<PAGE> 1
Rule 424(b)(4)
File No. 333-3998
2,300,000 Shares
LOGO
Common Stock
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All of the 2,300,000 shares of Common Stock offered hereby are being sold
by Ugly Duckling Corporation (the "Company"). Prior to this offering, there has
been no public market for the Common Stock of the Company. The Common Stock has
been approved for quotation on the Nasdaq Stock Market's National Market under
the symbol "UGLY." See "Underwriting," for a discussion of the factors
considered in determining the initial public offering price.
It is anticipated that SunAmerica Life Insurance Company ("SunAmerica")
will purchase from the Underwriters $1.0 million of the Common Stock offered
hereby. SunAmerica has agreed to convert $3.0 million of convertible
subordinated debt of the Company into additional Common Stock at the initial
public offering price. SunAmerica has also agreed to enter into certain
securitization transactions with the Company, the first of which was completed
in March 1996. See "Recapitalization and Related Transactions" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
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SEE "RISK FACTORS" AT PAGE 8 OF THIS PROSPECTUS FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK
OFFERED HEREBY.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY
IS A CRIMINAL OFFENSE.
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UNDERWRITING
PRICE TO DISCOUNTS PROCEEDS TO
PUBLIC AND COMMISSIONS(1) COMPANY(2)
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<S> <C> <C> <C>
Per Share......................... $6.75 $.506 $6.244
- -------------------------------------------------------------------------------------------------
Total(3).......................... $15,525,000 $1,163,800 $14,361,200
=================================================================================================
</TABLE>
(1) Excludes the value of warrants to purchase up to 170,000 shares of Common
Stock (the "Representative's Warrant") granted to the representative of the
several Underwriters (the "Representative"). The Company has agreed to
indemnify the Underwriters against certain liabilities under the Securities
Act of 1933, as amended, in connection with this offering. See
"Underwriting."
(2) Before deducting expenses of the offering payable by the Company estimated
at $1,262,500, including the Representative's non-accountable expense
allowance. See "Underwriting."
(3) The Company has granted the Underwriters a 45-day option to purchase up to
345,000 additional shares of Common Stock on the same terms and conditions
as set forth above solely to cover over-allotments, if any. If such option
is exercised in full, the total Price to Public, Underwriting Discounts and
Commissions, and Proceeds to Company will be $17,853,750, $1,338,370, and
$16,515,380, respectively. See "Underwriting."
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The shares of Common Stock are being offered severally by the Underwriters,
subject to prior sale, when, as, and if delivered to and accepted by the
Underwriters and subject to the right to reject any order in whole or in part
and certain other conditions. It is expected that delivery of the shares will be
made against payment therefor at the offices of Cruttenden Roth Incorporated,
Irvine, California, or the facilities of the Depository Trust Company, on or
about June 21, 1996.
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CRUTTENDEN ROTH
INCORPORATED
The date of this Prospectus is June 17, 1996
<PAGE> 2
IN CONNECTION WITH THE OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK AT
A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH
TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET OR OTHERWISE. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
<PAGE> 3
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information and consolidated financial statements, including the notes thereto,
appearing elsewhere in this Prospectus. Except as otherwise specified, all
information in this Prospectus assumes no exercise of the over-allotment option
granted to the Underwriters. Investors should carefully consider the information
set forth under the heading "Risk Factors."
THE COMPANY
Ugly Duckling Corporation (the "Company") is a fully integrated used car
sales and finance company that operates the largest chain of "buy here-pay here"
used car dealerships in Arizona. As part of its activities, the Company
underwrites, finances and services installment contracts generated by its
dealerships and by third party used car dealerships located in selected markets
throughout the United States. The Company targets customers who have limited
credit histories, low incomes, or past credit problems ("Sub-Prime Borrowers").
The rapidly growing used car sales and finance industry achieved record
sales in 1995 of 30.5 million units, representing approximately $290.0 billion
in sales. During this same period, more than $185.0 billion in retail
installment contracts were originated through the sale of used cars. Of this
amount, approximately 11.0 million units were sold to Sub-Prime Borrowers,
generating approximately $50.0 billion in retail installment contracts.
Consistent with the industry's growth, the Company has expanded
significantly in recent periods. From 1994 to 1995, total revenues increased by
72.2% from $33.8 million to $58.2 million. Reflecting development of its
infrastructure and expansion of its operations, the Company incurred losses of
approximately $2.0 million and $4.0 million for these periods.
During the three months ended March 31, 1996, the Company's net earnings
before preferred stock dividends were approximately $1.1 million. The Company's
first quarter of each year has historically been one of its most profitable and
may not necessarily be indicative of results to be expected for the rest of the
year. See "Risk Factors -- Fluctuations in Quarterly Results" and "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Seasonality." The Company's total revenues for the first quarter
of 1996 were $19.4 million, including $15.1 million on the sale of more than
2,000 used cars and $3.6 million in finance income. Revenues also included a
gain of approximately $540,000 on the sale of contracts pursuant to a newly
instituted securitization program. See "-- Capital Resources". In addition, the
Company purchased more than 1,200 contracts from third party dealers with an
aggregate principal balance of $7.2 million during the quarter. The combined
principal balance of the Company's wholly owned dealership and third party
dealer contract portfolios as of March 31, 1996 was $46.3 million.
Sales and Finance Operations. The Company sells used cars through seven
wholly owned used car dealerships ("Company Dealerships") serving the Phoenix
and Tucson, Arizona metropolitan areas and finances such sales through retail
installment contracts that the Company services. The Company also purchases and
services contracts originated by third party used car dealerships ("Third Party
Dealers"). Substantially all of the contracts the Company services are with
Sub-Prime Borrowers. As a result, the Company incurs substantial credit losses,
which it provides for through its Allowance for Credit Losses. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Allowance for Credit Losses" and "Business -- Comparison of
Contracts Originated at Company Dealerships and Third Party Dealers."
The Company's targeted competition for its Company Dealerships are the
numerous small independent used car dealerships that sell and finance sales of
used cars to Sub-Prime Borrowers ("Buy Here-Pay Here" dealers). The Company
estimates that there are over 63,000 independent used car dealers in the United
States, a substantial portion of which are Buy Here-Pay Here dealers. The
Company distinguishes its Company Dealership operations from those of typical
Buy Here-Pay Here dealers by providing multiple locations, upgraded facilities,
large inventories of used automobiles, centralized purchasing, value-added
marketing programs, and dedication to customer service. In addition, the Company
has developed flexible
3
<PAGE> 4
underwriting guidelines and techniques, which combine established underwriting
criteria with managerial discretion, to facilitate rapid credit decisions, as
well as networked computer systems and proprietary software that enable the
Company to monitor and service large volumes of contracts. See
"Business -- Business Strategy" and "Business -- Company Dealership Operations."
Recently, the growth of the used car sales and finance market has attracted
significant attention from a number of large companies, including Circuit City's
CarMax, AutoNation, U.S.A., Driver's Mart and CarChoice. The entrance into the
used car market by these companies, each of which have substantially greater
resources than the Company, could lead to greater competition and have a
negative impact on the Company's gross margins. See "Business -- Competition."
In 1994, the Company entered the Third Party Dealer financing market to
leverage the contract servicing expertise it had acquired through its Company
Dealership activities. Since that time, the Company has significantly expanded
its Third Party Dealer contract purchasing operations and, as of June 15, 1996,
had opened fourteen Third Party Dealer contract buying offices ("Branch
Offices") in selected markets throughout the United States (five in Arizona, two
each in Colorado, Indiana, and Texas, and one each in Florida, Nevada, and New
Mexico) and entered into contract purchasing agreements with over 300 Third
Party Dealers. The Company generally competes against independent automobile
finance companies and, to a lesser extent, traditional financial institutions
such as banks, savings and loans, credit unions, and captive finance companies
of major automobile manufacturers. See "Business -- Business Strategy,"
"Business -- Third Party Operations," and "Business -- Competition."
Marketing. The Company believes it has achieved widespread brand name
recognition through extensive television, radio, and billboard advertising
featuring its widely recognized animated duck mascot and logo. The Company
emphasizes its large network of Company Dealerships, its wide selection of
quality used cars, and its ability to finance most Sub-Prime Borrowers. The
Company has also established several innovative marketing programs that are
designed to attract Sub-Prime Borrowers by assisting them in re-establishing
their credit, offering rewards for timely payment on contracts, and promoting
customer loyalty. See "Business -- Company Dealership Operations -- Advertising
and Marketing."
Growth Strategy. Since commencing its used car sales and financing
operations in 1992, the Company has pursued an aggressive growth strategy
through both internal development and acquisition. Over the next two years, the
Company expects to develop or acquire approximately five additional Company
Dealerships and to open 15 to 20 additional Branch Offices in various states.
The Company believes that the aggregate cost of such expansion will be
approximately $8.5 million, which the Company expects to finance through
operating cash flows and supplemental borrowings. See "Use of Proceeds." In
conjunction with its expected expansion in the number of Branch Offices, during
the next two years the Company expects to add up to 300 additional Third Party
Dealers to its dealer network. Although the Company believes its current
management team, monitoring and collection operations, and corporate
infrastructure are capable of supporting the planned expansion of its
operations, the start-up costs and incremental overhead created by such
expansion could adversely affect the Company's results of operations in the
short-term. See "Business -- Business Strategy -- Growth Strategy" and
"Business -- Expansion Plans and Acquisition Opportunities."
Capital Resources. The Company finances its operations through a variety
of funding sources, including a $50.0 million revolving credit facility (the
"Revolving Facility") with General Electric Capital Corporation ("GE Capital").
In addition, the Company has entered into a securitization program (the
"Securitization Program") with SunAmerica Life Insurance Company ("SunAmerica")
pursuant to which SunAmerica may purchase up to $175.0 million of the Company's
asset-backed securities. The Company and SunAmerica have completed one
securitization of an aggregate of $13.0 million in contracts originated through
Company Dealerships. Standard & Poor's gave the $10.0 million in certificates
issued to SunAmerica in connection with the securitization a "BBB" rating, which
the Company believes is the first "investment grade" rating given to
certificates collateralized by used car installment contracts originated at Buy
Here-Pay Here dealerships without any external credit enhancement. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources." The Standard & Poor's rating is
unrelated to an investment in the securities being offered pursuant to this
Prospectus.
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<PAGE> 5
Recapitalization and Related Transactions. Upon the closing of this
offering, Verde Investments, Inc. ("Verde Investments"), an affiliate of the
Company whose sole stockholder is also the Chairman, Chief Executive Officer,
and majority stockholder of the Company, has agreed to sell to the Company,
subject to financing, nine properties owned by Verde Investments and leased to
the Company at the lower of $7.45 million or the appraised value (as determined
by an independent third party), and, pending such sale, to lower the rental
rates on such properties to an aggregate of $745,000 per year, which the Company
believes approximates the financing costs to be incurred in connection with the
purchase of such properties. In addition, Verde Investments has agreed to assign
to the Company its leasehold interest in two properties it sub-leases to the
Company. These two transactions would have resulted in savings to the Company of
approximately $730,000 for 1995 and $310,000 for the three months ended March
31, 1996. Also effective upon the closing of this offering, Verde Investments
has agreed to lower the interest rate on $14.0 million of subordinated debt
payable to Verde Investments from 18.0% to 10.0% per annum and to lower the
dividend rate on $10.0 million of Preferred Stock held by Verde Investments
(which currently accrues a dividend of 12.0% annually, increasing one percent
annually to a maximum of 18.0%) to 10.0% through 1997. SunAmerica, a significant
funding source for the Company, has agreed to convert $3.0 million of
subordinated debt into Common Stock at the public offering price. It is also
anticipated that SunAmerica will purchase $1.0 million of the Common Stock
offered hereby. Through the lowering of rents and financing costs as a result of
the above-referenced transactions (the "Recapitalization Transactions"), the
Company expects to save over $2.6 million annually through 1997. See
"Recapitalization and Related Transactions" and "Certain Relationships and
Related Transactions."
THE OFFERING
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Common Stock offered......................... 2,300,000 shares
Common Stock to be outstanding immediately
after the offering......................... 8,324,044 shares(1)
Use of proceeds.............................. Repayment of debt, with increased borrowing
capacity to be used for development and/or
acquisition of additional Company Dealerships
and Branch Offices, expansion of contract
portfolio, and general corporate purposes. See
"Use of Proceeds."
Nasdaq symbol................................ "UGLY"
</TABLE>
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(1) Includes 444,444 shares issuable to SunAmerica upon conversion of $3.0
million of convertible subordinated debt at the public offering price of
$6.75 per share. Excludes 345,000 shares of Common Stock that may be sold by
the Company upon exercise of the Underwriters' over-allotment option. Also
excludes: (i) 606,830 shares of Common Stock issuable upon exercise of stock
options outstanding at June 15, 1996 under the Company's Long-Term Incentive
Plan with a weighted average exercise price of $3.22 per share; (ii) 170,000
shares of Common Stock issuable upon exercise of the Representative's
Warrant; (iii) 116,000 shares of Common Stock issuable upon exercise of
warrants to be issued to SunAmerica; and (iv) 22,220 shares of Common Stock
issuable to the Company's independent directors upon their appointment to
the Board of Directors at the close of the offering. See "Recapitalization
and Related Transactions," "Management," "Description of Capital Stock," and
"Underwriting."
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
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<CAPTION>
PRO FORMA, AS ADJUSTED(1)
--------------------------------
THREE MONTHS YEAR ENDED THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31, DECEMBER 31, ENDED MARCH 31,
--------------------------- ----------------- ------------ -----------------
1993 1994 1995 1995 1996 1995 1995 1996
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STATEMENT OF OPERATIONS DATA:
Total Revenues................. $16,477 $33,774 $58,203 $11,546 $19,396 $ 48,747 $10,553 $19,396
Dealership Sales of Used
Cars....................... 13,969 27,768 47,824 9,683 15,081 38,368 8,690 15,081
Income on Dealership Finance
Receivables................ 1,629 4,739 8,227 1,564 2,490 8,227 1,564 2,490
Gain on Sale of Finance
Receivables................ -- -- -- -- 539 -- -- 539
Servicing Income............. -- -- -- -- 54 -- -- 54
Income on Residual in Finance
Receivables Sold........... -- -- -- -- 103 -- -- 103
Income on Third Party Finance
Receivables................ -- 710 1,844 217 1,069 1,844 217 1,069
Franchise Fees and Other
Income..................... 879 557 308 82 60 308 82 60
Cost of Used Cars Sold......... 6,089 12,577 27,964 4,858 8,358 20,685 4,311 8,348
Provision for Credit Losses.... 3,292 8,140 8,359 2,060 2,606 7,839 1,872 2,606
Net Revenues from Dealership
Activities................... 6,217 11,790 19,728 4,329 7,259 18,071 4,071 7,259
Income before Operating
Expenses..................... 7,096 13,056 21,880 4,628 8,442 20,223 4,370 8,442
Total Operating Expenses....... 5,411 12,150 19,600 3,946 5,694 16,468 3,409 5,214
Operating Income............... 1,685 906 2,280 682 2,748 3,755 961 3,228
Total Interest Expense......... 893 3,037 5,956 1,122 1,650 3,270 460 1,112
Net Earnings (Loss)............ 699 (1,967) (3,972) (465) 1,066 410 476 2,084
Net Earnings (Loss) Available
for Common Shares............ 699 (1,967) (3,972) (465) 766 410 476 1,834
Net Earnings (Loss) per Common
Share........................ $ 0.14 $ (0.35) $ (0.67) $ (0.08) $ 0.13 $ 0.05 $ 0.06 $ 0.21
Weighted Average Common Shares
Outstanding during
Period(2).................... 5,010 5,584 5,892 5,892 5,892 8,637 8,637 8,637
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PRO FORMA, AS ADJUSTED(1)
--------------------------------
DECEMBER 31, MARCH 31, DECEMBER 31, MARCH 31,
--------------------------- ----------------- ------------ -----------------
1993 1994 1995 1995 1996 1995 1995 1996
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BALANCE SHEET DATA:
Total Finance Receivables,
Net.......................... $ 7,089 $15,858 $40,726 $19,459 $39,479 $ 40,726 $19,459 $39,479
Total Assets................... 11,936 29,711 60,790 33,722 61,659 68,125 41,057 68,994
Total Subordinated Notes
Payable...................... 8,941 18,291 14,553 17,215 14,000 14,553 17,215 14,000
Total Debt..................... 9,380 28,617 50,737 29,804 49,755 42,207 21,274 41,226
Total Preferred Stock.......... -- -- 10,000 -- 10,000 10,000 -- 10,000
Total Common Stock............. 1 77 127 127 127 15,992 15,992 15,992
Total Stockholders' Equity
(Deficit)(3)................. 697 (1,194) 4,884 (1,609) 5,650 20,749 14,256 21,515
Principal Balances Outstanding:
Dealership Portfolio........... $ 9,588 $19,881 $34,227 $23,801 $27,830 $ 34,227 $23,801 $27,830
Third Party Dealer Portfolio... $ -- $ 1,620 $13,804 $ 1,998 $18,492 $ 13,804 $ 1,998 $18,492
Portfolio Securitized with
Servicing Retained........... $ -- $ -- $ -- $ -- $12,622 $ -- $ -- $12,622
</TABLE>
(footnotes on following page)
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SUMMARY CONSOLIDATED FINANCIAL INFORMATION -- (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
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<CAPTION>
PRO FORMA, AS ADJUSTED(1)
--------------------------------
THREE MONTHS YEAR ENDED THREE MONTHS
YEARS ENDED DECEMBER 31, ENDED MARCH 31, DECEMBER 31, ENDED MARCH 31,
--------------------------- ----------------- ------------ -----------------
1993 1994 1995 1995 1996 1995 1995 1996
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DEALERSHIP OPERATING DATA
(UNAUDITED):
Number of Used Cars Sold....... 3,359 5,270 7,383 1,654 2,119 6,326 1,496 2,119
Company Dealerships............ 5 8 8 8 7 7 7 7
Units Sold per Dealership...... 672 659 923 207 303 904 214 303
Number of Contracts
Outstanding.................. 2,929 5,515 8,049 6,414 6,194
Allowance as % of Outstanding
Principal.................... 30.0% 30.4% 21.9% 28.3% 23.0%
Average Principal Balances
Outstanding.................. $ 3,273 $ 3,605 $ 4,252 $ 3,711 $ 4,493
Delinquencies:
Principal Balances 31 to 60
Days......................... 10.5% 5.1% 4.2% 3.6% 2.6%
Principal Balances over 60
Days......................... 15.0% 1.3% 1.1% 2.0% 1.1%
Average Yield on Contracts..... 26.4% 28.2% 28.0% 27.9% 28.0%
THIRD PARTY OPERATING DATA
(UNAUDITED):
Number of Contracts
Purchased.................... -- 1,423 3,012 484 1,268
Number of Branch Offices....... -- 1 8 1 10
Number of Third Party
Dealers...................... -- 20 118 20 317
Number of Contracts
Outstanding.................. -- 726 2,733 1,029 3,592
Allowance as % of Outstanding
Principal.................... -- 9.8% 7.2% 7.6% 7.3%
Average Principal Balance
Outstanding.................. $ -- $ 2,232 $ 5,051 $ 1,942 $ 5,148
Delinquencies:
Principal Balances 31 to 60
Days......................... -- 6.0% 1.2% 2.8% 0.9%
Principal Balances over 60
Days......................... -- 2.6% 0.4% 3.0% 0.1%
Average Yield on Contracts..... -- 30.9% 26.7% 30.5% 26.9%
</TABLE>
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(1) Pro forma, as adjusted, financial information gives effect to the
Recapitalization Transactions, the sale of the Company's Gilbert, Arizona
dealership (the "Gilbert Dealership"), and the sale of the 2,300,000 shares
of Common Stock offered hereby and the initial application of the net
proceeds therefrom to repay indebtedness under the Company's Revolving
Facility, in each case as if such transaction had occurred as of December
31, 1994. See Notes (1) and (2) to "Selected Consolidated Financial Data"
and "Use of Proceeds."
(2) See Notes to the Consolidated Financial Statements for a determination of
the weighted average common shares outstanding.
(3) The Accumulated Deficit component of Total Stockholders' Equity does not
give any effect to the pro forma adjustments.
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RISK FACTORS
Investment in the Common Stock offered hereby involves certain risks. In
addition to the other information included elsewhere in this Prospectus,
prospective investors should give careful consideration to the following factors
before purchasing shares of the Common Stock offered hereby.
NO HISTORY OF PROFITABLE OPERATIONS; NO ASSURANCE OF CONTINUED PROFITABILITY
The Company began operations in 1992 and incurred significant losses in
1994 and 1995. For the three months ended March 31, 1996, however, the Company
achieved profitability with net earnings of approximately $1.1 million on total
revenues of $19.4 million. The Company's business strategy calls for aggressive
growth in its sales and financing activities. Over the next two years, the
Company anticipates developing or acquiring approximately five new Company
Dealerships and opening 15 to 20 new Branch Offices. The Company's ability to
remain profitable as it pursues this business strategy will depend upon its
ability to: (i) expand its revenue generating operations while not
proportionately increasing its administrative overhead; (ii) originate and
purchase contracts with an acceptable level of credit risk; (iii) locate
sufficient financing, with acceptable terms, to fund the expansion of used car
sales and the origination and purchase of additional contracts; and (iv) adapt
to the increasingly competitive market in which it operates. Outside factors,
such as the economic, regulatory, and judicial environments in which it
operates, will also have an effect on the Company's business. The Company's
inability to achieve or maintain any or all of these goals could have a material
adverse effect on the Company's operations, profitability, and growth. See
"Business -- Business Strategy."
POOR CREDITWORTHINESS OF BORROWERS; HIGH RISK OF CREDIT LOSSES
Substantially all of the contracts that the Company services are with
Sub-Prime Borrowers. Due to their poor credit histories, Sub-Prime Borrowers are
generally unable to obtain credit from traditional financial institutions, such
as banks, savings and loans, credit unions, or captive finance companies owned
by automobile manufacturers. The Company typically charges a fixed interest rate
of 29.9% on contracts originated at Company Dealerships while rates range from
21.0% to 29.9% on the Third Party Dealer contracts it purchases. In addition,
the Company has established an Allowance for Credit Losses, which approximated
17.7% and 16.7% of contract principal balances for the year ended December 31,
1995 and the three months ended March 31, 1996, respectively, to cover
anticipated credit losses on the contracts currently in its portfolio. At
December 31, 1995 and March 31, 1996, the principal balance of delinquent
contracts as a percentage of total outstanding contract principal balances was
4.2% and 2.8%, respectively. The Company's net charge offs as a percentage of
average principal outstanding for the year ended December 31, 1995 and the three
months ended March 31, 1996 were 21.7% and 4.7%, respectively. The Company
believes its Allowance for Credit Losses is adequate to absorb anticipated
credit losses. However, no assurance can be given that the Company has
adequately provided for, or will adequately provide for, such credit risks or
that credit losses in excess of reserves will not occur in the future. A
significant variation in the timing of or increase in credit losses on the
Company's portfolio would have a material adverse effect on the Company's
profitability. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Allowance for Credit Losses" and
"Business -- Monitoring and Collections."
HIGHLY COMPETITIVE INDUSTRY
Although the used car sales industry has historically been highly
fragmented, it has attracted significant attention recently from a number of
large companies, including Circuit City's CarMax, AutoNation, U.S.A., Driver's
Mart, and CarChoice, which have 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. The Company
believes 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 the Company. Among other things,
increased competition could result in increased wholesale costs for used cars,
decreased retail sales prices, and lower margins.
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<PAGE> 9
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 a
highly fragmented and very competitive market. In recent periods, several
consumer finance companies have completed public offerings in order 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 prices that the Company
believes are not commensurate with the associated risk. There are numerous
financial services companies serving, or capable of serving, this market,
including traditional financial institutions such as banks, savings and loans,
credit unions, and captive finance companies owned by automobile manufacturers,
and other non-traditional consumer finance companies, many of which have
significantly greater financial and other resources than the Company. Increased
competition may cause downward pressure on the interest rates the Company
charges on contracts originated by its Company Dealerships or cause the Company
to reduce or eliminate the nonrefundable acquisition discount on the contracts
it purchases from Third Party Dealers, which could have a material adverse
effect on the Company's profitability. See "Business -- Competition."
The Company believes that recent demographic, economic, and industry trends
favor growth in the used car sales and Sub-Prime Borrower financing markets. To
the extent such trends do not continue, however, the Company's profitability may
be materially and adversely affected. See "Business -- Overview of Used Car
Sales and Finance Industry."
GENERAL ECONOMIC CONDITIONS
The Company's business is directly related to sales of used cars, which are
affected by employment rates, prevailing interest rates, and other general
economic conditions. While the Company believes that current economic conditions
favor continued growth in the markets it serves and those in which it seeks to
expand, a future economic slowdown or recession could lead to increased
delinquencies, repossessions, and credit losses that could hinder the Company's
planned expansion. Because of the Company's focus on Sub-Prime Borrowers, its
actual rate of delinquencies, repossessions, and credit losses on contracts
could be higher under adverse conditions than those experienced in the used car
sales and finance industry in general. Economic changes are uncertain, and
sluggish sales of used cars and weakness in the economy could have an adverse
effect on the Company's business and that of the Third Party Dealers from which
it purchases contracts. See "Business -- Company Dealership Operations" and
"Business -- Third Party Dealer Operations."
NEED TO ESTABLISH AND MAINTAIN RELATIONSHIPS WITH THIRD PARTY DEALERS
The Company enters into nonexclusive agreements with Third Party Dealers,
which may be terminated by either party at any time, pursuant to which the
Company purchases contracts originated by such dealers that meet the Company's
established terms and conditions. The Company's Third Party Dealer financing
activities depend in large part upon its ability to establish and maintain
relationships with such dealers. While the Company believes that it has been
successful in developing and maintaining relationships with Third Party Dealers
in the markets that it currently serves, there can be no assurance that the
Company will be successful in maintaining or increasing its existing Third Party
Dealer base, or that such dealers will continue to generate a volume of
contracts comparable to the volume of contracts historically generated by such
dealers. See "Business -- Third Party Dealer Operations."
GEOGRAPHIC CONCENTRATION
The Company's direct used car sales and financing operations are currently
conducted in the Phoenix and Tucson, Arizona, metropolitan areas. In addition,
as of June 15, 1996, the Company had opened fourteen Branch Offices, five of
which were located in Arizona, two each in Colorado, Indiana, and Texas, and one
each in Florida, Nevada, and New Mexico. Of the $46.3 million in total contracts
owned by the Company at March 31, 1996, the Company estimates that approximately
$42.2 million were originated in Arizona. Because of this concentration, the
Company's business may be adversely affected in the event of a downturn in the
general economic conditions existing in Arizona and the southwestern United
States. See "Business -- Company Dealership Operations" and "Business -- Third
Party Dealer Operations."
9
<PAGE> 10
DEPENDENCE ON EXTERNAL FINANCING
The Company has borrowed, and will continue to borrow, substantial amounts
to fund its operations from financing companies and other lenders, some of which
are affiliated with the Company. Currently, the Company receives financing
pursuant to the Revolving Facility with GE Capital, which has a maximum
commitment of $50.0 million. Under the Revolving Facility, the Company may
borrow up to 65.0% of the principal balance of eligible Company Dealership
contracts and up to 90.0% of the principal balance of eligible Third Party
Dealer contracts. The Revolving Facility expires in September 1997, at which
time the Company has the option to renew it for one additional year. The
Revolving Facility is secured by substantially all of the Company's assets. As
of March 31, 1996, the Company's borrowing capacity under the Revolving Facility
was approximately $34.2 million, the aggregate principal amount outstanding
under the Revolving Facility was $31.8 million, and the amount available to be
borrowed was $2.4 million. There can be no assurance that the Company will be
able to continue to satisfy the terms and conditions of the Revolving Facility
or that it will be extended beyond its current expiration date. In addition, the
Company has agreed to terms with SunAmerica pursuant to which SunAmerica may
purchase up to $175.0 million of the Company's asset-backed securities created
pursuant to the Securitization Program. The Securitization Program is subject to
numerous terms and conditions, including the Company's ability to achieve
investment-grade ratings on its asset-backed securities. The Company and
SunAmerica have completed one securitization involving an aggregate of $10.0
million in certificates backed by $13.0 million in contracts originated through
Company Dealerships. There can be no assurance, however, that any further
securitizations will be completed or that the Company will be able to secure
additional financing when and as needed in the future, or on terms acceptable to
the Company. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Liquidity and Capital Resources."
SUBSTANTIAL LEVERAGE
In connection with its growth over the past several years, the Company has
incurred substantial indebtedness, resulting in a highly leveraged capital
structure. At March 31, 1996, the Company's total indebtedness was approximately
$49.8 million. See "Capitalization" and "Selected Consolidated Financial Data."
The Company's substantial leverage could have important consequences, including
limiting its ability to obtain additional financing, requiring the Company to
use substantial portions of operating cash flow to meet interest and principal
repayment obligations, exposing the Company to interest rate fluctuations due to
floating interest rates, increasing the Company's vulnerability to changes in
general economic conditions and competitive pressures, and limiting the
Company's ability to realize some or all of the benefits of significant business
opportunities. In addition, the Revolving Facility contains various covenants
that limit, among other things, the Company's ability to engage in mergers and
acquisitions, incur additional indebtedness, and pay dividends or make other
distributions. See "Dividend Policy." The covenants also require the Company to
meet certain financial tests. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources -- Revolving Facility." Although the Company believes that it is
currently in compliance with the terms and conditions of its borrowing
arrangements, a default thereunder could have a material adverse effect on the
Company's financial condition and results of operations.
SENSITIVITY TO INTEREST RATES; IMPACT OF USURY LAWS
A substantial portion of the Company's financing income results from the
difference between the rate of interest it pays on the funds it borrows and the
rate of interest it earns under the contracts in its portfolio. While the
contracts the Company services bear interest at a fixed rate, the indebtedness
that the Company incurs under its Revolving Facility bears interest at a
floating rate. In the event the Company's interest expense increases, it would
seek to compensate for such increases by raising the interest rates on its
Company Dealership contracts, increasing the acquisition discount at which it
purchases Third Party Dealer contracts, or raising the retail sales prices of
its used cars. To the extent the Company were unable to do so, the Company's net
interest margins would decrease, thereby adversely affecting the Company's
profitability.
10
<PAGE> 11
The Company typically charges a fixed interest rate of 29.9% on the
contracts originated at Company Dealerships, while rates range from 21.0% to
29.9% on the Third Party Dealer contracts it purchases. Currently, all of the
Company's used car sales activities are conducted in, and a majority of the
contracts the Company services are originated in, Arizona, which does not impose
limits on the rate that a lender may charge. The Company has expanded, and will
continue to expand, its operations into states that impose usury limits. The
Company attempts to mitigate these rate restrictions by purchasing contracts
originated in these states at a higher discount. The Company's inability to
achieve adequate discounts in states imposing usury limits would adversely
affect the Company's planned expansion and its results of operations. There can
be no assurance that Arizona will not adopt a usury statute or that Arizona or
other jurisdictions in which the Company operates will not adopt additional
laws, rules, and regulations that could adversely affect the Company's business.
See "Business -- Regulation, Supervision, and Licensing."
FLUCTUATIONS IN QUARTERLY OPERATING RESULTS
Historically, the Company has experienced higher revenues in the first two
quarters of the year (particularly in the first quarter) than in the latter half
of the year. The Company believes that these results are due to seasonal buying
patterns resulting in part from the fact that many of its customers receive
income tax refunds during the first part of the year, which are a primary source
of down payments on used car purchases. Given the possibility of such
fluctuations, the Company believes that quarterly comparisons of the results of
its operations during any fiscal year are not necessarily meaningful and that
results for any one fiscal quarter should not be relied upon as an indication of
future performance. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Seasonality."
DEPENDENCE UPON KEY PERSONNEL
The Company's future success will depend upon the continued services of the
Company's senior management as well as the Company's ability to attract
additional members to its management team with experience in the used car sales
and financing industry. The unexpected loss of the services of any of the
Company's key management personnel, or its inability to attract new management
when necessary, could have a material adverse effect upon the Company. The
Company has entered into employment agreements (which include non-competition
provisions) with certain of its officers. See "Management."
