ------------ ------------ ----------- ------------
14,162 4,590 3,705 660 4,369 707 28,193
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 1,878 $ 6,580 $ (3,595) $ 637 $ 1,526 $ (707) $ 6,319
=========== ============= =========== ============ ============ =========== ============
</TABLE>
Page 7
<PAGE>
<TABLE>
<CAPTION>
Dealership Operations Non Dealership Operations
------------------------------------ ---------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ------------ ----------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Six months ended June 30, 1999:
Sales of Used Cars $ 204,319 $ -- $ -- $ -- $ -- $ -- $204,319
Less: Cost of Used Cars Sold 115,656 -- -- -- -- -- 115,656
Provision for Credit Losses 42,024 11,529 -- 1,643 -- -- 55,196
----------- ------------ ----------- ------------ ------------ ----------- ------------
46,639 (11,529) -- (1,643) -- -- 33,467
----------- ------------ ----------- ------------ ------------ ----------- ------------
Interest Income -- 25,959 170 7,478 627 2 34,236
Servicing and Other Income 13 5,178 178 -- 11,926 -- 17,295
----------- ------------ ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 46,652 19,608 348 5,835 12,553 2 84,998
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 12,433 -- -- 59 3 -- 12,495
General and Administrative 22,010 9,150 9,959 1,937 10,807 1,518 55,381
Depreciation and Amortization 1,653 562 1,058 185 692 308 4,458
----------- ------------ ----------- ------------ ------------ ----------- ------------
36,096 9,712 11,017 2,181 11,502 1,826 72,334
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 10,556 $ 9,896 $ (10,669) $ 3,654 $ 1,051 $ (1,824) $ 12,664
=========== ============ =========== ============ ============ =========== ============
Six months ended June 30, 1998:
Sales of Used Cars $ 142,496 $ -- $ -- $ -- $ -- $ -- $142,496
Less: Cost of Used Cars Sold 78,968 -- -- -- -- -- 78,968
Provision for Credit Losses 29,297 10 -- 1,043 -- -- 30,350
----------- ------------ ----------- ------------ ------------ ----------- ------------
34,231 (10) -- (1,043) -- -- 33,178
----------- ------------ ----------- ------------ ------------ ----------- ------------
Interest Income -- 7,323 118 3,610 1,179 -- 12,230
Gain on Sale of Loans -- 8,273 -- -- -- -- 8,273
Servicing and Other Income 58 7,839 102 -- 5,443 -- 13,442
----------- ------------ ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 34,289 23,425 220 2,567 6,622 -- 67,123
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 9,096 -- -- 87 12 -- 9,195
General and Administrative 19,835 8,834 6,075 1,108 4,203 1,298 41,353
Depreciation and Amortization 1,228 648 450 45 154 -- 2,525
----------- ------------ ----------- ------------ ------------ ----------- ------------
30,159 9,482 6,525 1,240 4,369 1,298 53,073
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 4,130 $ 13,943 $ (6,305) $ 1,327 $ 2,253 $ (1,298) $ 14,050
=========== ============ =========== ============ ============ =========== ============
</TABLE>
Note 7. Discontinued Operations
In February 1998, we announced our intention to close our branch office
network, through which we purchased retail installment contracts from third
party dealers, and exit this line of business. We completed the branch office
closure as of March 31, 1998. As a result of the branch office network closure,
we reclassified the results of operations of the branch office network in the
accompanying condensed consolidated balance sheets and condensed consolidated
statements of operations to discontinued operations.
Page 8
<PAGE>
The components of Net Assets of Discontinued Operations as of June 30, 1999
and December 31, 1998 follow (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Finance Receivables, net $ 19,195 $ 30,649
Residuals in Finance Receivables Sold 4,503 7,875
Investments Held in Trust 2,638 3,665
Other Assets, net of Accounts Payable and
Accrued Liabilities 1,569 2,351
Disposal Liability (3,088) (6,024)
---------------- ---------------
Net Assets of Discontinued Operations $ 24,817 $ 38,516
================ ===============
</TABLE>
Note 8. Use of Estimates
The preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from our estimates.
Note 9. Certain Bankruptcy Remote Entities
Ugly Duckling Receivables Corporation (UDRC) and Ugly Duckling Receivables
Corporation II (UDRC II) (collectively referred to as Securitization
Subsidiaries), are our wholly-owned special purpose "bankruptcy remote
entities." Their assets, including assets classified as Discontinued Operations,
include Residuals in Finance Receivables Sold and Investments Held In Trust.
Total assets for UDRC and UDRC II are approximately $183.4 million and $5.3
million, respectively, at June 30, 1999. These amounts would not be available to
satisfy claims of our creditors on a consolidated basis.
Note 10. Reclassifications
We have made certain reclassifications to previously reported information to
conform to the current presentation.
Page 9
<PAGE>
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Our Quarterly Report on Form 10-Q contains forward looking statements. We
may make additional written or oral forward looking statements from time to time
in filings with the Securities and Exchange Commission or otherwise. Such
forward looking statements are within the meaning of that term in Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Such statements may include, but are not
limited to, projections of revenues, income, or loss, capital expenditures,
plans for future operations, financing needs or plans, Year 2000 readiness, and
plans relating to our products or services, as well as assumptions relating to
the foregoing. The words "believe," "expect," "intend," "anticipate,"
"estimate," "project," and similar expressions identify forward looking
statements, which speak only as of the date the statement was made. Forward
looking statements are inherently subject to risks and uncertainties, some of
which cannot be predicted or quantified. Future events and actual results could
differ materially from those set forth herein, contemplated by, or underlying
the forward looking statements. We undertake no obligation to publicly update or
revise any forward looking statements, whether as a result of new information,
future events, or otherwise. Statements in this Quarterly Report, including the
Notes to the Condensed Consolidated Financial Statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
describe factors, among others, that could contribute to or cause such
differences. Additional risk factors that could cause actual results to differ
materially from those expressed in such forward looking statements are set forth
in Exhibit 99 which is attached hereto and incorporated by reference into this
Quarterly Report on Form 10-Q.
Introduction
General. We operate the largest chain of buy here-pay here used car
dealerships in the United States. We sell and finance our used vehicles to
customers within the sub-prime segment of the used car market. Our customers
typically have limited credit histories, low incomes or past credit problems. At
June 30, 1999, we operated 59 dealerships located in several large markets,
including Los Angeles, Atlanta, Tampa, San Antonio, Phoenix and Dallas.
In addition to our dealership and financing operations, we also
o provide financing to other independent used car dealers through our
Cygnet dealer program,
o service and collect large portfolios of finance receivables owned by
others, and
o manage selected financial assets that we acquire from financially
distressed third parties.
From 1994 through the first quarter of 1998, we maintained a national branch
office network that acquired and serviced retail installment contracts from
numerous independent third party dealers. We discontinued these operations in
1998.
Below is a summary of our businesses by division and their related segments:
[Organizational Chart of Business Segments]
The chart above shows Ugly Duckling with two operating divisions. Dealership
operations is the first division. Dealership operations has three distinct
segments. Retail sales is its first segment. This is the segment that operates
our chain of Ugly Duckling Car Sales dealerships. Portfolio and loan servicing
is the second segment of dealership operations. This segment holds and services
the loan portfolios originated or acquired by our dealership operations.
Finally, dealership operations has an administration segment that provides
corporate administration to the division. Our non-dealership operations division
also contains three segments. The first non-dealership operations segment is the
bulk purchasing/loan servicing segment. In this segment, we acquire loan
portfolios in bulk from third parties and provide loan servicing for third
parties. The second segment of non-dealership operations is the Cygnet dealer
program under which we provide various credit facilities to independent used car
dealers. Finally, the non-dealership operations also have an administration
segment that provides corporate administration to the non-dealership operations.
Last, the chart shows our discontinued operations, which contains our branch
office network that we closed in February 1998 and the loans we acquired through
that network.
Page 10
<PAGE>
Company Dealership Operations
We commenced dealership operations in 1992 with the acquisition of two
dealerships in Arizona, and have expanded aggressively since then through a
combination of acquisitions and development of new stores. Our most significant
growth occurred in 1997, when
o we acquired from Seminole Finance, Inc. and related companies (Seminole),
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million;
o we purchased from E-Z Plan, Inc. (E-Z Plan), seven dealerships in San
Antonio and a contract portfolio of approximately $24.3 million;
o we purchased from Kars-Yes Holdings, Inc. and related companies (Kars),
six dealerships in the Los Angeles market, two in the Miami market, two
in the Atlanta market, and two in the Dallas market; and
o we opened our first used car dealership in the Las Vegas market, two
additional dealerships in the Albuquerque market and one additional
dealership in the Phoenix market. We also closed a dealership in
Arizona.
We continued our aggressive growth in 1998, adding 17 new dealerships in our
existing markets. We opened one dealership in the Albuquerque market, four
dealerships in the Atlanta market, three dealerships in the Dallas market, two
dealerships in the Los Angeles market, two dealerships in the Phoenix market,
two dealerships in the San Antonio market, and three dealerships in the Tampa
market. We also closed two dealerships in Miami and exited that market.
In the first quarter of 1999, we opened one dealership in the Dallas market
and one in the Tampa market. In the second quarter of 1999, we added a
dealership in the Los Angeles market, which brought our total number of
dealerships to 59.
The following table summarizes the number of stores we had in operation by
major market as of June 30, 1999, and each of the last three years ended
December 31, 1998, 1997, and 1996:
Number of Stores by Market
-------------------------------------------
June 30, December 31,
---------- -------------------------------
1999 1998 1997 1996
---------- --------- --------- ---------
Phoenix 9 9 7 5
San Antonio 9 9 7 --
Atlanta 9 9 5 --
Los Angeles 9 8 6 --
Tampa 9 8 5 --
Dallas 7 6 3 --
Tucson 3 3 3 3
Albuquerque 3 3 2 --
Las Vegas 1 1 1 --
Miami -- -- 2 --
---------- --------- --------- ---------
59 56 41 8
========== ========= ========= =========
Non-Dealership Operations
Cygnet Dealer Program. In 1997 we began operating the Cygnet dealer program,
which provides qualified dealers with warehouse purchase facilities and
revolving lines of credit primarily secured by the dealers' finance receivable
portfolios. We extend credit facilities that are subject to various collateral
coverage ratios, maximum advance rates, and performance measurements, depending
on the financial condition of the dealer and the quality of the finance
receivables originated. The dealer remains responsible for collection of finance
receivable payments and retains control of the customer relationship. As a
condition to providing financing, each dealer is required to satisfy certain
criteria to qualify for the program, report collection activities to us on a
daily basis and provide us with periodic financial statements. In addition, our
dealers are "audited" by our audit department on a periodic basis.
Bulk Purchasing and Loan Servicing Operations. We have entered into several
large servicing and/or bulk purchasing transactions involving third party dealer
contract portfolios. Under these transactions, we have acquired loan portfolios
or participation interests in loan portfolios that we also service. During the
second quarter of 1999, we closed our loan servicing facility in Nashville,
Tennessee, and consolidated our non-dealership loan servicing operations into
our two remaining facilities, which are located in Aurora, Colorado and Plano,
Texas.
Page 11
<PAGE>
In April 1998, we announced that our Board of Directors had directed our
management team to separate our dealership operations and non-dealership
operations into separate, publicly held companies. Our stockholders approved a
proposal to split-up the company through a rights offering at the annual
stockholders meeting held in August 1998. Due to a lack of stockholder interest,
however, we canceled the rights offering. In the first quarter of 1999, we
reclassified the Cygnet dealer program and bulk purchasing and loan servicing
operations into continuing operations for all periods presented in this
quarterly report.
Discontinued Operations
In 1994, we acquired Champion Financial Services, Inc., an independent
automobile finance company. In April 1995, we initiated an aggressive plan to
expand Champion's branch office network and, by December 31, 1997, we operated
83 branch offices across the country. In February 1998, we announced our
intention to close the branch office network and exit this line of business in
the first quarter of 1998. We recorded a pre-tax charge to discontinued
operations totaling approximately $9.1 million (approximately $5.6 million, net
of income taxes) during the first quarter of 1998. In addition, a $6.0 million
charge (approximately $3.6 million, net of income taxes) was taken during the
third quarter of 1998 due primarily to higher than anticipated loan losses and
servicing expenses. The branch office closure was substantially complete by the
end of the first quarter of 1998.
In the following discussion and analysis, we explain the general financial
condition and the results of operations of Ugly Duckling and its subsidiaries.