CONTROL BY MAJORITY STOCKHOLDER
Upon the completion of the offering, Mr. Ernest C. Garcia, II, the
Company's Chairman, Chief Executive Officer, and majority stockholder, will hold
55.7% of the outstanding Common Stock. As a result, Mr. Garcia will have a
significant influence upon the activities of the Company, as well as on all
matters requiring approval of the stockholders, including electing or removing
members of the Company's Board of Directors, causing the Company to engage in
transactions with affiliated entities, causing or restricting the sale or merger
of the Company, and changing the Company's dividend policy. See "Management" and
"Principal Stockholders."
POTENTIAL ANTI-TAKEOVER EFFECT OF PREFERRED STOCK
The Company's Certificate of Incorporation authorizes the Company to issue
"blank check" Preferred Stock, the designation, number, voting powers,
preferences, and rights of which may be fixed or altered from time to time by
the Board of Directors. Accordingly, the Board of Directors has the authority,
without stockholder approval, to issue Preferred Stock with dividend,
conversion, redemption, liquidation, sinking fund, voting, and other rights that
could adversely affect the voting power or other rights of the holders of the
Common Stock. The Preferred Stock could be utilized, under certain
circumstances, to discourage, delay, or prevent a merger, tender offer, or
change in control of the Company that a stockholder might consider to be in its
best interests. Although the Company has no present intention of issuing any
additional shares of its authorized Preferred Stock, there can be no assurance
that the Company will not do so in the future. See "Description of Capital
Stock -- Preferred Stock."
11
<PAGE> 12
REGULATION, SUPERVISION, AND LICENSING
The Company's operations are subject to ongoing regulation, supervision,
and licensing under various federal, state, and local statutes, ordinances, and
regulations. Among other things, these laws require that the Company obtain and
maintain certain licenses and qualifications, limit or prescribe terms of the
contracts that the Company originates and/or purchases, require specified
disclosures to customers, limit the Company's right to repossess and sell
collateral, and prohibit the Company from discriminating against certain
customers. The Company is also subject to federal and state franchising and
insurance laws. See "Business -- Regulation, Supervision, and Licensing."
The Company believes that it is currently in substantial compliance with
all applicable federal, state, and local laws and regulations. There can be no
assurance, however, that the Company will be able to remain in compliance with
such laws, and such failure could have a material adverse effect on the
operations of the Company. In addition, the adoption of additional statutes and
regulations, changes in the interpretation of existing statutes and regulations,
or the Company's entrance into jurisdictions with more stringent regulatory
requirements could have a material adverse effect on the Company's business.
PRIOR LEGAL ACTIONS INVOLVING CHIEF EXECUTIVE OFFICER
In October 1990, Mr. Garcia pled guilty to one felony count of bank fraud
brought by the United States, on behalf of the Resolution Trust Corporation
("RTC"), for his participation in a real estate transaction involving Lincoln
Savings and Loan Association, a federally insured savings and loan institution
that later went into receivership. In connection with this matter, Mr. Garcia
also settled civil lawsuits filed against him by the RTC and the Securities and
Exchange Commission (the "Commission"), and consented to an administrative order
imposed by the Commission. In addition, a real estate investment company owned
by Mr. Garcia, as well as several limited partnerships organized by that
company, filed petitions for reorganization under Chapter 11 of the United
States Bankruptcy Code in 1990 and 1991. Mr. Garcia and his wife filed a
petition for discharge under Chapter 7 of the United States Bankruptcy Code in
June 1990. Mr. Garcia's company and the related partnerships were successfully
reorganized in the period from 1990 to 1993 and Mr. Garcia was fully discharged
in 1991. See "Management -- Involvement in Certain Legal Proceedings."
ABSENCE OF PRIOR MARKET FOR COMMON STOCK; POSSIBLE VOLATILITY OF STOCK PRICES
Prior to this offering, there has been no public trading market for the
Common Stock and there can be no assurance that a regular trading market for the
Common Stock will develop after this offering or, if developed, that it will be
sustained following the offering. No assurance can be given that the Common
Stock will continue to be listed on the Nasdaq National Market. The initial
public offering price of the Common Stock offered hereby will be determined
through negotiations between the Company and the Representative and may not
necessarily bear any relationship to the price at which the Common Stock will
trade after completion of the offering, or to the Company's book value, assets,
past operating results, or financial condition or to any other established
criteria of value. The market price of the Common Stock could also be subject to
significant fluctuations in response to such factors as, among others,
variations in the anticipated or actual results of operations of the Company or
other companies in the used car sales and finance industry, changes in
conditions affecting the economy generally, analyst reports, or general trends
in the industry. See "Underwriting."
12
<PAGE> 13
THE COMPANY
The Company is a fully integrated used car sales and finance company that
operates the largest chain of Buy Here-Pay Here used car dealerships in Arizona.
As part of its activities, the Company underwrites, finances, and services
retail installment contracts generated by its Company Dealerships and Third
Party Dealers located in selected markets throughout the United States. The
Company began its used car sales and financing operations in 1992 and has
pursued an aggressive growth strategy since that time. As a result of both
internal development and acquisition, as of June 15, 1996, the Company had
developed or acquired seven Company Dealerships in Arizona and, since 1994, had
opened fourteen Branch Offices located in seven states.
In 1990, Duck Ventures, Inc., currently a subsidiary of the Company,
acquired the assets of the Ugly Duckling Rent-A-Car, Inc. franchise system. The
Company currently administers 45 Ugly Duckling Rent-A-Car franchises throughout
the United States. The Company has suspended efforts to solicit new franchisees
or otherwise expand the Ugly Duckling Rent-A-Car business and it does not expect
to reinitiate such activities in the foreseeable future.
The Company operates through numerous direct and indirect wholly owned
subsidiaries, including: Duck Ventures, Inc., which provides all administrative
services to the Company, such as corporate finance and accounting, personnel
administration, data processing, communication systems maintenance, and software
development; Ugly Duckling Car Sales, Inc., which operates the Company
Dealerships; Champion Acceptance Corp., which services contracts originated by
Company Dealerships and contracts purchased from Third Party Dealers; Champion
Financial Services, Inc., which purchases contracts originated by Third Party
Dealers; UDRAC, Inc., which provides administrative services to Ugly Ducking
Rent-A-Car franchisees; Champion Receivables Corp., which is the Company's
special purpose corporation for purposes of the Securitization Program; Drake
Insurance Services, Inc., which serves as a holding company for Drake Insurance
Agency, Inc., an Arizona licensed insurance agency, and Drake Casualty
Insurance, Inc. and Drake Life Insurance, Inc., which are Turks and Caicos
Islands-chartered and licensed reinsurance companies; and several other inactive
subsidiaries. The Company has not yet conducted significant insurance
operations.
The Company was formed in Arizona in 1992 for the purpose of purchasing
Duck Ventures, Inc. and other subsidiaries and was reincorporated in Delaware in
1996. Except as otherwise specified, all references in this Prospectus to the
"Company" refer to Ugly Duckling Corporation and its subsidiaries. The Company's
principal executive offices are located at and its mailing address is 2525 East
Camelback Road, Suite 1150, Phoenix, Arizona 85016. The telephone number of the
Company is 1-800-THE-DUCK.
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,300,000 shares of
Common Stock offered hereby are estimated to be approximately $13.0 million
($15.1 million if the Underwriters' over-allotment option is exercised in full).
The Company intends to use the net proceeds of the offering to reduce the debt
outstanding under its Revolving Facility with GE Capital (approximately $31.8
million as of March 31, 1996) by approximately $13.0 million. The Revolving
Facility has a maximum commitment of $50.0 million through September 1997, at
which time the Company has the option to renew it for one additional year. Debt
outstanding under the Revolving Facility accrues interest daily at an annual
rate of 4.25% over the 30-day average London Inter-Bank Offered Rate ("LIBOR")
(total rate of 9.6% as of March 31, 1996).
The amount repaid under the Revolving Facility will remain available for
use by the Company to implement its growth strategy. Over the next two years,
the Company anticipates developing or acquiring approximately five new Company
Dealerships and opening 15 to 20 new Branch Offices. The Company estimates that
it would cost an aggregate of approximately $7.5 million to develop these
Company Dealerships and an additional $750,000 to $1.0 million to establish the
Branch Offices. See "Business -- Business Strategy -- Growth Strategy" and
"Business -- Expansion Plans and Acquisition Opportunities."
13
<PAGE> 14
DIVIDEND POLICY
The Company has never paid cash dividends on the Common Stock and does not
anticipate doing so in the foreseeable future. It is the current policy of the
Company's Board of Directors to retain any earnings to finance the operations
and expansion of the Company's business. In addition, the terms of the Revolving
Facility prevent the Company from declaring or paying dividends in excess of
10.0% of each year's net earnings available for distribution. The Company is
also subject to certain prohibitions against the payment of cash dividends to
holders of Common Stock pursuant to the terms of its Preferred Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Revolving Facility" and
"Description of Capital Stock -- Preferred Stock."
RECAPITALIZATION AND RELATED TRANSACTIONS
Effective upon the closing of this offering, Verde Investments, an
affiliate of the Company whose sole stockholder, Ernest C. Garcia, II, is also
the Chairman, Chief Executive Officer, and majority stockholder of the Company,
has agreed to modifications to its present lease and financing arrangements with
the Company. In addition, SunAmerica, a significant funding source for the
Company, has agreed to convert $3.0 million of subordinated indebtedness into
Common Stock of the Company. As a result of the Recapitalization Transactions,
the Company expects to achieve savings of over $2.6 million annually through
1997.
VERDE INVESTMENTS
As of March 31, 1996, the Company leased nine properties and sub-leased two
additional properties from Verde Investments. Upon the closing of the offering,
Verde Investments has agreed to sell to the Company, subject to financing, those
properties owned by Verde Investments and leased to the Company at the lower of
$7.45 million or the appraised value (as determined by an independent third
party), and, pending such sale, to lower the rental rates on such properties to
an aggregate of $745,000 per year, which the Company believes approximates the
financing costs to be incurred in connection with the purchase of such
properties. In addition, Verde Investments has agreed to assign to the Company
its leasehold interest in the two properties it sub-leases to the Company. These
two transactions would have resulted in savings to the Company of approximately
$730,000 for 1995 and $310,000 for the three months ended March 31, 1996.
Verde Investments also currently holds $14.0 million of the Company's
subordinated debt and $10.0 million of the Company's Preferred Stock, which
accrues a dividend of 12.0% annually, increasing one percent per year up to a
maximum of 18.0%. At the closing of this offering, the interest rate on the
outstanding subordinated debt payable to Verde Investments will be reduced from
18.0% to 10.0% per annum. In addition, Verde Investments has agreed with the
Company to reduce the dividend rate on the Preferred Stock to 10.0% through the
end of 1997, at which time the rate will be raised to 12.0%. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources," "Certain Relationships and
Related Transactions," and "Description of Capital Stock -- Preferred Stock."
SUNAMERICA
In 1995, SunAmerica purchased $3.0 million of convertible subordinated debt
of the Company. Upon the effectiveness of the offering, SunAmerica has agreed to
convert this debt into Common Stock at the initial public offering price
(444,444 shares at the initial public offering price of $6.75 per share). In
connection with such conversion, the Company has agreed to grant SunAmerica a
ten-year warrant to purchase 116,000 shares of Common Stock at the initial
public offering price and to pay to SunAmerica fees totaling $150,000.
Separately, it is anticipated that SunAmerica will purchase $1.0 million of
Common Stock from the Underwriters in this offering at the initial public
offering price. See "Description of Capital Stock -- Other Securities."
14
<PAGE> 15
CAPITALIZATION
The following table sets forth the: (i) actual capitalization of the
Company as of March 31, 1996; (ii) the pro forma capitalization of the Company,
which assumes the consummation of the Recapitalization Transactions as of
December 31, 1994; and (iii) the pro forma capitalization of the Company as
adjusted to give effect to the sale of the 2,300,000 shares of Common Stock
offered hereby (exclusive of the over-allotment option) at the initial public
offering price of $6.75 per share and the initial application of the estimated
net proceeds therefrom to repay $13.0 million under the Revolving Facility as of
December 31, 1994. See "Recapitalization and Related Transactions." The table
should be read in conjunction with the Company's Consolidated Financial
Statements and the related notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1996
-------------------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
----------- ----------- -----------
<S> <C> <C> <C>
Debt:
Obligations under Capital Leases.................. $ 916,357 $ 916,357 $ 916,357
Revolving Facility................................ 31,839,050 31,839,050 18,859,375
Debt on real property to be acquired from Verde
Investments.................................... -- 7,450,000 7,450,000
Convertible Note Payable (excluding $114,950 in
unamortized debt issuance costs)............... 3,000,000 -- --
Subordinated Notes Payable........................ 14,000,000 14,000,000 14,000,000
----------- ----------- -----------
Total Liabilities......................... 49,755,407 54,205,407 41,225,732
----------- ----------- -----------
Stockholders' Equity:
Preferred Stock, $.001 par value; 10,000,000
shares authorized; 1,000,000 shares issued and
outstanding.................................... 10,000,000 10,000,000 10,000,000
Common Stock, $.001 par value; 20,000,000 shares
authorized; 5,579,600 shares issued and
outstanding, actual; 6,024,044 shares issued
and outstanding, pro forma; 8,324,044 shares
issued and outstanding, pro forma, as
adjusted(1).................................... 127,000 3,012,050 15,991,725
Accumulated Deficit(2)............................ (4,476,936) (4,476,936) (4,476,936)
----------- ----------- -----------
Total Stockholders' Equity................ 5,650,064 8,535,114 21,514,789
----------- ----------- -----------
Total Capitalization...................... $55,405,471 $62,740,521 $62,740,521
=========== =========== ===========
</TABLE>
- ---------------
(1) Includes 444,444 shares issuable to SunAmerica upon conversion of $3.0
million of convertible subordinated debt at the public offering price of
$6.75 per share. Excludes up to 345,000 shares of Common Stock that may be
sold by the Company upon the exercise of the Underwriters' over-allotment
option. Also excludes: (i) 606,830 shares of Common Stock issuable upon
exercise of stock options outstanding at June 15, 1996, under the Company's
Long-Term Incentive Plan with a weighted average exercise price of $3.22 per
share; (ii) 170,000 shares of Common Stock issuable upon exercise of the
Representative's Warrant; (iii) 116,000 shares of Common Stock issuable upon
exercise of warrants to be issued to SunAmerica; and (iv) 22,220 shares of
Common Stock issuable to the Company's independent directors upon their
appointment to the Board of Directors at the close of the offering. See
"Recapitalization and Related Transactions," "Management," "Description of
Capital Stock," and "Underwriting."
(2) The Accumulated Deficit component of Total Stockholders' Equity does not
give effect to the pro forma adjustments. See "Selected Consolidated
Financial Data."
15
<PAGE> 16
DILUTION
The pro forma net tangible book value (deficit) of the Company's Common
Stock at March 31, 1996, was approximately $(1.7 million), or $(0.29) per share.
Pro forma net tangible book value per common share represents the book value of
the Company's tangible assets less Preferred Stock and total liabilities (after
giving effect to the conversion by SunAmerica of its $3.0 million of convertible
subordinated debt into Common Stock at the initial public offering price)
divided by the number of shares of Common Stock outstanding.
Dilution per share to new investors represents the difference between the
amount per share paid by purchasers of Common Stock of the Company pursuant to
the offering and the pro forma net tangible book value per share of Common Stock
immediately after completion of the offering. After giving effect to the sale of
the 2,300,000 shares of Common Stock offered hereby and the application of the
net proceeds therefrom, the as adjusted pro forma net tangible book value of the
Common Stock at March 31, 1996, would have been $11.3 million, or $1.35 per
share. This represents an immediate increase in pro forma net tangible book
value of $1.64 per common share to existing stockholders and an immediate
dilution of $5.40 per common share to new investors purchasing Common Stock
pursuant to the offering. The following table illustrates the per share effect
of this dilution on an investor's purchase of shares:
<TABLE>
<S> <C>
Initial public offering price per common share......... $6.75
Pro forma net tangible book value per common
share before offering............................... $(0.29)
Increase in pro forma net tangible book value
per common share attributable to new investors...... $ 1.64
------
As adjusted pro forma net tangible book value per
common share after the offering..................... $1.35
-----
Dilution per common share to new investors............. $5.40
=====
</TABLE>
The following table summarizes, on an as adjusted basis as of March 31,
1996, the difference between the number of shares of Common Stock purchased from
the Company, the total price paid, and the average price per share paid by
existing stockholders and by new investors purchasing shares of Common Stock
pursuant to the offering, after giving effect to SunAmerica's conversion of $3.0
million of convertible subordinated debt into Common Stock at the initial public
offering price:
<TABLE>
<CAPTION>
TOTAL CONSIDERATION
SHARES PURCHASED PAID AVERAGE
--------------------- ----------------------- PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- ---------
<S> <C> <C> <C> <C> <C>
Existing stockholders......... 6,024,044 72.4% $ 3,012,050 16.2% $0.50
New investors................. 2,300,000 27.6% $15,525,000 83.8% $6.75
--------- --- ----------- ---
Total............... 8,324,044 100.0% $18,537,050 100.0%
========= === =========== ===
</TABLE>
The foregoing tables include 444,444 shares issuable to SunAmerica upon
conversion of $3.0 million of convertible subordinated debt at the public
offering price of $6.75 per share. The tables exclude up to 345,000 shares of
Common Stock that may be sold by the Company upon the exercise of the
Underwriters' over-allotment option. The tables also exclude: (i) 606,830 shares
of Common Stock issuable upon exercise of stock options outstanding at June 15,
1996, under the Company's Long-Term Incentive Plan with a weighted average
exercise price of $3.22 per share; (ii) 170,000 shares of Common Stock issuable
upon exercise of the Representative's Warrant; (iii) 116,000 shares of Common
Stock issuable upon exercise of warrants to be issued to SunAmerica; and (iv)
22,220 shares of Common Stock issuable to the Company's independent directors
upon their appointment to the Board of Directors at the close of the offering.
See "Recapitalization and Related Transactions," "Management," "Description of
Capital Stock," and "Underwriting."
16
<PAGE> 17
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
The following selected consolidated financial data are qualified by
reference to, and should be read in conjunction with, the Company's Consolidated
Financial Statements and the related Notes thereto and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this Prospectus. The following selected Consolidated Balance Sheet
data of the Company as of December 31, 1993, 1994 and 1995 and the Statement of
Operations data for the fiscal years ended December 31, 1993, 1994 and 1995, are
derived from the Consolidated Financial Statements of the Company audited by
KPMG Peat Marwick LLP, independent certified public accountants. The following
selected consolidated financial information as of and for the three months ended
March 31, 1995 and 1996 has been derived from the Company's unaudited
consolidated financial information for such periods. The following Consolidated
Balance Sheet data as of December 31, 1992 and the Statement of Operations data
for the year ended December 31, 1992 are derived from the Consolidated Financial
Statements of the Company audited by Toback & Co., independent certified public
accountants. Also presented is certain consolidated financial data as of
December 31, 1991 and for the fiscal year then ended which has been derived from
the Company's unaudited Consolidated Financial Statements for such periods. In
the opinion of management, such unaudited data reflect all adjustments,
consisting only of normal recurring adjustments, necessary to fairly present the
Company's financial position and results of operations for the periods
presented. The results of operations for any interim period are not necessarily
indicative of results to be expected for a full fiscal year.
<TABLE>
<CAPTION>
PRO FORMA(1)
---------------------
THREE
MONTHS
THREE MONTHS ENDED
ENDED MARCH
YEARS ENDED DECEMBER 31, MARCH 31, YEAR ENDED 31,
--------------------------------------------- ----------------- DECEMBER 31, -------
STATEMENT OF OPERATIONS DATA: 1991 1992 1993 1994 1995 1995 1996 1995 1995
------ ------ ------- ------- ------- ------- ------- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Dealership Revenues:
Sales of Used Cars........................ $ -- $2,136 $13,969 $27,768 $47,824 $ 9,683 $15,081 $ 38,368 $ 8,690
Income on Finance Receivables............. -- 148 1,629 4,739 8,227 1,564 2,490 8,227 1,564
Gain on Sale of Finance Receivables....... -- -- -- -- -- -- 539 -- --
Income on Residual in Finance Receivables
Sold..................................... -- -- -- -- -- -- 103 -- --
------ ------ ------- ------- ------- ------- ------- ------- -------
-- 2,284 15,598 32,507 56,051 11,247 18,213 46,595 10,254
------ ------ ------- ------- ------- ------- ------- ------- -------
Cost of Dealership Revenues:
Cost of Used Cars Sold.................... -- 1,010 6,089 12,577 27,964 4,858 8,348 20,685 4,311
Provision for Credit Losses............... -- 826 3,292 8,140 8,359 2,060 2,606 7,839 1,872
------ ------ ------- ------- ------- ------- ------- ------- -------
-- 1,836 9,381 20,717 36,323 6,918 10,954 28,524 6,183
------ ------ ------- ------- ------- ------- ------- ------- -------
Net Revenues from Dealership Activity..... -- 448 6,217 11,790 19,728 4,329 7,259 18,071 4,071
Other Income:
Servicing Income.......................... -- -- -- -- -- -- 54 -- --
Income on Third Party Finance
Receivables.............................. -- -- -- 710 1,844 217 1,069 1,844 217
Franchise Fees and Other Income........... 819 982 879 556 308 82 60 308 82
------ ------ ------- ------- ------- ------- ------- ------- -------
819 982 879 1,266 2,152 299 1,183 2,152 299
------ ------ ------- ------- ------- ------- ------- ------- -------
Income before Operating Expenses.......... 819 1,430 7,096 13,056 21,880 4,628 8,442 20,223 4,370
Operating Expenses:
Selling and Marketing..................... 302 656 1,293 2,402 3,856 751 1,041 3,229 710
General and Administrative................ 905 876 3,561 8,971 14,430 2,935 4,321 11,974 2,449
Depreciation and Amortization............. 326 429 557 777 1,314 260 332 1,265 250
------ ------ ------- ------- ------- ------- ------- ------- -------
1,533 1,961 5,411 12,150 19,600 3,946 5,694 16,468 3,409
------ ------ ------- ------- ------- ------- ------- ------- -------
Operating Income (Loss)................... (714) (531) 1,685 906 2,280 682 2,748 3,755 961
AS ADJUSTED(2)
-------------------------------
THREE MONTHS
ENDED
YEAR ENDED MARCH 31,
DECEMBER 31, -----------------
STATEMENT OF OPERATIONS DATA: 1996 1995 1995 1996
------- ------------ ------- -------
<S> <C> <C> <C> <C>
Dealership Revenues:
Sales of Used Cars........................ $15,081 $ 38,368 $ 8,690 $15,081
Income on Finance Receivables............. 2,490 8,227 1,564 2,490
Gain on Sale of Finance Receivables....... 539 -- -- 539
Income on Residual in Finance Receivables
Sold..................................... 103 -- -- 103
------- ------- ------- -------
18,213 46,595 10,254 18,213
------- ------- ------- -------
Cost of Dealership Revenues:
Cost of Used Cars Sold.................... 8,348 20,685 4,311 8,348
Provision for Credit Losses............... 2,606 7,839 1,872 2,606
------- ------- ------- -------
10,954 28,524 6,183 10,954
------- ------- ------- -------
Net Revenues from Dealership Activity..... 7,259 18,071 4,071 7,259
Other Income:
Servicing Income.......................... 54 -- -- 54
Income on Third Party Finance
Receivables.............................. 1,069 1,844 217 1,069
Franchise Fees and Other Income........... 60 308 82 60
------- ------- ------- -------
1,183 2,152 299 1,183
------- ------- ------- -------
Income before Operating Expenses.......... 8,442 20,223 4,370 8,442
Operating Expenses:
Selling and Marketing..................... 1,041 3,229 710 1,041
General and Administrative................ 3,841 11,974 2,449 3,841
Depreciation and Amortization............. 332 1,265 250 332
------- ------- ------- -------
5,214 16,468 3,409 5,214
------- ------- ------- -------
Operating Income (Loss)................... 3,228 3,755 961 3,228
Other Expenses:
Interest on Subordinated Debt............. -- -- 678 2,569 3,492 792 631 1,940 440
Interest Expense, Other................... 1 12 215 468 2,464 330 1,019 2,742 394
Other, Net................................ -- (48) 63 170 296 25 32 75 25
------ ------ ------- ------- ------- ------- ------- ------- -------
1 (36) 956 3,207 6,252 1,147 1,682 4,757 859
------ ------ ------- ------- ------- ------- ------- ------- -------
Income Tax Expense (Benefit).............. -- -- 30 (334) -- -- -- -- --
------ ------ ------- ------- ------- ------- ------- ------- -------
Net Earnings (Loss)....................... $ (715) $ (495) $ 699 $(1,967) $(3,972) $ (465) $ 1,066 $ (1,002) $ 102
------ ------ ------- ------- ------- ------- ------- ------- -------
Preferred Stock Dividend.................. $ -- -- -- -- -- -- $ 300 -- --
------ ------ ------- ------- ------- ------- ------- ------- -------
Net Earnings (Loss) Available to Common
Shares................................... $ (715) $ (495) $ 699 $(1,967) $(3,972) $ (465) $ 766 $ (1,002) $ 102
====== ====== ======= ======= ======= ======= ======= ======= =======
Net Earnings (Loss) per Common Share...... $(0.15) $(0.11) $ 0.14 $ (0.35) $ (0.67) $ (0.08) $ 0.13 $ (0.16) $ 0.02
====== ====== ======= ======= ======= ======= ======= ======= =======
Weighted Average Common Shares Outstanding
during Period(3)......................... 4,640 4,640 5,010 5,584 5,892 5,892 5,892 6,337 6,337
====== ====== ======= ======= ======= ======= ======= ======= =======
(footnotes on page 19)
<CAPTION>
Other Expenses:
<S> <C> <C> <C> <C>
Interest on Subordinated Debt............. 350 1,940 440 350
Interest Expense, Other................... 1,081 1,330 20 762
Other, Net................................ 32 75 25 32
------- ------- ------- -------
1,463 3,345 485 1,144
------- ------- ------- -------
Income Tax Expense (Benefit).............. -- -- -- --
------- ------- ------- -------
Net Earnings (Loss)....................... $ 1,765 $ 410 $ 476 $ 2,084
------- ------- ------- -------
Preferred Stock Dividend.................. $ 250 -- -- $ 250
------- ------- ------- -------
Net Earnings (Loss) Available to Common
Shares................................... $ 1,515 $ 410 $ 476 $ 1,834
======= ======= ======= =======
Net Earnings (Loss) per Common Share...... $ 0.24 $ 0.05 $ 0.06 $ 0.21
======= ======= ======= =======
Weighted Average Common Shares Outstanding
during Period(3)......................... 6,337 8,637 8,637 8,637
======= ======= ======= =======
(footnotes on page 19)
</TABLE>
17
<PAGE> 18
SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<TABLE>
<CAPTION>
PRO FORMA(1)
---------------------
MARCH
DECEMBER 31, MARCH 31, 31,
--------------------------------------------- ----------------- DECEMBER 31, -------
1991 1992 1993 1994 1995 1995 1996 1995 1995
------ ------ ------- ------- ------- ------- ------- ------------ -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total Finance Receivables, Net............ $ -- $1,758 $ 7,089 $15,858 $40,726 $19,459 $39,479 $ 40,726 $19,459
Total Assets.............................. 1,195 4,392 11,936 29,711 60,790 33,722 61,659 68,125 41,057
Total Subordinated Notes Payable.......... 93 8,941 18,291 14,553 17,215 14,000 14,553 17,215
Total Debt................................ 400 4,189 9,380 28,617 50,737 29,804 49,755 55,187 34,254
Total Preferred Stock..................... -- -- -- -- 10,000 -- 10,000 10,000 --
Total Common Stock........................ 1 1 1 77 127 127 127 3,012 3,012
Total Stockholders' Equity (Deficit)(4)... 4 (1) 697 (1,194) 4,884 (1,609) 5,650 7,769 1,276
Principal Balances Outstanding:
Dealership Sales Portfolio................ -- 2,492 9,588 19,881 34,227 23,801 27,830 34,227 23,801
Third Party Dealer Portfolio.............. -- -- -- 1,620 13,804 1,998 18,492 13,804 1,998
Portfolio Securitized with Servicing
Retained................................. -- -- -- -- -- -- 12,622 -- --
------ ------ ------- ------- ------- ------- ------- ------ -------
Total..................................... $ -- $2,492 $ 9,588 $21,501 $48,031 $25,799 $58,944 $ 48,031 $25,799
====== ====== ======= ======= ======= ======= ======= ======== =======
<CAPTION>
AS ADJUSTED(2)
-------------------------------
MARCH 31,
DECEMBER 31, -----------------
1996 1995 1995 1996
------- ------------ ------- -------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Total Finance Receivables, Net............ $39,479 $ 40,726 $19,459 $39,479
Total Assets.............................. 68,944 68,125 41,057 68,994
Total Subordinated Notes Payable.......... 14,000 14,553 17,215 14,000
Total Debt................................ 54,205 42,207 21,274 41,226
Total Preferred Stock..................... 10,000 10,000 -- 10,000
Total Common Stock........................ 3,012 15,992 15,992 15,992
Total Stockholders' Equity (Deficit)(4)... 8,535 20,749 14,256 21,515
Principal Balances Outstanding:
Dealership Sales Portfolio................ 27,830 34,227 23,801 27,830
Third Party Dealer Portfolio.............. 18,492 13,804 1,998 18,492
Portfolio Securitized with Servicing
Retained................................. 12,622 -- -- 12,622
------- ------ ------- -------
Total..................................... $58,944 $ 48,031 $25,799 $58,944
======= ======== ======= =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
---------------------------------------------- -----------------
1991 1992 1993 1994 1995 1995 1996
---- ------ ------- ------- ------- ------ -------
<S> <C> <C> <C> <C> <C> <C> <C>
DEALERSHIP OPERATING DATA (UNAUDITED):
Average Sales Price per Car.................................. -- n/a(5) $ 4,159 $ 5,269 $ 6,478 $5,854 $ 7,117
Number of Used Cars Sold..................................... -- n/a 3,359 5,270 7,383 1,654 2,119
Number of Contracts Originated............................... -- n/a 3,093 4,731 6,129 1,470 1,986
Principal Balances Originated (000 Omitted).................. -- n/a $12,984 $23,589 $36,568 $8,165 $13,635
Company Dealerships.......................................... -- 1 5 8 8 8 7
Units Sold per Dealership.................................... -- n/a 672 659 923 207 303
Number of Contracts Outstanding.............................. -- 803 2,929 5,515 8,049 6,414 6,194
Allowance as % of Outstanding Principal...................... -- 29.4% 30.0% 30.4% 21.9% 28.3% 23.0%
Average Principal Balance Outstanding........................ -- $3,105 $ 3,273 $ 3,605 $ 4,252 $3,711 $ 4,493
Average Yield on Contracts................................... -- n/a 26.4% 28.2% 28.0% 27.9% 28.0%
Delinquencies:
Principal Balances 31 to 60 Days............................. -- n/a 10.5% 5.1% 4.2% 3.6% 2.6%
Principal Balances over 60 Days.............................. -- n/a 15.0% 1.3% 1.1% 2.0% 1.1%
THIRD PARTY OPERATING DATA (UNAUDITED):
Number of Contracts Purchased................................ -- -- -- 1,423 3,012 484 1,268
Principal Balances Purchased (000 Omitted)................... -- -- -- $ 3,607 $16,455 $ 932 $ 7,186
Number of Branch Offices..................................... -- -- -- 1 8 1 10
Number of Third Party Dealers................................ -- -- -- 20 118 20 317
Number of Contracts Outstanding.............................. -- -- -- 726 2,733 1,029 3,592
Allowance as % of Outstanding Principal...................... -- -- -- 9.8% 7.2% 7.6% 7.3%
Average Principal Balance Outstanding........................ -- -- -- $ 2,232 $ 5,051 $1,942 $ 5,148
Average Yield on Contracts................................... -- -- -- 30.9% 26.7% 30.5% 26.9%
Delinquencies:
Principal Balances 31 to 60 days............................. -- -- -- 6.0% 1.2% 2.8% 0.9%
Principal Balances over 60 days.............................. -- -- -- 2.6% 0.4% 3.0% 0.1%
Per Contract Purchased:
Average Discount............................................. -- -- -- $ 504 $ 551 $ 212 $ 569
Average Percent Discount..................................... -- -- -- 12.5% 10.1% 11.0% 10.0%
<CAPTION>
PRO FORMA(1)
---------------------------
YEAR THREE MONTHS
ENDED ENDED
DECEMBER 31, MARCH 31,
1995 1995
------------ ------------
<S> <<C> <C>
DEALERSHIP OPERATING DATA (UNAUDITED):
Average Sales Price per Car.................................. $ 6,065 $5,809
Number of Used Cars Sold..................................... 6,326 1,496
Number of Contracts Originated............................... 5,768 1,338
Principal Balances Originated (000 Omitted).................. $ 34,419 $7,418
Company Dealerships.......................................... 7 7
Units Sold per Dealership.................................... 904 214
Number of Contracts Outstanding.............................. 8,049 6,414
Allowance as % of Outstanding Principal......................