In particular, we analyze and explain the changes in the results of operations
of our various business segments for the quarter and six month periods ended
June 30, 1999 compared to the quarter and six month periods ended June 30, 1998.
Results of Operations for the Three Months Ended June 30, 1999 and 1998
Income items in our Statement of Operations consist of:
o Sales of Used Cars
less Cost of Used Cars Sold
less Provision for Credit Losses
o Interest Income
o Gain on Sale of Loans
o Servicing and Other Income
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended
June 30,
(Dollars in Thousands)
---------------------------
1999 1998
------------ -----------
Used Cars Sold (Units) 11,416 8,631
============ ===========
Sales of Used Cars $ 97,876 $ 69,523
Cost of Used Cars Sold 55,559 39,237
------------ -----------
Gross Margin $ 42,317 $ 30,286
============ ===========
Gross Margin % 43.2% 43.6%
============ ===========
Per Unit Sold:
Sales of Used Cars $ 8,574 $ 8,055
Cost of Used Cars Sold 4,867 4,546
------------ -----------
Gross Margin $ 3,707 $ 3,509
============ ===========
The number of cars we sold (units) increased by 32.3% for the three months
ended June 30, 1999 over the same period in 1998. Same store unit sales for the
three months ended June 30, 1999 increased 3.3% compared to the three month
period ended June 30, 1998. The increase in our same store unit sales was
primarily a result of the maturation of stores purchased or opened in late 1997.
We anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Page 12
<PAGE>
Our Used Car Sales revenues increased by 40.8% for the three months ended
June 30, 1999 over the same period ended June 30, 1998. The growth for this
period reflects increases in the number of dealerships in operation and the
average unit sales price. The Cost of Used Cars Sold increased by 41.6% for the
three months ended June 30, 1999 over the same period ended June 30, 1998. The
gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold
excluding Provision for Credit Losses) increased by 39.7% for the three months
ended June 30, 1999 over the same period ended June 30, 1998. The gross margin
per car sold for the second quarter of 1999 is comparable to the second quarter
of 1998.
Our average sales price per car increased by 6.4% for the three months ended
June 30, 1999 over the three months ended June 30, 1998. The increase in the
average sales price was necessary to offset the increase in the Cost of Used
Cars Sold. On a per unit basis, the Cost of Used Cars Sold increased by 7.0% for
the three months ended June 30, 1999 over the three months ended June 30, 1998.
The increase in our average cost per used car sold is primarily due to an
increase in the direct cost of the cars we sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Three Months Ended
June 30,
--------------------------
1999 1998
------------ ------------
Provision for Credit Losses (in thousands) $ 25,789 $ 14,273
============ ============
Provision per contract originated $ 2,275 $ 1,676
============ ============
Provision as a percentage of
principal balances originated 26.9% 21.3%
============ ============
The Provision for Credit Losses in our dealership operations increased by
80.7% in the three months ended June 30, 1999 over the three months ended June
30, 1998. The Provision for Credit Losses per unit originated at our dealerships
increased by $599 or 35.7% in the three months ended June 30, 1999 over the
three months ended June 30, 1998. When we changed how we structure
securitizations for accounting purposes in the fourth quarter of 1998, we also
changed the timing of providing for credit losses. For periods prior to the
fourth quarter of 1998, we generally provided a Provision for Credit Losses of
approximately 21% of the loan principal balance at the time of origination to
record the loan at the lower of cost or market. However, as a consequence of our
revised securitization structure, we will now be retaining securitized loans on
our balance sheet for accounting purposes and recognizing income over the life
of the contracts. We record a provision for credit losses of approximately 27%
of the principal balance at the time of origination.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 18.3% to $846,000 in the three months
ended June 30, 1999 from $715,000 in the three months ended June 30, 1998. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our securitization transactions that were
structured as sale transactions for accounting purposes (Securitized Contract
Sales). Interest Income increased by 342.6% to $15.8 million for the three
months ended June 30, 1999 from $3.6 million for the three months ended June 30,
1998. The increase was primarily due to the increase in the average finance
receivables retained on our balance sheet. Because we structured most of our
securitizations to recognize income as sales for accounting purposes prior to
1999, there were fewer receivables retained on our balance sheet and Interest
Income was lower in these periods. See "Securitizations-Dealership Operations"
below for additional discussion of our securitization transactions and our on
balance sheet portfolio.
Page 13
<PAGE>
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Three Months Ended
June 30,
---------------------
1999 1998
--------- ---------
Percentage of sales revenue financed 97.8% 96.2%
Percentage of sales units financed 99.3% 98.7%
The average effective yield on finance receivables from our dealerships was
approximately 26.3% for the three months ended June 30, 1999 and 25.3% for the
three months ended June 30, 1998. Our policy is to charge 29.9% per year on our
dealership contracts. However, in those states that impose interest rate limits,
such as Texas and Florida, we charge the maximum interest rate permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from our Cygnet dealer program and from a loan we made
to First Merchants as part of its bankruptcy proceedings. Interest Income from
the First Merchants transaction decreased by 30.3% to $315,000 for the three
months ended June 30, 1999 from $452,000 for the three months ended June 30,
1998. Interest Income from the Cygnet dealer program increased by 104.5% to $4.1
million for the three months ended June 30, 1999 from $2.0 million for the three
months ended June 30, 1998. The increase in interest income in the Cygnet dealer
program reflects a significant increase in the amount of loans outstanding
during the three months ended June 30, 1999 compared to the three months ended
June 30, 1998.
Gain on Sale of Loans
Dealership Operations. The gain on sale of finance receivables we have
recorded prior to the fourth quarter of 1998 was generated from securitizations
that were structured as sale transactions. During the fourth quarter of 1998, we
began structuring our securitization transactions as financings for accounting
purposes (securitized borrowings) instead of sales transactions and, therefore,
we have not recognized gains on the sale of loans from securitization
transactions subsequent to the change. We recorded Gains on Sale of Loans
related to securitized contract sales of zero for the three months ended June
30, 1999 and $3.7 million during the three months ended June 30, 1998. See
"Securitizations-Dealership Operations" below for a summary of the structure of
our securitizations.
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the three months ending June 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
-------------- -------------- --------------
June 30, 1999 $ 2,435 $ 5,235 $ 7,670
============== ============== ==============
June 30, 1998 $ 4,088 $ 5,443 $ 9,531
============== ============== ==============
Dealership Operations. Servicing and Other Income decreased by 40.4% to $2.4
million in the three months ended June 30, 1999 compared to the $4.1 million
recognized in the three months ended June 30, 1998. We service the securitized
contracts that were included in the Securitized Contract Sales transactions for
monthly fees ranging from .25% to .33% of the beginning of month principal
balances (3.0% to 4.0% per year). We do not, however, recognize service fee
income on the contracts included in our Securitized Borrowings. The significant
decrease in Servicing and Other Income is primarily due to the decrease in the
principal balance of (1) contracts being serviced under the previous
securitization structure and (2) a portfolio we service on behalf of a third
party. We anticipate that our future Servicing and Other Income will continue to
decline as the principal balance of the contracts serviced under the Securitized
Contract Sales agreements and the third party portfolio continues to decrease.
Page 14
<PAGE>
Non-Dealership Operations. Our Servicing and Other Income decreased 3.8% to
$5.2 million in the three months ended June 30, 1999 compared to the $5.4
million recognized in the three months ended June 30, 1998. Our servicing fee is
generally a percentage of the portfolio balance (generally 3.25% to 4.0% per
year) with a minimum fee per loan serviced (generally $14 to $17 per month). The
decrease in our Servicing and Other income is due to an approximately $200,000
decrease in service fees earned by our loan servicing operations. Our service
fee income is tied to the contract principal dollars and units that we service
and will continue to decline, subject to the incentive compensation discussed
below, unless we increase the number and amount of contracts we are servicing.
We have not entered into any loan servicing agreements thus far in 1999 and
expect that our service fee income will continue to decline as the principal
balances of the portfolios that we are currently servicing decrease. We did not
recognize any servicing income in the first quarter 1998, as we did not begin
servicing loans in our non-dealership operations until April 1998.
Our non-dealership operations have entered into servicing agreements with
two companies that have filed and subsequently emerged from bankruptcy and
continue to operate under their approved plans of reorganization. Under the
terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, we are entitled to certain incentive compensation in excess of the
servicing fees that we have earned to date. As of June 30, 1999, we estimate
that the total incentive compensation from both agreements could range from $0
to $8.0 million. We have not accrued any fee income from these incentives as an
amount is not determinable at this time
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 26.2% to $43.5 million for the three months ended June 30, 1999 from
$34.5 million for the three months ended June 30, 1998. Growth of Sales of Used
Cars and Interest Income, were the primary contributors to the increase.
Operating Expenses
Operating Expenses consist of:
o Selling and Marketing Expenses,
o General and Administrative Expenses, and
o Depreciation and Amortization.
A summary of operating expenses for our business segments for the three
months ended June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
--------------------------------- -----------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ---------- ------------ ----------- ---------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999:
Selling and Marketing $ 5,864 $ -- $ -- $ 23 $ -- $ -- $ 5,887
General and Administrative 11,101 4,567 4,621 974 4,986 773 27,022
Depreciation and Amortization 859 280 537 107 370 168 2,321
----------- ---------- ------------ ----------- ---------- ----------- ---------------
$ 17,824 $ 4,847 $ 5,158 $ 1,104 $ 5,356 $ 941 $ 35,230
=========== =========== ============ =========== ============ =========== ===========
1998:
Selling and Marketing $ 4,218 $ -- $ -- $ 44 $ 12 $ -- $ 4,274
General and Administrative 9,329 4,279 3,456 593 4,203 707 22,567
Depreciation and Amortization 615 311 249 23 154 -- 1,352
----------- ---------- ------------ ----------- ---------- ----------- ---------------
$ 14,162 $ 4,590 $ 3,705 $ 660 $ 4,369 $ 707 $ 28,193
=========== =========== ============ =========== ============ =========== ===========
</TABLE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
for the three months ended June 30, 1999 and 1998 as a percentage of Sales of
Used Cars and Selling and Marketing Expense per car sold from our company
dealership segment follows:
Page 15
<PAGE>
1999 1998
---------- ---------
Selling and Marketing Expense as a
Percentage of Sales of Used Cars 6.0% 6.1%
Selling and Marketing Expense
per Car Sold $ 514 $ 489
For the three months ended June 30, 1999 and 1998, Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Total Selling and Marketing Expenses increased by
37.7% to $5.9 million for the three months ended June 30, 1999 from $4.3 million
for the three months ended June 30, 1998. Selling and Marketing Expense as a
percentage of Sales of Used Cars is comparable for the three months ended June
30, 1999 and 1998. Selling and Marketing Expense per car sold increased due to
an increase in advertising expenditures for the three months ended June 30, 1999
compared to the three months ended June 30, 1998.
General and Administrative Expenses. A summary of General and Administrative
Expenses as a percentage of Sales of Used Cars ad General and Administrative
Expenses per car sold from our company dealership segment follows:
1999 1998
----------- ----------
General and Administrative Expense
as a Percentage of Used Car Sales 11.3% 13.4%
General and Administrative Expense
per Car Sold $ 972 $ 1,081
For the three months ended June 30, 1999 total General and Administrative
Expenses increased by 19.7% to $27.0 million from $22.6 million for the three
months ended June 30, 1998. The increase in General and Administrative Expenses
was primarily a result of the addition of new dealerships, our bulk purchasing
and loan servicing operations, the expansion of infrastructure to administer the
increased number of used car dealerships in operation, and the growth of the
Cygnet dealer program.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 71.9% to
$2.3 million for the three months ended June 30, 1999 from $1.4 million for the
three months ended June 30, 1998. The increase in 1999 was primarily due to
depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 325.0% to $5.8 million for the three months
ended June 30, 1999 from $1.4 million for the three months ended June 30, 1998.
The increase in the second quarter of 1999 was primarily due to increased
borrowings under our Securitization Notes Payable, Notes Payable and
Subordinated Notes Payable. The increased borrowings were used primarily to fund
the increases in Finance Receivables.
Income Taxes
Income taxes totaled $1.0 million for the three months ended June 30, 1999,
and $2.0 million for the three months ended June 30, 1998. Our effective tax
rate was 41.0% for the three months ended June 30, 1999 and 40.5% for the three
months ended June 30, 1998.