Average Principal Balance Outstanding........................ $ 4,252 $3,711
Average Yield on Contracts................................... 28.0% 27.9%
Delinquencies:
Principal Balances 31 to 60 Days.............................
Principal Balances over 60 Days..............................
THIRD PARTY OPERATING DATA (UNAUDITED):
Number of Contracts Purchased................................
Principal Balances Purchased (000 Omitted)...................
Number of Branch Offices.....................................
Number of Third Party Dealers................................
Number of Contracts Outstanding..............................
Allowance as % of Outstanding Principal......................
Average Principal Balance Outstanding........................
Average Yield on Contracts...................................
Delinquencies:
Principal Balances 31 to 60 days.............................
Principal Balances over 60 days..............................
Per Contract Purchased:
Average Discount.............................................
Average Percent Discount.....................................
</TABLE>
(footnotes on following page)
18
<PAGE> 19
SELECTED CONSOLIDATED FINANCIAL INFORMATION (CONTINUED)
(FOOTNOTES)
- ---------------
(1) The pro forma financial data presented herein gives information concerning
the continuing impact of certain transactions on the Company's operations by
showing how such transactions might have affected the Company's historical
financial statements if the transactions had been consummated as of December
31, 1994. Unless otherwise indicated, the transactions to which such
retroactive effect has been given in the pro forma financial data are the
Recapitalization Transactions, which will take effect upon the closing of
the offering, and the sale of the Company's Gilbert Dealership, which took
effect as of December 31, 1995. See "Recapitalization and Related
Transactions" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Introduction." The pro forma effect
of the Recapitalization Transactions is presented for all periods since
December 31, 1994. The pro forma effect of the sale of the Gilbert
Dealership is presented only for the three months ended March 31, 1995 and
the year ended December 31, 1995, since the dealership was not operating
during the three months ended March 31, 1996. The following table indicates
the transactions giving rise to the pro forma presentation, the line items
of the Company's results of operations affected by the pro forma
presentation, the amounts of such adjustments, and the periods in which such
adjustments have been made.
<TABLE>
<CAPTION>
THREE MONTHS
ENDED
YEAR ENDED MARCH 31,
DECEMBER 31, -----------------------
1995 1995 1996
------------ --------- ---------
<S> <C> <C> <C>
Pro Forma Adjustments due to the Recapitalization Transactions:
Reduction in Interest on Subordinated Debt due to rate reduction
on Subordinated Debt from 18.0% to 10.0%...................... $1,551,855 $ 352,151 $ 280,615
Elimination of rent expense charged to General and
Administrative Expense on real property to be purchased from
Verde Investments............................................. 1,185,432 258,999 433,380
Additional Interest Expense, Other arising from the purchase of
real property financed at an assumed rate of 10.0%............ (645,000) (151,250) (167,500)
Reduction in rent expense charged to General and Administrative
Expense on properties sub-leased from Verde Investments....... 187,000 46,750 46,750
Reduction in Preferred Stock Dividend due to rate reduction on
the Series A Preferred Stock from 12.0% to 10.0%.............. -- -- 50,000
Reduction in Interest Expense, Other arising from the purchase
of $3.0 million of Common Stock at the public offering price
pursuant to the conversion of convertible debt held by
SunAmerica and the pro forma reduction of borrowings.......... 366,222 86,565 105,641
---------- --------- ---------
Total pro forma increase in Net Earnings Available to Common
Shares arising from the Recapitalization Transactions......... $2,645,509 $ 593,215 $ 748,886
---------- --------- ---------
Pro Forma Adjustments due to the Sale of the Gilbert Dealership:
Reduction in:
Sales of Used Cars............................................ 9,456,814 992,869 --
Cost of Used Cars Sold........................................ 7,279,436 546,765 --
Provision for Credit Losses................................... 520,077 187,653 --
---------- --------- ---------
Net Revenues from Dealership Activities.................. 1,657,301 258,451 --
---------- --------- ---------
Selling and Marketing Expenses................................ 627,021 40,373 --
General and Administrative Expenses........................... 1,083,689 180,460 --
Depreciation.................................................. 48,808 10,759 --
Other Expenses (loss on sale of leasehold improvements,
property, and equipment).................................... 221,396 -- --
---------- --------- ---------
Total pro forma increase (decrease) in Net Earnings Available to
Common Shares arising from the sale of the Gilbert
Dealership.................................................... 323,613 (26,859) --
---------- --------- ---------
Total pro forma increase in Net Earnings Available to Common
Shares arising from all pro forma adjustments................. $2,969,122 $ 566,356 $ 748,886
========== ========= =========
</TABLE>
(2) As adjusted financial information reflects the sale of the 2,300,000 shares
of Common Stock offered hereby at the initial public offering price of $6.75
per share and the initial application of the estimated net proceeds
therefrom to repay indebtedness under the Company's Revolving Facility as of
December 31, 1994. Such adjustment reduces the Company's Interest Expense,
Other and increases the Company's Net Earnings for the year ended December
31, 1995 by $1,412,679, for the three months ended March 31, 1995 by
$374,527, and for the three months ended March 31, 1996 by $319,776
(variances are due to the fluctuating rate under the Revolving Facility).
(3) See Notes to the Consolidated Financial Statements for a determination of
the weighted average common shares outstanding.
(4) The Accumulated Deficit component of Total Stockholders' Equity does not
give any effect to the pro forma adjustments.
(5) n/a -- not available.
19
<PAGE> 20
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information regarding the
Company's consolidated financial position as of December 31, 1994 and 1995 and
March 31, 1995 and 1996, and its results of operations for the years ended
December 31, 1993, 1994, and 1995 and the three months ended March 31, 1995 and
1996. This discussion should be read in conjunction with the preceding "Selected
Consolidated Financial Data" and the Company's Consolidated Financial Statements
and related Notes thereto and other consolidated financial data appearing
elsewhere in this Prospectus. In the opinion of management, such unaudited
interim data reflect all adjustments, consisting only of normal recurring
adjustments, necessary to fairly present the Company's financial position and
results of operations for the periods presented. The results of operations for
any interim period are not necessarily indicative of results to be expected for
a full fiscal year. For information relating to factors that could affect future
operating results, see "Risk Factors." Any forward-looking statements included
in this Prospectus should be considered in light of such factors, as well as the
information set forth below.
INTRODUCTION
General. The Company commenced its used car sales and finance operations
with the acquisition of two Company Dealerships in 1992. During 1993, the
Company acquired three additional Company Dealerships. In 1994, the Company
constructed and opened four new Company Dealerships that were built specifically
to meet the Company's new standards of appearance, reconditioning capabilities,
size, and location. During 1994, the Company closed one Company Dealership
because the facility failed to satisfy these new standards and, at the end of
1995, closed its Gilbert, Arizona dealership (the "Gilbert Dealership").
The Gilbert Dealership was used by the Company to evaluate the sale of
later model used cars. These cars had an average age of approximately three
years, which is two to five years newer than the cars typically sold at Company
Dealerships, and cost more than twice that of typical Company Dealership cars.
The Company determined that its standard financing program could not be
implemented on these higher cost cars. Furthermore, operation of this dealership
required additional corporate infrastructure to support its market niche, such
as distinct advertising and marketing programs, which the Company was unable to
leverage across its other operations. Accordingly, the Company terminated this
program, and sold the land, dealership building, and other improvements to a
third party for $1.7 million. Pursuant to this sale and the disposition of other
assets, the Company recognized a loss of approximately $221,000. See "Certain
Relationships and Related Transactions." During fiscal year 1995, the Gilbert
Dealership produced sales of $9.5 million (average of $8,946 per car sold) and
gross profits (Sales of Used Cars less Cost of Used Cars Sold) of $2.2 million
(average of $2,060 per car sold), and the Company incurred selling and marketing
expenses of $627,000 (average of $593 per car sold). The pro forma results of
operations discussed below have been adjusted as if the Gilbert Dealership had
been terminated as of December 31, 1994, as management believes these pro forma
results are more indicative of ongoing operations.
In 1994, the Company acquired Champion Financial Services, Inc., an
independent automobile finance company, primarily for its management expertise
and contract servicing software and systems. Champion had a portfolio of
approximately $1.9 million in sub-prime contracts averaging approximately $2,000
in principal amount. For the balance of 1994, the Company purchased an
additional $1.7 million in contracts.
In April 1995, the Company initiated an aggressive plan for purchasing
contracts from Third Party Dealers and by June 15, 1996 had opened fourteen
Branch Offices in seven states serving over 300 Third Party Dealers. This
expansion of its Third Party Dealer network enabled the Company to leverage its
existing infrastructure and increase its contract portfolio much more quickly
than it could through the expansion of its Company Dealerships.
Growth in Finance Receivables. As a result of the Company's rapid
expansion, total assets, consisting primarily of contract receivables, increased
from $11.9 million at December 31, 1993, to $29.7 million at December 31, 1994,
to $60.8 million at December 31, 1995 to $61.7 million at March 31, 1996 (which
excludes $13.0 million in contracts sold and securitized in March 1996).
20
<PAGE> 21
The following tables reflect the growth in contract originations by Company
Dealerships and contract purchases from Third Party Dealers as well as the
period end balances measured in terms of the principal amount and the number of
contracts.
TOTAL CONTRACTS ORIGINATED/PURCHASED
<TABLE>
<CAPTION>
THREE
MONTHS
ENDED MARCH
YEARS ENDED DECEMBER 31, 31,
--------------------------------------------------------------------------- -----------
1993 1994 1995 1995
----------------------- ----------------------- ----------------------- -----------
PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL
AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
----------- --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Company Dealerships.............. $12,983,997 3,093 $23,589,458 4,731 $36,568,158 6,129 $ 8,164,833
Third Party Dealers.............. -- -- 3,606,554 1,423 16,455,472 3,012 931,831
----------- ----- ----------- ----- ----------- ----- -----------
Total......................... $12,983,987 3,093 $27,196,012 6,154 $53,023,630 9,141 $ 9,096,664
=========== ===== =========== ===== =========== ===== ===========
<CAPTION>
1996
-----------------------
NO. OF PRINCIPAL NO. OF
CONTRACTS AMOUNT CONTRACTS
--------- ----------- ---------
<S> <C> <C> <C>
Company Dealerships.............. 1,470 $13,635,146 1,986
Third Party Dealers.............. 484 7,185,662 1,268
----- ----------- ------
Total......................... 1,954 $20,820,808 3,254
===== =========== ======
</TABLE>
TOTAL CONTRACTS OUTSTANDING
<TABLE>
<CAPTION>
AS OF MARCH
AS OF DECEMBER 31, 31,
--------------------------------------------------------------------------- -----------
1993 1994 1995 1995
----------------------- ----------------------- ----------------------- -----------
PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL
AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT
----------- --------- ----------- --------- ----------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Company Dealerships.............. $ 9,587,995 2,929 $19,881,034 5,515 $34,226,909 8,049 $23,801,383
Third Party Dealers.............. -- -- 1,620,098 726 13,804,533 2,733 1,997,896
----------- ----- ----------- ----- ----------- ----- -----------
Total Portfolio Serviced......... $ 9,857,995 2,929 $21,501,132 6,241 $48,031,442 10,782 $25,799,279
----------- ----- ----------- ----- ----------- ----- -----------
Less Portfolio Securitized and
Sold............................ -- -- -- -- -- -- --
----------- ----- ----------- ----- ----------- ----- -----------
Company Total.................... $ 9,587,995 2,929 $21,501,132 6,241 $48,031,442 10,782 $25,799,279
=========== ===== =========== ===== =========== ===== ===========
<CAPTION>
1996
-----------------------
NO. OF PRINCIPAL NO. OF
CONTRACTS AMOUNT CONTRACTS
--------- ----------- ---------
<S> <C> <C> <C>
Company Dealerships.............. 6,414 $40,451,684 8,880
Third Party Dealers.............. 1,029 18,492,469 3,592
----- ----------- -----
Total Portfolio Serviced......... 7,443 $58,944,153 12,472
----- ----------- -----
Less Portfolio Securitized and
Sold............................ -- (12,621,846) (2,686)
----- ----------- -----
Company Total.................... 7,443 $46,322,307 9,786
===== =========== =====
</TABLE>
RESULTS OF OPERATIONS
Presentation of Dealership Revenues and Cost of Revenues. Revenues from
Company Dealership operations consist of Sales of Used Cars, Income on Finance
Receivables and, beginning in 1996, Gain on Sale of Finance Receivables and
Income on Residual in Finance Receivables Sold. Cost of Revenues of Dealership
operations is comprised of Costs of Used Cars Sold and the Provision for Credit
Losses.
The prices at which the Company sells its cars and the interest rate that
it charges to finance these sales take into consideration that the Company's
primary customers are high-risk borrowers, many of whom ultimately default. The
Provision for Credit Losses reflects these factors and is treated by the Company
as a cost of both the future finance income derived on the contract receivables
originated at Company Dealerships as well as a cost of the sale of the cars
themselves. Accordingly, unlike traditional car dealerships, the Company does
not present gross profits in its Statement of Operations calculated as Sales of
Used Cars less Cost of Used Cars Sold.
THREE MONTHS ENDED MARCH 31, 1995 AND 1996
Sales of Used Cars. Sales of Used Cars increased by 73.6% from $8.7
million (pro forma) for the three months ended March 31, 1995 to $15.1 million
for the three months ended March 31, 1996. This growth reflects increases in the
average unit sales price and the average number of units sold by each Company
Dealership. The sales for both periods reflect the results of all seven current
Company Dealerships.
The average sales price per car increased by 22.5% from $5,809 (pro forma)
for the three months ended March 31, 1995 to $7,117 for the three months ended
March 31, 1996. This increase reflects management's decision to sell higher
quality vehicles at its seven operating dealerships. Units sold per Company
Dealership averaged 214 (pro forma) for the three months ended March 31, 1995,
and 303 for the three months ended March 31, 1996. The Company attributes the
increase in units sold per Company Dealership to the success of the Company's
business strategy, most notably its advertising and marketing programs.
21
<PAGE> 22
Income on Finance Receivables from Dealership Sales. A primary element of
the Company's sales strategy is to provide financing to customers with poor
credit histories who are unable to obtain automobile financing through
traditional sources. The Company financed 89.4% (pro forma) and 93.7% of the
used cars sold at Company Dealerships for the three months ended March 31, 1995
and 1996, respectively. Finance income rose in conjunction with the growth in
the Company Dealership contract portfolio, increasing by 56.3% from $1.6 million
for the three months ended March 31, 1995 to $2.5 million for the three months
ended March 31, 1996. Finance income was reduced in March 1996 and will be
reduced further in future periods by the securitization completed in March 1996
and by additional securitizations. Substantially all contracts have been
originated with a 29.9% annual percentage rate ("APR").
The Company defers certain costs associated with the origination of finance
receivables at its Company Dealerships and amortizes these loan origination
costs against Income on Finance Receivables using the interest method. In each
of the three month periods ended March 31, 1995 and 1996, the Company deferred
$100 in loan origination costs per contract originated. Total costs deferred for
these three month periods in 1995 and 1996 were $181,000 and $206,000,
respectively. Income on receivables was reduced for these periods by the
amortization of the loan origination costs by $107,000 and $152,000,
respectively. The effective yield on finance receivables from Company
Dealerships was 28.0% at both March 31, 1995 and 1996.
Gain on Sale of Finance Receivables. During the quarter ended March 31,
1996, the Company initiated a securitization program ("Securitization Program")
with SunAmerica under which the Company sells certificates backed by Company
Dealership contracts to SunAmerica. The Company retains a residual in the
contracts sold and records a gain on the sale. The Company's intention is to
periodically securitize an amount of contracts commensurate with the amount of
contracts produced during the period. Through the recognition of a gain on the
sale of finance receivables, the Company has effectively present valued the
income from finance receivables generated from the sale of used cars, net of all
associated administrative, servicing, credit loss, and financing costs. To the
extent that the amount of finance receivables generated from used car sales in a
period is equal to the amount of receivables sold, the Company's results of
operations in a given period will more closely reflect the profitability of used
car sales and financing for the period. Such sales will also have the effect of
reducing the Company's future finance income.
The amount of the gain on sale reflects the difference between the yield
earned on the contract portfolio securitized and the return on the certificates
sold, and is computed based on the difference between: (i) the dollar amount
received for the certificates plus the value of the residual retained by the
Company, and (ii) the principal balance of the contract portfolio sold less the
amount of the Allowance for Credit Losses allocable to such contract portfolio
and direct expenses.
The first securitization was completed in March 1996 with the sale to
SunAmerica of $10.0 million in certificates backed by $13.0 million in
contracts. The Company reduced its Allowance by $1.7 million in this transaction
and retained a residual in the contracts sold of $2.6 million, recording a gain
on sale of $539,000, net of expenses of $318,000. The Company plans to complete
a securitization approximately every three to four months.
Income on Residual in Finance Receivables Sold. The Residual in Finance
Receivables Sold is based on the Company's right to cash flows from the trust to
which the finance receivables are sold in the Securitization Program to the
extent cash is not required to make payments on the certificates sold to
SunAmerica or for associated costs. The amount of the residual is calculated
using estimates for prepayments and losses (charge-offs), with cash flows
discounted at a rate for similar maturing instruments. In the event actual
performance of the receivables sold results in less cash flow than originally
anticipated, and to the extent that the net realizable value of the Residual is
impaired, the Residual's value will be reduced with a corresponding charge to
operations in the period in which the adjustment is made. For the quarter ended
March 31, 1996, income on the residual was $103,000 reflecting activity from
March 12, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 93.0% from $4.3 million (pro forma) for the three months ended
March 31, 1995 to $8.3 million for the three months ended March 31, 1996. On a
per unit basis, the Cost of Used Cars Sold increased by 36.7% from $2,882 (pro
forma) for the three months ended March 31, 1995 to $3,939 for the three months
ended March 31, 1996,
22
<PAGE> 23
largely due to management's determination to sell higher quality cars throughout
its operations. The gross margin on used car sales (Sales of Used Cars less Cost
of Used Cars Sold excluding Provision for Credit Losses) increased by 52.3% from
$4.4 million (pro forma) for the three months ended March 31, 1995 to $6.7
million for the three months ended March 31, 1996. As a percentage of sales, the
gross margin decreased from 50.4% (pro forma) for the three months ended March
31, 1995 to 44.6% for the three months ended March 31, 1996. The Company
attributes the decline in the gross margin percentage to the increased cost of
the higher quality cars sold at Company Dealerships which was not accompanied by
a proportionate increase in sales price. The decline in the gross margin
percentage was offset by corresponding increases in the quality of finance
contracts generated (resulting in a lower Provision for Credit Losses) and
greater unit sales per Company Dealership. On a per unit basis, the gross margin
per car sold was $2,927 (pro forma) for the three months ended March 31, 1995
and $3,178 for the three months ended March 31, 1996.
Provision for Credit Losses. A high percentage of Company Dealership
customers ultimately do not make all of their contractually scheduled payments,
requiring the Company to charge off the remaining principal balance due. The
Company maintains an Allowance for Credit Losses to absorb such losses. To fund
the Allowance as it relates to cars financed through Company Dealerships, a
direct charge to revenues is recorded through the Provision for Credit Losses
for each contract originated. The Provision for Credit Losses increased by 36.8%
from $1.9 million (pro forma) for the three months ended March 31, 1995 to $2.6
million for the three months ended March 31, 1996. As a percentage of contract
balances originated, the Provision decreased from 25.2% (pro forma) for the
three months ended March 31, 1995 to 19.1% for the three months ended March 31,
1996. The decrease for the three months ended March 31, 1996, reflects the
Company's strengthened underwriting requirements, the higher quality of used
cars sold, and the Company's improved collection efforts. The amount of the
Provision in a given period is based on the amount the Company estimates is
required to maintain an adequate Allowance. See "-- Allowance for Credit
Losses," for additional information about the Allowance, including with respect
to contracts purchased from Third Party Dealers.
The Company charges its Provision for Credit Losses to current operations
and does not recognize any portion of the unearned interest income as a
component of its Allowance for Credit Losses. Accordingly, the Company's
unearned finance income is comprised of the full APR on its contracts less
amortization of loan origination costs.
Net Revenues from Dealership Activities. Net Revenues from Dealership
Activities increased significantly in the three months ended March 31, 1996
compared to the three months ended March 31, 1995, reflecting primarily the
rapid growth of the Company Dealerships and the completion of the first
securitization in March 1996. Net revenues as a percentage of total revenues
from dealership activities were 39.7% (pro forma) and 39.9% for the three months
ended March 31, 1995 and 1996, respectively. The increase in 1996 reflects first
time revenues from the Gain on Sale and Income on Residual in Finance
Receivables from the first securitization, and the decrease in the Provision for
Credit Losses as a percentage of sales. These factors were offset by increases
in the Cost of Used Cars Sold.
Servicing Income. The Company services the $13.0 million in contracts sold
in the initial sercuritization for a monthly fee of .417% of beginning of period
principal balance (5.0% annualized). Servicing Income for March 1996 totaled
$54,000.
Income on Third Party Finance Receivables. Finance income has increased in
conjunction with the increases in Third Party Dealer contracts purchased and
outstanding. See "-- Introduction -- Growth in Finance Receivables." Finance
income increased by 406.9% from $217,000 for the three months ended March 31,
1995, which was prior to the expansion of the Company's Third Party Dealer
operations, to $1.1 million for the three months ended March 31, 1996.
Subsequent to March 31, 1995, as a result of its migration to more creditworthy
borrowers and expansion into markets with interest rate limits of 21.0%, the
Company's yield on its Third Party Dealer contract portfolio has trended
downward. Portfolio yield was approximately 30.5% and 26.7% at March 31, 1995
and 1996, respectively.
Franchise Fees and Other Income. Franchise Fees and Other Income consist
primarily of franchise fees from the Company's rent-a-car franchisees. This
income decreased by 26.8% from $82,000 for the three months ended March 31, 1995
to $60,000 for the three months ended March 31, 1996. The Company no
23
<PAGE> 24
longer actively engages in the rent-a-car franchise business. The Company has
informed its rent-a-car franchisees that it will not advertise or actively
support the rent-a-car business and that they may terminate their franchise
agreements provided that they cease to use the Company's trademarks.
Income before Operating Expenses. As a result of the Company's rapid
expansion, Income before Operating Expenses grew by 90.9% from $4.4 million (pro
forma) for the three months ended March 31, 1995 to $8.4 million for the three
months ended March 31, 1996. Net Revenue from Dealership Activity was the
primary contributor to the increase. The increase also reflects the growth of
the Company's Third Party Dealer operations.
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, Depreciation and Amortization,
and Amortization of Covenants. The allocation of these expenses to each of the
Company's business segments (Company Dealerships, Third Party Dealers, and
Corporate and Other) is shown at Note 21 to the Consolidated Financial
Statements.
Selling and Marketing Expenses. For the three months ended March 31, 1995
and 1996, Selling and Marketing Expenses were comprised entirely of advertising
costs and commissions relating to Company Dealership operations. Selling and
Marketing Expenses increased by 40.8% from $710,000 (pro forma) for the three
months ended March 31, 1995 to $1.0 million for the three months ended March 31,
1996 . As a percentage of Sales of Used Cars, these expenses averaged 8.2% (pro
forma) for the three months ended March 31, 1995 and 6.9% for the three months
ended March 31, 1996. On a per unit sold basis, Selling and Marketing Expenses
of Company Dealerships increased by 3.5% from $475 (pro forma) for the three
months ended March 31, 1995 to $491 for the three months ended March 31, 1996.
Beginning in the middle of 1994 and continuing throughout March 1996, the
Company undertook to significantly expand its advertising and marketing efforts.
Advertising increased by 30.1% from $428,000 (pro forma) for the three months
ended March 31, 1995 to $557,000 for the three months ended March 31, 1996.
General and Administrative Expenses. General and Administrative Expenses
increased by 48.3% from $2.9 million for the three months ended March 31, 1995
to $4.3 million for the three months ended March 31, 1996. These expenses
represented 25.4% of total revenues for the three months ended March 31, 1995
and 22.3% for the three months ended March 31, 1996. For the three months ended
March 31, 1995, 76.9% of General and Administrative Expenses were attributable
to Company Dealership sales and financing activities, 3.1% to Third Party Dealer
activities and 20.0% to Corporate overhead. For the three months ended March 31,
1996, 67.0% of General and Administrative Expenses were attributable to Company
Dealership sales and financing activities, 13.0% to Third Party Dealer
activities and 20.0% to Corporate overhead. Increased lease costs attributable
to base and percentage rent factors on leases relating to six Company
Dealerships leased from an affiliate, Verde Investments, were primary
contributors to the increase in General and Administrative Expenses. These rents
increased 47.7% from $394,000 for the three month period ended March 31, 1995 to
$582,000 for the three month period ended March 31, 1996. Upon the closing of
the offering, Verde Investments, an affiliate of the Company, has agreed to sell
to the Company, subject to financing, nine properties owned by Verde Investments
and leased to the Company at the lower of $7.45 million or the appraised value
(as determined by an independent third party), and, pending such sale, to lower
the rental rates on such properties to an aggregate of $745,000 per year, which
the Company believes approximates the financing costs to be incurred in
connection with the purchase of such properties. In addition, Verde Investments
has agreed to assign to the Company its leasehold interest in two properties it
sub-leases to the Company. These two transactions would have resulted in savings
to the Company of approximately $310,000 for the three months ended March 31,
1996. See "Recapitalization and Related Transactions." In addition, the build up
of these expenses reflects the development of a corporate infrastructure,
including the hiring of senior management and the implementation of
sophisticated contract servicing facilities and systems, to accommodate future
growth.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation on the Company's property and equipment and amortization of the
Company's trademarks. Depreciation and amortization increased by 32.8% from
$250,000 (pro forma) for the three months ended March 31, 1995 to $332,000 for
the three months ended March 31, 1996. The increase was due primarily to the
construction of Company servicing facilities, which opened in June 1995, and the
purchase of associated equipment. For the three
24
<PAGE> 25
months ended March 31, 1996, 75.6% of these expenses were attributable to
Company Dealership sales and financing activities, 10.1% to Third Party Dealer
activities and 14.3% to Corporate overhead. Amortization of Covenants was
$70,000 for the three months ended March 31, 1995. As of December 31, 1995, all
existing covenants had been fully amortized.
Other Expenses. Interest on Subordinated Debt, which bears interest at
18.0%, decreased by 20.3% from $792,000 for the three months ended March 31,
1995 to $631,000 for the three months ended March 31, 1996, due to the decrease
in the average principal balance outstanding during the quarter. Effective upon
the closing of this offering, the interest rate on the subordinated debt will be
decreased from 18.0% to 10.0%. On a pro forma basis, such adjustments would have
lowered subordinated debt interest expense for the three months ended March 31,
1995 and 1996 by approximately $352,000 and $281,000, respectively.
Interest Expense, Other increased by 203.0% from $330,000 for the three
months ended March 31, 1995 to $1.0 million for the three months ended March 31,
1996, due to increased borrowings from GE Capital under the Revolving Facility
and from SunAmerica under the $3.0 million convertible note issued in August
1995. The amount outstanding on the Revolving Facility increased from $12.1
million at March 31, 1995 to $31.8 million at March 31, 1996. For the three
months ended March 31, 1995 and March 31, 1996, the average interest rates on
the Revolving Facility were 11.5% and 10.5%, respectively. See "Liquidity and
Capital Resources," below. Effective upon the closing of the offering,
SunAmerica will convert its convertible note into Common Stock. On a pro forma
basis this conversion to Common Stock would have lowered Interest Expense, Other
by $86,000 and $106,000 for the three months ended March 31, 1995 and 1996,
respectively.
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995
Sales of Used Cars. Sales of Used Cars increased by 98.6% from $14.0
million in 1993 to $27.8 million in 1994 and by 38.1% to $38.4 million (after
giving pro forma effect to the sale of the Gilbert Dealership) in 1995. This
growth reflects increases in the number of Company Dealerships, the average unit
sales price, and, in 1995, the average number of units sold by each Company
Dealership. The number of Company Dealerships increased from two to five in
1993. In 1994 the Company opened four additional Company Dealerships, and closed
one in August 1994. Seven Company Dealerships, excluding the Gilbert Dealership,
were open throughout 1995.
The average sales price per car increased by 26.7% from $4,159 in 1993 to
$5,269 in 1994 and by 15.1% to $6,065 (pro forma) in 1995. These increases
reflect management's decision to sell higher quality vehicles at its seven
operating dealerships. Units sold per Company Dealership averaged 672 in 1993,
659 in 1994, and 904 (pro forma) in 1995. The Company attributes the decrease in
average units sold in 1994 as compared to 1993 to the adoption of stricter
underwriting guidelines in mid-1994, resulting in an increase in the rate of
rejection of credit applications. The increase in units sold per Company
Dealership in 1995 over 1994 is attributed to the success of the Company's
business strategy, most notably its advertising and marketing programs.
Income on Finance Receivables from Dealership Sales. The Company financed
92.1%, 89.8%, and 91.2% (pro forma) of the used cars sold at Company Dealerships
in 1993, 1994, and 1995, respectively. As of December 31, 1995, the Company had
retained all of the contracts originated by its Company Dealerships, including
its Gilbert Dealership. Finance income rose in conjunction with the growth in
the Company Dealership contract portfolio, increasing by 193.8% from $1.6
million in 1993 to $4.7 million in 1994 and by 74.5% to $8.2 million in 1995.
During this three year period, substantially all contracts were originated with
a 29.9% APR.
The Company defers certain costs associated with the origination of finance
receivables at its Company Dealerships and amortizes these loan origination
costs against Income on Finance Receivables using the interest method. In 1993,
1994 and 1995, the Company deferred $75, $85, and $100 in loan origination costs
per contract originated, respectively. Total costs deferred for 1993, 1994 and
1995 were $252,000, $503,000 and $737,000, respectively. Income on finance
receivables was reduced by the amortization of the loan origination costs by
$79,000, $309,000 and $522,000 in 1993, 1994 and 1995, respectively. The
effective yield on finance receivables from Company Dealerships was 26.4%, 28.2%
and 28.0% for 1993, 1994 and 1995, respectively.
25
<PAGE> 26
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 106.6% from $6.1 million in 1993 to $12.6 million in 1994 and by
64.3% to $20.7 million (pro forma) in 1995. On a per unit basis, the Cost of
Used Cars Sold increased by 31.7% from $1,813 in 1993 to $2,387 in 1994 and by
37.0% to $3,270 (pro forma) in 1995, largely due to management's determination
to sell higher quality cars throughout its operations. The gross margin on used
car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision
for Credit Losses) increased by 92.4% from $7.9 million in 1993 to $15.2 million
in 1994 and by 16.4% to $17.7 million (pro forma) in 1995. As a percentage of
sales, the gross margins for such periods were 56.4%, 54.7% and 46.1% (pro
forma), respectively. The Company attributes the decline in the gross margin
percentage to the increased cost of the higher quality cars sold at Company
Dealerships which was not accompanied by a proportionate increase in sales
price. The decline in the gross margin percentage was offset by corresponding
increases in the quality of finance contracts generated resulting in a lower
Provision for Credit Losses and greater unit sales per Company Dealership. On a
per unit basis, the gross margin per car sold was $2,346 in 1993, $2,882 in
1994, and $2,795 (pro forma) in 1995.
Provision for Credit Losses. The Provision for Credit Losses increased by
145% from $3.3 million in 1993 to $8.1 million in 1994 and by 3.7% to $8.4
million in 1995. As a percentage of contract balances originated, the Provision
for Credit Losses increased from 25.4% in 1993 to 34.5% in 1994 and then
decreased to 22.9% in 1995. The decrease in 1995 resulted from the Company's
strengthened underwriting requirements, the higher quality of used cars sold,
and the Company's improved collection efforts. The amount of the Provision for
Credit Losses in a given period is based on the amount the Company estimates is
required to maintain an adequate Allowance. See "-- Allowance for Credit
Losses."