Page 16
<PAGE>
Results of Operations for the Six Months Ended June 30, 1999 and 1998
Sales of Used Cars and Cost of Used Cars Sold
Six Months Ended
June 30,
(Dollars in Thousands)
-------------------------------
1999 1998
------------- --------------
Used Cars Sold (Units) 24,170 18,070
============= ==============
Sales of Used Cars $ 204,319 $ 142,496
Cost of Used Cars Sold 115,656 78,968
------------- --------------
Gross Margin $ 88,663 $ 63,528
============= ==============
Gross Margin % 43.4% 44.6%
============= ==============
Per Unit Sold:
Sales of Used Cars $ 8,453 $ 7,886
Cost of Used Cars Sold 4,785 4,370
------------- --------------
Gross Margin $ 3,668 $ 3,516
============= ==============
The number of cars we sold (units) increased by 33.8% for the six months
ended June 30, 1999 over the same period in 1998. Same store unit sales for the
six months ended June 30, 1999 increased 24.7% compared to the six month period
ended June 30, 1998. The increase in our same store unit sales was primarily a
result of the maturation of stores purchased or opened in late 1997. We
anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Our Used Car Sales revenues increased by 43.4% for the six months ended June
30, 1999 over the same period ended June 30, 1998. The growth for this period
reflects increases in the number of dealerships in operation and the average
unit sales price. The Cost of Used Cars Sold increased by 46.5% for the six
months ended June 30, 1999 over the same period ended June 30, 1998. The gross
margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold
excluding Provision for Credit Losses) increased by 39.6% for the six months
ended June 30, 1999 over the same period ended June 30, 1998. The gross margin
per car sold for the six months ended June 30, 1999 is comparable to the six
months ended June 30, 1998.
Our average sales price per car increased by 7.2% for the six months ended
June 30, 1999 over the six months ended June 30, 1998. The increase in the
average sales price was necessary to offset the increase in the Cost of Used
Cars Sold. On a per unit basis, the Cost of Used Cars Sold increased by 9.5% for
the six months ended June 30, 1999 over the six months ended June 30, 1998. The
increase in our average cost per used car sold is primarily due to an increase
in the direct cost of the cars we sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Six Months Ended
June 30,
---------------------------
1999 1998
------------- ------------
Provision for Credit Losses (in thousands) $ 53,553 $ 29,307
============= ============
Provision per contract originated $ 2,234 $ 1,641
============= ============
Provision as a percentage of
principal balances originated 26.9% 21.5%
============= ============
Page 17
<PAGE>
The Provision for Credit Losses in our dealership operations increased by
82.7% in the six months ended June 30, 1999 over the six months ended June 30,
1998. The Provision for Credit Losses per unit originated at our dealerships
increased by $593 or 36.1% in the six months ended June 30, 1999 over the six
months ended June 30, 1998. The increase is primarily a result of the change in
how we structure securitizations for accounting purposes.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 57.5% to $1.6 million in the six months
ended June 30, 1999 from $1.0 million in the six months ended June 30, 1998. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our Securitized Contract Sales. Interest Income
increased by 251.2% to $26.1 million for the six months ended June 30, 1999 from
$7.4 million for the six months ended June 30, 1998. The increase was primarily
due to the increase in the average finance receivables retained on our balance
sheet. Because we structured most of our securitizations to recognize income as
sales for accounting purposes prior to 1999, there were fewer receivables
retained on our balance sheet and Interest Income was lower in these periods.
See "Securitizations-Dealership Operations" below for additional discussion of
our securitization transactions and our on balance sheet portfolio.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Six Months Ended
June 30,
----------------------------------
1999 1998
--------------- -------------
Percentage of sales revenue financed 97.3% 95.9%
Percentage of sales units financed 99.2% 98.8%
The average effective yield on finance receivables from our dealerships was
approximately 26.3% for the six months ended June 30, 1999 and 25.7% for the six
months ended June 30, 1998.
Non-Dealership Operations. Interest Income from the First Merchants
transaction decreased by 46.8% to $627,000 for the six months ended June 30,
1999 from $1.2 million for the six months ended June 30, 1998. Interest Income
from the Cygnet dealer program increased by 107.1% to $7.5 million for the six
months ended June 30, 1999 from $3.6 million for the six months ended June 30,
1998. The increase in interest income in the Cygnet dealer program reflects a
significant increase in the amount of loans outstanding during the six months
ended June 30, 1999 compared to the six months ended June 30, 1998.
Gain on Sale of Loans
Dealership Operations. Because of the change in the way we structure our
securitization transactions for accounting purposes in the fourth quarter of
1998, we no longer recognize gains on the sale of loans from securitization
transactions. We recorded Gains on Sale of Loans related to securitized contract
sales of zero for the six months ended June 30, 1999 and $8.3 million during the
six months ended June 30, 1998. See "Securitizations-Dealership Operations"
below for a summary of the structure of our securitizations.
Page 18
<PAGE>
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the six months ending June 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
------------- ------------------ -------------
June 30, 1999 $ 5,369 $ 11,926 $ 17,295
============= ================== =============
June 30, 1998 $ 7,999 $ 5,443 $ 13,442
============= ================== =============
Dealership Operations. Servicing and Other Income decreased by 32.9% to $5.4
million in the six months ended June 30, 1999 compared to the $8.0 million
recognized in the six months ended June 30, 1998. As previously noted, we
anticipate that our future Servicing and Other Income will decline as the
principal balance of the contracts serviced under the Securitized Contract Sales
agreements and the third party portfolio will continue to decrease.
Non-Dealership Operations. Our Service Fee and Other Income increased 119.1%
to $11.9 million in the six months ended June 30, 1999 compared to the $5.4
million recognized in the six months ended June 30, 1998. Our Service Fee and
Other Income increased because our non-dealership operations did not begin
servicing loans until April 1998. As previously noted, we have not entered into
any loan servicing agreements thus far in 1999 and expect that our service fee
income will continue to decline as the principal balances of the portfolios that
we are currently servicing decrease.
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 26.6% to $85.0 million for the six months ended June 30, 1999 from $67.1
million for the six months ended June 30, 1998. Growth of Sales of Used Cars,
Interest Income, and Servicing and Other Income were the primary contributors to
the increase.
A summary of operating expenses for our business segments for the six months
ended June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
---------------------------------- ---------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
---------- ---------- ---------- --------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999:
Selling and Marketing $ 12,433 $ -- $ -- $ 59 $ 3 $ -- $ 12,495
General and 22,010 9,150 9,959 1,937 10,807 1,518 55,381
Administrative
Depreciation and 1,653 562 1,058 185 692 308 4,458
Amortization
---------- ---------- ---------- --------- ---------- ---------- ------------
$ 36,096 $ 9,712 $ 11,017 $ 2,181 $11,502 $ 1,826 $ 72,334
========== ========== ========== ========= ========== ========== ============
1998:
Selling and Marketing $9,096 $ -- $ -- $ 87 $ 12 $ -- $ 9,195
General and 19,835 8,834 6,075 1,108 4,203 1,298 41,353
Administrative
Depreciation and 648 450 45 154 -- 2,525
Amortization 1,228
---------- ---------- ---------- --------- ---------- ---------- ------------
$30,159 $ 9,482 $ 6,525 $ 1,240 $ 4,369 $ 1,298 $ 53,073
========== ========== ========== ========== ========== =========== ============
</TABLE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
for the six months ended June 30, 1999 and 1998 as a percentage of Sales of Used
Cars and Selling and Marketing Expense per car sold from our company dealership
segment follows:
Page 19
<PAGE>
1999 1998
----------- ----------
Selling and Marketing Expense as a
Percent of Sales of Used Cars 6.1% 6.4%
=========== ==========
Selling and Marketing Expense
per Car Sold $ 514 $ 503
=========== ==========
For the six months ended June 30, 1999 and 1998, total Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Total Selling and Marketing Expenses increased by
35.9% to $12.5 million for the six months ended June 30, 1999 from $9.2 million
for the six months ended June 30, 1998. Selling and Marketing Expense as a
percentage of Sales of Used Cars and on a per unit basis is comparable for the
six months ended June 30, 1999 compared to the six month period in 1998.
General and Administrative Expenses. A summary of General and Administrative
Expenses for the six months ended June 30, 1999 and 1998 as a percentage of
Sales of Used Cars and General and Administrative Expenses per car sold from our
Company Dealership segment follows:
1999 1998
---------- ----------
General and Administrative Expense
as a Percentage of Used Car Sales 10.8% 13.9%
General and Administrative Expense
per Car Sold $ 911 $ 1,098
For the six months ended June 30, 1999 total General and Administrative
Expenses increased by 33.9% to $55.4 million from $41.4 million for the six
months ended June 30, 1998. The increase in General and Administrative Expenses
was primarily a result of an increase in the number of dealerships in operation,
the addition of our bulk purchasing and loan servicing operations, the expansion
of infrastructure to administer the increased number of used car dealerships in
operation, and the growth of the Cygnet dealer program.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 76.6% to
$4.5 million for the six months ended June 30, 1999 from $2.5 million for the
six months ended June 30, 1998. The increase in 1999 was primarily due to
depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 230.0% to $9.5 million for the six months
ended June 30, 1999 from $2.9 million for the six months ended June 30, 1998.
The increase for the six months ended June 30, 1999 was primarily due to
increased borrowings under our Securitization Notes Payable, Notes Payable and
Subordinated Notes Payable. The increased borrowings were used primarily to fund
the increases in Finance Receivables.
Income Taxes
Income taxes totaled $1.3 million for the six months ended June 30, 1999,
and $4.5 million for the six months ended June 30, 1998. Our effective tax rate
was 40.8% for the six months ended June 30, 1999 and 40.3% for the six months
ended June 30, 1998.
Discontinued Operations
We recorded a pre-tax charge to discontinued operations totaling
approximately $9.1 million (approximately $5.6 million, net of income taxes)
during the first quarter of 1998 related to the closure of our branch office
network. In addition, we recorded a $6.0 million charge (approximately $3.6
million, net of income taxes) during the third quarter of 1998 due primarily to
higher than anticipated loan losses and servicing expenses. The charges we
recorded to Discontinued Operations represent the total estimated net loss we
expect to realize from the branch office network closure. As a result, there was
no income or loss from Discontinued Operations for the six months ended June 30,
1999.
Page 20
<PAGE>
Financial Position
Total assets increased by 34.5% to $465.2 million at June 30, 1999 from
$346.0 million at December 31, 1998. The increase was due primarily to an
increase in Finance Receivables of $144.0 million to $307.2 million at June 30,
1999 from $163.2 million at December 31, 1998. Our dealership operations'
Finance Receivables increased approximately $128.6 million due primarily to the
change in our securitization structure, and our non-dealership operations'
Finance Receivables increased approximately $15.4 million primarily as a result
of growth of the Cygnet dealer program.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable. Notes Payable increased by $115.7
million to $233.0 million at June 30, 1999 from $117.3 million at December 31,
1998. The increase in our Notes Payable is attributable to an increase of $24.9
million in our revolving line of credit, which totaled approximately $76.7
million at June 30, 1999, compared to $51.8 million at December 31, 1998. Our
Securitization Notes Payable increased by $68.7 million as a result of the
securitization transaction we closed in April 1999. Our Note Payable
Collateralized by the Common Stock of our Securitization Subsidiaries increased
by $25.3 million as a result of a loan obtained from an unrelated third party in
May 1999. We also repaid $3.4 million in mortgage loans from an unrelated
finance company.
Growth in Finance Receivables. As a result of our continued expansion,
contract receivables managed by our dealership operations have continued to
increase. The following table reflects the growth in period end balances of our
dealership operations measured in terms of the principal amount and the number
of contracts outstanding.
The following table reflects the growth in contract originations measured in
terms of the principal amount and the number of contracts.
<TABLE>
<CAPTION>
Total Contracts Outstanding - Dealership Operations
(In thousands, except number of contracts)
June 30, 1999 December 31, 1998
---------------------------- -----------------------------
Principal Number of Principal Number of
Amount Contracts Amount Contracts
------------- ------------- -------------- ------------
<S> <C> <C> <C> <C>
Managed Portfolio $ 383,596 61,661 $ 292,683 49,501
Less: Portfolios Securitized and Sold 126,951 27,596 198,747 37,186
-------------- ------------ -------------- ------------
Total Retained Principal $ 256,645 34,065 $ 93,936 12,415
============== ============ ============== ============
</TABLE>
In addition to the loan portfolio summarized above, we also service loan
portfolios totaling approximately $69.7 million ($27.2 million for Kars and
$42.5 million from branch office originations) as of June 30, 1999 and $121.2
million ($47.9 million for Kars and $73.3 million from branch office
originations) as of December 31, 1998.
Three Months Ending Six Months Ending
June 30, June 30,
----------------------- ---------------------------
1999 1998 1999 1998
----------- ---------- ------------ -------------
Principal Amount $ 96,098 $ 66,908 $ 198,831 $ 136,616
Number of Contracts 11,335 8,518 23,969 17,857
Average Principal $ 8,478 $ 7,855 $ 8,295 $ 7,651
Finance Receivable principal balances generated or acquired by our
dealership operations during the three months period ended June 30, 1999
increased by 43.6% to $96.1 million from $66.9 million for the three months
ended June 30, 1998. For the six months ended June 30, 1999, Finance Receivables
increased by 45.5% to $198.8 million from $136.6 million for the six months
ended June 30, 1998. The increase in average principal financed is due to the
increase in our average sales price per car sold.
Our non-dealership operations began servicing loans on behalf of First
Merchants in April 1998, and began servicing additional loan portfolios on
behalf of other third parties throughout 1998. At June 30, 1999 our
non-dealership bulk purchasing/loan servicing operations were servicing a total
of approximately $356.3 million in finance receivables (approximately 56,000
contracts) compared to $587.3 million in finance receivables (approximately
80,000 contracts) at December 31, 1998.
Page 21
<PAGE>
Cygnet dealer's net investment in finance receivables purchased from a third
party dealer totaled approximately $10.8 million representing approximately
18.0% of Cygnet dealer's net finance receivables portfolio as of June 30, 1999.
We did not have any other third party dealer loans that exceeded 10% of our
Cygnet dealer finance receivable portfolio as of June 30, 1999.
Allowance for Credit Losses
We have established an Allowance for Credit Losses (Allowance) to cover
anticipated credit losses on the contracts currently in our portfolio. We
established the Allowance by recording an expense through the Provision for
Credit Losses.
For Finance Receivables generated at our dealerships, our policy is to
charge off a contract the earlier of:
o when we believe it is uncollectible, or
o when it is delinquent for more than 90 days.
The following table reflects activity in the Allowance for our dealership
operations, as well as information regarding charge off activity for the three
and six months ended June 30, 1999 and 1998, in thousands.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
1999 1998 1999 1998
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 48,628 $ 6,153 $ 24,777 $ 10,356
Provision for Credit Losses 25,789 14,273 53,553 29,307
Reduction Attributable to Loans Sold -- (13,082) -- (30,722)
Net Charge Offs (7,512) (1,394) (11,425) (2,991)
-------------- --------------- -------------- --------------
Balance, End of Period $ 66,905 $ 5,950 $ 66,905 $ 5,950
============== =============== ============== ==============
Allowance as a Percent of Period End Balances 26.1% 18.5% 26.1% 18.5%
============== =============== ============== ==============
Charge off Activity:
Principal Balances $ (9,570) $ (2,068) $ (14,580) $ (4,331)
Recoveries, Net 2,058 674 3,155 1,340
-------------- --------------- -------------- --------------
Net Charge Offs $ (7,512) $ (1,394) $ (11,425) $ (2,991)
============== =============== ============== ==============
Net Charge Offs as a Percent of Average Principal Outstanding 3.4% 2.9% 6.4% 5.0%
============== =============== ============== ==============
Average Principal Balance Outstanding $ 220,655 $ 48,172 $ 178,758 $ 60,242
============== =============== ============== ==============
</TABLE>
The Allowance on contracts from dealership operations was 26.1% of the
outstanding principal balances as of June 30, 1999 and 26.4% of outstanding
principal balances as of December 31, 1998. We changed the structure of our
securitization transactions for accounting purposes in the fourth quarter of
1998, which resulted in us retaining the securitized loans from securitization
transactions closed subsequent to the third quarter of 1998. We increased the
provision for credit losses to approximately 27% of the principal balance for
loans originated beginning in the fourth quarter of 1998 as we intend to hold
the balance sheet portfolio for investment and not for sale.
A Summary of the Allowance on contracts from non-dealership operations
follows:
<TABLE>
<CAPTION>
Non-Dealership Operations
------------------------------------------------------------------
June 30, December 31,
------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
1999 1998 1998 1997
--------------- --------------- --------------- ----------------
As Percent of Period End Balances:
Allowance 3.9% 3.2% 3.9% 3.8%
Non-refundable discount and security deposits 32.9% 28.1% 29.9% 26.0%
--------------- --------------- --------------- ----------------
Total Allowance, discount and security deposits 36.8% 31.3% 33.8% 29.8%
=============== =============== =============== ================
</TABLE>
Page 22
<PAGE>
Even though a contract is charged off, we continue to attempt to collect the
contract. Recoveries as a percentage of principal balances charged off from
dealership operations averaged 21.5% for the three months ended June 30, 1999
compared to 32.6% for the three months ended June 30, 1998. Such recoveries for
the six month periods ended June 30, 1999 and 1998 averaged 21.6% and 30.9%,
respectively. Recoveries as a percentage of principal balances charged off from
non-dealership operations averaged 37.7% for the three months ended June 30,
1999 compared to 27.6% for the three months ended June 30, 1998. Such recoveries
for the six month periods ended June 30, 1999 and 1998 averaged 34.7% and 29.3%,
respectively.
For Finance Receivables acquired by our non-dealership operations with
recourse to the seller, our general policy is to exercise the recourse
provisions in our agreements under the Cygnet dealer program when a contract is
delinquent for 45 days. For contracts not purchased with recourse, our policy is
similar to that for our dealership operations.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for contracts we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge offs for each pool
separately. We calculate the cumulative net charge offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge off. The table below
displays the cumulative net charge offs of each pool as a percentage of original
contract cumulative balances, based on the quarter the loans were originated.
The table is further stratified by the number of payments made by our customers
prior to charge off. For periods denoted by "x", the pools have not seasoned
sufficiently to allow us to compute cumulative losses. For periods denoted by
"-", the pools have not yet reached the indicated cumulative age. While we
monitor static pools on a monthly basis, for presentation purposes, we are
presenting the information in the table below on a quarterly basis.
Currently reported cumulative losses may vary from those previously reported
for the reasons listed below, however, management believes that such variation
will not be material:
o ongoing collection efforts on charged off accounts, and
o the difference between final proceeds on the sale of repossessed
collateral versus our estimates of the sale proceeds.
The following table sets forth as of July 31, 1999, the cumulative net
charge offs as a percentage of original contract cumulative (pool) balances,
based on the quarter of origination and segmented by the number of monthly
payments completed by customers before charge off. The table also shows the
percent of principal reduction for each pool since inception and cumulative
total net losses incurred (TLI).
Page 23
<PAGE>
<TABLE>
<CAPTION>
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
Monthly Payments Completed by Customer Before Charge Off
-----------------------------------------------------------------------
Orig. 0 3 6 12 18 24 TLI Reduced
------------- ------ -------- -------- -------- ------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1994:
1st Quarter $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter $ 8,191 1.6% 9.1% 14.7% 20.4% 22.7% 23.6% 23.8% 100.0%
2nd Quarter $ 9,846 2.0% 8.5% 13.3% 18.1% 20.7% 22.1% 22.5% 100.0%
3rd Quarter $ 10,106 2.5% 7.9% 12.2% 18.8% 22.1% 23.5% 24.2% 99.7%
4th Quarter $ 8,426 1.5% 6.6% 11.7% 18.2% 22.5% 24.0% 24.6% 99.6%
1996:
1st Quarter $ 13,635 1.6% 8.0% 13.7% 20.6% 24.7% 26.1% 27.0% 98.9%
2nd Quarter $ 13,462 2.2% 9.2% 13.4% 22.0% 25.9% 27.6% 28.8% 97.3%
3rd Quarter $ 11,082 1.6% 6.8% 12.5% 21.3% 25.5% 27.7% 28.6% 94.9%
4th Quarter $ 10,817 0.6% 8.4% 15.9% 24.8% 29.2% 31.0% 31.7% 92.4%
1997:
1st Quarter $ 16,279 2.1% 10.5% 17.8% 24.4% 29.4% 31.8% 32.0% 88.8%
2nd Quarter $ 25,875 1.5% 9.9% 15.8% 22.7% 27.4% 29.3% 29.3% 82.3%
3rd Quarter $ 32,147 1.4% 8.4% 13.2% 22.5% 27.1% 27.7% 27.7% 75.9%
4th Quarter $ 42,529 1.4% 6.8% 12.6% 21.9% 25.3% 25.3% 25.3% 69.6%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.5% 21.1% 22.6% -- 22.6% 62.2%
2nd Quarter $ 66,908 1.1% 8.0% 14.3% 19.9% -- -- 20.0% 50.4%
3rd Quarter $ 71,027 1.0% 8.0% 13.6% -- -- -- 16.3% 39.6%
4th Quarter $ 69,583 0.9% 6.8% -- -- -- -- 10.6% 25.6%
1999:
1st Quarter $ 102,733 0.8% -- -- -- -- -- 4.5% 0.0%
2nd Quarter $ 96,098 -- -- -- -- -- -- 0.5% 0.0%
</TABLE>
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of outstanding contract
principal balances from dealership operations.
Retained Securitized Managed
---------- ----------- ---------
June 30, 1999:
31 to 60 days 3.9% 6.4% 4.7%
61 to 90 days 2.2% 3.3% 2.6%
December 31, 1998:
31 to 60 days 2.3% 5.2% 4.6%
61 to 90 days 0.5% 2.2% 1.9%
In accordance with our charge off policy, there are no accounts more than 90
days delinquent as of June 30, 1999 and December 31, 1998.
Securitizations--Dealership Operations
Structure of Securitizations. In the fourth quarter of 1998 we announced
that we were changing the way we structure transactions for accounting purposes
under our securitization program. Through September 30, 1998, we had structured
these transactions as sales for accounting purposes (Securitized Contract
Sales). However, beginning in the fourth quarter of 1998, we began structuring
Page 24
<PAGE>
securitizations for accounting purposes to retain the contract, and the related
Securitization Note Payable on our balance sheet and recognize the income over
the life of the contracts (Securitized Borrowings). This change will not affect
our prior securitizations. Historically, Gains on Sale of Loans have been
material to our reported revenues and net earnings. Altering the structure of
these transactions so that no gain is recognized at the time of a securitization
transaction will have a material effect on our reported revenues and net
earnings until such time as we accumulate Finance Receivables on our balance
sheet sufficient to generate interest income (net of interest, credit losses,
and other expenses) equivalent to the revenues that we had historically
recognized on our securitization transactions.
Under our securitization program, we transfer the securitized Finance
Receivables to our securitization subsidiaries who then assign and transfer the
Finance Receivables to separate trusts for either Securitized Contract Sales or
Securitized Borrowings. The trusts issue Class A certificates and subordinated
Class B certificates (Residuals in Finance Receivables Sold) to the
securitization subsidiaries. The securitization subsidiaries then sell the Class
A certificates to the investors and retain the Class B certificates. We continue
to service the securitized contracts.
Residuals in Finance Receivables Sold. The residuals are a component of
Finance Receivables and represent our retained interest (the Class B
certificates) in the Finance Receivables included in our Securitized Contract
Sales. We utilize a number of assumptions to determine the initial value of the
Residuals in Finance Receivables Sold. The Residuals in Finance Receivables Sold
represent the present value of the expected net cash flows of the securitization
trusts using the out of the trust method. The net cash flows out of the trusts
are the collections on the loans in the trust in excess of the Class A
certificate principal and interest payment and certain other trust expenses. The
assumptions used to compute the Residuals in Finance Receivables Sold include,
but are not limited to:
o charge off rates,
o repossession recovery rates,
o portfolio delinquency,
o prepayment rates, and
o trust expenses.
The Residuals in Finance Receivables Sold are adjusted monthly to
approximate the present value of the expected remaining net cash flows out of
the trusts. If actual cash flows on a securitization are below our original
estimates, and those differences appear to be other than temporary in nature, we
are required to revalue Residuals in Finance Receivables Sold and record a
charge to earnings based upon the reduction. The cumulative net loss at
origination assumption inherent in the securitization transactions we entered
into in 1996 and 1997 is approximately 27.5%. For the securitizations that we
completed during the nine month period ended September 30, 1998, net losses were
estimated using total expected cumulative net losses at loan origination of
approximately 29.0%. The remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts was approximately 19.8% as of June 30, 1999, compared to
22.0% as of December 31, 1998. Because we now structure our securitization
transactions to retain the Finance Receivables securitized, we will no longer be
adding to our Residuals in Finance Receivables Sold. Further, the remaining
Residuals in Finance Receivables Sold that were originated under our prior
method will continue to decline as the underlying loan portfolios mature.