Net Revenues from Dealership Activities. Net Revenues from Dealership
Activities increased significantly over the past three fiscal years, reflecting
primarily the rapid growth of the Company Dealerships. Net revenues as a
percentage of total revenues from dealership activities were 39.9%, 36.3% and
38.8% (pro forma) in 1993, 1994 and 1995, respectively. The percentage decrease
from 1993 to 1994 was primarily the result of a substantial increase in the
Provision for Credit Losses prompted by the rapid growth of the Company's
portfolio. The increase from 1994 to 1995 reflected a decrease in the Provision
as a percentage of Company Dealership revenues due to the Company's ability to
maintain its sales growth while strengthening its underwriting requirements,
sale of better quality and higher priced cars (which both increased sales and
lowered net losses), and improved collection efforts. See "-- Allowance for
Credit Losses."
Income on Third Party Finance Receivables. Finance income has increased in
conjunction with the increases in Third Party contracts purchased and
outstanding. See "-- Introduction -- Growth in Finance Receivables." Finance
income increased by 153.5% from $710,000 in 1994, when the Company initiated its
Third Party Dealer operations, to $1.8 million in 1995. During this two year
period, substantially all contracts purchased carried APR's ranging from 21.0%
to 29.9%. As a result of its migration in 1995 to more creditworthy borrowers
financed at lower interest rates, the Company's yield on its Third Party Dealer
contract portfolio trended downward. Portfolio yield was approximately 30.9% and
26.7% at the end of 1994 and 1995, respectively.
Franchise Fees and Other Income. Franchise Fees and Other Income decreased
by 36.7% from $879,000 in 1993 to $557,000 in 1994 and by 44.7% to $308,000 in
1995, reflecting the Company's suspension of active engagement in the rent-a-car
business.
Income before Operating Expenses. As a result of the Company's rapid
expansion, Income before Operating Expenses grew by 84.5% from $7.1 million in
1993 to $13.1 million in 1994, and by 54.2% to $20.2 million (pro forma) in
1995. Net Revenue from Dealership Activity was the primary contributor to the
increase. The increase also reflects the development of the Company's Third
Party Dealer operations.
Selling and Marketing Expenses. In 1995, Selling and Marketing Expenses
were comprised entirely of advertising costs and commissions relating to Company
Dealership operations. Excluding expenses of $400,000 in 1993 and $140,000 in
1994 attributable to rent-a-car franchising, Selling and Marketing Expenses
increased by 155.6% from $900,000 in 1993 to $2.3 million in 1994 and by 39.1%
to $3.2 million (pro forma) in 1995. As a percentage of Sales of Used Cars,
these expenses averaged 6.3% in 1993, 8.1% in 1994, and 8.4% (pro forma) in
1995. On a per unit sold basis, Selling and Marketing Expenses of Company
Dealerships increased by 63.7%
26
<PAGE> 27
from $262 in 1993 to $429 in 1994 and by 18.9% to $510 (pro forma) in 1995.
Beginning in the middle of 1994 and continuing throughout 1995, the Company
undertook to significantly expand its advertising and marketing efforts.
Advertising increased by 226.3% from $429,000 in 1993 to $1.4 million in 1994
and by 57.1% to $2.2 million in 1995. In the Company's view, by the middle of
1994 its dealership network had achieved a sufficient critical mass in the
Tucson and Phoenix markets to justify a more extensive advertising campaign. In
addition, the Company believed that it could develop programs that would
distinguish its Company Dealerships from other Buy Here-Pay Here dealers.
Although the development and implementation of the advertising and marketing
programs has raised costs on a per unit basis substantially, the Company
believes that these efforts have produced corresponding increases in unit sales
per Company Dealership.
General and Administrative Expenses. General and Administrative Expenses
increased by 150.0% from $3.6 million in 1993 to $9.0 million in 1994, and by
60.0% to $14.4 million in 1995. These expenses represented 21.6% of total
revenues in 1993, 26.6% in 1994, and 24.8% in 1995. In 1995, 73.4% of General
and Administrative Expenses were attributable to Company Dealership sales and
financing activities, 8.1% to Third Party Dealer activities, and 18.5% to
Corporate overhead. Increased lease costs attributable to base and percentage
rent factors on leases relating to six Company Dealerships leased from an
affiliate, Verde Investments, contributed to the increase in General and
Administrative Expenses. These rents increased by 410.6% from $235,000 in 1993
to $1.2 million in 1994 and by 50.0% to $1.8 million in 1995. Upon the closing
of the offering, Verde Investments, an affiliate of the Company, has agreed to
sell to the Company, subject to financing, nine properties owned by Verde
Investments and leased to the Company at the lower of $7.45 million or the
appraised value (as determined by an independent third party), and, pending such
sale, to lower the rental rates on such properties to an aggregate of $745,000
per year, which the Company believes approximates the financing costs to be
incurred in connection with the purchase of such properties. In addition, Verde
Investments has agreed to assign to the Company its leasehold interest in two
properties it sub-leases to the Company. These two transactions would have
resulted in savings to the Company of approximately $730,000 for 1995. See
"Recapitalization and Related Transactions." In addition, the build up of these
expenses reflected the development of a corporate infrastructure, including the
hiring of senior management and the establishment of sophisticated contract
servicing facilities and systems, to accommodate future growth.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation on the Company's property and equipment and amortization of the
Company's trademarks. In 1995, 57.7% of these expenses were attributable to
Company Dealership sales and financing activities, 6.8% to Third Party Dealer
activities, and 35.5% to Corporate overhead. Depreciation and Amortization
increased by 39.5% from $557,000 in 1993 to $777,000 in 1994 and by 69.1% to
$1.3 million in 1995. These increases were due primarily to the construction of
Company Dealerships and servicing facilities and the purchase of associated
equipment.
Amortization of Covenants. Amortization of Covenants was $366,000 in 1993,
$296,000 in 1994 and $296,000 in 1995. As of December 31, 1995, all existing
covenants had been fully amortized.
Other Expenses. Interest on Subordinated Debt increased by 283.5% from
$678,000 in 1993 to $2.6 million in 1994 and by 34.6% to $3.5 million in 1995 as
additional subordinated debt borrowings were incurred to meet the Company's cash
needs. Effective upon the closing of this offering, the interest rate on the
subordinated debt will be decreased from 18.0% to 10.0%. On a pro forma basis,
such adjustments would have lowered subordinated debt interest expense in 1995
by approximately 45.7%, from $3.5 million to $1.9 million.
Interest Expense, Other relating primarily to the Revolving Facility with
GE Capital and to a much lesser extent in 1995 on the convertible subordinated
note issued to SunAmerica, increased by 117.7% from $215,000 in 1993 to $468,000
in 1994 and by 434.2% to $2.5 million in 1995. The Revolving Facility commenced
in June 1994 and had a balance of $9.9 million outstanding at the end of 1994,
which increased to $32.2 million at the end of 1995. For 1995, the average
interest rate on the Revolving Facility was 10.7%. See "Liquidity and Capital
Resources," below. Effective upon the closing of the offering, SunAmerica will
convert its convertible note into Common Stock. On a pro forma basis this
conversion to Common Stock would have lowered Interest Expense, Other by
$366,000 for the year ended December 31, 1995.
27
<PAGE> 28
Other Expenses increased by 166.8% from $64,000 in 1993 to $170,000 in 1994
and by 73.6% to $296,000 in 1995. The primary cause for the increase from 1994
to 1995 was the accrual of an estimated loss of $120,000 related to the sale of
the Gilbert Dealership.
ALLOWANCE FOR CREDIT LOSSES
The Company has established an Allowance for Credit Losses to cover
anticipated credit losses on the contracts currently in its portfolio. The
Allowance has been established through the Provision for Credit Losses on
contracts originated at Company Dealerships, and through nonrefundable
acquisition discounts on contracts purchased from Third Party Dealers.
The following tables reflect activity in the Allowance for Credit Losses
for the years ended December 31, 1994 and 1995 and for the three months ended
March 31, 1995 and 1996.
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------------------
1994 1995
------------------------------------- --------------------------------------
COMPANY THIRD COMPANY THIRD
DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL
----------- --------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, Beginning of
Period.................... $ 2,876,399 $ -- $ 2,876,399 $ 6,049,439 $ 159,221 $ 6,208,660
Provision for Credit
Losses.................... 8,139,791 -- 8,139,791 8,359,585 -- 8,359,585
Discount Acquired........... -- 766,820 766,820 -- 1,659,798 1,659,798
Discount Accreted to
Income.................... -- (187,692) (187,692) -- -- --
Net Charge Offs............. (4,966,751) (419,907) (5,386,658) (6,909,024) (819,019) (7,728,043)
----------- --------- ----------- ----------- ---------- -----------
Balance, End of Period...... $ 6,049,439 $ 159,221 $ 6,208,660 $ 7,500,000 $1,000,000 $ 8,500,000
=========== ========= =========== =========== ========== ===========
Allowance as % of
Principal................. 30.4% 9.8% 28.9% 21.9% 7.2% 17.7%
=========== ========= =========== =========== ========== ===========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------------------------------
1995 1996
------------------------------------- --------------------------------------
COMPANY THIRD COMPANY THIRD
DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL
----------- --------- ----------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance, Beginning of
Period.................... $ 6,049,439 $ 159,221 $ 6,208,660 $ 7,500,000 $1,000,000 $ 8,500,000
Provision for Credit
Losses.................... 2,217,331 -- 2,217,331 2,606,112 -- 2,606,112
Discount Acquired........... -- 102,814 102,814 -- 720,931 720,931
Reduction in Allowance for
Finance Receivables
Sold...................... -- -- -- (1,658,534) -- (1,658,534)
Net Charge Offs............. (1,521,887) (110,883) (1,632,770) (2,047,578) (370,931) (2,418,509)
----------- --------- ----------- ----------- ---------- -----------
Balance, End of Period...... $ 6,744,883 $ 151,152 $ 6,896,035 $ 6,400,000 $1,350,000 $ 7,750,000
=========== ========= =========== =========== ========== ===========
Allowance as % of
Principal................. 28.3% 7.6% 26.7% 23.0% 7.3% 16.7%
=========== ========= =========== =========== ========== ===========
</TABLE>
The reduction in the Allowance as a percentage of principal balances
reflects the increase in Third Party Dealer contracts as a percentage of the
Company's total contract portfolio, the strengthening of the Company's
underwriting procedures, increases in collateral ratios, and improved collection
procedures.
The Provision for Credit Losses is charged to Company Dealership revenues
for contracts originated at Company Dealerships. The Provision has declined as a
percentage of principal balances originated due to the factors discussed above.
See "-- Results of Operations -- Provision for Credit Losses."
Each of the contracts acquired from Third Party Dealers are purchased at a
discount to the principal amount of the contract. Beginning January 1, 1995, the
Company has allocated all nonrefundable discounts to the Allowance. In 1994, the
acquisition discount averaged $504 per contract, or 12.5% of the principal
balance. In 1995, the acquisition discount averaged $551 per contract, or 10.1%
of the principal balance. For the three months ended March 31, 1996, the
discount averaged $569 per contract or 10.0%. The decrease in the discount as a
percentage of the contract principal balance from 1994 through the end of the
first quarter of 1996 reflects the increase in the quality of contracts
purchased. As with the Allowance on Company Dealership contracts, the Company
does not allocate any portion of the unearned interest income on its Third
28
<PAGE> 29
Party Dealer contracts to its Allowance for Credit Losses. Accordingly, the
Company's unearned finance income is comprised of the full APR on its contracts.
Net Charge Offs. The Company's policy is to charge off contracts when they
are deemed uncollectible, but in any event at such time as a contract is
delinquent for 90 days. The net charge off amount is the principal balance of
the contract at the time of the charge off plus accrued but unpaid interest,
less any recovery. The following tables set forth information regarding charge
off activity for the years ended December 31, 1994 and 1995, and for the periods
ended March 31, 1995 and 1996:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------------
1994 1995
-------------------------------------- ----------------------------------------
COMPANY THIRD COMPANY THIRD
CHARGE OFF ACTIVITY: DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL
- ------------------------------ ----------- ---------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Principal Balances:
Collateral Repossessed...... $ 5,743,090 $ 289,708 $ 6,032,798 $ 6,685,926 $ 806,619 $ 7,492,545
Other....................... 2,456,919 106,920 2,563,839 2,478,353 219,652 2,698,005
----------- ---------- ----------- ----------- ----------- ------------
Total Principal Balances.... 8,200,009 396,628 8,596,637 9,164,279 1,026,271 10,190,550
Accrued Interest............ 653,969 23,279 677,248 652,592 58,723 711,315
Recoveries.................. (3,887,227) -- (3,887,227) (2,907,847) (265,975) (3,173,822)
----------- ---------- ----------- ----------- ----------- ------------
Net Charge Offs............... $ 4,966,751 $ 419,907 $ 5,386,658 $ 6,909,024 $ 819,019 $ 7,728,043
============ ========== ============ ============ ============ =============
Ave. Principal Outstanding.... $16,507,497 $1,788,245 $18,295,742 $28,764,336 $ 6,889,247 $ 35,653,583
============ ========== ============ ============ ============ =============
Net Charge Offs as % of Ave.
Principal Outstanding....... 30.1% 23.5% 29.4% 24.0% 11.9% 21.7%
============ ========== ============ ============ ============ =============
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------------
1995 1996
-------------------------------------- ----------------------------------------
COMPANY THIRD COMPANY THIRD
CHARGE OFF ACTIVITY: DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL
- ------------------------------ ----------- ---------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Principal Balances:
Collateral Repossessed...... $ 1,155,327 $ 57,646 $ 1,212,973 $ 2,252,042 $ 542,028 $ 2,794,070
Other....................... 569,865 47,369 617,234 462,299 90,902 553,201
----------- ---------- ----------- ----------- ----------- ------------
Total Principal Balances.... 1,725,192 105,015 1,830,207 2,714,341 632,930 3,347,271
Accrued Interest............ 119,612 5,868 125,480 167,157 29,785 196,942
Recoveries.................. (322,917) -- (322,917) (833,920) (291,784) (1,125,704)
----------- ---------- ----------- ----------- ----------- ------------
Net Charge Offs............... $ 1,521,887 $ 110,883 $ 1,632,770 $ 2,047,578 $ 370,931 $ 2,418,509
============ ========== ============ ============ ============ =============
Ave. Principal Outstanding.... $22,348,582 $1,927,865 $24,276,447 $35,426,966 $16,522,191 $ 51,949,157
============ ========== ============ ============ ============ =============
Net Charge Offs as % of Ave.
Principal Outstanding....... 6.8% 5.8% 6.7% 5.8% 2.2% 4.7%
============ ========== ============ ============ ============ =============
</TABLE>
The Company significantly revised and expanded its Third Party Dealer
program in April 1995. Prior to April 1995, the Company purchased from Third
Party Dealers, at discounts of approximately 15.0% to 25.0%, contracts with
average principal balances of approximately $4,000 bearing a typical APR of
29.9%. Under the Company's revised program, which is aimed at more creditworthy
borrowers, it purchases from Third Party Dealers, at discounts averaging
approximately 10.0%, contracts with average principal balances of approximately
$5,600 bearing an average APR of 25.0%. As a result, Net Charge Offs as a
percentage of contract principal balances outstanding were 23.5% in the year
ended December 31, 1994 and 5.8% in the three months ended March 31, 1995 versus
11.9% in the year ended December 31, 1995 and 2.2% in the three months ended
March 31, 1996. The continued improvement in the Company's Net Charge Off
percentage is considered by management in reviewing the adequacy of the
Allowance for Credit Losses as a percentage of contract principal balances
outstanding.
29
<PAGE> 30
The Company's Net Charge Offs on its Third Party Dealer contract portfolio
are significantly lower than those incurred on its Company Dealership contract
portfolio. This is attributable to the generally more creditworthy customers
served by Third Party Dealers and the relationship of the average amount
financed to the underlying collateral's wholesale value. In its Third Party
Dealer portfolio, the Company generally limits its investment (advance to
wholesale book ratio) to not more than 120.0% of the wholesale value of the
underlying car, as determined by various recognized valuation services such as
NADA or Kelly Blue Book, plus tax and license, although the Company will make
exceptions on a case-by-case basis. For 1995, the advance to wholesale book
ratio on the Third Party Dealer contract portfolio averaged 117.0%, as compared
to 184.0% for the Company Dealership portfolio (105.0% of Kelly Blue Book retail
value). Accordingly, when it becomes necessary to repossess the collateral
securing Third Party Dealer contracts, the Company's net recovery is expected to
be approximately 45.0% to 55.0% of the outstanding contract balance, while on
the Company Dealership portfolio the net recovery is expected to be
approximately 33.0%.
Recoveries averaged 47.4% of principal balances charged off on contracts
originated through Company Dealerships in 1994 versus 31.7% in 1995 and 30.7%
for the three months ended March 31, 1996, primarily reflecting reductions in
the percentage of repossessed cars sold at its Company Dealerships from 57.5% in
1994 to 33.6% in 1995, and to 16.5% for the three months ended March 31, 1996.
Repossessed cars not sold through Company Dealerships are sold in wholesale
transactions. The average recovery on repossessed cars sold at Company
Dealerships was $4,869 in 1995 compared to an average recovery of $481 in
wholesale transactions. The Company's net charge offs on contracts generated
through Company Dealerships are favorably affected by a reduction in sales tax
liability as a result of loan defaults.
Recoveries of charge offs on Third Party Dealer purchased contracts were
25.9% in 1995 and 46.1% for the three months ended March 31, 1996. Management
believes that recoveries in 1995 related primarily to contracts purchased prior
to April 1995. Since then, the Company has purchased contracts with more
creditworthy borrowers, where the value of the amount financed more closely
approximates the wholesale value of the car.
Static Pool Analysis. The Company has reduced its Allowance for Credit
Losses as a percentage of contract principal balances as a result of the
improved performance of its Company Dealership contract portfolio. To monitor
portfolio performance, beginning in June 1995, the Company implemented "static
pool" analysis for all contracts originated since January 1, 1993. Static pool
analysis is a monitoring methodology by which each month's originations and
subsequent charge offs are assigned to a unique pool and the pool performance is
monitored separately. Improving or deteriorating performance is measured based
on cumulative gross and net charge offs as a percentage of original principal
balances, based on the number of complete payments made by the customer before
charge off.
The following table, which relates to Company Dealership contracts only as
of April 30, 1996, sets forth the cumulative net charge offs as a percentage of
original contract cumulative balances, based on the quarter of origination and
segmented by the number of payments made prior to charge off. While the Company
analyzes its static pools on a monthly basis, for presentation purposes the
information in the table is presented on a quarterly basis:
<TABLE>
<CAPTION>
POOLS' CUMULATIVE NET LOSSES AS PERCENT OF POOLS'
ORIGINAL AGGREGATE PRINCIPAL BALANCE
-------------------------------------------------------------------------------------------
PAYMENTS COMPLETED 1993 1994 1995
BY CUSTOMER ----------------------------- ----------------------------- ---------------------------
BEFORE CHARGE OFF 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH 1ST 2ND 3RD 4TH
- --------------------- ----- ----- ----- ----- ----- ----- ----- ----- ----- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
0 Payments........... 6.6% 7.7% 8.5% 7.1% 3.5% 3.6% 3.4% 2.9% 1.6% 2.5% 2.0% 0.8%
3 Payments........... 18.3% 18.4% 19.9% 16.9% 10.7% 11.3% 8.3% 8.8% 7.9% 7.5% 6.1% x
6 Payments........... 26.6% 26.2% 25.2% 23.4% 14.2% 15.3% 12.6% 12.8% 13.1% 11.9% x --
12 Payments.......... 33.2% 30.6% 30.4% 27.7% 17.5% 19.7% 16.5% 16.9% x -- -- --
18 Payments.......... 35.1% 32.1% 31.5% 28.9% 18.9% 21.4% x -- -- -- -- --
24 Payments.......... 35.3% 32.3% 31.7% 29.5% x -- -- -- -- -- -- --
</TABLE>
For periods denoted by an "x", the pools have not seasoned sufficiently to
allow for computation of cumulative losses. With respect to periods denoted by a
"--", the pools have not yet attained the indicated
30
<PAGE> 31
cumulative age. However, management has factored the improved trends indicated
by its static pool analysis into its determination of the adequacy of the
Allowance for Credit Losses for these periods.
The Company attributes the improvement in its credit loss experience as a
percentage of contracts originated to a variety of factors. First, the Company
believes that it has strengthened its underwriting requirements at the Company
Dealerships. Second, as a result of the higher quality of cars sold at Company
Dealerships, defaults arising from mechanical problems tend to be less frequent,
and when repossession is necessary, the amount recovered upon resale is
generally higher as a percentage of the contract balance. Finally, the Company
believes it has significantly improved its servicing and collection efforts.
Although the Company intends to apply static pool analysis to its Third
Party Dealer portfolio, this portfolio has not had sufficient seasoning for
meaningful analysis. In the meantime, management evaluates the adequacy of the
Allowance on the Third Party Dealer portfolio through comparisons in the
characteristics of the collateral ratios and borrowers on the Third Party Dealer
contracts versus those of the Company Dealership contracts, as well as through
comparisons of actual contract performance.
Delinquencies. Analysis of delinquency trends is also considered in
evaluating the adequacy of the Allowance. The following tables reflect the
principal balances of delinquent contracts as a percentage of total outstanding
contract principal balances as of December 31, 1993, 1994, and 1995, and as of
March 31, 1995 and 1996.
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
---------------------------------------------------------------------------------------
1993 1994 1995
--------------------------- --------------------------- ---------------------------
COMPANY THIRD COMPANY THIRD COMPANY THIRD
DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL DEALERSHIPS PARTY TOTAL
----------- ----- ----- ----------- ----- ----- ----------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
31 Days to 60 Days.............. 10.5% -- 10.5 % 5.1% 6.0% 5.2% 4.2% 1.2% 3.3%
Over 60 Days.................... 15.0% -- 15.0 % 1.3% 2.6% 1.4% 1.1% 0.4% 0.9%
--- ----- ----- --- ----- ----- --- ----- -----
Total Over 30 Days.............. 25.5% -- 25.5 % 6.4% 8.6% 6.6% 5.3% 1.6% 4.2%
========== ===== ===== ========== ===== ===== ========== ===== =====
</TABLE>
<TABLE>
<CAPTION>
AS OF MARCH 31,
-------------------------------------------------------------------------------------
1995 1996
----------------------------------------- -----------------------------------------
COMPANY SECURITIZED THIRD COMPANY SECURITIZED THIRD
DEALERSHIPS PORTFOLIO PARTY TOTAL DEALERSHIPS PORTFOLIO PARTY TOTAL
----------- ----------- ----- ----- ----------- ----------- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
31 Days to 60 Days................ 3.6% -- 2.8% 3.5% 2.6% 2.9% 0.9% 2.1%
Over 60 Days...................... 2.0% -- 3.0% 2.1% 1.1% 0.6% 0.1% 0.7%
--- --- ----- ----- --- --- ----- -----
Total Over 30 Days................ 5.6% -- 5.8% 5.6% 3.7% 3.5% 1.0% 2.8%
========== ========== ===== ===== ========== ========== ===== =====
</TABLE>
The Company's improved delinquency experience on its Company Dealership
contract portfolio is attributable to the factors discussed above. See
"-- Allowance for Credit Losses -- Static Pool Analysis." The Company attributes
the improved delinquency experience of its Third Party Dealer contract portfolio
to the increased quality of the contracts it purchases from Third Party Dealers.
Because its Third Party Dealer contract portfolio is relatively unseasoned, the
Company expects delinquencies in this portfolio to increase in the aggregate,
reflecting the fact that delinquencies occur throughout the term of a contract.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support increases in its contract
portfolio, expansion of Company Dealerships and Branch Offices, the purchase of
inventories, the purchase of property and equipment, and for working capital and
general corporate purposes. The funding sources available to the Company include
operating cash flow and supplemental borrowings.
The Company's Net Cash Provided by Operating Activities decreased by 10.5%
from $3.8 million in 1993 to $3.4 million in 1994, and then increased by 85.3%
to $6.3 million in 1995. The decrease from 1993 to 1994 was primarily
attributable to significant increases in inventory in connection with the
Company's opening of
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<PAGE> 32
four new Company Dealerships, while the increase from 1994 to 1995 was primarily
due to increases in accrued expenses and other long-term liabilities. The Net
Cash Used in Investing Activities increased by 291.4% from $9.3 million in 1993
to $36.4 million in 1995. The principal uses in 1995 were $33.2 million for the
increase in the contract portfolio and $3.2 million for purchase of property and
equipment.
The Company's Net Cash Provided by Operating Activities increased by 54.5%
from $3.3 million for the three months ended March 31, 1995 to $5.1 million for
the three months ended March 31, 1996. The increase was primarily due to
increases in net earnings, Provision for Credit Losses and accrued expenses, and
other long-term liabilities offset by a reduction in prepaid expenses. The Net
Cash Used in Investing Activities decreased by 30.3% from $6.6 million in the
three months ended March 31, 1995 to $4.6 million in the three months ended
March 31, 1996. The principal uses in 1996 were $10.8 million for the increase
in the contract portfolio and the $2.6 million increase in the residual in
finance receivables offset by $10.0 million provided by the sale of finance
receivables.
The Company's Net Cash Provided by Financing Activities in 1995 was $31.3
million, the primary sources of which were the Revolving Facility with GE
Capital, subordinated debt from Verde Investments, and a convertible note issued
to SunAmerica. The Company's Net Cash Used in Financing Activities for the three
months ended March 31, 1996 was $1.3 million, the primary uses of which were pay
down of the Revolving Facility of $362,000, repayments on subordinated debt of
$552,000, and a dividend on the Preferred Stock of $300,000.
Revolving Facility. The Revolving Facility with GE Capital has a maximum
commitment of up to $50.0 million. Under the Revolving Facility, the Company may
borrow up to 65.0% of the principal balance of eligible Company Dealership
contracts and up to 90.0% of the principal balance of eligible Third Party
Dealer contracts. The Revolving Facility expires in September 1997, at which
time the Company has the option to renew the Revolving Facility for one
additional year. The facility is secured by substantially all of the Company's
assets. As of March 31, 1996, the Company's borrowing capacity under the
Revolving Facility was approximately $34.2 million, the aggregate principal
amount outstanding under the Revolving Facility was $31.8 million, and the
amount available to be borrowed under the facility was $2.4 million. The
Revolving Facility bears interest at the 30-day LIBOR plus 4.25%, payable daily
(total rate of 9.6% as of March 31, 1996). The Company intends to use all or
substantially all of the net proceeds of this offering to temporarily repay
indebtedness under the Revolving Facility. See "Use of Proceeds."
The Revolving Facility contains covenants that, among other things, limit
the Company's ability to, without GE Capital's consent: (i) incur additional
indebtedness; (ii) engage in securitization transactions; (iii) merge with,
consolidate with, acquire, or otherwise combine with any other person or entity,
transfer any division or segment of its operations to another person or entity,
or form new subsidiaries; (iv) make changes in its capital structure; (v) pay
dividends or make certain other distributions; (vi) make certain investments and
capital expenditures; and (vii) engage in certain transactions with affiliates.
These covenants also require the Company to maintain specified financial ratios
and comply with all laws relating to the Company's business. The Revolving
Facility also provides that a transfer of ownership of the Company's outstanding
voting securities resulting in a change in control in which Mr. Ernest C.
Garcia, II, the Company's majority stockholder, owns less than 51.0% of the
Company will result in an event of default under the Revolving Facility. No
change in control will occur as a result of this offering.
Subordinated Indebtedness and Preferred Stock. The Company has borrowed
substantial amounts from Verde Investments, a company owned by the Company's
Chairman, Chief Executive Officer and majority stockholder. The balances
outstanding to Verde Investments under these arrangements totaled $8.9 million
as of December 31, 1993, $18.3 million as of December 31, 1994, and $14.6
million as of December 31, 1995 ($24.6 million prior to the conversion of $10.0
million to Preferred Stock as discussed below), and $14.0 million as of March
31, 1996. At all times, these borrowings have accrued interest at an annual rate
of 18.0%.
On December 31, 1995, Verde converted $10.0 million of subordinated debt to
Preferred Stock of the Company. The Preferred Stock accrues a dividend of 12.0%
annually, increasing one percent per year up to a maximum of 18.0%. Concurrently
with the closing of the offering, the dividend on the Preferred Stock will be
32
<PAGE> 33
decreased to 10.0% through December 31, 1997, at which time the rate will be
raised to 12.0%. See "Recapitalization and Related Transactions" and
"Description of Capital Stock -- Preferred Stock."
Upon the closing of this offering, the interest rate on the $14.0 million
of subordinated debt payable to Verde Investments will be lowered to 10.0%, and
the Company will be required to make monthly payments of interest and annual
payments of principal in the amount of $2.0 million. This debt will be junior to
all of the Company's other indebtedness. The Company may suspend interest and
principal payments in the event it is in default on obligations to any other
creditors.
Convertible Note. In 1995, the Company entered into a note purchase
agreement with SunAmerica pursuant to which SunAmerica purchased a $3.0 million
convertible subordinated note. The convertible note, which is due June 30, 1998,
bears interest at a rate of 12.5%, payable quarterly, and is secured by a pledge
of the Common Stock of the Company held by the Company's Chairman, Chief
Executive Officer and majority stockholder. The note is convertible into Common
Stock of the Company at the initial public offering price of the Common Stock.
Effective upon the closing of the offering, SunAmerica will exercise its
conversion rights. In return for the conversion, the Company has agreed to grant
SunAmerica a ten-year warrant to purchase 116,000 shares of Common Stock at the
initial public offering price and pay to SunAmerica fees totaling $150,000. See
"Recapitalization and Related Transactions."
Securitizations. SunAmerica and the Company have entered into the
Securitization Program under which SunAmerica may purchase up to $175.0 million
of certificates secured by contracts. The Securitization Program is intended to
provide the Company with an additional source of funding to the Revolving
Facility. At the closing of each securitization, the Company receives payment
from SunAmerica for the certificates sold (net of investments held in trust).
The Company also generates cash flow under this program from ongoing servicing
fees and excess cash flow distributions resulting from the difference between
the payments received from customers on the contracts and the payments paid to
SunAmerica.
Although the Securitization Program had significant up-front expenses which
reduced the Company's gain on sale on the first securitization, management
expects that the ongoing funding costs will be lower than those of the Revolving
Facility. In addition, securitization allows the Company to fix its borrowing
cost for a given contract portfolio, broadens the Company's capital source
alternatives, and provides a higher advance rate than that available under the
Revolving Facility.
Capital Expenditures and Commitments. Pursuant to its growth strategy, the
Company anticipates developing or acquiring five new Company Dealerships and
opening 15 to 20 new Branch Offices over the next two years. The Company
estimates that it will cost an aggregate of approximately $7.5 million to
develop these Company Dealerships and an additional $750,000 to $1.0 million to
establish the Branch Offices. The Company intends to finance these expenditures
through operating cash flows and supplemental borrowings, including under the
Revolving Facility.
SEASONALITY
Historically, the Company has experienced higher revenues in the first two
quarters (particularly in the first quarter) of the year than in the latter half
of the year. The Company believes that these results are due to seasonal buying
patterns resulting in part from the fact that many of its customers receive
income tax refunds during the first half of the year, which are a primary source
of down payments on used car purchases.
INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's borrowings would decrease the profitability of
the Company's existing portfolio. The Company will seek to limit this risk
through its Securitization Program and, to the extent market conditions permit,
for contracts originated at Company Dealerships, either by increasing the
interest rate charged, or the profit margin on, the cars sold, or for contracts
acquired from Third Party Dealers, either by acquiring contracts at a higher
discount or with a higher APR. To date, inflation has not had a significant
impact on the Company's operations.
33
<PAGE> 34
ACCOUNTING MATTERS
Statement of Financial Accounting Standards No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of "
(SFAS No. 121), which the Company will adopt for its fiscal year ending December
31, 1996, will require "that long-lived assets and certain identifiable
intangibles to be held and used by an entity be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable." In the opinion of management, the adoption of SFAS No.
121 will not have any effect on the Company's financial position.