Consequently, the remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts will continue to decline as the related loan portfolios
mature. The balance of the Residuals in Finance Receivables sold was $22.6
million at June 30, 1999 and $33.3 million as of December 31, 1998. We classify
the residuals as "held-to-maturity" securities in accordance with SFAS No. 115.
Spread Account Requirements. We maintain a spread account under our
securitization agreements. The spread account is a reserve account that would be
used to repay the Class A certificates in the event collections on a particular
pool of finance receivables was insufficient to make the required payments. At
the time a securitization transaction is entered into, our securitization
subsidiary makes an initial cash deposit into the spread account, generally
equivalent to 4% to 6% of the initial underlying Finance Receivables principal
balance, and pledges this cash to the spread account. The trustee then makes
additional deposits to the spread account out of collections on the securitized
receivables as necessary to maintain the spread account to a specified
percentage, ranging from 6.0% to 10.5%, of the underlying Finance Receivables'
principal balance. The trustee will not make distributions to the securitization
subsidiaries on the Class B certificates unless:
o the spread account has the required balance,
o the required periodic payments to the Class A certificate holders are
current, and
o the trustee, servicer and other administrative costs are current.
Page 25
<PAGE>
At June 30, 1999, we met the targeted spread account balances under our
securitization agreements of $27.9 million. We also maintain spread accounts for
the securitization transactions that were consummated by our discontinued
operations. We had satisfied the spread account funding obligation of $2.6
million as of June 30, 1999 with respect to these securitization transactions.
Certain financial information regarding securitizations. During April 1999
we closed a Securitized Borrowing transaction in which we securitized $119.7
million of contracts, issuing $87.4 million in Class A certificates. During the
first two quarters of 1998, we securitized $152.9 million in contracts, issuing
$110.1 million in Class A certificates, and $42.8 million in Class B
certificates. We recorded the carrying value of the related Residuals in Finance
Receivables Sold at $25.5 million for the first and second quarters of 1998. Due
to the change in the structure of our securitization transactions, we did not
record any Residuals in Finance Receivables for the securitization transaction
we closed in April 1999.
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have increased
in connection with the growth of our business. We require capital for:
o increases in our contract portfolio,
o expansion of our dealership network,
o our commitments under the First Merchants transaction,
o expansion of the Cygnet dealer program,
o common stock repurchases,
o the purchase of inventories,
o the purchase of property and equipment, and
o working capital and general corporate purposes.
We fund our capital requirements primarily through:
o operating cash flow,
o our revolving facility with General Electric Capital Corporation (GE
Capital),
o securitization transactions,
o supplemental borrowings, and
o in the past, equity offerings.
While to date we have met our liquidity requirements as needed, there can be
no assurance that we will be able to continue to do so in the future.
Operating Cash Flow
Net Cash Provided by Operating Activities increased by $73.1 million in the
six months ended June 30, 1999 to $80.7 million compared to the six months ended
June 30, 1998 of $7.7 million. The change in inventory and accounts payable and
accrued expenses contributed to the increase in operating cash flow for the
quarter. The changes in the Net Cash Provided by Operating activities and Net
Cash Used in Investing Activities is largely due to a change in classification
of portfolio activity related to the change in the structure of our
securitization transactions. Under our old structure contracts were held for
sale and, consequently, Finance Receivable purchases and related sales proceeds
were considered operating activities. Under our revised structure, contracts are
held for investment and such purchases are considered investing activities.
Net Cash Used in Investing Activities increased by $203.3 million to $199.3
million in the six months ended June 30, 1999 compared to $4.0 million of Net
Cash Provided by Investing Activities in the six months ended June 30, 1998. The
increase is primarily due to increases in Cash Used in Investing Activities from
purchases of Finance Receivables, net decreases in Cash advanced under our Notes
Receivable, which were offset by increased collections of Finance Receivables
and Notes Receivable.
Net Cash Provided by Financing Activities increased by $107.2 million to
$103.4 million in the six months ended June 30, 1999 compared to $3.8 million of
Net Cash Used in Financing Activities in the six months ended June 30, 1998. The
increase is due to increases in Notes Payable, net of increases in repayments of
Notes Payable and the acquisition of Treasury Stock.
Page 26
<PAGE>
Financing Resources
Revolving Facility. The maximum commitment under our revolving credit
facility with GE Capital is $125.0 million. Under the revolving facility, we may
borrow:
o up to 65.0% of the principal balance of eligible contracts originated from
the sale of used cars,
o up to 86.0% of the principal balance of eligible contracts previously
originated by our branch office network,
o the lesser of $20 million or 58% of the direct vehicle costs for eligible
vehicle inventory, and
o the lesser of $15 million or 50% of eligible contracts or loans originated
under the Cygnet dealer program.
However, an amount up to $8.0 million of the borrowing capacity under the
revolving facility is not available at any time while our guarantee to the
purchaser of contracts acquired from First Merchants is outstanding. The
revolving facility expires in June 2000 and contains a provision that requires
us to pay GE Capital a termination fee of $200,000 if we terminate the revolving
facility prior to the expiration date. We secure the facility with substantially
all of our assets.
As of June 30, 1999, our borrowing capacity under the revolving facility was
$105.9 million, the aggregate principal amount outstanding under the revolving
facility was approximately $76.6 million, and the amount available to be
borrowed under the facility was $29.3 million. The revolving facility bears
interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.06% as
of June 30, 1999).
The revolving facility contains covenants that, among other things, limit
our ability to do the following without GE Capital's consent:
o incur additional indebtedness,
o make any change in our capital structure,
o declare or pay dividends, except in accordance with all applicable laws
and not in excess of fifteen percent (15%) of each year's net earnings
available for distribution, and
o make certain investments and capital expenditures.
The revolving facility also provides that an event of default will occur if
Mr. Ernest C. Garcia II owns less than 15.0% of our voting stock. Mr. Garcia
owned approximately 32.1% of our common stock at June 30, 1999.
We were also required to be Year 2000 compliant no later than June 30, 1999
(see discussion below under the Year 2000 Readiness Disclosure), and we are also
required to maintain specified financial ratios, including a debt to equity
ratio of 2.2 to 1 and a net worth of at least $150 million.
Securitizations. Our securitization program is a primary source of our
working capital. Since September 30, 1997, we have closed all of our
securitizations with private investors through Greenwich Capital Markets, Inc.
(Greenwich Capital). In March 1999, we executed a commitment letter with
Greenwich Capital to act as our exclusive agent in placing up to $300 million of
surety wrapped securities under our securitization program.
Securitizations generate cash flow for us from:
o the sale of Class A certificates,
o ongoing servicing fees, and
o excess cash flow distributions from collections on the contracts
securitized after:
o payments on the Class A certificates sold to third party investors,
o payment of fees, expenses, and insurance premiums, and
o required deposits to the spread account.
In April 1999, we closed a securitization transaction through Greenwich
Capital. Under this transaction, we securitized approximately $119.7 million of
contracts and issued approximately $87.4 million of Class A certificates with an
annual interest rate of 5.7%.
Page 27
<PAGE>
Securitization also allows us to fix our cost of funds for a given contract
portfolio. Failure to regularly engage in securitization transactions will
adversely affect us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Securitizations--Dealership operations" for
a more complete description of our securitization program.
Supplemental Borrowings
Verde Debt. Prior to our public offering in September 1996, we historically
borrowed substantial amounts from Verde Investments, Inc. (Verde), which is
owned by our Chairman, Ernest C. Garcia II. The Subordinated Notes Payable
balances outstanding to Verde totaled $8.0 and $10.0 million as of June 30, 1999
and as of December 31, 1998. Under the terms of this note, we are required to
make monthly payments of interest and annual payments of principal in the amount
of $2.0 million. These borrowings accrue interest at an annual rate of 10.0%.
Except for the debt incurred related to our exchange offer, this debt is junior
to all of our other indebtedness and we may suspend interest and principal
payments if we are in default on obligations to any other creditors. In July
1997, our Board of Directors approved the prepayment of the total balance of the
Verde subordinated debt after the earlier of the following:
o the completion of a debt offering,
o the First Merchants transactions have been completed or the cash
requirements for completion of the transaction are known, or
o we either have cash in excess of our current needs or have funds
available under our financing sources in excess of our current needs.
No such prepayment has been made as of the date of filing of this Form 10-Q.
Any prepayment would require the consent of certain of our lenders.
Exchange Offer. In the fourth quarter of 1998, we acquired approximately 2.7
million shares of our common stock in exchange for approximately $17.5 million
of subordinated debentures. The debentures are unsecured and are subordinate to
all of our existing and future indebtedness. We must pay interest on the
debentures twice a year at 12% per year. We are required to pay the principal
amount of the debentures on October 23, 2003.
We issued the debentures at a premium of approximately $3.9 million over the
market value of the shares of our common stock that were exchanged for the
debentures. Accordingly, the debt was recorded at $13.6 million on our balance
sheet. The premium will be amortized over the life of the debentures and results
in an effective annual interest rate of approximately 18.8%. We can redeem all
or part of the debentures at any time, subject to the subordination provision of
the debentures. The balance of the subordinated debentures was $13.9 million at
June 30, 1999.
Senior Subordinated Notes. In February 1998, we borrowed a total of $15.0
million of subordinated debt from unrelated third parties for a three year term.
We pay interest on this debt quarterly at 12% per annum. This debt is:
o senior to the Verde subordinated note (described above) and the
subordinated debentures issued in our exchange offer (also described
above), and
o subordinate to our other indebtedness.
We issued warrants to the lenders of this debt to purchase up to 500,000
shares of our common stock at an exercise price of $10.00 per share, exercisable
at any time until the later of February 2001, or when the debt is paid in full.
In July 1998, we borrowed a total of $5.0 million in subordinated debt from
unrelated third parties for a three-year term. In the first quarter of 1999, we
prepaid $3.0 million of the loans. We repaid the remaining $2.0 million in June
1999.
Additional Financing. On November 12, 1998, we borrowed $15.0 million for a
term of 364 days from Greenwich Capital. We pay interest on this loan at an
interest rate equal to LIBOR plus 400 basis points. We secured the loan with the
common stock of our securitization subsidiaries. In March 1999, we borrowed
$20.0 million for a term of 278 days from Greenwich Capital. $1.5 million was
used to repay the remaining balance of the $15 million Greenwich Capital loan.
The new loan was secured by the common stock of our securitization subsidiaries.
The interest rate is at LIBOR plus 500 basis points and we paid an origination
fee of 100 basis points. We repaid this loan in the second quarter of 1999.
On March 26, 1999, we borrowed approximately $28.9 million from Greenwich
Capital under a repurchase facility with a 62% advance rate, bearing interest at
8.5%, and maturing May 31, 1999. This repurchase facility was repaid in April
1999.
Page 28
<PAGE>
In March 1999, we executed a commitment letter with Greenwich Capital in
which, subject to satisfaction of certain conditions, Greenwich Capital agreed
to provide us with a $100 million surety-wrapped warehouse line of credit at a
rate equal to LIBOR plus 110 basis points.
On May 14, 1999, we borrowed approximately $38.0 million from an unrelated
party for a term of three years maturing on May 1, 2001.The note calls for
monthly principal payments of generally not less than $500,000 plus interest at
a rate equal to LIBOR plus 550 basis points. The loan is secured by our
Residuals in Finance Receivables Sold and certain Finance Receivables.
Debt Shelf Registration. In 1997, we registered up to $200 million of our
debt securities under the Securities Act of 1933. There can be no assurance that
we will be able to use this registration statement to sell debt securities, or
successfully register and sell other debt securities in the future.
Capital Expenditures and Commitments
During the three months ended June 30, 1999, we opened one new dealership.
We also have three additional dealerships under development. The direct cost of
opening a dealership is primarily a function of whether we lease a facility or
construct a facility. A leased facility costs approximately $650,000 to develop,
while a facility we construct costs approximately $1.7 million. In addition, we
require capital to finance the portfolio that we carry on our balance sheet for
each store. It takes approximately $2.2 million in cash to support a typical
stabilized store portfolio with our existing 65% advance rate under our GE
facility. Additionally, it takes approximately 30 months for a store portfolio
to reach a stabilized level.
On July 11, 1997, we entered into an agreement to provide debtor in
possession financing to First Merchants (DIP facility). As of June 30, 1999, the
maximum commitment on the DIP facility was $11.5 million and the outstanding
balance on the DIP facility totaled $11.5 million. When First Merchants
defaulted on the DIP facility, we negotiated a settlement agreement with them
that has increased our funding obligation by $2.0 million, subject to
satisfaction of certain conditions, and in exchange for other concessions. These
conditions were satisfied in August 1999 and the loan is no longer in default.
We intend to finance the construction of new dealerships and the DIP
facility financing through operating cash flows and supplemental borrowings,
including amounts available under the revolving facility and the securitization
program.
Common Stock Repurchase Program. During the first quarter of 1999 we
repurchased approximately 928,000 shares of our common stock for $5.2 million
under our stock repurchase program. We have repurchased a total of one million
shares of our common stock under the program, which is the total number of
shares the Board of Directors authorized. In April 1999, our Board of Directors
authorized, subject to certain conditions and lender approval, a second stock
repurchase program that would allow us to repurchase up to 2.5 million
additional shares of our common stock. Purchases may be made depending on market
conditions, share price, and other factors. We did not repurchase any of our
common stock during the second quarter of 1999.
Year 2000 Readiness Disclosure
Many older computer programs refer to years only in terms of their final two
digits. Such programs may interpret the year 2000 to mean the year 1900 instead.
The problem affects not only computer software, but also computer hardware and
other systems containing processors and embedded chips. Business systems
affected by this problem may not be able to accurately process date related
information before, during or after January 1, 2000. This is commonly referred
to as the Year 2000 issue. Failures of our own business systems due to Year 2000
issues as well as those of our suppliers and business partners could materially
adversely affect our business. We are in the process of addressing these issues.
Our Year 2000 compliance program consists of:
o identification and assessment of critical computer programs, hardware and
other business equipment and systems,
o remediation and testing,
o assessment of the Year 2000 readiness of our critical suppliers, vendors
and business partners, and
o contingency planning.
Identification and Assessment
The first component of our Year 2000 compliance program is complete. We have
identified our critical computer programs, hardware, and other equipment to
determine which systems are compliant, or must be replaced or remediated.
Page 29
<PAGE>
Remediation and Testing
Dealership Operations. We have finished remediating the program code and
underlying data, testing the remediated code modifications and have implemented
these changes into operation for our integrated car sales and loan servicing
system (CLASS System). We placed the modified program code into production in
April 1999 and have completed performing date testing on the modified code.
Non-Dealership Operations. Our non-dealership loan servicing operations
currently utilize several loan processing and collections programs provided
through third party service bureaus. Based upon certifications we have received
from the software vendors, and independent testing we have performed, we believe
that our loan processing and collections programs are Year 2000 compliant.
Our Cygnet dealer program utilizes one of the same loan processing and
collections programs used by our loan servicing operations. The service bureau
that provides the program has written a custom module for us and has stated the
custom module is Year 2000 compliant. In addition, we have performed independent
Year 2000 compliance testing on the Cygnet dealer program's custom module, and
believe it is year 2000 compliant.
The remediation and testing of the critical business systems used by our
dealership and non-dealership operations was completed during the second quarter
of 1999.
Assessment of Business Partners
We have also identified critical suppliers, vendors, and other business
partners and have taken steps to determine their Year 2000 readiness. These
steps include interviews, questionnaires, and other types of inquiries. Because
of the large number of business systems that our business partners use and their
varying levels of Year 2000 readiness, it is difficult to determine how any Year
2000 issues of our business partners will affect us. We are not currently aware
of any business relationships with third parties that we believe will likely
result in a significant disruption of our businesses. We believe that our
greatest risk is with our utility suppliers, banking and financial institution
partners, and suppliers of telecommunications services, all of which are
operating within the United States. Potential consequences if we, or our
business partners, are not Year 2000 compliant include:
o failure to operate from a lack of power,
o shortage of cash flow,
o disruption or errors in loan collection and processing efforts, and
o delays in receiving inventory, supplies, and services.
If any of these events occurred, the results could have a material adverse
impact on us and our operations.
Contingency Plans
We are also developing contingency plans to mitigate the risks that could
occur in the event of a Year 2000 business disruption. Contingency plans may
include:
o increasing inventory levels,
o securing additional financing,
o relocating operations to unaffected sites,
o vendor/supplier replacement,
o utilizing temporary manual or spreadsheet-based processes, or
o other prudent actions,
We are currently working on updating our disaster recovery plan and
formulating our Year 2000 contingency plans. We will continue to develop our
contingency plans throughout the rest of the year and expect to complete them by
December 31, 1999.
Page 30
<PAGE>
Costs
We currently estimate that remediation and testing of our business systems
will cost between $2.4 million and $2.7 million. Most of these costs will be
expensed and funded by our operating line of credit. Costs incurred as of June
30, 1999 approximate $2.4 million, including approximately $231,000 of internal
payroll costs, substantially all of which have been charged to general and
administrative expense. Costs incurred in the six month period ended June 30,
1999 approximate $970,000. No such costs were incurred in the comparable period
in 1998. We believe costs associated with developing and implementing
contingency measures will not be material to our operating results. The
scheduled completion dates and costs associated with the various components of
our Year 2000 compliance program described above are estimates and are subject
to change.
Accounting Matters
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132) which became
effective for us January 1, 1999. SFAS No. 132 establishes standards for the
information that public enterprises report in annual financial statements. The
adoption of SFAS No. 132 did not have a material impact on us.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133) which becomes effective for us June 15,
2000. We believe the adoption of SFAS No. 133 will not have a material impact on
us.
ITEM 3.
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use instruments for trading purposes or to manage
interest rate risk. Our earnings are substantially affected by our net interest
income, which is the difference between the income earned on interest-bearing
assets and the interest paid on interest bearing notes payable. Increases in
market interest rates could have an adverse effect on profitability.
Our financial instruments consist primarily of fixed rate finance
receivables, residual interests in pools of fixed rate finance receivables,
short term variable rate revolving Notes Receivable, and variable and fixed rate
Notes Payable. Our finance receivables are classified as subprime loans and
generally bear interest at the lower of 29.9% or the maximum interest rate
allowed in states that impose interest rate limits. At June 30, 1999, the
scheduled maturities on our finance receivables range from one to 52 months with
a weighted average maturity of 31.3 months. The interest rates we charge our
customers on finance receivables has not changed as a result of fluctuations in
market interest rates, although we may increase the interest rates we charge in
the future if market interest rates increase. A large component of our debt at
June 30, 1999 is the Collateralized Note Payable (Class A certificates) issued
under our securitization program. Issuing debt through our securitization
program allows us to mitigate our interest rate risk by reducing the balance of
the variable revolving line of credit and replacing it with a lower fixed rate
note payable. We are subject to interest rate risk on fixed rate Notes Payable
to the extent that future interest rates are higher than the interest rates on
our existing Notes Payable.
We believe that our market risk information has not changed materially from
December 31, 1998.
Page 31
<PAGE>
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. Although we cannot determine at this
time the amount of the ultimate exposure from these lawsuits, if any, we, based
on the advice of counsel, do not expect the final outcome to have a material
adverse effect on our financial position.
Item 2. Changes in Securities and Use of Proceeds.
(a) None
(b) None
(c) None
(d) Not Applicable
Item 3. Defaults Upon Senior Securities.
Under the terms of the revolving facility, we are required to maintain an
interest coverage ratio that we failed to satisfy during the three months ended
March 31, 1999. We failed to meet this covenant primarily due to the reduction
in earnings we recognized as a result of the change in our securitization
structure. GE Capital waived the covenant violation as of March 31, 1999.
Subsequently, the revolving facility was amended to take into account the change
in structure of our securitization transactions and as a result of this change
there was no default as of June 30, 1999.
Item 4. Submission of Matters to a Vote of Security Holders.
Set forth below is information concerning the sole matter submitted to a
vote at Ugly Duckling's Annual Meeting of Stockholders on June 2, 1999:
Election of Directors. Each of the following persons was elected as a
director of Ugly Duckling to hold office until the 2000 Annual Meeting of
Stockholders, until his successor is duly elected and qualified, or until
retirement, resignation or removal: Ernest C. Garcia II, Christopher D.
Jennings, John N. MacDonough, Gregory B. Sullivan, and Frank P. Willey. Each of
these persons received 13,919,162 votes "for" reelection and 292,896 votes
"withheld."
Item 5. Other Information.
On July 26, 1999, Gregory B. Sullivan, President, Chief Operating Officer
and a director of Ugly Duckling, was appointed Chief Executive Officer by our
Board of Directors. Mr. Sullivan replaced Ernest C. Garcia II, who remains as
Chairman of the Board and our largest stockholder with over 32% of Ugly
Duckling's stock.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.1-- Amendment No. 4 to the Amended and Restated Motor Vehicle
Installment Contract Loan and Security Agreement between General
Electric Capital Corporation and Registrant dated June 30, 1999
Exhibit 11 -- Statement regarding computation of per share earnings (see
note 5 of Notes to condensed consolidated Financial Statements)
Exhibit 27 -- Financial Data Schedule
Exhibit 99 -- Risk Factors
Page 32
<PAGE>
(b) Reports on Form 8-K.
During the second quarter of 1999, Ugly Duckling did not file any reports
on Form 8-K. In addition, after the second quarter of 1999, Ugly Duckling has
not filed any reports on Form 8-K.
Page 33
<PAGE>
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 13, 1999
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT INDEX
Exhibit
Number Description
<S> <C>
10.1 Amendment No. 4 to the Amended and Restated Motor Vehicle and Installment
Contract Loan and Security Agreement between General Electric Capital
Corporation and Registrant dated June 30, 1999
11 Statement regarding computation of per share earnings (see note 5 of Notes
to Condensed Consolidated Financial Statements)
27 Financial Data Schedule
99 Risk Factors
</TABLE>
Amendment No. 4 to Amended and Restated Motor Vehicle Installment Contract
Loan and Security Agreement
This Amendment is entered into by and between Ugly Duckling Corporation,
successor in interest to Ugly Duckling Holdings, Inc. ("Ugly Duckling"), a
Delaware corporation; Ugly Duckling Car Sales and Finance Corporation
("UDCSFC"), an Arizona corporation formerly known as Duck Ventures, Inc.; Ugly
Duckling Credit Corporation ("UDCC") formerly known as Champion Acceptance
Corporation, an Arizona corporation; Ugly Duckling Car Sales, Inc. ("Sales"); an
Arizona corporation; Champion Financial Services, Inc. ("Champion"), an Arizona
corporation; Ugly Duckling Car Sales Florida, Inc. ("Car Sales Florida"), a
Florida corporation; Ugly Duckling Car Sales Texas, L.L.P. ("Car Sales Texas"),
an Arizona limited liability partnership; Ugly Duckling Car Sales New Mexico,
Inc. ("Car Sales New Mexico"), a New Mexico corporation; Ugly Duckling Car Sales
California, Inc. ("Car Sales California"), a California corporation; Ugly
Duckling Car Sales Georgia, Inc. ("Car Sales Georgia"), a Georgia corporation;
Cygnet Financial Corporation ("Cygnet'), a Delaware corporation; Cygnet Dealer
Finance, Inc. ("Dealer Finance"), an Arizona corporation; Cygnet Finance
Alabama, Inc. ("Cygnet Alabama"), an Arizona corporation; Cygnet Support
Services, Inc. ("Services"), an Arizona corporation; Cygnet Financial Services,
Inc. ("Cygnet Services"), an Arizona corporation; Cygnet Financial Portfolio,
Inc. ("Cygnet Portfolio"), an Arizona corporation; (all of the foregoing
entities collectively referred to herein as "Borrower"); and General Electric
Capital Corporation, a New York corporation ("Lender").
RECITALS
A. Borrower and Lender are parties to an Amended and Restated Motor
Vehicle Installment Contract Loan and Security Agreement dated as of August 15,
1997, as amended by an Assumption and Amendment Agreement dated October 23,
1997, Amendment No. 1 dated December 22, 1997, Amendment No. 2 dated September
9, 1998 and Amendment No. 3 dated January 18, 1999 (the Amended and Restated
Motor Vehicle Installment Contract Loan and Security Agreement as so amended is
referred to herein as the "Agreement") pursuant to which Lender agreed to make
Advances to Existing Borrower on the terms and conditions set forth in the
Agreement.