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation," (SFAS No. 123) establishes financial accounting and
reporting standards for stock-based employee compensation plans. These plans
include all arrangements by which employees receive shares of stock or other
equity instruments of the employer or the employer incurs liabilities to
employees in amounts based on the price of the employer's stock. Examples
include stock purchase plans, stock options, restricted stock, and stock
appreciation rights. SFAS No. 123 also applies to transactions in which an
entity issues its equity instruments to acquire goods or services from
nonemployees. These transactions must be accounted for, or at least disclosed in
the case of stock options, based on the fair value of the consideration received
or the equity instruments issued, whichever is the more reliable measure. The
Company will adopt the disclosure requirements of SFAS No. 123 for its fiscal
year ending December 31, 1996.
34
<PAGE> 35
BUSINESS
GENERAL
Ugly Duckling Corporation (the "Company") is a fully integrated used car
sales and finance company that operates the largest chain of Buy Here-Pay Here
used car dealerships in Arizona. As part of its activities, the Company
underwrites, finances and services installment contracts generated by its
dealerships and by third party used car dealerships located in selected markets
throughout the United States. The Company targets Sub-Prime Borrowers who have
limited credit histories, low incomes, or past credit problems.
The rapidly growing used car sales and finance industry achieved record
sales in 1995 of 30.5 million units, representing approximately $290.0 billion
in sales. During this same period, more than $185.0 billion in retail
installment contracts were originated through the sale of used cars. Of this
amount, approximately 11.0 million units were sold to Sub-Prime Borrowers,
generating approximately $50.0 billion in retail installment contracts.
Consistent with the industry's growth, the Company has expanded
significantly in recent periods. From 1994 to 1995, total revenues increased by
72.2% from $33.8 million to $58.2 million. Reflecting development of its
infrastructure and expansion of its operations, the Company incurred losses of
approximately $2.0 million and $4.0 million for these periods, respectively.
During the three months ended March 31, 1996, the Company's net earnings
before preferred stock dividends were approximately $1.1 million. The Company's
first quarter of each year has historically been one of its most profitable and
may not necessarily be indicative of results to be expected for the rest of the
year. The Company's total revenues for the first quarter of 1996 were $19.4
million, including $15.1 million on the sale of more than 2,000 used cars, and
$3.6 million in finance income. Revenues also included a gain of approximately
$540,000 on the sale of contracts pursuant to a newly instituted securitization
program. In addition, the Company purchased more than 1,200 contracts from Third
Party Dealers with an aggregate principal balance of $7.2 million during the
quarter. The combined principal balance of the Company's dealership and third
party dealer contract portfolios as of March 31, 1996 was $46.3 million.
OVERVIEW OF USED CAR SALES AND FINANCE INDUSTRY
Used Car Sales. Used car retail sales typically occur through franchised
new car dealerships that sell used cars or independent used car dealerships. The
market for used car sales in the United States is significant and has steadily
increased over the past five years. The Company believes that the factors that
have led to growth in this industry include substantial increases in new car
prices, which have made vehicles less affordable to the average consumer
relative to used cars, the greater reliability and durability of used cars
resulting from the production of higher quality cars, and the increasing number
of vehicles coming off-lease in recent years. Many analysts expect these trends
to continue, leading to further expansion of the used car sales market.
The used car sales industry is highly fragmented and, traditionally, sales
to customers have occurred through franchised and independent dealerships owned
by individuals, families, and small groups. According to industry sources, there
are over 23,000 franchised and 63,000 independent used car dealership locations
in the United States. Used car sales from franchised dealerships (or affiliated
used-only car lots) accounted for approximately 61.3% of these sales, with the
remaining 38.7% resulting from sales by independent dealerships. Approximately
675 independent used car dealerships are located in Arizona.
The Company participates in the sub-prime segment of the independent used
car sales and finance market. This segment is serviced primarily by Buy Here-Pay
Here dealers that sell and finance sales of used cars to Sub-Prime Borrowers.
Buy Here-Pay Here dealers typically offer their customers certain advantages
over more traditional financing sources, such as expanded credit opportunities,
flexible payment terms (including prorating customer payments due within one
month into several smaller payments and scheduling
35
<PAGE> 36
payments to coincide with a customer's pay days), and the ability to make
payments in person, an important feature to many Sub-Prime Borrowers who may not
have checking accounts or are otherwise unable to make payments by the due date
through use of the mail because of the timing of paychecks.
Recently, the growth of the used car sales and finance market has attracted
significant attention from a number of large companies, including Circuit City's
CarMax, AutoNation, U.S.A., Driver's Mart, and CarChoice, which have entered the
used car sales business or announced plans to develop large used car sales
operations. The Company believes that these companies are attracted by the
relatively high gross margins that can be earned in this business and the lack
of consolidation in this market. None of these companies have indicated an
intention to focus on the Buy Here-Pay Here segment.
Used Car Financing. The automobile financing industry is the third-largest
consumer finance market in the country, after mortgage debt and credit card
revolving debt, with more than $350.0 billion in contracts on new and used cars
originated in 1995. The sub-prime segment of this industry accounted for
approximately $50.0 billion of the overall market. Growth in automobile
financing has been fueled by the increasing prices of both new and used cars,
which has forced greater numbers of purchasers to seek financing when purchasing
a car. This industry is served by such traditional lending sources as banks,
savings and loans, and captive finance subsidiaries of automobile manufacturers,
as well as by independent finance companies and Buy Here-Pay Here dealers. In
general, the industry is categorized according to the type of car sold (new
versus used) and the credit characteristics of the borrower. With respect to the
borrowers, finance companies classify such individuals according to the
following generalized criteria:
- An "A" credit or "prime" borrower is a person who has a long credit
history with no defaults, has been employed in the same job for a period
of at least 18 months, and can easily finance a new car purchase through
a bank, a captive finance subsidiary of an automobile manufacturer, or an
independent finance company.
- A "B" credit or "non-prime" borrower is a person who has a substantial
credit history that includes late payments, an inconsistent employment
history, or significant or unresolved problems with credit in the past.
To finance a used car purchase, this borrower will generally not be able
to obtain a loan from a captive finance subsidiary or a bank, and will
have to obtain financing from an independent finance company that lends
into this market category.
- A "C" credit or "sub-prime" borrower generally has little or no credit
history or a credit history characterized by consistently late payments
and sporadic employment. Like "B" credit borrowers, "C" credit borrowers
generally are not able to obtain a loan from a captive finance subsidiary
or a bank, and have to obtain financing from an independent finance
company that lends into this market category.
- A "D" credit borrower is also referred to as a "sub-prime" borrower.
These persons, however, in addition to having an unfavorable employment
history, have also experienced debt charge offs, foreclosures, or
personal bankruptcy. In purchasing a car, this borrower's only choice is
to obtain financing from an independent finance company or Buy Here-Pay
Here lot.
As with its sales operations, the Company's finance operations are directed
to the sub-prime segment of the market. In particular, the finance operations of
Company Dealerships are directed toward Sub-Prime Borrowers classified in the
"C" and "D" categories, while its Third Party Dealer finance operations are
generally directed to "C" credit borrowers. Despite significant opportunities,
many of the traditional lending sources do not consistently provide financing to
the sub-prime consumer finance market. The Company believes traditional lenders
avoid this market because of its high credit risk and the associated collection
efforts.
The industry statistical information presented herein is derived from
information provided to the Company by CNW Marketing/Research of Bandon, Oregon.
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BUSINESS STRATEGY
The Company's primary objective is to increase income from its used car
sales and financing operations through the application of a comprehensive
business strategy combining various operating, marketing, and growth objectives.
Company Dealership Operations. The Company distinguishes its direct sales
and financing operations from typical Buy Here-Pay Here dealers by providing
multiple locations, upgraded facilities, large inventories of used automobiles,
centralized purchasing, value-added marketing programs, and dedication to
customer service. In addition, the Company has developed flexible underwriting
guidelines and techniques, which combine established underwriting criteria with
managerial discretion, to facilitate rapid credit decisions, as well as an
integrated, technology-based corporate infrastructure that enables the Company
to monitor and service large volumes of contracts. See "-- Company Dealership
Operations."
Company Dealership Marketing Strategy. The Company has designed and
implemented a marketing program that promotes its image as a professional, yet
approachable, operation, in contrast to the generally unfavorable public image
of typical Buy Here-Pay Here dealers. The Company's advertising employs its
widely recognized duck mascot and logo in television, radio, and billboard
advertisements and features its multiple locations, wide selection of quality
used cars, and ability to finance most Sub-Prime Borrowers. The Company has also
implemented innovative marketing programs that are designed to attract Sub-Prime
Borrowers by assisting them in reestablishing their credit, offering incentives
for timely payment on contracts, and promoting customer loyalty. The Company
believes that these programs have enabled it to create brand name awareness in
its target market. See "-- Company Dealership Operations -- Advertising and
Marketing."
Third Party Operations. The Company has leveraged the contract servicing
experience and capabilities it acquired through its Company Dealership
activities by purchasing and servicing contracts originated by Third Party
Dealers. The Company hires experienced branch managers having existing
relationships with Third Party Dealers. The Company's branch managers have an
average of approximately 12 years of experience in the sub-prime automobile
finance industry. The Company also continually evaluates expansion into
additional geographic areas with Third Party Dealers whose contracts meet the
Company's underwriting standards. The Company expects that contracts purchased
from Third Party Dealers will make up an increasingly greater percentage of its
total contract portfolio. See "-- Third Party Dealer Operations."
Growth Strategy. Since commencing its used car sales and financing
operations in 1992, the Company has pursued an aggressive growth strategy
through both internal development and acquisition. As of June 15, 1996, the
Company had developed or acquired seven Company Dealerships (excluding two
others which it has subsequently closed) and, since 1994, had opened fourteen
Branch Offices (five in Arizona, two each in Colorado, Indiana, and Texas, and
one each in Florida, Nevada, and New Mexico.). These Branch Offices service the
more than 300 Third Party Dealers with whom the Company currently has dealer
agreements. The Company intends to leverage its management team, collection
facilities, and computer networks and proprietary software to grow its Company
Dealership and Third Party Dealer activities, both in Arizona and in other
geographic locales. Over the next two years, the Company anticipates developing
or acquiring approximately five additional Company Dealerships and opening 15 to
20 additional Branch Offices in various states, and also expects to add up to
300 Third Party Dealers to its dealer network. See "-- Expansion Plans and
Acquisition Opportunities."
COMPANY DEALERSHIP OPERATIONS
Company Dealership operations include the retail sale of used cars and the
underwriting, financing, and servicing of contracts originated from such sales.
The Company's total revenues from its Company Dealership operations were $15.6
million, $32.5 million, and $56.1 million ($46.6 million excluding sales at the
Gilbert Dealership) for fiscal years 1993, 1994, and 1995, respectively. See
"Selected Consolidated Financial Data."
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<PAGE> 38
Retail Car Sales. The Company operates a chain of seven used car
dealerships serving the Phoenix and Tucson, Arizona metropolitan areas. The
Company distinguishes its direct sales and financing operations from those of
typical Buy Here-Pay Here dealers through its network of multiple locations,
upgraded facilities, large inventories of used cars, centralized purchasing,
value-added marketing programs, and dedication to customer service. All Company
Dealerships are located in high visibility, high traffic commercial areas, and
generally are newer and cleaner in appearance than other Buy Here-Pay Here
dealers, which helps promote the Company's image as a friendly and reputable
business. The Company believes that these factors, coupled with its widespread
brand name recognition (achieved through extensive promotion of its duck mascot
and logo), enable it to attract customers who might otherwise visit another Buy
Here-Pay Here dealer.
Each Company Dealership generally maintains an extensive inventory of 100
to 300 used cars and features a broad selection of makes and models (with ages
generally ranging from 5 to 10 years) and a range of sale prices, all of which
enables the Company to meet the tastes and budgets of a broad range of potential
customers. The Company acquires its inventory from new or late-model used car
dealers, used car wholesalers, used car auctions, and customer trade-ins, as
well as from repossessions. The Company's size enables it to cut inventory costs
by making volume purchases for all Company Dealerships. In making its purchases,
the Company takes into account each car's retail value and the costs of buying,
reconditioning, and delivering the car for resale. After purchase, cars are
delivered to the individual dealerships, where they are inspected and
reconditioned for sale. Although the prices of used cars are subject to market
variance, the Company does not believe that it will encounter significant
difficulty in maintaining its current inventory levels.
The average sales price per car at Company Dealerships was $7,117 for the
three months ended March 31, 1996, and $6,065 for the fiscal year ended December
31, 1995 (exclusive of sales at the Company's Gilbert Dealership). Customer down
payments during these periods approximated 10.0% to 15.0% of the purchase price.
The Company typically finances the balance of the purchase price at a fixed
interest rate of 29.9% over periods ranging from 12 to 36 months. Company
Dealerships use a standardized sales contract. The Company sells cars on an "as
is" basis, and requires its customers to sign an agreement at the date of sale
releasing the Company from any obligation with respect to vehicle-related
problems that subsequently occur. See "-- Legal Proceedings."
Used Car Financing. The Company finances sales by Company Dealerships
through retail installment contracts which the Company services. Subject to the
discretion of its sales managers, potential customers must meet the Company's
underwriting guidelines, referred to as minimum deal standards, before the
Company will agree to finance the purchase of a car. The Company created these
minimum deal standards to control its exposure to credit risk while providing
its sales managers with sufficient flexibility to consummate sales when
appropriate. In connection with each sale, customers are required to complete a
credit application. Company personnel analyze and verify the application, which
contains employment and residence histories, income information, and references,
as well as the customer's personal cash flow statement (taking into account the
completion of the sale), credit bureau reports, and other information regarding
the customer's credit history.
The Company's credit underwriting process takes into account the ability of
its managers and other sales employees, who have extensive experience, to make
sound judgments regarding the extension of credit to Sub-Prime Borrowers and to
personalize financing terms to meet the needs of individual customers. For
example, contract payments may be scheduled to coincide with the customer's pay
days, whether weekly, biweekly, semi-monthly, or monthly. In addition, each
manager makes credit approvals only after a "face-to-face" interview with the
potential customer in which the manager gains firsthand information regarding
the customer's financial situation, sources of income, and past credit problems.
The Company believes that its customers value the expanded credit opportunities
that such flexibility provides and, consequently, will pay a higher price for
their cars. The Company believes that the higher prices it charges are necessary
to fund the high rate of credit losses incurred as a result of financing
Sub-Prime Borrowers. To the extent the Company were unable to charge such higher
prices or otherwise obtain acceptable margins, its results of operations would
be adversely affected.
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<PAGE> 39
Subsequent to each sale, all finance transactions are "audited" by the
Company's corporate staff and reviewed for compliance with minimum deal
standards. To the extent such audits reveal non-compliance with minimum deal
standards, such non-compliance is discussed with dealership management and,
where appropriate, remedial action against the responsible manager, ranging from
oral or written reprimands to termination, is taken.
The Company's use of wide area and local area networks, which feature its
proprietary software, enables it to service large volumes of contracts from its
centralized servicing facilities while allowing the customer the flexibility to
make payments at and otherwise deal with the individual dealerships. In
addition, the Company has developed comprehensive databases and sophisticated
management tools, including static pool analysis, to analyze customer payment
history and contract performance and to monitor underwriting effectiveness.
The Company reserves a percentage of the principal balance of each contract
originated by a Company Dealership for future credit losses, recording this
amount as a direct charge to expense through its Provision for Credit Losses,
which increases the Allowance for Credit Losses. The size of this Allowance,
which as of March 31, 1996 averaged 23.0% of the total outstanding principal
balance of all contracts originated by Company Dealerships, reflects the credit
risk presented by the customers of Company Dealerships, the relatively low
wholesale value of the cars securing the contracts, and the generally high
margins earned by Company Dealerships on sales of used cars. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Results of Operations -- Provision for Credit Losses" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Allowance for Credit Losses."
At December 31, 1994 and 1995, the Company was servicing approximately
$19.9 million and $34.2 million, respectively, in contracts originated by
Company Dealerships.
Advertising and Marketing. The Company believes that it maintains the
largest advertising budget of any single independent dealer in Arizona. In
general, the Company's advertising campaigns emphasize its multiple locations,
wide selection of quality used cars, and ability to provide financing to most
Sub-Prime Borrowers. The Company's advertising campaign revolves around a series
of television commercials that feature the Company's animated duck mascot, as
well as complementary radio, billboard, and print advertisements. The Company
believes that its marketing approach creates brand name recognition and promotes
its image as a professional, yet approachable, business, in contrast to the lack
of name recognition and generally unfavorable public image of many Buy Here-Pay
Here dealers. The Company believes that its advertising has helped establish it
as the most widely recognized Buy Here-Pay Here dealership network in Arizona.
A primary focus of the Company's marketing strategy is its ability to
finance consumers with poor credit histories. Under the slogan "Ugly Duckling
Car Sales -- Putting You on the Road to Good Credit," the Company has initiated
innovative marketing programs designed to attract Sub-Prime Borrowers, assist
such customers in reestablishing their credit, reward those customers who pay on
time, develop customer loyalty, and increase referral and repeat business. Among
these programs are:
- The Down Payment Back Program. This program encourages customers to make
timely payments on their contracts by enabling them to receive a refund
of their initial down payment (typically representing 10%-15% of the
initial purchase price of the car) at the end of the contract term if all
(or, in some cases, substantially all) payments have been made by the
scheduled due date.
- The Income Tax Refund Program. During the first quarter of each year,
the Company offers assistance to customers in the preparation of their
income tax returns, including forwarding customers' tax information to a
designated preparer, paying the preparation fee, and, if there is a
forthcoming tax refund, crediting such refund toward the required down
payment. This program enables customers to purchase cars without having
to wait to receive their income tax refund.
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<PAGE> 40
- Secured $250 Visa Card Program. The Company has implemented a program
pursuant to which the Company arranges for qualified applicants to obtain
a Visa credit card secured by a $250 deposit paid by the Company to the
credit card company. This program offers otherwise unqualified customers
the chance to obtain the convenience of a credit card and rebuild their
credit records.
The Company also utilizes various telemarketing programs. For example,
potential customers are contacted within several days of their visit to a
Company Dealership to follow up on leads and obtain information regarding their
experience while at a Company Dealership. In addition, customers with
satisfactory payment histories are contacted several months before contract
maturity and are offered an opportunity to purchase another vehicle with a
nominal down payment requirement. The Company also maintains a loan-by-phone
program utilizing its toll-free telephone number of 1-800-THE-DUCK.
Sales Personnel and Compensation. Each Company Dealership is run by a
general manager who has complete responsibility for the operations of the
dealership facility, including final approval of sales and contract
originations, inventory maintenance, the appearance and condition of the
facility, and the hiring, training, and performance of Company Dealership
employees. In addition to the general manager, the Company typically staffs each
dealership with, among others, up to three sales managers, an office manager, a
lot supervisor, five to twelve salespersons, and several mechanics.
The Company trains its managers to be contract underwriters. The Company
pays its managers a base salary and allows them to earn bonuses based upon a
variety of factors, including the overall performance of the contract portfolio
originated. Although sales persons are paid on commission, each sale must be
underwritten and approved by a manager. By giving its managers a strong
incentive to underwrite quality contracts, the Company believes that it can
maintain its current level of credit losses while continuing to achieve
significant growth in sales revenue.
THIRD PARTY DEALER OPERATIONS
In 1994, the Company acquired Champion Financial Services, Inc., an
independent automobile finance company, primarily for its management expertise
and contract servicing software and systems. Champion had a portfolio of
approximately $1.9 million in sub-prime contracts averaging approximately $2,000
in principal amount. For the balance of 1994, the Company purchased an
additional $1.7 million in contracts.
In April 1995, the Company initiated an aggressive plan for purchasing
contracts from Third Party Dealers and by June 15, 1996 had opened fourteen
Branch Offices serving over 300 Third Party Dealers. The Company has hired
experienced branch managers having existing relationships with Third Party
Dealers and opened Branch Offices near its Third Party Dealers to better service
their needs. The Company services the Third Party Dealer contract portfolio from
its centralized collection and servicing centers. The expansion of its Third
Party Dealer network enabled the Company to leverage its existing infrastructure
and increase its contract portfolio much more quickly than it could through the
planned expansion of its Company Dealerships. The Company was also able to
increase the socioeconomic and geographic diversity of its contract portfolio by
purchasing higher quality contracts and contracts from areas where there are no
Company Dealerships.
The Company generally purchases contracts originated with customers that
are superior in quality to those of Company Dealerships (i.e., customers who are
"C" rated or higher). Consequently, its Third Party Dealer contracts generally
present a reduced credit and collateral risk. The Company's total revenues from
its Third Party Dealer operations were $700,000 and $1.8 million in fiscal years
1994 and 1995, respectively, and $1.1 million for the three months ended March
31, 1996. See "Selected Consolidated Financial Data."
Third Party Dealer Financing. The Company purchases contracts from Third
Party Dealers at a nonrefundable acquisition discount from the principal amount
of the contract that generally ranges from 5.0% to 20.0%, and averages
approximately 10.0%. The Company allocates the discount to the Allowance for
Credit Losses, which enables the Company to establish such Allowance without
having to record a Provision for Credit Losses. The Company determines the
appropriate discount needed on a contract-by-contract basis,
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taking into account, among other things, the principal amount of the contract in
relation to the wholesale value of the underlying car and the credit risk
presented by the particular customer. The Company generally will not purchase a
contract from a Third Party Dealer if the discounted price exceeds 120.0% of the
Kelly Blue Book wholesale value of the underlying car plus license and tax,
although it will make exceptions on a contract-by-contract basis. If the Company
cannot negotiate an appropriate discount, it will not purchase the contract.
At December 31, 1994 and 1995, and March 31, 1996, the Company owned and
serviced $1.6 million, $13.8 million, and $18.5 million in contracts,
respectively, that were originated by Third Party Dealers. As of March 31, 1996,
the Company had entered into dealer agreements with more than 300 Third Party
Dealers as compared to approximately 20 at December 31, 1994.
Branch Offices. As of June 15, 1996, the Company had established fourteen
Branch Offices in seven states for the purpose of identifying, and purchasing
contracts from, Third Party Dealers interested in affiliating with the Company.
In opening a new office, the Company hires experienced branch managers having
existing relationships with Third Party Dealers. The Company's branch managers
have an average of approximately 12 years of experience in the sub-prime
automobile finance industry. Upon the execution of a dealer agreement with a
Third Party Dealer, Branch Office employees will introduce the dealer to the
Company's systems and procedures. The Company provides uniform contract buying
criteria as well as expedient application processing and funding. The Company
expects its Branch Office employees to develop and maintain excellent
relationships with its Third Party Dealers.
Branch Office employees monitor and evaluate Third Party Dealer contracts
for conformity to established policies and procedures. Selected finance
transactions are examined each month and a written report on each Branch Office
is prepared. Included in the report is an evaluation of Branch Office decisions
and practices as well as the portfolio performance of individual Third Party
Dealers. Branch Office management is notified and counseled with respect to
variances from minimum deal standards that are found. Branch Office management
monitors the first six months of contract performance. Substandard contract
performance during this period is discussed with the Third Party Dealers.
COMPARISON OF CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS AND THIRD PARTY
DEALERS
The chart below compares the characteristics of the average contract
originated by Company Dealerships and purchased from Third Party Dealers in
December 1995:
<TABLE>
<CAPTION>
COMPANY THIRD PARTY
------- -----------
<S> <C> <C>
Principal amount of contract................................... $ 6,260 $ 6,035
Annual percentage rate......................................... 29.7% 25.5%
Loan term (months)............................................. 35.9 34.8
Total down payment............................................. $ 851 $ 1,495
Company cost or Third Party Dealer advance..................... $ 2,853 $ 5,470
Blue book value................................................ $ 3,302 $ 5,185
Model year..................................................... 1987 1989
Age of borrower................................................ 35 35
Annual income.................................................. $24,165 $31,545
Years at current residence..................................... 5.2 3.3
Years at current job........................................... 3.6 3.1
</TABLE>
The Company expects that approximately 35.0% to 40.0% of Company Dealership
contracts will ultimately default at some time prior to maturity. The aggregate
principal balances of all Company Dealership contracts charged-off is estimated
to be 30.0% of the original principal amount financed. Recoveries on the Company
Dealership portfolio are expected to average approximately 33.0% of the
principal balance charged-off, for a net loss of approximately 20.0% of the
original principal amount financed. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Allowance for Credit Losses --
Static Pool Analysis."
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The Company expects that approximately 25.0% of Third Party Dealer
contracts will ultimately default at some time prior to maturity. The aggregate
principal balances of all Third Party Dealer contracts charged-off is estimated
to be 20.0% of the original principal amount financed. Recoveries on the Third
Party Dealer portfolio are expected to average approximately 50.0% of the
principal balance charged-off, for a net loss of approximately 10.0% of the
original principal amount financed, which is the amount of the average
acquisition discount included in the Company's Allowance for Credit Losses. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Allowance for Credit Losses -- Static Pool Analysis."
MONITORING AND COLLECTIONS
The Company believes that its ability to minimize credit losses is due in
great part to its sophisticated monitoring and collection systems which are used
with respect to contracts originated by Company Dealerships and those purchased
from Third Party Dealers.
Upon the origination or purchase of a contract, Company personnel enter all
terms of the contract into the Company's centralized computer system. The
Company's monitoring and collections staff then utilizes the Company's
proprietary collections software to monitor the performance of all of the
contracts.
Unlike most other used car dealerships with multiple locations or
automobile finance companies, the Company permits its customers to make cash
payments on their contracts in person at Company Dealerships or at the Company's
collection facilities. Historically, cash payments account for over 40.0% of
monthly contract receipts on the Company Dealership portfolio. The Company's
computer technology enables it to process these payments on-line in real time
and its internal procedures enable it to verify that cash receipts are deposited
and credited to the appropriate accounts.
The collections software provides the Company with, among other things,
up-to-date activity reports, allowing immediate identification of customers
whose accounts have become past due. In accordance with Company policy,
collections personnel contact a customer with a past due account within three
days of delinquency (or in the case of first payment delinquencies, within one
day) to inquire as to the reasons for such delinquency and to suggest ways in
which the customer can resolve the underlying problem, thereby enabling the
customer to continue making payments and keep the car. The Company's early
detection of a customer's delinquent status, as well as its commitment to
working with its customers, allows it to identify and address payment problems
quickly, thereby reducing the chance of credit loss. The successful results of
this program are evidenced by the steady decline over the past several quarters
in the average percentage of the Company's contracts that are delinquent. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Allowance for Credit Losses -- Delinquencies."
If the Company's efforts to work with a customer are unsuccessful and the
customer becomes seriously delinquent, the Company will take the necessary steps
to protect its collateral. Frequently, delinquent customers will recognize their
inability to honor their contractual obligations and will work with the Company
to coordinate a "voluntary repossession" of the car. For cases involving
uncooperative customers, the Company retains independent firms to repossess the
cars pursuant to prescribed legal procedures. Upon repossession and after a
statutorily-mandated waiting period, the Company will recondition the car, if
necessary, and sell it in the wholesale market or at retail through its Company
Dealerships. The Company's statistics indicate that it recovers over 80.0% of
the cars that it attempts to repossess, and that of these, approximately
two-thirds are sold on a wholesale basis and the rest are sold through Company
Dealerships. The Company's access to a retail outlet for its repossessed
collateral lessens its credit losses and provides the Company with additional
flexibility with respect to the disposal of the collateral. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Net
Charge Offs."
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EXPANSION PLANS AND ACQUISITION OPPORTUNITIES
The Company's business strategy calls for aggressive growth in both its
Company Dealership and Third Party Dealer operations. Consistent with its
historical practice, the Company intends to expand its operations through a
combination of internal development and acquisitions. The Company anticipates
that, over the next two years, it will develop or acquire approximately five
Company Dealerships. The Company is in the process of opening a Company
Dealership in Prescott, Arizona and other locations under consideration include
Albuquerque, New Mexico, and Las Vegas, Nevada. The Company also intends to open
15 to 20 Branch Offices during that period and significantly increase the number
of Third Party Dealers under contract.
The Company also intends to explore acquisition opportunities. Because the
used car sales and financing market is highly fragmented, participants with
access to sufficient funding have an opportunity to act as market consolidators.
The Company believes its current management team, monitoring and collection
operations, and corporate infrastructure are capable of supporting substantially
larger operations. In addition, the Company believes that, with the improved
capital base and access to capital resulting from this offering, it will have
greater access to the financing required for its growth. With respect to Company
Dealership operations, the Company intends to explore the acquisition of both
single dealership locations and multiple dealership networks. In its Third Party
Dealer operations, the Company reviews opportunities to acquire contract
portfolios and independent finance companies.
COMPETITION
Although the used car industry has historically been highly fragmented, it
has attracted significant attention recently from a number of large companies,
including Circuit City's CarMax, AutoNation, U.S.A., Driver's Mart, and
CarChoice, which have entered the used car sales business or announced plans to
develop large used car sales operations. Many franchised automobile dealers have
increased their focus on the used car market as well. The Company believes that
these companies are attracted by the relatively high gross margins that can be
achieved in this market as well as the industry's lack of consolidation. Many of
these companies and franchised dealers have significantly greater financial,
marketing, and other resources than the Company.
The Company's targeted competition for its Company Dealerships are the
numerous independent Buy Here-Pay Here dealers that sell and finance sales of
used cars to Sub-Prime Borrowers. The Company distinguishes its direct sales and
financing operations from those of typical Buy Here-Pay Here dealers by
providing multiple locations, upgraded facilities, large inventories of used
automobiles, centralized purchasing, value-added marketing programs, and
dedication to customer service. In addition, the Company has developed flexible
underwriting guidelines and techniques to facilitate rapid credit decisions, as
well as an integrated, technology-based corporate infrastructure that enables
the Company to monitor and service large volumes of contracts. The Company
believes that it is the largest Buy Here-Pay Here dealer in Arizona. Of the
numerous large companies that have entered the used car business, none have
announced an intention to focus on the Buy Here-Pay Here segment.
The sub-prime segment of the used car financing business is also highly
fragmented and very competitive. In recent periods, several consumer finance
companies have completed public offerings in order to raise the capital
necessary to fund expansion and support increased purchases of used car retail
installment contracts. These companies have increased the competition for the
purchase of contracts, in many cases purchasing contracts at prices which the
Company believes are not commensurate with the associated risk. In addition,
there are numerous financial services companies serving, or capable of serving,
this market. While traditional financial institutions, such as commercial banks,
savings and loans, credit unions, and captive finance companies of major
automobile manufacturers, have not consistently serviced Sub-Prime Borrowers,
the high rates of return earned by companies involved in sub-prime financing
have encouraged certain of these traditional institutions to enter, or
contemplate entering, this market. Increased competition may cause downward
pressure on the interest rate the Company charges on contracts originated by its
Company Dealerships or cause the Company to reduce or eliminate the
nonrefundable acquisition discount on the
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contracts it purchases from Third Party Dealers. Such events would have a
material adverse affect on the Company's profitability.
REGULATION, SUPERVISION, AND LICENSING
The Company's operations are subject to ongoing regulation, supervision,
and licensing under various federal, state, and local statutes, ordinances, and
regulations. Among other things, these laws require that the Company obtain and
maintain certain licenses and qualifications, limit or prescribe terms of the
contracts that the Company originates and/or purchases, require specified
disclosures to customers, limit the Company's right to repossess and sell
collateral, and prohibit the Company from discriminating against certain
customers. The Company is also subject to federal and state franchising and
insurance laws.
The Company typically charges a fixed interest rate of 29.9% on the
contracts originated at Company Dealerships while rates range from 21.0% to
29.9% on the Third Party Dealer contracts it purchases. Currently, all of the
Company's used car sales activities are conducted in, and a majority of the
contracts the Company services are originated in, Arizona, which does not impose
limits on the rate that a lender may charge. The Company has expanded, and will
continue to expand, its operations into states that impose usury limits. The
Company currently operates in Indiana and Colorado, each of which impose
interest rate limits of 21.0%. The Company attempts to mitigate these rate
restrictions by purchasing contracts originated in these states at a higher
discount.
The Company believes that it is currently in substantial compliance with
all applicable federal, state, and local laws and regulations. There can be no
assurance, however, that the Company will be able to remain in compliance with
such laws, and such failure could have a material adverse effect on the
operations of the Company. In addition, the adoption of additional statutes and
regulations, changes in the interpretation of existing statutes and regulations,
or the Company's entrance into jurisdictions with more stringent regulatory
requirements could have a material adverse effect on the Company's business.