B. Borrower and Lender desire to amend certain provisions of the
Agreement pursuant to the terms set forth in this Amendment.
In consideration of the premises and other good and valuable
consideration, the receipt of which is hereby acknowledged by each of the
parties hereto, the parties agree as follows:
1. Defined Terms. Unless otherwise specified herein, all capitalized terms
used in this Amendment shall have the same meaning given to such term(s) in the
Agreement.
2. Amendments to Agreement. Effective as of June 30, 1999 , the Agreement
is hereby amended as follows:
(a) Cash Flow Based Interest Coverage Ratio. The definition of Cash Flow
Based Interest Coverage Ratio in Section 16.0 of the Agreement shall
be deleted; provided, however, should Borrower revert to utilizing any
form of "gain on sale" accounting treatment on future securitizations,
the Cash Flow Based Interest Coverage Ratio definition shall be
reinstated.
1
<PAGE>
(b) Financial Condition. Section 13.6 of the Agreement shall be amended in
its entirety to read as follows:
Financial Condition.
(A) Borrower shall not allow its Debt Ratio to exceed 2.2:1.
(B) Borrower shall maintain a Net Worth of at least One Hundred Fifty
Million Dollars ($150,000,000.00) at all times. If Borrower is in
default of any securitized tranche/trust, Net Worth shall be
reduced by the residual value associated with the defaulted
securitization.
(C) Borrower shall maintain an Interest Coverage ratio each quarter
of at least the following level:
Quarter Ratio
------- -----
2Q 1999 0.60
3Q 1999 0.70
4Q 1999 0.80
1Q 2000 1.15
2Q 2000 1.25
3Q 2000 and thereafter 1.30
If, however, Borrower reverts to utilizing any form of "gain on
sale" accounting treatment on future securitizations, the
modification of the Interest Coverage ratio covenant listed above
is automatically deleted from the Agreement and the Interest
Coverage ratio of 1.5 is automatically reinstated.
(D) Borrower's Rolling Average Delinquency shall not exceed 8.5%.
(E) Borrower's three-month Rolling Average Managed Portfolio
Delinquency shall not exceed 10%.
(F) Borrower's Average Charged-Off Losses shall not exceed 1.75%.
(G) Borrower's Average Charged-Off Losses for all Managed Portfolio
Contracts shall not exceed 2.75%.
(H) Borrower's Managed Portfolio Leverage Ratio shall not exceed: (i)
3.5:1 from the effective date of Amendment No. 2 until the 1-year
anniversary of the effective date of Amendment No. 2; and (ii)
4.0:1 thereafter.
(I) Borrower's Rolling Average Managed Portfolio Deferral Rate shall
not exceed 2.25.
(J) Lender may, in its sole discretion, amend the Rolling Average
Delinquency on an annual basis.
(K) Borrower shall notify Lender in writing, promptly upon its
learning thereof of any material adverse change in the financial
condition of Borrower, Validity of Collateral Guarantor, or
Guarantor.
(L) Borrower shall provide Lender a monthly report on Borrower's
Motor Vehicle inventory detailing Borrower's purchase price for
all such inventory, which shall be received by Lender by the 15th
of each calendar month.
(c) Loans and Advances. Section 14.3 is deleted in its entirety and
replaced with the following:
Loans and Advances. Except for routine and customary salary advances,
Borrower shall not make any unsecured loans or other advances of
money to officers, directors, employees, stockholders or Affiliates
in excess of Two Million Dollars ($2,000,000.00) in total. Borrower
shall not incur any long term or working capital debt (other than the
Indebtedness) secured by Contracts, and shall not create, incur,
2
<PAGE>
assume or suffer to exist any short term indebtedness which is not
Subordinated Debt. All obligations and security interests owned by
any Borrower with respect to any other Borrower are subordinated to
the Loan and the Lender's security interest in the Collateral.
Borrower shall not have loans or purchases of more than Three Million
Five Hundred Dollars ($3,500,000) outstanding at the same time under
any Dealer Contract, except for DCT and Texas Auto Outlet.
(d) Debt Ratio. The definition of "Debt Ratio" in Section 16.0 of the
Agreement is amended in its entirety to be:
Debt Ratio: the debt-to-equity ratio of Borrower, calculated in
accordance with generally accepted accounting principles by comparing
Borrower's total liabilities other than Subordinated Debt less amounts
owed by any bankruptcy-remote subsidiary via associated securitization
trusts to unaffiliated bondholders or certificate holders which are
included in Borrower's on-book liabilities (including amounts owed to
any bondholders who may not have any legal recourse to any
non-bankruptcy remote subsidiaries), divided by Net Worth of Borrower.
(e) Managed Portfolio Leverage Ratio. The definition of "Managed Portfolio
Leverage Ratio" in Section 16.0 of the Agreement is amended in its
entirety to be:
Managed Portfolio Leverage Ratio: Borrower's on-book liabilities other
than Subordinated Debt, plus amounts owed by any bankruptcy-remote
subsidiary via associated securitization trusts to unaffiliated
bondholders or certificate holders which are not included in
Borrower's on-book liabilities (including amounts owed to any
bondholders who may not have any legal recourse to any non-bankruptcy
remote subsidiaries), divided by Net Worth of Borrower.
3. Incorporation of Amendment: The parties acknowledge and agree that this
Amendment is incorporated into and made a part of the Agreement, the terms and
provisions of which, unless expressly modified herein, or unless no longer
applicable by their terms, are hereby affirmed and ratified and remain in full
force and effect. To the extent that any term or provision of this Amendment is
or may be deemed expressly inconsistent with any term or provision of the
Agreement, the terms and provisions of this Amendment shall control. Each
reference to the Agreement shall be a reference to the Agreement as amended by
this Amendment. This Amendment, taken together with the Agreement, which is
affirmed and ratified by Borrower, contains the entire agreement among the
parties regarding the transactions described herein and supersedes all prior
agreements, written or oral, with respect thereto.
4. Borrower Remains Liable. Borrower hereby confirms that the Agreement and
each document executed by Borrower in connection therewith continue unimpaired
and in full force and effect and shall cover and secure all of Borrower's
existing and future obligations to Lender.
5. Headings. The paragraph headings contained in this Amendment are for
convenience of reference only and shall not be considered a part of this
Amendment in any respect.
6. Governing Law. This Amendment shall be governed by and construed in
accordance with the laws of the State of Arizona. Nothing herein shall preclude
Lender from bringing suit or taking other legal action in any jurisdiction.
7. Execution in Counterparts. This Amendment may be executed in any number
of counterparts and by different parties hereto in separate counterparts, each
of which when so executed and delivered shall be deemed to be an original and
all of which taken together shall constitute one and the same instrument.
3
<PAGE>
IN WITNESS WHEREOF, the undersigned have entered into this Amendment as of July
19, 1999.
<TABLE>
<CAPTION>
<S> <C>
GENERAL ELECTRIC CAPITAL
CORPORATION UGLY DUCKLING CAR SALES, INC.
By: /S/ JEFF BATKA By: /S/ JON D. EHLINGER
Title: Account Executive Title: Secretary
UGLY DUCKLING CORPORATION UGLY DUCKLING CAR SALES NEW MEXICO, INC.
By: /S/ DONALD L. ADDINK By: /S/ JON D. EHLINGER
Title: Vice President Title: Secretary
UGLY DUCKLING CAR SALES AND CHAMPION FINANCIAL SERVICES, INC.
FINANCE CORPORATION
By: /S/ JON D. EHLINGER By: /S/ JON D. EHLINGER
Title: Secretary Title: Secretary
UGLY DUCKLING CAR SALES FLORIDA, UGLY DUCKLING CREDIT CORPORATION
By: /S/ JON D. EHLINGER By: /S/ JON D. EHLINGER
Title: Secretary Title: Secretary
UGLY DUCKLING CAR SALES TEXAS, UGLY DUCKLING CAR SALES
L.L.P. CALIFORNIA, INC.
By: Ugly Duckling Car Sales, Inc.
Its: General Partner By: /S/ JON D. EHLINGER
Title: Secretary
By: /S/ JON D. EHLINGER
Title: Secretary UGLY DUCKLING CAR SALES GEORGIA, INC.
By: /S/ JON D. EHLINGER
Title: Secretary
CYGNET FINANCIAL CORPORATION CYGNET DEALER FINANCE, INC.
By: /S/ DONALD L. ADDINK By: /S/ JUDITH A. BOYLE
Title: Vice President Title: Secretary
CYGNET FINANCE ALABAMA, INC. CYGNET SUPPORT SERVICES, INC.
By: /S/ JUDITH A. BOYLE By: /S/ JUDITH A. BOYLE
Title: Secretary Title: Secretary
CYGNET FINANCIAL SERVICES, INC. CYGNET FINANCIAL PORTFOILIO, INC.
By: /S/ DONALD L. ADDINK By: /S/ DONALD L. ADDINK
Title: Vice President Title: Vice President
</TABLE>
4
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This financial data schedule contains summary financial information as of and
for the six months ended June 30, 1999, which is extracted from the Condensed
Consolidated Balance Sheets, Statements of Operations, and Statements of Cash
Flows, and is qualified in its entirety by reference to the financial statements
within the report of Form 10-Q filing.
</LEGEND>
<CIK> 0001012704
<NAME> UGLY DUCKLING CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> Year
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> JUN-30-1999
<CASH> 1,302
<SECURITIES> 0
<RECEIVABLES> 423,937
<ALLOWANCES> 95,421
<INVENTORY> 37,810
<CURRENT-ASSETS> 0
<PP&E> 45,684
<DEPRECIATION> 10,934
<TOTAL-ASSETS> 465,177
<CURRENT-LIABILITIES> 0
<BONDS> 0
0
0
<COMMON> 19
<OTHER-SE> 159,376
<TOTAL-LIABILITY-AND-EQUITY> 465,177
<SALES> 204,319
<TOTAL-REVENUES> 255,850
<CGS> 115,656
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 72,334
<LOSS-PROVISION> 55,196
<INTEREST-EXPENSE> 9,473
<INCOME-PRETAX> 3,191
<INCOME-TAX> 1,301
<INCOME-CONTINUING> 1,890
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,890
<EPS-BASIC> 0.12
<EPS-DILUTED> 0.12
</TABLE>
Exhibit-99
RISK FACTORS
There are various risks in purchasing our securities or 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.
Capitalized terms not otherwise defined in this Exhibit 99 shall have the
meaning assigned to them in the Form 10-Q.
Future losses could impair our ability to raise capital or borrow money, as
well as affect our stock price.
Although we recorded earnings of $1.9 million for the six months ended June
30, 1999, we incurred a net loss of $5.7 million in 1998. We cannot assure you
that we will be profitable in future periods. Losses in subsequent periods could
impair our ability to raise additional capital or borrow money as needed, and
could adversely affect our stock price. The net loss in 1998 was due in large
part to:
o a charge of approximately $9.1 million ($5.6 million, net of income
taxes) to discontinued operations in the first quarter of 1998 for the
closure of our branch office network;
o a charge of approximately $6.0 million ($3.6 million, net of income
taxes) to discontinued operations during the third quarter of 1998 due
primarily to higher than anticipated loan losses and servicing expenses
in connection with our branch office loan portfolio;
o a charge of $2.0 million ($1.2 million, net of income taxes) during the
third quarter of 1998 to write off costs associated with our attempt to
spin off Cygnet Financial Corporation through a rights offering to our
stockholders; and
o a change in the fourth quarter of 1998 in the way we structure
securitization transactions for accounting purposes.
We may not be able to continue to obtain the financing we need to fund our
operations.
We have borrowed, and will continue to borrow, substantial amounts to fund
our operations. Our operations require large amounts of capital. If we cannot
obtain the financing we need on a timely basis and on favorable terms, our
business will be adversely affected. We currently obtain our financing through
three primary sources:
o a revolving credit facility with General Electric Capital Corporation;
o securitization transactions; and
o loans from other sources.
Revolving Credit Facility with GE Capital. Our revolving facility with GE
Capital is our primary source of operating capital. We have pledged
substantially all of our assets to GE Capital to secure the borrowings we make
under this facility. Although this facility has a maximum commitment of $125
million, the amount we can borrow is limited by the amount of certain types of
assets that we own. In addition, we cannot borrow approximately $8 million of
the capacity while our guarantee to the First Merchants contract purchaser is in
effect. As of June 30, 1999, we owed approximately $76.6 million under the
revolving facility, and had the ability to borrow an additional $29.3 million.