TRADEMARKS AND PROPRIETARY RIGHTS
The Company has obtained federal trademark registrations on its duck mascot
and logo, as well as the trade names "Ugly Duckling Car Sales," "Ugly Duckling
Rent-A-Car," and "America's Second Car." These registrations are effective
though 2002 and are renewable for additional terms of ten years. The Company
grants its Ugly Duckling Rent-a-Car franchisees the limited right to use its
duck mascot and logo in their used rental car operations. The Company has
applied for a federal trademark registration for the slogan "Putting You On the
Road to Good Credit," although there can be no assurances that such registration
will be obtained.
The Company licenses software from various third parties. It has also
developed and copyrighted customized software to facilitate its sales and
financing activities. Although the Company believes it takes appropriate
measures to protect its proprietary rights and technology, there can be no
assurance that such efforts will be successful. The Company believes it is in
material compliance with all third party licensing requirements.
EMPLOYEES
At March 31, 1996, the Company employed 425 persons, of which 46 were
employed in the Company's executive and administrative offices, 216 were
employed in its Company Dealership operations, 112 were employed in the
Company's credit and collection activities, and 51 were employed in Third Party
Dealer operations. None of the Company's employees are covered by a collective
bargaining agreement. The Company considers its relations with its employees to
be good.
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<PAGE> 45
PROPERTIES
As of June 15, 1996, the Company leased 29 facilities. The Company's
corporate headquarters are located in approximately 13,300 square feet of leased
space in Phoenix, Arizona. This lease commenced in April 1996 and expires in
August 2001. Of the Company's seven dealerships, six are leased from Verde
Investments and one is leased from an unrelated third party. The principal lease
on this latter facility expires in 1998 and the Company has a five year renewal
option. The Company's other facilities at that date included three monitoring
and collection facilities, two storage lots, one reconditioning facility,
fourteen Branch Offices, and one dealership under development. Rent expense
totaled $1.4 million and $2.4 million for 1994 and 1995, respectively, and
$736,000 for the three months ended March 31, 1996. See "Recapitalization and
Related Transactions" and "Certain Relationships and Related Transactions."
LEGAL PROCEEDINGS
The Company sells its cars on an "as is" basis, and requires all customers
to sign an agreement on the date of sale pursuant to which the Company disclaims
any obligation for vehicle-related problems that subsequently occur. Although
the Company believes that such disclaimers are enforceable under Arizona and
other applicable law, there can be no assurance that they will be upheld in
every instance. Despite obtaining these disclaimers, the Company, in the
ordinary course of business, receives complaints from customers relating to such
vehicle-related problems as well as alleged violations of federal and state
consumer lending or other similar laws and regulations. While most of these
complaints are made directly to the Company or to various consumer protection
organizations, the Company is named occasionally as a defendant in civil suits
filed by customers in state or local courts. There can be no assurance that the
Company will not be a target of similar claims in the future. In the opinion of
the Company, the ultimate disposition of these matters on an individual basis
will not have a material adverse effect on the Company's financial position or
results of operations. However, there can be no assurance in this regard.
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<PAGE> 46
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Information concerning the Company's current directors and executive
officers, and persons nominated to become directors upon the closing of the
offering, is set forth below:
<TABLE>
<CAPTION>
NAME AGE POSITION WITH THE COMPANY
- ------------------------------------------ --- ----------------------------------
<S> <C> <C>
Ernest C. Garcia, II...................... 39 Chairman of the Board and Chief
Executive Officer
Gregory B. Sullivan....................... 38 President and Chief Operating
Officer
Steven P. Johnson......................... 36 Senior Vice President and General
Counsel
Steven T. Darak........................... 48 Senior Vice President and Chief
Financial Officer
Scott A. Allen............................ 40 Vice President -- Sales
Walter T. Vonsh........................... 53 Vice President -- Credit
Donald L. Addink.......................... 46 Vice President -- Senior Analyst
Sheila A. Brandt.......................... 31 Vice President and Chief
Information Officer
Peter R. Fratt............................ 38 Vice President -- Real Estate
Eric J. Splaver........................... 33 Corporate Controller
Robert J. Abrahams........................ 69 Director-Nominee
Christopher D. Jennings................... 42 Director-Nominee
John N. MacDonough........................ 52 Director-Nominee
Arturo R. Moreno.......................... 49 Director-Nominee
Frank P. Willey........................... 42 Director-Nominee
</TABLE>
Ernest C. Garcia, II, has served as the Chairman of the Board and Chief
Executive Officer of the Company since its founding in 1992, and served as
President from 1992 to 1996. In 1990, Mr. Garcia founded Duck Ventures, Inc.,
currently a subsidiary of the Company, to buy the assets of the Ugly Duckling
Rent-a-Car System. Since 1991, Mr. Garcia has served as President of Verde
Investments, a real estate investment corporation that is also an affiliate of
the Company. Prior to 1990, when he founded the Company, Mr. Garcia was involved
in various real estate, securities, and banking ventures. See "Recapitalization
and Related Transactions" and "Certain Relationships and Related Transactions."
Gregory B. Sullivan was appointed President and Chief Operating Officer of
the Company in February 1996 after serving as a consultant to the Company since
1995. Mr. Sullivan formerly served as President and principal stockholder of
National Sports Games, Inc., an amusement game manufacturing company that he
co-founded in 1989 and sold in 1994. Prior to 1989, Mr. Sullivan was involved in
the securities industry and practiced law with a large Arizona firm. He is a
member of the State Bar of Arizona.
Steven P. Johnson has served as the Senior Vice President, Secretary, and
General Counsel of the Company since its founding in 1992. Since 1991, Mr.
Johnson has also served as the General Counsel of Verde Investments, an
affiliate of the Company. Prior to 1991, Mr. Johnson practiced law in Tucson,
Arizona. Mr. Johnson is licensed to practice law in Arizona and Colorado and is
married to the sister of Mr. Garcia.
Steven T. Darak has served as the Senior Vice President and Chief Financial
Officer of the Company since 1995, having joined the Company in 1994 as Vice
President and Chief Financial Officer. From 1989 to 1994, Mr. Darak owned and
operated Champion Financial Services, Inc., a used car finance company that the
Company acquired in early 1994. Prior to 1989, Mr. Darak served in various
positions in the banking industry and in public accounting.
Scott A. Allen has served as the Vice President -- Sales of the Company
since 1994, having joined the Company in 1993 as a general manager of one of the
Company Dealerships. From 1979 until joining the
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<PAGE> 47
Company, Mr. Allen was a principal of Harris Mobile Home Sales, a manufactured
housing sales and finance company.
Walter T. Vonsh has served as the Vice President -- Credit of the Company
since July 1995. Mr. Vonsh joined the Company in March 1995 as the President of
Champion Financial Services, Inc., the Company's Third Party Dealer financing
subsidiary, and also serves as the President of Champion Acceptance Corp. From
1992 to 1995, Mr. Vonsh served as a Regional Director for Mercury Finance Co., a
consumer finance company. Prior to 1992, Mr. Vonsh was President of Gemini
Leasing Corp., an equipment leasing company, and held various positions at other
finance companies.
Donald L. Addink has served as the Vice President -- Senior Analyst of the
Company since 1995 and also serves as the Vice President of Verde Investments.
From 1988 to 1995, Mr. Addink served as Executive Vice President of Pima Capital
Co., a life insurance holding company. Prior to 1988, Mr. Addink served in
various capacities with a variety of insurance companies. Mr. Addink is a Fellow
of the Society of Actuaries and a Member of the American Academy of Actuaries.
Sheila A. Brandt was appointed Vice President and Chief Information Officer
of the Company in May 1996. Prior thereto, Ms. Brandt served as a Research
Scientist for the Center for the Management of Information at the University of
Arizona. From 1992 to 1995, Ms. Brandt received her M.S. and her Ph.D. in
Management Information Systems at the University of Arizona while practicing as
an independent systems consultant. Prior to 1992, Ms. Brandt held various
positions with Andersen Consulting and Eastman Kodak Company.
Peter R. Fratt has served as Vice President -- Real Estate of the Company
since October 1993. From 1989 to 1993, Mr. Fratt was an associate of CB
Commercial Real Estate Services. Prior to that time, Mr. Fratt was involved in
commercial real estate brokerage and investment.
Eric J. Splaver has served as Corporate Controller of the Company since May
1994. From 1985 to 1994, Mr. Splaver worked as a certified public accountant
with KPMG Peat Marwick LLP.
Robert J. Abrahams has been nominated and has agreed to serve as a director
of the Company upon the closing of the offering. Mr. Abrahams has served since
1988 as a consultant to the financing industry, including service as a consult
to the Company from 1994 to 1995. From 1960 to 1988, Mr. Abrahams was an
executive officer of Heller Financial, Inc., a finance company. Prior to joining
Heller Financial, Inc., Mr. Abrahams co-founded Financial Acceptance Company in
1948. During 1995, Mr. Abrahams served as a consultant to the Company. Mr.
Abrahams has agreed to serve as a member of the Audit Committee of the Board of
Directors.
Christopher D. Jennings has been nominated and has agreed to serve as a
director of the Company upon the closing of the offering. Mr. Jennings has
served as a managing director of Cruttenden Roth Incorporated, an investment
banking firm that is the Representative of the several Underwriters of this
offering, since 1995. From 1992 to 1994, Mr. Jennings served as a Managing
Director of investment banking at Sutro & Co., an investment banking firm. From
1989 to 1992, Mr. Jennings served as a Senior Managing Director at Maiden Lane
Associates, Ltd., a private equity fund. Prior to 1989, Mr. Jennings served in
various positions with, among others, Dean Witter Reynolds, Inc. and Warburg
Paribas Becker, Inc., both of which are investment banking firms.
John N. MacDonough has been nominated and has agreed to serve as a director
of the Company upon the closing of the offering. Mr. MacDonough has served as
Chairman and Chief Executive Officer of Miller Brewing Company, a brewer and
marketer of beer, since 1993, having previously served from 1992 to 1993 as
President and Chief Operating Officer. Prior to 1992, Mr. MacDonough was
employed in various positions at Anheuser Busch, Inc., also a brewer and
marketer of beer. Mr. MacDonough is married to the sister of Mr. Sullivan.
Arturo R. Moreno has been nominated and has agreed to serve as a director
of the Company upon the closing of the offering. Mr. Moreno has served as the
President and Chief Executive Officer of Outdoor Systems Advertising, Inc., one
of the largest outdoor media companies in the United States, since 1984. Prior
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<PAGE> 48
to 1984, Mr. Moreno held various executive positions in the outdoor advertising
industry. Mr. Moreno has agreed to serve as a member of the Audit Committee of
the Board of Directors.
Frank P. Willey has been nominated and has agreed to serve as a director of
the Company upon the closing of the offering. Mr. Willey has served as the
President of Fidelity National Financial, Inc., one of the nation's largest
title insurance underwriters, since January 1995. From 1984 to 1995, Mr. Willey
served as the Executive Vice President and General Counsel of Fidelity National
Title. Mr. Willey is also a director of CKE Restaurants, Inc., an operator of
various quick-service restaurant chains, and Southern Pacific Funding
Corporation, a specialty finance company that originates, purchases and sells
high-yielding, non-conforming mortgage loans.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
In March 1987, Mr. Ernest C. Garcia, II, the Company's Chairman, Chief
Executive Officer, and principal stockholder, obtained $20 million in financing
from Lincoln Savings and Loan Association ("Lincoln") to repurchase stock in his
real estate development company held by a corporate investor. Subsequently, Mr.
Garcia agreed to facilitate the purchase of certain land from a Lincoln
subsidiary. The two transactions closed simultaneously. Soon thereafter, Lincoln
was placed into receivership and federal regulators from the RTC and other
government agencies began investigating numerous transactions involving Lincoln
and a variety of third parties, including Mr. Garcia.
Upon being notified of the RTC's investigation, Mr. Garcia met voluntarily
with RTC investigators, without counsel, for several months and provided full
disclosure concerning the details of his dealings with Lincoln. Nearly one year
later, the RTC asserted that the financing transaction and the land transaction,
though documented separately, were linked and that, as a result of the
transaction, Lincoln improperly recorded a gain in violation of certain
accounting rules applicable to Lincoln. As a result, in October 1990, the United
States, on behalf of the RTC, informed Mr. Garcia that it intended to charge him
with bank fraud. Mr. Garcia was never indicted for his role in the transaction,
but, facing severe financial pressures, agreed to plead guilty to one count of
bank fraud.
Prior to his sentencing in 1993, the RTC submitted a letter to the United
States District Court for the Central District of California urging that the
court take favorable account of Mr. Garcia's relative responsibility and
culpability, as well as his timely and honest cooperation, in determining an
appropriate sentence. In this letter, the RTC stated its belief that the chief
executive officer of Lincoln's parent company, Charles H. Keating, Jr., not Mr.
Garcia, devised the transaction and that Mr. Garcia was not even aware of the
existence of Mr. Keating's illegal schemes and had no reason to believe that the
transaction would enable Mr. Keating to defraud Lincoln. The RTC letter also
noted Mr. Garcia's extensive cooperation with federal investigators, which began
prior to the time he was charged and continued until his sentencing. In December
1993, the court, following the RTC's recommendation, sentenced Mr. Garcia to
three years of probation and fined him $50 (the minimum fine that the court
could assess). Under the terms of the probation, Mr. Garcia was barred from
affiliating in any way with a federally insured banking institution without
prior approval. Mr. Garcia's probation is scheduled to be lifted in December
1996.
In connection with the criminal action, the RTC filed a civil suit against
Mr. Garcia, which the parties settled after Mr. Garcia agreed to cooperate fully
with the RTC in its investigation and prosecution of Lincoln-related matters.
Pursuant to the terms of his settlement agreement, and in light of Mr. Garcia's
cooperation, the RTC released Mr. Garcia from civil liability. Also in
connection with this action, the Securities and Exchange Commission commenced
civil and administrative actions against Mr. Garcia. Without admitting or
denying any of the Commission's allegations, Mr. Garcia consented to a court
order permanently enjoining him and his affiliates from violating the federal
securities laws and to a Commission order barring him (with a right to reapply
upon the cessation of his probation) from associating in any capacity with any
broker, dealer, municipal securities dealer, investment adviser, or investment
company.
As a result of a decline in the Arizona real estate market in the late
1980s, changes in the tax laws affecting real estate, and the 1987 stock market
crash, in April 1990 a real estate investment company controlled by Mr. Garcia,
as well as several limited partnerships organized by that company, filed
petitions for
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<PAGE> 49
reorganization under Chapter 11 of the United States Bankruptcy Code (the
"Bankruptcy Code"). All of these reorganization proceedings were successfully
concluded by 1993. Many of the obligations of these entities were personally
guaranteed by Mr. Garcia and his wife. As a result, Mr. Garcia and his wife
filed a petition under Chapter 7 of the Bankruptcy Code in 1990, which was
discharged in October 1991.
SUMMARY OF EXECUTIVE COMPENSATION
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities to the Company during the
fiscal year ended December 31, 1995, of those persons who were, at December 31,
1995: (i) the chief executive officer of the Company and (ii) the other
executive officers of the Company whose total annual salary and bonus exceeded
$100,000 (the "Named Executive Officers"):
<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION
COMPENSATION -------------
------------------ SECURITIES ALL OTHER
NAME AND SALARY BONUS UNDERLYING COMPENSATION
PRINCIPAL POSITION ($) ($) OPTIONS(#)(1) ($)(2)
- ------------------------------------------------ ------- ------- ------------- ------------
<S> <C> <C> <C> <C>
Ernest C. Garcia, II............................ 100,000 -- -- 201
Chairman and Chief Executive Officer
Steven P. Johnson............................... 100,000 -- -- 177
Senior Vice President and General Counsel
Steven T. Darak................................. 100,000 100,000 -- --
Senior Vice President and Chief Financial
Officer
Scott A. Allen.................................. 100,000 100,000 116,000 187
Vice President -- Sales
</TABLE>
- ---------------
(1) The amounts shown in this column represent outstanding stock options granted
pursuant to the Company's Long-Term Incentive Plan. See "-- Long-Term
Incentive Plan."
(2) The amounts shown in this column represent the dollar value of 401(k) plan
contributions made by the Company for the benefit of the Named Executive
Officers. See "-- 401(k) Plan."
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth information regarding stock options granted
pursuant to the Company's Long-Term Incentive Plan during the fiscal year ended
December 31, 1995, to the Named Executive Officers:
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
VALUE AT ASSUMED
PERCENT OF ANNUAL RATES OF
NUMBER OF TOTAL STOCK PRICE
SECURITIES OPTIONS APPRECIATION FOR
UNDERLYING GRANTED TO EXERCISE OPTION TERM(3)
OPTIONS EMPLOYEES IN PRICE PER EXPIRATION ---------------------
NAME GRANTED(#)(1) FISCAL YEAR SHARE($/SH)(2) DATE 5%($) 10%($)
- ------------------------ ----------- ------------ -------------- ---------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia, II.... -- -- -- -- -- --
Steven P. Johnson....... -- -- -- -- -- --
Steven T. Darak......... -- -- -- -- -- --
Scott A. Allen.......... 116,000 26.3% 0.86 06/30/01 1,002,000 1,426,000
</TABLE>
- ---------------
(1) Generally, options are subject to vesting over a five-year period, with
20.0% of the options becoming exercisable on each successive anniversary of
the date of grant.
(2) The exercise price of the options granted to Mr. Allen approximated the fair
market value of the Common Stock on the date of grant, as determined by the
Board of Directors of the Company.
49
<PAGE> 50
(3) Gains are reported net of the option exercise price, but before taxes
associated with exercise. These amounts represent certain assumed rates of
appreciation. Actual gains, if any, on stock option exercises are dependent
on the future performance of the Common Stock and overall stock market
conditions, as well as the option holder's continued employment with the
Company throughout the vesting period. The amounts reflected in this table
will not necessarily be achieved.
FISCAL YEAR END OPTION VALUES
The following table sets forth information concerning the value of
unexercised options held by the Named Executive Officers as of December 31,
1995. No Named Executive Officer exercised any options in 1995.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
FISCAL YEAR END(#)(1) FISCAL YEAR END($)(2)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ------------------------------------------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Ernest C. Garcia, II............................. -- -- -- --
Steven P. Johnson................................ -- -- -- --
Steven T. Darak.................................. -- -- -- --
Scott A. Allen................................... -- 116,000 -- $ 683,240
</TABLE>
- ---------------
(1) Generally, options are subject to vesting over a five-year period, with
20.0% of the options becoming exercisable on each successive anniversary of
the date of grant.
(2) Assumes a market price for the Common Stock at December 31, 1995, equal to
the initial public offering price of $6.75 per share less the exercise price
thereof.
LONG-TERM INCENTIVE PLAN
In June 1995, the Company's stockholders approved the Ugly Duckling
Corporation Long-Term Incentive Plan (the "Incentive Plan"). Under the Incentive
Plan, the Company may grant incentive stock options, non-qualified stock
options, stock appreciation rights, performance shares, restricted stock,
dividend equivalents, and other Common Stock-based awards to employees,
consultants, and advisors of the Company. The Company believes that the
Incentive Plan promotes the success and enhances the value of the Company by
linking the personal interests of participants to those of the Company's
stockholders and providing participants with an incentive for outstanding
performance. The total number of shares of Common Stock available for awards
under the Incentive Plan, as amended, is 800,000, subject to a proportionate
increase or decrease in the event of a stock split, reverse stock split, stock
dividend, or other adjustment to the Company's total number of issued and
outstanding shares of Common Stock.
Following the offering, the Incentive Plan will be administered by the
Board of Directors or a committee that is appointed by, and serves at the
discretion of, the Board of Directors consisting of at least two nonemployee
directors. The Board of Directors or the committee, as the case may be, will
have the exclusive authority to administer the Incentive Plan, including the
power to determine eligibility, the type and number of awards to be granted, and
the terms and conditions of any award granted, including the price and timing of
awards. As of the date of this Prospectus, the Company has granted options to
purchase 606,830 shares of Common Stock to various of its employees. Generally,
such options are subject to vesting over a five-year period, with 20.0% of the
options becoming exercisable by the holder thereof on each successive
anniversary date of the grant. The exercise price of the options granted to date
is the fair market value of the Common Stock on the date of grant, as determined
by the Board of Directors.
401(K) PLAN
Under the Company's 401(k) plan, adopted in October 1995, eligible
employees may direct that a portion of their compensation, up to a legally
established maximum, be withheld by the Company and contributed to their
account. All 401(k) plan contributions are placed in a trust fund to be invested
by the
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<PAGE> 51
401(k) plan's trustee, except that the 401(k) plan may permit participants to
direct the investment of their account balances among mutual or investment funds
available under the plan. The 401(k) plan provides a matching contribution of
10.0% of a participant's contributions. Amounts contributed to participant
accounts under the 401(k) plan and any earnings or interest accrued on the
participant accounts are generally not subject to federal income tax until
distributed to the participant and may not be withdrawn until death, retirement,
or termination of employment.
EMPLOYMENT CONTRACTS
On January 1, 1996, the Company entered into a three-year employment
agreement with Mr. Ernest C. Garcia, II, the Company's Chairman and Chief
Executive Officer. The agreement establishes Mr. Garcia's base salary for 1996
at $120,000 per year and provides a minimum 10.0% increase in the base salary
each year throughout the term of the agreement. In addition, the agreement
provides for the continuation of Mr. Garcia's base salary and certain benefits
for a period of one year in the event Mr. Garcia is terminated by the Company
without cause prior to that time. The agreement also contains confidentiality
and non-compete covenants. The Company also has an employment agreement with Mr.
Steven T. Darak, which sets his base salary at $100,000 per year and contains
confidentiality and non-compete covenants. The agreement with Mr. Darak expires
on December 31, 1996.
COMMITTEES OF THE BOARD OF DIRECTORS
Effective upon the closing of the offering, the Company will establish a
Compensation Committee and an Audit Committee. The Compensation Committee, a
majority of which will be independent directors, will review executive salaries
and administer any bonus, incentive compensation, and stock option plans of the
Company, including the Long-Term Incentive Plan. In addition, the Compensation
Committee will consult with management of the Company regarding compensation
policies and practices of the Company. The Audit Committee, which will consist
of Messrs. Abrahams and Moreno, both of whom are independent directors, will
review the professional services provided by the Company's independent auditors,
the annual financial statements of the Company, and the Company's system of
internal controls.
DIRECTOR FEES
The Company's independent directors will be compensated $1,000 for
attendance at meetings of the Board of Directors and at meetings of committees
of the Board of Directors of which they are members, and will be reimbursed for
reasonable travel expenses incurred in connection with attendance at each Board
and committee meeting. In addition, upon the closing of the offering, each
independent director will receive Common Stock of the Company valued at $30,000
(4,444 shares each based upon the initial public offering price of $6.75 per
share), which will be subject to vesting in equal annual increments over a
three-year period. Directors who are also officers of the Company will not be
compensated for their services as directors.
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<PAGE> 52
PRINCIPAL STOCKHOLDERS
The following table sets forth, as of June 15, 1996, the number and
percentage of outstanding shares of Common Stock beneficially owned by: (i) each
director and director-nominee of the Company; (ii) the Named Executive Officers
of the Company; (iii) all directors, director-nominees, and executive officers
of the Company as a group; and (iv) each beneficial owner of more than 5% of the
outstanding Common Stock. To the knowledge of the Company, all persons listed
below have sole voting and investment power with respect to their shares, except
to the extent that authority is shared by their respective spouses under
applicable law.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER
OFFERING(1) OFFERING(1)
--------------------- ---------------------
NAME OF BENEFICIAL OWNER(2) NUMBER PERCENT NUMBER PERCENT
------------------------------------------ --------- ------- --------- -------
<S> <C> <C> <C> <C>
Ernest C. Garcia, II...................... 4,640,000 83.2 4,640,000 55.7
SunAmerica Life Insurance Company(3)...... -- -- 708,592 8.3
Steven P. Johnson......................... 290,000 5.2 290,000 3.5
Robert J. Abrahams(4)..................... -- -- 4,444 *
Christopher D. Jennings(4)................ -- -- 4,444 *
John N. MacDonough(4)..................... -- -- 4,444 *
Arturo R. Moreno(4)....................... -- -- 4,444 *
Frank P. Willey(4)........................ -- -- 4,444 *
Steven T. Darak........................... 232,000 4.2 232,000 2.8
Scott A. Allen(5)......................... 139,200 2.5 139,200 1.7
All directors, director-nominees and
executive
officers as a group (15 persons)(6)..... 5,426,480 96.7 5,448,700 65.2
</TABLE>
- ---------------
* Represents less than one percent of the outstanding Common Stock.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired within 60 days from the date set forth above through the exercise
of any option, warrant, or right. Shares of Common Stock subject to options,
warrants, or rights which are currently exercisable or exercisable within 60
days are deemed outstanding for computing the percentage of the person
holding such options, warrants, or rights, but are not deemed outstanding
for computing the percentage of any other person. The amounts and
percentages are based upon 5,579,600 shares of Common Stock outstanding as
of June 15, 1996, and 8,324,044 shares of Common Stock outstanding as of the
closing of the offering, respectively.
(2) Unless otherwise noted, the address of each of the listed stockholders is
2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016.
(3) The total for SunAmerica gives effect to the conversion by SunAmerica of
$3.0 million of subordinated debt into Common Stock at the initial public
offering price and the purchase by SunAmerica of $1.0 million of Common
Stock in the offering. The total also includes 116,000 shares of Common
Stock issuable upon the exercise of warrants to be issued to SunAmerica upon
the closing of the offering. The address of SunAmerica is 1 SunAmerica
Center, Los Angeles, California 90067.
(4) The totals for Messrs. Abrahams, Jennings, MacDonough, Moreno, and Willey
include 4,444 shares of Common Stock that each will receive upon their
appointment to the Board of Directors at the closing of the offering. See
"Management -- Director Fees."
(5) The total for Mr. Allen includes 23,200 shares subject to unexercised
options that are exercisable on June 15, 1996 or within 60 days thereafter.
(6) The total for all directors, director-nominees, and executive officers as a
group includes 32,480 shares subject to unexercised options that are
exercisable on June 15, 1996 or within 60 days thereafter.
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<PAGE> 53
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since its inception, the Company has maintained business relationships and
engaged in certain transactions with the affiliated companies and parties
described below. In the future, any transactions between the Company and its
affiliated entities, executive officers, directors, or significant stockholders
will require the approval of a majority of the independent directors of the
Company and will be on terms that will be no less favorable to the Company than
the Company could obtain from non-affiliated parties.
As of March 31, 1996, the Company leased nine operating facilities owned by
Verde Investments under operating leases, with one lease expiring in July 1998
and the remaining leases expiring in December 2008. Mr. Ernest C. Garcia, II,
the Company's Chairman, Chief Executive Officer, and majority stockholder, is
the President and sole stockholder of Verde Investments. These leases require
the Company to make monthly base rent payments aggregating approximately
$100,000, contain provisions for additional contingent rents, and have renewal
options for periods ranging from one to ten years. The Company is also
responsible for occupancy and maintenance costs, including real estate taxes,
insurance, and utilities. In connection with these leases, the Company has paid
security deposits to Verde Investments totaling $364,000, which are included in
other assets in the consolidated balance sheets of the Company as of March 31,
1996. Rents paid to Verde Investments pursuant to these leases totaled $235,000,
$1.2 million, and $1.9 million during fiscal years 1993, 1994, and 1995,
respectively, and $582,000 during the three months ended March 31, 1996. Upon
the closing of the offering, Verde Investments has agreed to sell to the
Company, subject to financing, those properties owned by Verde Investments and
leased to the Company at the lower of $7.45 million or the appraised value (as
determined by an independent third party), and, pending such sale, to lower the
rents on such properties to an aggregate of $745,000 per year, which the Company
believes approximates the financing costs to be incurred in connection with the
purchase of such properties. In addition, Verde Investments has agreed to assign
to the Company its leasehold interest in the two properties it sub-leases to the
Company. These two transactions would have resulted in savings to the Company of
approximately $730,000 for 1995 and $310,000 for the three months ended March
31, 1996. See "Recapitalization and Related Transactions."
From time to time, the Company has borrowed money from Verde Investments on
a subordinated basis, which amounts bear interest at a per annum rate of 18.0%,
payable monthly. Immediately prior to the end of 1995, the aggregate amount
outstanding under these subordinated notes was $24,553,000. At December 31,
1995, $10.0 million of this subordinated debt was converted into Preferred Stock
of the Company. The Preferred Stock accrues a dividend of 12.0% annually,
increasing one percent per year up to a maximum of 18%. In March 1996, the
Company paid $553,000 in principal to Verde Investments, lowering the total
amount of subordinated debt owed to Verde Investments to $14.0 million.
Effective upon closing of the offering, Verde Investments has agreed to enter
into a new subordinated note payable agreement that will lower the interest rate
on the outstanding subordinated debt payable to Verde Investments from 18.0% to
10.0% per annum and that will require monthly payments of interest and annual
principal payments of $2.0 million, with the note balance payable in full seven
years after the date of the closing of this offering. In addition, Verde
Investments has agreed to lower the dividend rate on the Preferred Stock stock
to 10.0% through the end of 1997, at which time the rate will be raised to
12.0%. See "Description of Capital Stock -- Preferred Stock."
In January 1996, in connection with the sale of the Gilbert Dealership, the
Company purchased the land for the Gilbert Dealership from Verde Investments for
a total price of $750,000, which the Company believes approximated fair market
value. Simultaneous with such purchase, the Company sold the land purchased from
Verde Investments together with the dealership building and other improvements
(which had been constructed by the Company) to a third party for $512,500 in
cash and a promissory note in the principal amount of $1.2 million. The Company
recognized a loss on the sale of $120,000, for which a reserve was established
as of December 31, 1995.
Mr. Christopher D. Jennings, a managing director of the Representative, has
been nominated and has agreed to serve as a director of the Company upon the
closing of the offering.
53
<PAGE> 54
DESCRIPTION OF CAPITAL STOCK
The Company is a Delaware corporation and its affairs are governed by its
Certificate of Incorporation and Bylaws and the Delaware General Corporation
Law. The following description of the Company's capital stock, which is complete
in all material respects, is qualified in its entirety by reference to the
provisions of the Company's Certificate of Incorporation and Bylaws, copies of
which have been filed as exhibits to the Registration Statement of which this
Prospectus is a part.
The authorized capital stock of the Company consists of 20,000,000 shares
of Common Stock, par value $.001 per share, and 10,000,000 shares of Preferred
Stock, par value $.001 per share. Immediately following the completion of this
offering, 8,324,044 shares of Common Stock will be issued and outstanding
(assuming no exercise of outstanding options or warrants), and 1,000,000 shares
of Preferred Stock will be issued and outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held of
record on all matters on which stockholders are entitled to vote. Holders of
Common Stock do not have cumulative voting rights, and therefore holders of a
majority of the shares voting for the election of directors can elect all of the
directors. In such event, the holders of the remaining shares will not be able
to elect any directors.
Holders of Common Stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. The Company does not anticipate paying cash dividends in the
foreseeable future. In the event of liquidation, dissolution, or winding up of
the Company, the holders of Common Stock are entitled to share ratably in any
corporate assets remaining after payment of all debts, subject to any
preferential rights of any outstanding Preferred Stock. See "Dividend Policy."
Holders of Common Stock have no preemptive, conversion, or redemption
rights and are not subject to further calls or assessments by the Company. All
of the outstanding shares of Common Stock are, and the shares offered by the
Company hereby will be, if issued, validly issued, fully paid, and
nonassessable. As of the date of this Prospectus, there are ten holders of
Common Stock.
PREFERRED STOCK
The Board of Directors of the Company has the authority, without further
action by the Company's stockholders, to issue from time to time up to
10,000,000 shares of Preferred Stock in one or more series and to fix the number
of shares, designations, voting powers, preferences, optional and other special
rights, and the restrictions or qualifications thereof. The rights, preferences,
privileges, and restrictions or qualifications of different series of Preferred
Stock may differ with respect to dividend rates, amounts payable on liquidation,
voting rights, conversion rights, redemption provisions, sinking fund
provisions, and other matters. The issuance of Preferred Stock could: (i)
decrease the amount of earnings and assets available for distribution to holders
of Common Stock; (ii) adversely affect the rights and powers, including voting
rights, of holders of Common Stock; and (iii) have the effect of delaying,
deferring, or preventing a change in control of the Company.
The Company's Certificate of Incorporation designates a series of Preferred
Stock as the "Series A Preferred Stock." The series consists of 1,000,000
shares, $.001 par value per share, all of which were issued to Verde Investments
on December 31, 1995, in exchange for $10.0 million of 18.0% subordinated debt.