The revolving facility expires in June 2000. Even if we continue to satisfy the
terms and conditions of the revolving facility, we may not be able to extend its
term beyond the current expiration date.
Securitization Transactions. We can restore capacity under the GE facility
from time to time by securitizing portfolios of finance receivables. Our ability
to successfully complete securitizations in the future 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 contract portfolio; and
o the performance of our servicing operations.
1
<PAGE>
Our securitization subsidiaries are wholly-owned "bankruptcy remote"
entities. Their assets, including the line items "Residuals in Finance
Receivables Sold" and "Investments Held in Trust," within dealership operations,
which are components of Finance Receivables on our balance sheet, are not
available to satisfy the claims of our creditors.
On November 17, 1998, we announced that we were changing the way that we
structure transactions under our securitization program. In the past, we
structured these transactions as sales for accounting purposes. In the fourth
quarter of 1998, however, we began to structure securitizations for accounting
purposes to retain the financed receivables and related debt on our balance
sheet and recognize the income over the life of the contracts. In the past, gain
on sales of loans in securitization transactions has been material to our
results of operation. This change has caused and will continue to cause a
material adverse effect on our reported earnings until the net interest earnings
from new contracts added to our balance sheet approximates those net revenues
that we historically recognized on our securitization sales.
Contractual Restrictions. The revolving facility, the securitization
program, and our other credit facilities contain various restrictive covenants.
Under these credit facilities, we must also meet certain financial tests. We
believe that we are in compliance with the terms and conditions of the revolving
facility and our other credit facilities. Failure to satisfy the covenants in
our credit facilities and/or our securitization program, could preclude us from
further borrowing under the defaulted facility and could prevent us from
securing alternate sources of funds necessary to operate our business.
We have a high risk of credit losses because of the poor creditworthiness of
our borrowers.
Substantially all of the sales financing that we extend and the contracts
that we service are with sub-prime borrowers. Sub-prime borrowers generally
cannot obtain credit from traditional financial institutions, such as banks,
savings and loans, credit unions, or 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. However, we cannot assure you that we have
adequately provided for such credit risks or that we will continue to do so in
the future. A significant variation in the timing of or increase in credit
losses in our portfolio would have a material adverse effect on our net
earnings.
We also operate our Cygnet dealer program, under which we provide third
party dealers who finance the sale of used cars to sub-prime borrowers with
financing primarily secured by those dealers' retail installment contract
portfolios and/or inventory. While we require third party dealers to meet
certain minimum net worth and operating history criteria before we loan money to
them, these dealers may not otherwise be able to obtain debt financing from
traditional lending institutions. We have established an allowance for credit
losses to cover our anticipated credit losses. However, we cannot assure you
that we have adequately provided for such credit risks or that we will continue
to do so in the future. Like our other financing activities, these loans subject
us to a high risk of credit losses that could have a material adverse effect on
our net earnings and ability to meet our other financing obligations.
We are affected by various industry considerations and legal contingencies.
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation, and other events. Companies in the used vehicle
sales and financing market have also been named as defendants in an increasing
number of class action lawsuits brought by customers claiming violations of
various federal and state consumer credit and similar laws and regulations. In
addition, certain of these companies have filed for bankruptcy protection. These
events:
o have lowered the value of securities of sub-prime automobile finance
companies;
o have made it more difficult for sub-prime lenders to borrow money; and
o could cause more restrictive regulation of this industry.
2
<PAGE>
Compliance with additional regulatory requirements may also increase our
operating expenses and reduce our profitability.
Interest rates affect our profitability.
A substantial portion of our financing income results from the difference
between the rate of interest we pay on the funds we borrow and the rate of
interest we earn on the contracts in our portfolio. While we earn interest on
the contracts we own at a fixed rate, we pay interest on our borrowings under
our GE facility 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 we can charge can adversely affect our
profitability.
Historically, a significant portion of the contracts we service were
originated in states that did not impose limits on the interest rate that a
lender may charge. However, we have expanded, and will continue to expand, into
states that impose interest rate limitations. When a state limits the amount of
interest we can charge on our installment sales contracts, 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 regulation 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. Among other things, these laws:
o require that we obtain and maintain certain licenses and qualifications;
o limit or prescribe terms of the contracts that we originate and/or
purchase;
o require specified disclosures to customers;
o limit our right to repossess and sell collateral; and
o prohibit us from discriminating against certain customers.
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 could experience problems with the recent conversion of our loan servicing
and data processing operations to a single computer system.
We recently converted our chain of dealerships and related loan servicing
data processing operations to a single computer system. These conversions can
cause various problems that can affect our servicing operations and result in
increases in contract delinquencies and charge-offs and decreases in our
servicing income. Failure to successfully complete our conversions could
materially affect our business and profitability.
3
<PAGE>
Our computer systems may be subject to a Year 2000 date failure.
We could be affected by failures of our business systems, as well as those
of our suppliers and vendors, due to Year 2000 issues. Any failure could result
in a disruption of our collection efforts, which would impair our operations. We
have evaluated and remediated our mission critical computer systems to determine
our exposure to Year 2000 issues. We have made modifications to our computer
systems that we believe will allow them to properly process transactions
relating to the Year 2000 and beyond. Even though we believe our Year 2000
issues have been resolved, there can be no assurances that all of these
modifications have been properly made or that the modifications will not cause
other system problems. We estimate that we will spend between $2.4 million to
$2.7 million for Year 2000 evaluation, remediation, testing, and replacement. We
have spent approximately $2.4 million through June 30, 1999. We can also be
adversely affected by Year 2000 issues in the business systems of our suppliers,
vendors, and business partners, such as utility suppliers, banking partners and
telecommunication service providers. We can also be adversely affected if Year
2000 issues result in business disruptions or failures that impact our
customers' ability to make their loan payments. Failure to fully address and
resolve these Year 2000 issues could have a material adverse effect on our
operations. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Year 2000 Readiness Disclosure."
We could have a system failure if our current contingency plan is not adequate.
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. However, we believe that we need to revise our current
contingency plan because of our recent system conversions and significant
growth. Although we intend to update our contingency plan during 1999, there
could be a failure in the interim. In addition, the plan as revised may not
prevent a systems failure or allow us to timely resolve any systems failure.
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.
We have certain risks relating to the First Merchants transaction.
We have entered into several transactions in the bankruptcy proceedings of
First Merchants. We purchased 78% of First Merchants' senior bank debt at a 10%
discount. We agreed to pay the selling banks additional consideration up to the
amount of this 10% discount (or approximately $7.6 million) if First Merchants
makes cash payments or issues notes at market rates to its unsecured creditors
and equity holders in excess of 10% of their allowed claims against First
Merchants. First Merchants may make future cash payments to its unsecured
creditors and equity holders from recoveries on the contracts which originally
secured the senior bank debt and from certain residual interests in First
Merchants' securitized loan pools, after First Merchants pays certain other
amounts ("Excess Collections"). Under First Merchants' plan of reorganization,
we will split these Excess Collections with First Merchants.
If we satisfy certain requirements, we may be able to issue shares of our
common stock in exchange for all or part of First Merchants' share of the Excess
Collections. This would reduce the cash distributions that could be made to
First Merchants' unsecured creditors and/or equity holders. We would then be
entitled to receive First Merchants' share of the Excess Collections up to the
price of the shares we issue. The shares would be priced at 98% of the average
closing price of our common stock for the 10 trading days prior to the date of
issuance. This market price must be at least $8.00 per share or we cannot
exercise this option.
Even if we are able to issue common stock for this purpose:
o the number of shares that we issue may not be sufficient to prevent
First Merchants from paying unsecured creditors and equity holders more
than 10% of their claims against First Merchants. Should this happen,
we would be required to pay the selling banks additional consideration
(up to approximately $7.6 million) for our purchase of 78% of First
Merchants' senior bank debt; and
o the issuance of shares would cause dilution to our common stock.
4
<PAGE>
We also have other risks in the First Merchants' bankruptcy case:
o we sold the contracts securing the bank claims at a profit to a third
party purchaser (the "Contract Purchaser"). We guaranteed the Contract
Purchaser a specified return on the contracts with a current maximum of
$8 million. Although we obtained a related guarantee from First
Merchants secured by certain assets, there is no assurance that the
First Merchants guarantee will cover all of our obligations under our
guarantee to the Contract Purchaser;
o we have made debtor-in-possession loans to First Merchants, secured by
certain assets. We have continuing obligations under our
debtor-in-possession credit facility. We asserted that First Merchants
was in default on the DIP Facility. We have negotiated a settlement
with them that has cured the asserted default and increased our funding
obligation by $2.0 million, in exchange for other concessions; and
o we entered into various agreements to service the contracts in the
securitized pools of First Merchants and the contracts sold to the
Contract Purchaser. If we lose our right to service these contracts,
our 17 1/2% share of the Excess Collections can be reduced or
eliminated.
Each of the risks described in this section could have a material adverse
effect on our operations.
We may make acquisitions that are unsuccessful or strain or divert our
resources.
In 1997, we completed three significant acquisitions (Seminole, E-Z Plan,
and Kars). We intend to consider additional acquisitions, alliances, and
transactions involving other companies that could complement our existing
business. We may not, however, be able to identify suitable acquisition parties,
joint venture candidates, or transaction counterparties. Additionally, even if
we can identify suitable parties, we may not be able to consummate these
transactions on terms that we find favorable.
Furthermore, we may not be able to successfully integrate any businesses
that we acquire into our existing operations. If we cannot successfully
integrate acquisitions, our operating expenses may increase in the short-term.
This increase would affect our net earnings, which could adversely affect the
value of our outstanding securities. Moreover, these types of transactions may
result in potentially dilutive issuances of equity securities, the incurrence of
additional debt, and amortization of expenses related to goodwill and intangible
assets, all of which could adversely affect our profitability. In addition to
the risks already mentioned, these transactions 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.
Increased competition could adversely affect our operations and profitability.
Although a large number of smaller companies have historically operated in
the used car sales industry, this industry has attracted significant attention
from a number of large companies. These large companies include AutoNation,
U.S.A., CarMax, and Driver's Mart. These companies have either entered the used
car sales business or announced plans to develop large used car sales
operations. Many franchised new car dealerships have also increased their focus
on the used car market. We believe that these companies are attracted by the
relatively high gross margins that can be achieved in this market and the
industry's lack of consolidation. Many of these companies and franchised dealers
have significantly greater financial, marketing, and other resources than we do.
Increased competition in our dealership operations could result in increased
wholesale costs for used cars, decreased retail sales prices, and lower margins.
Like the sale of used cars, the business of purchasing and servicing
contracts originated from the sale of used cars to sub-prime borrowers is highly
fragmented and very competitive. In recent years, several consumer finance
companies have completed public offerings. Through these public offerings, these
companies have been able to raise the capital necessary to fund expansion and
support increased purchases of contracts. These companies have increased the
competition for the purchase of contracts, in many cases purchasing contracts at
higher prices than we would be willing to pay.
5
<PAGE>
There are numerous financial services companies serving, or capable of
serving, our market. These companies include traditional financial institutions
such as banks, savings and loans, credit unions, and captive finance companies
owned by automobile manufacturers, as well as other non-traditional consumer
finance companies, many of which have significantly greater financial and other
resources than our own. Increased competition may cause downward pressure on the
interest rates that we charge. This pressure could affect the interest rates we
charge on contracts originated by our dealerships or cause us to reduce or
eliminate the acquisition discount on the contracts we purchase from third party
dealers. Either change could have a material adverse 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 currently maintain
key person life insurance on our President and Chief Executive Officer, Gregory
B. Sullivan. Other than Mr. Sullivan, we do not maintain key person life
insurance on any members of our senior management team.
We may be required to issue stock in the future that will dilute the value of
our existing stock.
Issuance of any 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 1.6
million shares of our common stock to various parties with exercise
prices ranging from $6.75 to $20.00 per share;
o we may be required to 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 First Merchants' portion of the Excess Collections.
The voting power of our principal stockholder may limit your voting rights.
Mr. Ernest C. Garcia, II, our Chairman, and principal stockholder, or his
affiliates held approximately 32% of our outstanding common stock as of June 30,
1999. As a result, Mr. Garcia has a significant influence upon our activities as
well as on all matters requiring approval of our stockholders. These matters
include electing or removing members of our board of directors, engaging in
transactions with affiliated entities, causing or restricting our sale or
merger, and changing our dividend policy. The interests of Mr. Garcia may
conflict with the interests of our other stockholders.
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.
6