The Series A Preferred Stock is redeemable at any time by the Company upon 30
days' notice at the issuance price per share plus all accrued and unpaid
dividends. Except as expressly provided in the Company's Certificate of
Incorporation or by applicable law, shares of Series A Preferred Stock are not
entitled to vote on matters submitted to a vote of the stockholders of the
Company. The approval of 66 2/3% of the outstanding shares of Series A Preferred
Stock, voting separately as a class, is necessary to, among other things, change
the rights, preferences, or privileges of the shares of the Series A Preferred
Stock or create any new class of stock having
54
<PAGE> 55
preference over or being on a parity with the shares of the Series A Preferred
Stock as to distributions upon the liquidation, winding up, or dissolution of
the Company. Cumulative dividends are payable quarterly out of funds legally
available therefor at an annual rate of 12.0%, which rate increases one percent
per year through 2002 at which point they reach their maximum rate of 18.0% per
annum. If dividends for an entire calendar year have not been declared and paid
within 30 days after the end of the calendar year, then until said dividends are
paid, holders of Series A Preferred Stock are entitled to vote in the election
of members of the Board of Directors of the Company. The Company is prohibited
from paying dividends to holders of Common Stock unless all dividends on the
Series A Preferred Stock have been paid or declared and a sum sufficient for the
payment thereof set aside. In the event of any liquidation, dissolution or
winding up of the Company, either voluntarily or involuntarily, the holders of
Series A Preferred Stock shall be entitled to receive, prior and in preference
to any distribution of any of the assets or surplus funds of the Company to
holders of Common Stock of the Company, an amount equal to the issuance price
per share plus all accrued and unpaid dividends.
At the closing of the offering, Verde Investments has agreed to lower the
dividend rate on the Preferred Stock to 10.0% through the end of 1997, at which
time the rate will be raised to 12.0%. See "Recapitalization and Related
Transactions."
OTHER SECURITIES AND REGISTRATION RIGHTS
Upon the closing of the offering, the Company will issue warrants to
SunAmerica to purchase 116,000 shares of Common Stock at an exercise price per
share of $6.75. Other warrants will be issued to the Representative to purchase
170,000 shares of Common Stock at an exercise price per share of $9.45. The
agreements with respect to the issuance of such warrants provide that in the
event the Company proposes to register any of its securities under the
Securities Act for its own account at any time or times, subject to certain
exceptions, SunAmerica and the Representative, as the case may be, shall be
entitled to include the shares underlying such warrants (and, in the
Representative's case, the warrants) in such registration, subject to the rights
of the managing underwriter of any such offering to exclude for marketing
reasons some or all of such securities. In addition, SunAmerica and the
Representative have the right to require the Company to prepare and file (i) in
the case of SunAmerica, on two occasions a registration statement under the
Securities Act with respect to such shares if at least 10.0% in interest of such
holders so request, and (ii) in the case of the Representative, a registration
statement under the Securities Act with respect to such shares if at least 50.0%
in interest of such holders so request. The Company is required to use its best
efforts to effect such registrations, subject to certain conditions and
limitations. The Company is not required to effect any such registration prior
to 180 days following the effective date of this offering. The Company is
required to pay all expenses of SunAmerica and the Representative, as the case
may be, in connection with any registration of such securities, except for any
underwriting discounts and commissions. See "Recapitalization and Related
Transactions" and "Underwriting."
The Company has authorized for issuance 800,000 shares of Common Stock
under its Incentive Plan, as amended. See "Management -- Long-Term Incentive
Plan."
LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Certificate of Incorporation provides that to the fullest
extent permitted by Delaware law, a director of the Company shall not be
personally liable to the Company or its stockholders for monetary damages for
breach of such director's fiduciary duty, except for liability: (i) for any
breach of the director's duty of loyalty to the Company or its stockholders;
(ii) for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law; (iii) in respect of certain unlawful
dividend payments or stock redemptions or repurchases; and (iv) for any
transaction from which the director derives an improper benefit. The effect of
the provision of the Company's Certificate of Incorporation is to eliminate the
rights of the Company and its stockholders (through stockholders' derivative
suits on behalf of the Company) to recover monetary damages against a director
for breach of the fiduciary duty of care as a director (including breaches
resulting from negligent or grossly negligent behavior), except in the
situations described in clauses
55
<PAGE> 56
(i) through (iv) above. This provision does not limit or eliminate the rights of
the Company or any stockholder to seek nonmonetary relief such as an injunction
or recision in the event of a breach of a director's duty of care. In addition,
the Company's Certificate of Incorporation provides that the Company shall
indemnify any person who is or was a director, officer, employee, or agent of
the Company, or who is or was serving at the request of the Company as a
director, officer, employee, or agent of another corporation or entity, against
expenses, liabilities, and losses incurred by any such person by reason of the
fact that such person is or was acting in such capacity. The Company has also
obtained insurance on behalf of its directors and officers for any liability
arising out of such person's actions in such capacity.
The Company has entered into agreements to indemnify its directors and
officers. These agreements, among other things, indemnify the Company's
directors and officers for certain expenses (including attorneys' fees),
judgments, fines, and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of the Company,
arising out of such person's services as a director or officer of the Company,
any subsidiary of the Company, or any other company or enterprise to which such
person provides services at the request of the Company. To the extent that the
Board of Directors or the stockholders of the Company may in the future wish to
limit or repeal the ability of the Company to provide indemnification as set
forth in the Company's Certificate of Incorporation, such repeal or limitation
may not be effective as to directors or officers who are parties to the
indemnification agreements because their rights to full protection would be
contractually assured by such agreements. It is anticipated that similar
contracts may be entered into, from time to time, with future directors of the
Company. The Company believes that the indemnification provisions in its
Certificate of Incorporation and in the indemnification agreements are necessary
to attract and retain qualified persons as directors and officers.
CERTAIN BYLAW PROVISIONS
The Company's Bylaws contain several provisions that regulate the
nomination of directors and the submission of proposals in connection with
stockholder meetings. The Company's Bylaws require that, subject to certain
exceptions, any stockholder desiring to propose business or nominate a person to
the Board of Directors at a stockholders meeting must give notice of any
proposals not less than 30 days nor more than 90 days prior to the meeting. Such
notice is required to contain certain information as set forth in the Bylaws. No
business matter shall be transacted nor shall any person be eligible for
election as a director of the Company unless proposed or nominated, as the case
may be, in strict accordance with this procedure set forth in the Company's
Bylaws.
Although the Bylaws do not give the Board of Directors any power to approve
or disapprove of stockholder nominations for the election of directors or of any
other business desired by stockholders to be conducted at an annual or any other
meeting, the Bylaws may have the effect of precluding a nomination for the
election of directors or the conduct of business at a particular annual meeting
if the proper procedures are not followed or may discourage or deter a third
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of the Company, even if the
conduct of such solicitation or such attempt might be beneficial to the Company
and its stockholders. The Company's procedures with respect to all stockholder
proposals and the nomination of directors will be conducted in accordance with
Section 14 of the Securities Exchange Act of 1934, as amended, and the rules
promulgated thereunder.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock of the Company is
Harris Trust Company of California, 601 S. Figueroa, Los Angeles, California
90017.
56
<PAGE> 57
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have outstanding
8,324,044 shares of Common Stock. Of these shares, the 2,300,000 shares of
Common Stock sold in the offering, plus any additional shares sold upon exercise
of the Underwriters' over-allotment option, will be freely tradeable without
restriction under the Securities Act of 1933, as amended (the "Securities Act").
Commencing 180 days following the date of this Prospectus, 5,579,600 shares of
Common Stock held by existing stockholders will become eligible for sale under
Rule 144, subject to compliance with the volume limitations and other
requirements of Rule 144.
In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned "restricted" shares for
at least two years, including persons who may be deemed "affiliates" of the
Company, as that term is defined under Rule 144, would be entitled to sell (in
accordance with the provisions specified in the rule) within any three-month
period a number of shares that does not exceed the greater of one percent of the
then outstanding shares of the Company's Common Stock (approximately 83,240
shares immediately following the offering assuming no exercise of the
Underwriters' over-allotment option) or the average weekly trading volume of the
Common Stock during the four calendar weeks preceding the date on which notice
of the sale is filed with the Commission. An "affiliate" of the Company or of a
business it has acquired within two years by merger or share exchange may sell
securities that are not "restricted" without regard to the period of beneficial
ownership but subject to the volume limitations described above and other
conditions of Rule 144. A person (or persons whose shares are aggregated) who is
not deemed an "affiliate" of the Company (and has not been at any time during
the three months immediately preceding the sale) and who has beneficially owned
his or her shares for at least three years, would be entitled to sell such
shares under Rule 144 without regard to the volume limitations described above,
manner of sale provisions, notice requirements, or availability of public
information.
The Company and its directors, director-nominees, and officers have agreed
with the Underwriters that, except in certain circumstances, they will not
issue, offer to sell, sell, contract to sell, or otherwise dispose of any shares
of Common Stock or any shares convertible or exchangeable into any shares of
Common Stock for a period of 180 days after the date of this Prospectus without
the prior written consent of the Representative. The Company does not intend to
make a public announcement in the event the Representative consents to sales
prior to the 180-day period expiring.
Prior to this offering, there has been no public market for the Company's
Common Stock and no prediction can be made of the effect, if any, that market
sales of shares or the availability of such shares for sale will have on the
market price prevailing from time to time. Nevertheless, sales of substantial
amounts of the Common Stock in the public market could adversely affect
prevailing market conditions and could impair the Company's future ability to
raise capital through the sale of its equity securities.
57
<PAGE> 58
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
underwriters named below (the "Underwriters") for whom Cruttenden Roth
Incorporated is acting as Representative, have severally agreed to purchase from
the Company, and the Company has agreed to sell to the Underwriters, the
respective number of shares of Common Stock set forth opposite each
Underwriter's name below:
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITERS SHARES
------------------------------------------------------------ ---------
<S> <C>
Cruttenden Roth Incorporated................................ 1,675,000
Fahnestock & Co. Inc........................................ 75,000
Ladenburg, Thalmann & Co. Inc............................... 75,000
McDonald & Company Securities, Inc.......................... 75,000
The Robinson-Humphrey Company, Inc.......................... 75,000
Sutro & Co. Incorporated.................................... 75,000
Brean Murray, Foster Securities Inc......................... 50,000
Commonwealth Associates..................................... 50,000
Norcross Securities......................................... 50,000
Peacock, Hislop, Staley & Given............................. 50,000
Sands Brothers & Co., Ltd................................... 50,000
---------
Total........................................ 2,300,000
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to certain conditions precedent, including
the absence of any material adverse change in the Company's business and the
receipt of certain certificates, opinions, and letters from the Company and its
respective counsel and the Company's independent certified public accountants.
The nature of the Underwriters' obligation is such that they are committed to
purchase and pay for all the shares of Common Stock if any are purchased.
The Company has been advised by the Representative that the Underwriters
propose to offer the shares of Common Stock directly to the public at the
initial public offering price set forth on the cover page of this Prospectus and
to certain securities dealers at such price less a concession not in excess of
$0.28 per share. The Underwriters may allow, and such selected dealers may
reallow, a discount not in excess of $0.10 per share to certain brokers and
dealers. After the initial public offering of the shares, the public offering
price and other selling terms may be changed by the Representative. No change in
such terms shall change the amount of proceeds to be received by the Company as
set forth on the cover page of this Prospectus.
The Company has granted an option to the Underwriters, exercisable for a
period of 45 days after the date of this Prospectus, to purchase up to an
additional 345,000 shares of Common Stock at the public offering price set forth
on the cover page of this Prospectus, less the underwriting discounts and
commissions. The Underwriters may exercise this option only to cover
over-allotments, if any. To the extent that the Underwriters exercise this
option, each of the Underwriters will be committed, subject to certain
conditions, to purchase such additional shares of Common Stock in approximately
the same proportion as set forth in the above table.
In connection with the offering, it is anticipated that SunAmerica, a
significant funding source for the Company, will purchase, at the initial public
offering price, $1.0 million of the Common Stock offered hereby.
The Company has agreed to issue to the Representative, for a total of
$1,700, warrants (the "Representative's Warrants") to purchase up to 170,000
shares of Common Stock at an exercise price per share of $9.45. The
Representative's Warrants are exercisable for a period of four years beginning
one year from the date of this Prospectus, and are not transferable for a period
of one year except to officers of the Representative or any successor to the
Representative. The holders of the Representative's Warrants will have no
voting, dividend, or other stockholder rights until the Representative's
Warrants are exercised. In addition, the Company has granted certain rights to
the holders of the Representative's Warrants to register the Common Stock
underlying the Representative's Warrants under the Securities Act.
58
<PAGE> 59
The Company has agreed to pay the Representative a non-accountable expense
allowance equal to 2.61% of the aggregate Price to Public (including with
respect to shares of Common Stock underlying the over-allotment option, if and
to the extent it is exercised) set forth on the front cover of this Prospectus
for expenses in connection with this offering, of which the sum of $30,000 has
been paid. The Representative's expenses in excess of such allowance will be
borne by the Representative. To the extent that the expenses of the
Representative are less than the non-accountable expense allowance, the excess
may be deemed to be compensation to the Representative.
The Representative has advised the Company that it does not expect any
sales of the shares of Common Stock offered hereby to be made to discretionary
accounts controlled by the Underwriters.
Prior to this offering, there has been no established trading market for
the Common Stock. Consequently, the initial public offering price for the Common
Stock offered hereby has been determined by negotiation among the Company and
the Representative. Among the factors considered in such negotiations were the
preliminary demand for the Common Stock, the prevailing market and economic
conditions, the Company's results of operations, estimates of the business
potential and prospects of the Company, the present state of the Company's
business operations, an assessment of the Company's management, the
consideration of these factors in relation to the market valuation of comparable
companies in related businesses, the current condition of the markets in which
the Company operates, and other factors deemed relevant. There can be no
assurance that an active trading market will develop for the Common Stock or
that the Common Stock will trade in the public market subsequent to this
offering at or above the initial public offering price.
The Underwriting Agreement provides that the Company will indemnify the
Underwriters and their controlling persons against certain liabilities under the
Securities Act or will contribute to payments the Underwriters and their
controlling persons may be required to make in respect thereof. The Company has
been advised that, in the opinion of the Commission, such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable.
Mr. Christopher D. Jennings, a managing director of the Representative, has
been nominated and has agreed to serve as a director of the Company upon the
closing of the offering.
LEGAL MATTERS
The validity of the shares offered hereby is being passed upon for the
Company by Snell & Wilmer L.L.P, Phoenix, Arizona. Certain legal matters will be
passed upon for the Underwriters by Squire, Sanders & Dempsey, Phoenix, Arizona.
EXPERTS
The consolidated financial statements and schedule of the Company as of
December 31, 1994 and 1995, and for each of the three fiscal years in the period
ended December 31, 1995, have been included herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
59
<PAGE> 60
ADDITIONAL INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act of 1933 with respect to the Common Stock offered
hereby. This Prospectus constitutes a part of the Registration Statement and
does not contain all of the information set forth therein and in the exhibits
thereto, certain portions of which have been omitted as permitted by the rules
and regulations of the Commission. For further information with respect to the
Company and the Common Stock offered hereby, reference is hereby made to such
Registration Statement and exhibits. Statements contained in this Prospectus as
to the contents of any document are not necessarily complete and in each
instance are qualified in their entirety by reference to the copy of the
appropriate document filed with the Commission. The Registration Statement,
including the exhibits thereto, may be examined without charge at the
Commission's public reference facility at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. In addition, copies of all or any part of
the Registration Statement, including such exhibits thereto, may be obtained
from the Commission at its principal office in Washington, D.C., upon payment of
the fees prescribed by the Commission.
The Registration Statement and the reports and other information to be
filed by the Company following the offering in accordance with the Securities
and Exchange Act of 1934, as amended, can be inspected and copied at the
principal office of the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington D.C. 20549, and at the following regional offices of
the Commission: 7 World Trade Center, New York, NY 10048, and Northwestern
Atrium Center, 500 West Madison Street, Suite 1400, Chicago, IL 60601. Copies of
such material may be obtained from the Public Reference Section of the
Commission at its principal office at 450 Fifth Street, N.W., Washington D.C.
20549, upon payment of the fees prescribed by the Commission. The Commission
maintains a Web site (http://www.sec.gov) that contains reports, proxy, and
information statements and other information regarding registrants, such as the
Company, that file electronically with the Commission.
The Company intends to provide its stockholders with annual reports
containing financial statements audited by independent auditors and quarterly
reports for the first three fiscal quarters of each year containing unaudited
summary consolidated financial information.
60
<PAGE> 61
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report.......................................................... F-2
Consolidated Financial Statements
Consolidated Balance Sheets as of December 31, 1994 and 1995, and
March 31, 1996 (unaudited)....................................................... F-3
Consolidated Statements of Operations for the years ended December 31,
1993, 1994, and 1995, and the three months ended March 31, 1995 (unaudited)
and 1996 (unaudited)............................................................. F-4
Consolidated Statements of Stockholders' Equity (Deficit) for the years
ended December 31, 1993, 1994, and 1995, and the three months ended
March 31, 1996 (unaudited)....................................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1993, 1994, and 1995, and the three months ended March 31, 1995 (unaudited)
and 1996 (unaudited)............................................................. F-6
Notes to Consolidated Financial Statements............................................ F-7
</TABLE>
F-1
<PAGE> 62
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Ugly Duckling Corporation:
We have audited the accompanying consolidated balance sheets of Ugly
Duckling Corporation and subsidiaries as of December 31, 1994 and 1995, and the
related consolidated statements of operations, stockholders' equity (deficit),
and cash flows for each of the years in the three-year period ended December 31,
1995. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Ugly
Duckling Corporation and subsidiaries as of December 31, 1994 and 1995, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1995 in conformity with generally accepted
accounting principles.
KPMG Peat Marwick LLP
Phoenix, Arizona
January 24, 1996, except as to Note 23,
which is as of April 24, 1996.
F-2
<PAGE> 63
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1994 AND 1995, AND MARCH 31, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- MARCH 31,
1994 1995 1996
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and Cash Equivalents............................... $ 168,092 $ 1,419,043 $ 663,979
Finance Receivables (notes 3 and 11):
Principal Balances.................................... 22,066,711 49,226,410 47,228,925
Less: Allowance for Credit Losses..................... (6,208,660) (8,500,000) (7,750,000)
----------- ---------- ----------
Finance Receivables, Net........................ 15,858,051 40,726,410 39,478,925
----------- ---------- ----------
Residual in Finance Receivables Sold (note 4)........... -- -- 2,645,419
Investments Held in Trust (note 5)...................... -- -- 624,770
Note Receivable (note 6)................................ -- -- 1,175,000
Inventory, at Cost (note 11)............................ 4,848,685 6,328,973 6,205,028
Income Taxes Receivable (note 14)....................... -- 850,300 432,958
Prepaid Expenses........................................ 458,636 642,827 154,192
Property and Equipment Held for Sale (note 6)........... -- 1,086,020 --
Property and Equipment, Net (notes 7 and 11)............ 5,974,579 7,797,155 7,900,188
Covenants Not to Compete and Trademarks, Net (note 8)... 628,855 269,246 253,402
Deferred Income Taxes (note 14)......................... 1,374,000 925,000 925,000
Other Assets............................................ 399,827 745,247 1,200,537
----------- ---------- ----------
$29,710,725 $60,790,221 $61,659,398
=========== ========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Liabilities:
Accounts Payable...................................... $ 773,877 $ 594,894 $ 1,319,521
Accrued Expenses and Other Liabilities (note 9)....... 1,380,630 4,574,134 4,934,406
Income Taxes Payable (note 14)........................ 133,700 -- --
Obligations Under Capital Leases (note 10)............ 383,592 982,754 916,357
Note Payable (note 11)................................ 9,942,147 32,201,329 31,839,050
Convertible Note Payable (note 12).................... -- 3,000,000 3,000,000
Subordinated Notes Payable (note 13).................. 18,290,916 14,552,804 14,000,000
----------- ---------- ----------
Total Liabilities.................................. 30,904,862 55,905,915 56,009,334
----------- ---------- ----------
Stockholders' Equity (Deficit) (notes 17 and 23):
Preferred Stock, $.001 Par Value; Authorized 10,000,000
Shares; Zero and 1,000,000 and 1,000,000
(unaudited)Shares Issued and Outstanding at December
31,1994, 1995 and March 31, 1996, Respectively........ -- 10,000,000 10,000,000
Common Stock, $.001 Par Value; Authorized 20,000,000
Shares; 5,521,600, 5,579,600 and 5,579,600 (unaudited)
Shares Issued and Outstanding at December 31, 1994,
1995 and March 31, 1996, Respectively................. 77,000 127,000 127,000
Accumulated Deficit..................................... (1,271,137) (5,242,694) (4,476,936)
----------- ---------- ----------
Total Stockholders' Equity (Deficit)............... (1,194,137) 4,884,306 5,650,064
----------- ---------- ----------
Commitments, Contingencies and Subsequent Events
(notes 6, 16, 18, 19, and 23).........................
----------- ---------- ----------
$29,710,725 $60,790,221 $61,659,398
=========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-3
<PAGE> 64
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995, AND THREE MONTHS ENDED MARCH 31,
1995 (UNAUDITED) AND MARCH 31, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31, THREE MONTHS ENDED MARCH
--------------------------------------- 31,
1993 1994 1995 -------------------------
----------- ----------- ----------- 1995 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Dealership Revenues:
Sales of Used Cars................................ $13,969,287 $27,768,095 $47,824,074 $ 9,683,175 $15,081,069
Income on Finance Receivables..................... 1,628,628 4,739,348 8,227,360 1,564,375 2,490,300
Gain on Sale of Finance Receivables............... -- -- -- -- 538,528
Income on Residual in Finance Receivables Sold.... -- -- -- -- 103,290
----------- ---------- ---------- ---------- ----------
15,597,915 32,507,443 56,051,434 11,247,550 18,213,187
----------- ---------- ---------- ---------- ----------
Cost of Dealership Revenues:
Cost of Used Cars Sold............................ 6,089,093 12,577,696 27,964,258 4,857,746 8,347,707
Provision for Credit Losses (note 3).............. 3,291,620 8,139,791 8,359,585 2,060,271 2,606,112
----------- ---------- ---------- ---------- ----------
9,380,713 20,717,487 36,323,843 6,918,017 10,953,819
----------- ---------- ---------- ---------- ----------
Net Revenues from Dealership Activities......... 6,217,202 11,789,956 19,727,591 4,329,533 7,259,368
Other Income:
Servicing Income.................................. -- -- -- -- 54,321
Income on Third Party Finance Receivables......... -- 709,710 1,844,577 216,723 1,068,695
Franchise Fees and Other Income (note 15)......... 878,663 556,509 307,741 82,111 60,099
----------- ---------- ---------- ---------- ----------
878,663 1,266,219 2,152,318 298,834 1,183,115
----------- ---------- ---------- ---------- ----------
Income before Operating Expenses................ 7,095,865 13,056,175 21,879,909 4,628,367 8,442,483
Operating Expenses:
Selling and Marketing............................. 1,292,773 2,401,998 3,855,771 750,630 1,041,004
General and Administrative (note 16).............. 3,560,526 8,970,923 14,429,925 2,935,206 4,321,445
Depreciation and Amortization..................... 191,311 481,152 1,018,047 186,519 331,614
Amortization of Covenants (note 8)................ 365,911 296,232 296,231 74,058 --
----------- ---------- ---------- ---------- ----------
5,410,521 12,150,305 19,599,974 3,946,413 5,694,063
----------- ---------- ---------- ---------- ----------
Operating Income................................ 1,685,344 905,870 2,279,935 681,954 2,748,420
Other Expenses:
Interest on Subordinated Notes Payable (note
13)............................................. 677,625 2,568,738 3,491,673 792,339 631,383
Interest, Other................................... 215,292 467,813 2,464,119 330,318 1,018,853
Other, Net........................................ 63,846 170,333 295,700 23,996 32,426
----------- ---------- ---------- ---------- ----------
956,763 3,206,884 6,251,492 1,146,653 1,682,662
----------- ---------- ---------- ---------- ----------
Income (Loss) before Income Taxes............... 728,581 (2,301,014) (3,971,557) (464,699) 1,065,758
Income Tax Expense (Benefit) (note 14):............. 30,000 (333,626) -- -- --
----------- ---------- ---------- ---------- ----------
Net Earnings (Loss)............................. $ 698,581 $(1,967,388) $(3,971,557) $ (464,699) $ 1,065,758
Preferred Stock Dividend........................ -- -- -- -- (300,000)
----------- ---------- ---------- ---------- ----------
Net Earnings Available to Common Shares......... $ 698,581 $(1,967,388) $(3,971,557) $ (464,699) $ 765,758
=========== ========== ========== ========== ==========
Earnings (Loss) per Common Share................ $ 0.14 $ (0.35) $ (0.67) $ (0.08) $ 0.13
=========== ========== ========== ========== ==========
Weighted Average Common and Common
Equivalent Shares Outstanding..................... 5,010,513 5,584,125 5,892,113 5,892,113 5,892,113
=========== ========== ========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-4
<PAGE> 65
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995, AND THREE MONTHS ENDED MARCH 31,
1996 (UNAUDITED)
<TABLE>
<CAPTION>
RETAINED TOTAL
SHARES AMOUNT EARNINGS STOCKHOLDERS'
---------------------- ---------------------- (ACCUMULATED EQUITY
PREFERRED COMMON PREFERRED COMMON DEFICIT) (DEFICIT)
--------- ---------- ----------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1992........... -- 4,640,000 $ -- $ 1,000 $ (2,330) $ (1,330)
Net Earnings for the Year............... -- -- -- -- 698,581 698,581
--------- --------- ----------- ------- ---------- ---------
Balances at December 31, 1993........... -- 4,640,000 -- 1,000 696,251 697,251
Issuance of Common Stock for Purchase
of Subsidiary (note 1 and 17)......... -- 174,000 -- 15,000 -- 15,000
Issuance of Common Stock for Cash
(note 17)............................. -- 707,600 -- 61,000 -- 61,000
Net Loss for the Year................... -- -- -- -- (1,967,388) (1,967,388)
--------- --------- ----------- ------- ---------- ---------
Balances at December 31, 1994........... -- 5,521,600 -- 77,000 (1,271,137) (1,194,137)
Issuance of Common Stock (note 17)...... -- 58,000 -- 50,000 -- 50,000
Conversion of Subordinated Notes Payable
to Preferred Stock (note 17).......... 1,000,000 -- 10,000,000 -- -- 10,000,000
Net Loss for the Year................... -- -- -- -- (3,971,557) (3,971,557)
--------- --------- ----------- ------- ---------- ---------
Balances at December 31, 1995........... 1,000,000 5,579,600 10,000,000 127,000 (5,242,694) 4,884,306
Three Months Ended
March 31, 1996 (Unaudited)
Preferred Stock Dividend................ -- -- -- -- (300,000) (300,000)
Net Earnings for the Period............. -- -- -- -- 1,065,758 1,065,758
--------- --------- ----------- ------- ---------- ---------
Balances at March 31, 1996
(unaudited)........................... 1,000,000 5,579,600 $10,000,000 $127,000 $ (4,476,936) $ 5,650,064
========= ========= =========== ======= ========== =========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-5
<PAGE> 66
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1993, 1994, AND 1995, AND THREE MONTHS ENDED MARCH 31,
1995 (UNAUDITED) AND
MARCH 31, 1996 (UNAUDITED)
<TABLE>
<CAPTION>
DECEMBER 31, THREE MONTHS ENDED
---------------------------------------- MARCH 31,
1993 1994 1995 --------------------------
---------- ------------ ------------ 1995 1996
----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss)............................... $ 698,581 $ (1,967,388) $ (3,971,557) $ (464,698) $ 1,065,758
Adjustments to Reconcile Net Earnings (Loss) to
Net Cash Provided by Operating Activities:
Provision for Credit Losses..................... 3,291,620 8,139,791 8,359,585 2,060,271 2,606,112
Gain on Sale of Finance Receivables............. -- -- -- -- (538,528)
Compensation Expense Related to Sale of Common -- -- 45,000 45,000 --
Stock.........................................
Decrease (Increase) in Deferred Income Taxes.... (913,000) (461,000) 449,000 (168,000) --
Loss on Disposal of Property and Equipment...... -- 20,221 123,781 381 --
Depreciation and Amortization................... 557,222 777,384 1,314,278 260,577 331,614
Minority Interest............................... 1,252 5,210 -- -- --
Changes in Assets and Liabilities, Net of
Effects from the Purchase of Champion
Financial Services, Inc.:
Decrease (Increase) in Inventory................ (1,081,130) (3,098,247) (1,500,288) 482,208 123,945
Decrease (Increase) in Prepaid Expenses......... (139,476) (160,299) (184,191) 96,801 488,635
Increase in Other Assets........................ (281,347) (134,483) (345,420) (21,692) (455,290)
Increase in Accounts Payable, Accrued Expenses, 709,540 1,063,740 3,034,521 920,138 1,084,899
and Other Liabilities.........................
Increase (Decrease) in Income Taxes Receivable/ 943,000 (809,300) (984,000) 68,000 417,342
Payable.......................................
---------- ----------- ----------- ---------- ----------
Net Cash Provided by Operating 3,786,262 3,375,629 6,340,709 3,278,986 5,124,487
Activities...............................
---------- ----------- ----------- ---------- ----------
Cash Flows from Investing Activities:
Increase in Finance Receivables................... (8,621,895) (14,992,896) (33,227,944) (5,660,755) (13,402,831)
Proceeds from Sale of Finance Receivables......... -- -- -- -- 9,937,313
Increase in Investments Held in Trust............. -- -- -- -- (624,770)
Increase in Notes Receivable...................... (82,341) -- -- -- --
Repayments of Notes Receivable.................... 85,688 120,483 -- -- 25,000
Purchase of Property and Equipment (270,701) (5,333,797) (3,194,772) (901,624) (532,783)
Payment for Purchase of Inventory and Equipment... (424,850) -- -- -- --
Purchase of Minority Interest of Subsidiary....... -- (15,000) -- -- --
Payment for Purchase of Subsidiary, Net of Cash -- (376,070) -- -- --
Acquired........................................
---------- ----------- ----------- ---------- ----------
Net Cash Used in Investing Activities...... (9,314,099) (20,597,280) (36,422,716) (6,562,379) (4,598,071)
---------- ----------- ----------- ---------- ----------
Cash Flows from Financing Activities:
Increase in Deposit Liability..................... -- -- -- 2,250,000 --
Repayments of Obligations Under Capital Leases.... -- (15,463) (193,112) (17,841) (66,397)
Additions to Notes Payable........................ -- 9,942,147 22,259,182 2,202,811 --
Repayments of Notes Payable....................... (3,749,547) (2,026,944) -- -- (362,279)
Addition to Convertible Note Payable.............. -- -- 3,000,000 -- --
Net Issuance (Repayment) of Subordinated Notes 8,941,055 9,349,861 6,261,888 (1,076,131) (552,804)
Payable.........................................
Preferred Stock Dividend Paid..................... -- -- -- -- (300,000)
Proceeds from Issuance of Common Stock............ -- 61,000 5,000 5,000 --
---------- ----------- ----------- ---------- ----------
Net Cash Provided by (Used in) Financing 5,191,508 17,310,601 31,332,958 3,363,839 (1,281,480)
Activities...............................
---------- ----------- ----------- ---------- ----------
Net Increase (Decrease) in Cash and Cash (336,329) 88,950 1,250,951 80,446 (755,064)
Equivalents.......................................
Cash and Cash Equivalents at Beginning of Period.... 415,471 79,142 168,092 168,092 1,419,043
---------- ----------- ----------- ---------- ----------
Cash and Cash Equivalents at End of Period.......... $ 79,142 $ 168,092 $ 1,419,043 $ 248,538 $ 663,979
========== =========== =========== ========== ==========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-6
<PAGE> 67
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995
AND THE THREE MONTHS ENDED MARCH 31, 1995 (UNAUDITED) AND MARCH 31, 1996
(UNAUDITED)
(1) ORGANIZATION AND ACQUISITIONS
Ugly Duckling Corporation, a Delaware corporation (the Company), was
incorporated in April 1996 as the successor to Ugly Duckling Holdings, Inc.
(UDH), an Arizona corporation, formed in 1992. Contemporaneous with the
formation of the Company, UDH was merged into the Company with each share of
UDH's common stock exchanged for 1.16 shares of common stock in the Company and
each share of UDH's preferred stock exchanged for one share of preferred stock
in the Company under identical terms and conditions. The resulting effect of the
merger was a recapitalization increasing the number of authorized shares of
common stock to 20,000,000 and a 1.16-to-1 common stock split effective April
24, 1996 (note 23). The stockholders' equity section of the Consolidated Balance
Sheets as of December 31, 1994, 1995 and March 31, 1996, reflects the number of
authorized shares after giving effect to the merger and common stock split. The
Company's majority stockholder is also the sole stockholder of Verde Holdings,
Inc. and Verde Investments, Inc., affiliated entities under common control. The
Company's subordinated debt (note 13) is held by, and the land for certain of
its operating facilities is leased from, Verde Investments, Inc. (Verde) (note
16).
As of March 31, 1996 (unaudited), the Company has twelve wholly owned
subsidiaries: Duck Ventures, Inc.; Champion Acceptance Corporation (formerly
Ugly Duckling Credit Corp.); Ugly Duckling Car Sales, Inc.; UDRAC, Inc. (rental
car franchisor); Champion Financial Services, Inc.; UDRAC Rentals, Inc.; Ugly
Duckling Franchising, Inc.; Drake Insurance Services, Inc.; Drake Insurance
Agency, Inc.; Drake Casualty Insurance Inc.; Drake Life Insurance, Inc., and
Champion Receivables Corp. (CRC). CRC is a special purpose corporation formed to
accommodate the structure under which the Company sells its finance receivables.
Verde Holdings, Inc. originally acquired Duck Ventures, Inc. and its
subsidiaries (Ventures) from an unrelated entity in January 1992. The
acquisition price was $1,530,000, which represented the net book value of
Ventures plus an additional $716,373 for a covenant not to compete (note 8) and
$580,855 for trademarks (note 8). No "goodwill" was recorded in connection with
the acquisition. During December 1992, Verde Holdings, Inc. transferred the
common stock of Ventures to UDH for a price of $2,913,000, representing the net
book value of Ventures, in exchange for the assumption by UDH of notes payable
to unrelated third parties of $1,375,000 and the issuance of a note payable to
Verde Holdings, Inc. in the amount of $1,538,000. The assets were recorded at
their historical cost basis in a manner similar to a pooling of interests
because of the common ownership of UDH and Verde Holdings, Inc.. Subsequently,
the notes became a component of the subordinated debt (note 13) when Verde
acquired these notes, at face value, from Verde Holdings, Inc..
During 1993, Ugly Duckling Car Sales, Inc. purchased from an unrelated
entity the assets of a used car lot for $424,850 in cash. No liabilities were
assumed in connection with the acquisition. The acquisition was recorded in
accordance with the "purchase method" of accounting. The cost was allocated,
based upon the estimated fair value of the assets on the acquisition date, as
follows: $349,850 to inventory and $75,000 to property, equipment, and leasehold
improvements.
During 1994, Champion Acceptance Corporation (CAC) acquired from unrelated
parties 100% of the common stock of Champion Financial Services, Inc. (CFS) for
$420,886. CAC paid $125,886 in cash, $15,000 in common stock of UDH (174,000
shares), and financed the balance of $280,000, which was subsequently paid in
full prior to December 31, 1994. The acquisition was recorded in accordance with
the "purchase method" of accounting with the results of CFS being included in
the accompanying statements of operations from the February 1, 1994 acquisition
date. The purchase price approximated the fair value of the tangible net assets
acquired.
F-7
<PAGE> 68
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summary, prepared on a pro forma basis, combines the
consolidated results of operations as if CFS had been acquired as of the
beginning of the periods presented:
<TABLE>
<CAPTION>
YEAR ENDED YEAR ENDED
DECEMBER 31, 1993 DECEMBER 31, 1994
----------------- -----------------
<S> <C> <C>
Income on Third Party Finance
Receivables........................ $ 1,004,879 $ 787,891
Income (Loss) before Income Taxes.... 1,079,570 (2,283,825)
Net Earnings (Loss).................. 930,234 (1,956,043)
</TABLE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations
The Company, through its subsidiaries, owns and operates a sales finance
company and used car sales lots, and is a franchiser of rental car operations.
The Company's recently formed insurance companies will sell car casualty, credit
life and disability insurance.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions have
been eliminated in consolidation.
Concentration of Credit Risk
CAC and CFS provide sales finance services in connection with the sale of
used cars to individuals residing primarily in the metropolitan areas of Phoenix
and Tucson, Arizona. The Company operated two, three and three dealerships in
the Tucson metropolitan area in 1993, 1994, and 1995, respectively; and three,
five, and five dealerships in the Phoenix metropolitan area in 1993, 1994, and
1995, respectively (company dealerships). As of March 31, 1996, CFS maintains
relationships with approximately 317 (unaudited) third party car dealers (third
party dealers) in five states from whom it purchases sales finance contracts.
Periodically during the year, the Company maintains cash in financial
institutions in excess of the amounts insured by the federal government.
Cash Equivalents and Supplemental Statement of Cash Flow Information
The Company considers all highly liquid debt instruments purchased with an
original maturity of three months or less to be cash equivalents. Cash
equivalents consist of demand deposit accounts.
Interest paid totaled $921,892 during the year ended December 31, 1993;
there were no income taxes paid during the year ended December 31, 1993.
Interest paid totaled $3,030,778 during the year ended December 31, 1994; income
taxes paid totaled $960,000 during the year ended December 31, 1994. Interest
paid totaled $5,889,606 during the year ended December 31, 1995; income taxes
paid totaled $535,000 during the year ended December 31, 1995. Interest paid
totaled $850,675 (unaudited) during the period ended March 31, 1995; income
taxes paid totaled $100,000 (unaudited) during the period ended March 31, 1995.
Interest paid totaled $1,660,750 (unaudited) during the period ended March 31,
1996; there were no (unaudited) income taxes paid during the period ended March
31, 1996.
During 1994, the Company purchased 100% of the common stock of CFS for
$420,886. In connection with the acquisition, liabilities were assumed as
follows:
<TABLE>
<S> <C>
Fair Value of Assets Acquired.......................... $2,178,346
Purchase Price of the Common Stock..................... (420,886)
----------
Liabilities Assumed.................................... $1,757,460
==========
</TABLE>
The Company entered into capital lease obligations totaling $399,055 and
$792,274 for certain equipment during 1994 and 1995, respectively.
F-8
<PAGE> 69
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue Recognition
Income on finance receivables is recognized using the interest method.
Direct loan origination costs related to contracts originated at the company
dealerships are deferred and charged against finance income over the life of the
related installment sales contract as an adjustment of yield. The accrual of
interest is suspended if collection becomes doubtful and is resumed when the
loan becomes current.
Revenue from the sale of cars is recognized upon delivery, when the sales
contract is signed and the agreed-upon down payment has been received.
Franchise fees recorded by UDRAC, Inc. are accounted for in accordance with
Statement of Financial Accounting Standards No. 45, "Accounting for Franchise
Fee Revenue," issued by the Financial Accounting Standards Board. Initial
franchise fees are recognized as revenue at the time of sale of the related
franchise. Franchise fees, based on the franchise's sales, are recognized as
earned.
Gain on Sale of Finance Receivables and Income on Residual in Finance
Receivables Sold
In 1996, the Company initiated a securitization program under which it
sells finance receivables to a trust which uses the finance receivables to
create asset backed securities (certificates) which are remitted to the Company
in consideration for the sale. The Company then sells senior certificate(s) to
third party investors and retains subordinated certificate(s). In consideration
of such sale, the Company receives cash proceeds from the sale of certificates
collateralized by the finance receivables and the right to future cash flows
under the subordinated certificates (residual in finance receivables sold, or
residual) arising from those receivables to the extent not required to make
payments on the senior certificates sold to a third party or to pay associated
costs.
Gains or losses are determined based upon the difference between the sales
proceeds for the portion of finance receivables sold and the Company's recorded
investment in the finance receivables sold. The Company allocates the recorded
investment in the finance receivables between the portion of the finance
receivables sold and the portion retained based on the relative fair values of
those portions on the date of sale.
Servicing Income
Servicing income is recognized when earned. Servicing costs are charged to
expense as incurred. In the event delinquencies and/or losses on the portfolio
serviced exceed specified levels, the trustee may require the transfer of
servicing of the portfolio to another servicer.
Finance Receivables, Allowance for Credit Losses and Nonrefundable Acquisition
Discount
The Company originates installment sales contracts from its company
dealerships and purchases contracts from third party dealers. Finance
receivables consist of contractually scheduled payments from installment sales
contracts net of unearned finance charges, accrued interest receivable, direct
loan origination costs, and an allowance for credit losses, including
nonrefundable acquisition discounts.
Unearned finance charges represent the balance of finance income (interest)
remaining from the capitalization of the total interest to be earned over the
original term of the related installment sales contract. Direct loan origination
costs represent the unamortized balance of costs incurred in the origination of
contracts at the Company's dealerships.
The Company follows the provisions of Statement of Financial Accounting
Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases."
An allowance for credit losses (allowance) is established by charging the
provision for credit losses and the allocation of nonrefundable acquisition
discount. For contracts generated by the company dealerships, the allowance is
established by charging the provision for credit losses. Contracts purchased
from third party dealers are generally purchased with a nonrefundable
acquisition discount (discount). The discount is
F-9
<PAGE> 70
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
negotiated with third party dealers pursuant to a financing program that bases
the discount on, among other things, the credit risk of the borrower and the
amount to be financed in relation to the car's wholesale value. The discount is
allocated between discount available for credit losses and discount available
for accretion to interest income. The portion of discount allocated to the
allowance is based upon historical performance and write-offs of contracts
acquired from third party dealers, as well as the general creditworthiness of
the borrowers and the wholesale value of the vehicle. The remaining discount, if
any, is deferred and accreted to income using the interest method. To the extent
that the discount is considered insufficient to absorb anticipated losses on the
third party dealer portfolio, additions to the allowance are established through
a charge to the provision for credit losses. The evaluation of the discount and
allowance considers such factors as the performance of each third party dealer's
loan portfolio, the Company's historical credit losses, the overall portfolio
quality and delinquency status, the review of specific problem loans, the value
of underlying collateral, and current economic conditions that may affect the
borrower's ability to pay.
Inventory
Inventory consists of used vehicles held for sale and is valued at the
lower of cost or market. Vehicle reconditioning costs are capitalized as a
component of inventory cost. The cost of used vehicles sold is determined on a
specific identification basis. Repossessed vehicles are valued at the lower of
estimated net realizable value or the related loan balance.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed using
the straight-line and accelerated methods over the estimated useful lives of the
assets which range from three to ten years for equipment and thirty years for
buildings. Leasehold and land improvements are amortized using straight-line and
accelerated methods over the shorter of the lease term or the estimated useful
lives of the related improvements.
The Company has capitalized costs related to the development of software
products for internal use. Capitalization of costs begins when technological
feasibility has been established and ends when the software is available for
general use. Amortization is computed using the straight-line method over the
estimated economic life of five years.
Trademarks, Trade Names, Logos, and Contract Rights
The registered trade names, "Ugly Duckling Car Sales," "Ugly Duckling
Rent-A-Car," and "America's Second Car" and related trademarks, logos, and
contract rights are stated at cost. The cost of trademarks, trade names, logos,
and contract rights is amortized on a straight-line basis over their estimated
economic lives of ten years.
Covenants Not to Compete
The covenants not to compete are stated at cost. Amortization is provided
using the straight-line method over the respective terms of the contracts.
Post Sale Customer Support Programs
A liability (reserve) for the estimated cost of post sale customer support,
including car repairs and the Company's down payment back and credit card
programs, is established at the time the used car is sold by charging Cost of
Used Cars Sold. The liability is evaluated for adequacy through a separate
analysis of the various programs' historical performance.
Income Taxes
The Company utilizes the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable
F-10
<PAGE> 71
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Advertising
The Company expenses production and other costs of advertising as incurred.
Earnings per Share
Earnings per share is based upon the weighted average number of common
shares outstanding plus common stock equivalents after giving effect to the
1.16-to-1 common stock split (note 1). Pursuant to the Securities and Exchange
Commission Staff Accounting Bulletin No. 83, common stock and common stock
equivalents issued during the 12-month period prior to the Company's proposed
initial public offering have been included in the calculation as if they were
outstanding for all periods presented (even if antidilutive, using the treasury
stock method and an anticipated public offering price of $6.75 per share).
Use of Estimates
Management of the Company has made a number of estimates and assumptions
relating to the reporting of assets and liabilities to prepare the Consolidated
Financial Statements in conformity with generally accepted accounting
principals. Actual results could differ from those estimates.
Unaudited Interim Financial Information
The unaudited interim financial statements as of March 31, 1996 and for the
three month periods ended March 31, 1995 and 1996 reflect, in the opinion of
management all adjustments (which include only normal recurring adjustments)
necessary to fairly present the results of operations, changes in cash flows,
and financial position as of and for the periods presented. The results for the
interim periods presented are not necessarily indicative of results to be
expected for the full year.
(3) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
The Company provides financing for a substantial portion of its company
dealerships' retail sales and purchases contracts from a network of third party
dealers. Installment sales contracts generated by company dealerships are
executed by customers with terms which typically include down payments of
approximately 15%, interest rates of 29.9%, and maturity terms ranging from 12
to 36 months. Purchased installment sales contracts generally contain interest
rates ranging from 21% to 29.9% and maturity terms ranging from 12 to 48 months.
F-11
<PAGE> 72
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of net finance receivables at December 31, 1994 and 1995 and
March 31, 1996 (unaudited) follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- MARCH 31,
1994 1995 1996
----------- ------------ ------------
(UNAUDITED)
<S> <C> <C> <C>
Contractually Scheduled Payments.......... $27,964,991 $ 66,425,902 $ 64,845,537
Less: Unearned Finance Income............. (6,463,859) (18,394,460) (18,523,230)
----------- ------------ ------------
Installment Sales Contract Principal
Balances................................ 21,501,132 48,031,442 46,322,307
Add: Accrued Interest Receivable.......... 270,123 612,979 510,614
Loan Origination Costs, Net......... 367,307 581,989 396,004
Less: Dealer Holdbacks.................... (71,851) -- --
----------- ------------ ------------
Principal Balances, Net................... 22,066,711 49,226,410 47,228,925
Less: Allowance for Credit Losses......... (6,208,660) (8,500,000) (7,750,000)
----------- ------------ ------------
Finance Receivables, Net.................. $15,858,051 $ 40,726,410 $ 39,478,925
=========== ============ ============
</TABLE>
The allowance for credit losses as a percent of principal balances totaled
28.9% and 17.7% at December 31, 1994 and 1995, respectively, and 16.7%
(unaudited) at March 31, 1996.
The changes in the allowance and the discount for the years ended December
31, 1994 and 1995 and the period ended March 31, 1996 (unaudited) follow:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- MARCH 31,
1994 1995 1996
----------- ------------ -----------
(UNAUDITED)
<S> <C> <C> <C>
Balances, Beginning of Period.............. $ 2,876,399 $ 6,208,660 $ 8,500,000
Provision for Credit Losses on:
Company Dealership Contracts.......... 8,023,576 8,359,585 2,606,112
Third Party Dealer Contracts.......... 116,215 -- --
Discount Acquired........................ 766,820 1,659,798 720,931
Discount Accreted to Income.............. (187,692) -- --
Charge Off Activity:
Principal Balances Charged Off........ (8,596,637) (10,190,550) (3,347,271)
Accrued Interest Balances Charged
Off................................. (677,248) (711,315) (196,942)
Recoveries............................ 3,887,227 3,173,822 1,125,704
----------- ------------ -----------
Net Charge Offs..................... (5,386,658) (7,728,043) (2,418,509)
----------- ------------ -----------
Amount Relieved from Sale of
Associated Contracts............. -- -- (1,658,534)
----------- ------------ -----------
Balances, End of Period.................... $ 6,208,660 $ 8,500,000 $ 7,750,000
========== =========== ==========
</TABLE>
For the year ended December 31, 1994, approximately seventy-five percent
(75%) of the non-refundable acquisition discount acquired was allocated to
acquisition discount available for credit losses. For the year ended December
31, 1995, and the three months ended March 31, 1996 (unaudited), the entire
nonrefundable acquisition discount acquired was allocated to acquisition
discount available for credit losses.
F-12
<PAGE> 73
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(4) RESIDUAL IN FINANCE RECEIVABLES SOLD (UNAUDITED)
The valuation of the residual in finance receivables sold as of March 31,
1996 follows:
<TABLE>
<CAPTION>
MARCH 31, 1996
--------------
(UNAUDITED)
<S> <C>
Present Value of Future Cash Flows............................. $ 4,261,696
Discounted Allowance for Credit Losses......................... (1,616,277)
-----------
Residual in Finance Receivables Sold........................... $ 2,645,419
===========
</TABLE>
At March 31, 1996, the remaining balance of finance receivables sold
totaled $12,621,846 (unaudited). The discounted allowance as a percentage of the
remaining balance of finance receivables sold was 12.8% (unaudited). The Company
services these finance receivables, originated solely in the state of Arizona,
for one client.
(5) INVESTMENTS HELD IN TRUST (UNAUDITED)
In connection with its securitization, the Company is required to make an
initial cash deposit into an account held by the trustee (spread account) and to
pledge this cash to the trust to which the finance receivables were sold. The
trust in turn invests the cash in high quality liquid investment securities. In
addition, the Company (through the trustee) deposits additional cash flows from
the residual to the spread account as necessary to attain and maintain the
spread account at a specified percentage of the underlying finance receivables
principal balance.
In the event that the cash flows generated by the finance receivables sold
to the trust are insufficient to pay obligations of the trust, including
principal or interest due to certificate holders or expenses of the trust, the
trustee will draw funds from the spread account as necessary to pay the
obligations of the trust. The spread account must be maintained at a specified
percentage of the principal balance of the finance receivables held by the
trust, which can be increased in the event delinquencies or losses exceed
specified levels. If the spread account exceeds the specified percentage, the
trustee will release the excess cash to the Company from the pledged spread
account. Except for releases in this manner, the cash in the spread account is
restricted from use by the Company. Investments Held in Trust, which are funds
deposited in an interest-bearing, money market account, totaled $624,770
(unaudited) at March 31, 1996.
(6) NOTE RECEIVABLE
In January 1996, the Company sold the land and improvements of one of its
used car dealerships to an unrelated party. In connection with the sale, the
Company received a note receivable totaling $1,200,000. The note calls for
monthly principal payments of $12,500 plus interest at the prime rate plus 1%
through January 2001, at which time the Company is scheduled to receive a
balloon payment of $450,000 plus any accrued but unpaid interest. The note is
secured by a first deed of trust on the related land and improvements. The
balance on this note receivable totaled $1,175,000 (unaudited) at March 31,
1996.
F-13
<PAGE> 74
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(7) PROPERTY AND EQUIPMENT
A summary of property and equipment as of December 31, 1994 and 1995 and
March 31, 1996 (unaudited) follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- MARCH 31,
1994 1995 1996
---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Buildings and Leasehold Improvements
(note 16).................................. $4,139,230 $ 5,142,551 $ 5,198,877
Furniture and Equipment (note 10)............ 1,766,984 3,401,111 3,731,232
Vehicles..................................... 114,941 133,258 133,258
Software Development Costs................... 439,909 532,884 550,601
Land......................................... 15,524 15,524 15,524
Construction in Process...................... 69,852 10,748 11,975
---------- ----------- -----------
6,546,440 9,236,076 9,641,467
Less Accumulated Depreciation and
Amortization............................... (571,861) (1,438,921) (1,741,279)
---------- ----------- -----------
Property and Equipment, Net.................. $5,974,579 $ 7,797,155 $ 7,900,188
========== =========== ===========
</TABLE>
There was no interest expense capitalized during 1993 due to immateriality.
Interest Expense capitalized in 1994, 1995 and in the period ending March 31,
1996 totaled $142,324, $54,475, and zero (unaudited), respectively.
(8) COVENANTS NOT TO COMPETE AND TRADEMARKS
A summary of covenants not to compete as of December 31, 1994 and 1995 and
March 31, 1996 (unaudited) follows:
<TABLE>
<CAPTION>
ORIGINAL ACCUMULATED NET
COST AMORTIZATION COVENANTS
---------- ----------- ---------
<S> <C> <C> <C>
December 31, 1994:
Original Date
January 1992.................................. $ 716,373 $ 557,179 $ 159,194
December 1992................................. 411,112 274,075 137,037
---------- ---------- --------
$1,127,485 $ 831,254 $ 296,231
========== ========== ========
December 31, 1995 and March 31, 1996
(unaudited):
Original Date
January 1992.................................. $ 716,373 $ 716,373 $ --
December 1992................................. 411,112 411,112 --
---------- ---------- --------
$1,127,485 $ 1,127,485 $ --
========== ========== ========
</TABLE>
Amortization Expense relating to the covenants not to compete for the years
ended December 31, 1993, 1994, and 1995 totaled $365,911, $296,232, and
$296,231. The covenants were fully amortized as of December 31, 1995.
F-14
<PAGE> 75
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of trademarks as of December 31, 1994 and 1995 and March 31, 1996
(unaudited) follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- MARCH 31,
1994 1995 1996
--------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Original Cost......................... $ 580,855 $ 580,855 $ 580,855
Accumulated Amortization.............. (248,231) (311,609) (327,453)
--------- --------- ---------
Trademarks, Net..................... $ 332,624 $ 269,246 $ 253,402
========= ========= =========
</TABLE>
Amortization Expense relating to trademarks for the years ended December
31, 1993, 1994, 1995 and the periods ended March 31, 1995 and 1996 totaled
$63,378, $63,378, $63,378, $15,884 (unaudited) and $15,844 (unaudited),
respectively.
(9) ACCRUED EXPENSES AND OTHER LIABILITIES
A summary of accrued expenses as of December 31, 1994 and 1995 and March
31, 1996 (unaudited) follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- MARCH 31,
1994 1995 1996
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Sales Taxes.............................. $ 500,826 $2,257,780 $ 2,304,171
Accrued Payroll and Payroll Taxes........ 347,288 510,047 481,603
Accrued Promotions....................... 67,692 220,000 160,000
Deferred Revenue......................... 15,339 157,130 143,933
Provision for Loss on Disposal of
Property and Equipment.................. -- 120,000 --
Accrued Property Taxes................... 78,952 132,593 148,809
Accrued Rent Payable..................... 63,142 100,805 326,437
Accrued Professional Fees................ 65,000 85,000 204,200
Amounts Collected on Behalf of Others.... -- -- 118,626
Post-sale Customer Support Programs...... -- 450,000 550,000
Others................................... 242,391 540,779 496,627
---------- --------- ---------
$1,380,630 $4,574,134 $ 4,934,406
========== ========= =========
</TABLE>
In connection with the retail sale of vehicles, the Company is required to
pay sales taxes to certain government jurisdictions. The Company has elected to
pay these taxes using the "cash basis", which requires the Company to pay the
sales tax obligation for a sale transaction over the life of the receivable
contract.
(10) OBLIGATIONS UNDER CAPITAL LEASES
During the years ended December 31, 1994 and 1995, the Company acquired
certain equipment under lease agreements which expire through 2000. These leases
meet various criteria of a capital lease and are, therefore, classified as
obligations under capital leases. The cost of the equipment was $399,055 in 1994
and $792,274 in 1995. The total cost of equipment under capital leases totaled
$1,191,329 at December 31, 1995 and at March 31, 1996 (unaudited) and is
included in property and equipment (note 7). Accumulated depreciation totaled
$229,097 at December 31, 1995 and $304,081 (unaudited) at March 31, 1996.
Amortization expense related to these capital leases is included in depreciation
and amortization on the accompanying Consolidated Statements of Operations.
F-15
<PAGE> 76
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the present value of future minimum capital lease payments
after December 31, 1995 follows:
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1995 1996
------------ -----------
(UNAUDITED)
<S> <C> <C>
1996............................................. $ 366,328 $ 366,328
1997............................................. 366,328 366,328
1998............................................. 290,627 242,395
1999............................................. 112,491 86,124
2000............................................. 33,967 16,985
------------ -----------
Total Minimum Lease Payments.......................... 1,169,741 1,078,160
Less Amount Representing Interest
(ranging from approximately 10% to 12%).............. (186,987) (161,803)
------------ -----------
Present Value of Net Minimum Capital Lease Payments... $ 982,754 $ 916,357
============ ===========
</TABLE>
(11) NOTE PAYABLE
In October 1995, the Company amended its loan agreement for a revolving
loan with a finance company. The note calls for interest payable daily at an
annual rate of 30 day LIBOR (5.83% at December 31, 1995) plus 4.25%. The note is
secured by certain assets of the Company, and the personal guarantee of the
Company's President. As of December 31, 1995, the note had a maximum commitment
of $50,000,000 through September 1997, at which time the Company retains the
right to extend the loan for one additional year. The Company had borrowed
$9,942,147, $32,201,329 and $31,839,050 (unaudited) under this loan as of
December 31, 1994, 1995 and March 31, 1996, respectively.
The loan agreement contains various reporting and performance covenants,
including the maintenance of certain ratios and limitations on additional
borrowings from other sources. The Company was in compliance with the covenants
at December 31, 1994 and 1995 and at March 31, 1996 (unaudited).
Interest expense related to this note payable totaled $439,137 and
$2,232,282 for the years ended December 31, 1994 and 1995, respectively, and
$886,780 (unaudited) for the period ended March 31, 1996.
(12) CONVERTIBLE NOTE PAYABLE
In August 1995, the Company executed a $3,000,000 convertible note with an
insurance company. The note calls for interest payable quarterly at an annual
rate of 12.5% and is scheduled to mature in June 1998. The note is secured by a
pledge of 100% of the common stock owned by the Company's President, and the
guarantee of Verde. The note is subordinate to the aforementioned revolving
loan. The Company had borrowed $3,000,000 related to this note as of December
31, 1995 and at March 31, 1996 (unaudited).
Pursuant to the terms of the related loan agreement, the insurance company
retains the right to convert the loan to common stock in the Company at any time
prior to repayment of the loan balance should the Company have previously
completed an initial public offering (IPO) of its common stock. The loan balance
may be converted at a price equal to the price paid per share of common stock in
the IPO.
The loan agreement contains various reporting and performance covenants
including the maintenance of certain ratios and limitations on additional
borrowings from other sources. The Company was in compliance with the covenants
at December 31, 1995 and at March 31, 1996 (unaudited).
Interest expense related to this convertible note payable totaled zero and
$140,855 for the years ended December 31, 1994 and 1995, respectively, and
$105,641 (unaudited) for the period ended March 31, 1996.
F-16
<PAGE> 77
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(13) SUBORDINATED NOTES PAYABLE
The Company has executed three subordinated notes payable with Verde. As
discussed in the following paragraphs, the balance outstanding under these notes
totaled $18,290,916, $14,552,804 and $14,000,000 (unaudited) at December 31,
1994, 1995 and March 31, 1996, respectively. There was no accrued interest
payable related to these notes payable at December 31, 1994, 1995, and at March
31, 1996 (unaudited).
In August 1993, the Company entered into a ten-year, subordinated note
payable agreement with Verde. This unsecured $15,000,000 note bears interest at
an annual rate of 18%, with interest payable monthly and is subordinated to all
other Company liabilities. The note also provides for suspension of interest
payments should the Company be in default with any other creditors. Through
December 31, 1997, the note bears a prepayment penalty of 20% of the then
outstanding principal balance. The prepayment penalty percentage decreases to
15% beginning January 1, 1998, and decreases 5% per year each year thereafter,
with no prepayment penalty beginning January 1, 2001. The Company has
$15,000,000 and $10,000,000 outstanding related to this note payable at December
31, 1994 and 1995, respectively and $10,000,000 (unaudited) at March 31, 1996.
In September 1994, the Company entered into a nine-year, senior
subordinated note payable agreement with Verde. This $2,000,000 note is senior
to and contains terms identical to the aforementioned subordinated note payable.
The Company had $2,000,000 outstanding related to this note payable at December
31, 1994. In 1995, Verde agreed to waive any prepayment penalty associated with
the payment of the note, and the note was paid in full.
In December 1995, the Company amended its five-year junior subordinated
revolving note payable agreement with Verde. The note was increased from
$3,000,000 to $5,000,000, bears interest at an annual rate of 18%, with interest
payable monthly, and is scheduled to mature in December 1999. The note, which
may be prepaid without penalty, provides for suspension of interest payments in
the event the Company is in default with any other creditors. The Company has
$1,290,916 and $4,552,804 outstanding related to this note payable at December
31, 1994 and 1995, respectively and $4,000,000 (unaudited) at March 31, 1996.
Unused amounts related to this revolving note payable totaled $1,709,084 and
$447,196 at December 31, 1994 and 1995, respectively and $1,000,000 (unaudited)
at March 31, 1996.
Interest expense related to these notes totaled $677,625, $2,568,738,
$3,491,673 and $631,383 (unaudited) for the years ended December 31, 1993, 1994,
1995, and the period ended March 31, 1996, respectively.
On December 31, 1995, Verde converted $10,000,000 of subordinated notes
payable to preferred stock (note 17) of the Company. Verde agreed to waive any
prepayment penalties associated with the reduction of the subordinated notes
payable in connection with the conversion.
(14) INCOME TAXES
Income tax expense (benefit) amounted to $30,000, ($333,626), zero and zero
(unaudited) for the years ended December 31, 1993, 1994, and 1995 and the period
ended March 31, 1996, respectively (an effective
F-17
<PAGE> 78
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
tax rate of 4.1%, 14.5%, 0% and 0% (unaudited), respectively). A reconciliation
between taxes computed at the federal statutory rate of 34% and at the effective
tax rate on income (loss) before income taxes follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------- MARCH 31,
1993 1994 1995 1996
--------- --------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Computed "Expected" Tax Expense
(Benefit)....................... $ 247,718 $(782,345) $(1,350,329) $ 362,357
State Income Taxes, Net of Federal
Effect.......................... 3,960 (125,442) (216,513) 58,101
Change in Valuation Allowance..... (191,000) 897,000 1,418,000 (682,000)
Others, Net....................... (30,678) (322,839) 148,842 261,542
--------- --------- ----------- ---------
$ 30,000 $(333,626) $ -- $ --
========= ========= =========== =========
</TABLE>
Components of income tax expense (benefit) for the years ended December 31,
1993, 1994, and 1995 and the period ended March 31, 1996 (unaudited) follow:
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
--------- --------- ---------
<S> <C> <C> <C>
1993:
Federal............................. $ 741,000 $(717,000) $ 24,000
State............................... 202,000 (196,000) 6,000
--------- --------- ---------
$ 943,000 $(913,000) $ 30,000
========= ========= =========
1994:
Federal............................. $ 79,422 $(367,000) $(287,578)
State............................... 47,952 (94,000) (46,048)
--------- --------- ---------
$ 127,374 $(461,000) $(333,626)
========= ========= =========
1995:
Federal............................. $(449,000) $ 449,000 $ --
State............................... -- -- --
--------- --------- ---------
$(449,000) $ 449,000 $ --
========= ========= =========
March 31, 1996 (unaudited):
Federal............................. $ -- $ (30,000) $ (30,000)
State............................... -- 30,000 30,000
--------- --------- ---------
$ -- $ -- $ --
========= ========= =========
</TABLE>
F-18
<PAGE> 79
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1994 and 1995 and as of March 31, 1996 (unaudited) are presented below:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------- MARCH 31,
1994 1995 1996
---------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Deferred tax assets:
Finance Receivables, Principally Due to the
Allowance for Credit Losses............. $2,387,000 $ 2,987,000 $ 2,463,000
Acquisition Discount....................... -- 95,000 --
Federal and State Income Tax Net Operating
Loss Carryforward....................... 197,000 317,000 257,000
Accrued Vacation Benefits.................. 43,000 67,000 67,000
Accrued Post-Sale Liabilities.............. -- 194,000 309,000
Property and Equipment, Principally Due
to Depreciation......................... 15,000 87,000 90,000
---------- ----------- -----------
Total Gross Deferred Tax Assets............ 2,642,000 3,747,000 3,186,000
Less: Valuation Allowance.................. (897,000) (2,315,000) (1,633,000)
---------- ----------- -----------
Net Deferred Tax Assets................. 1,745,000 1,432,000 1,553,000
---------- ----------- -----------
Deferred Tax Liabilities:
Acquisition Discount....................... -- -- (153,000)
Covenant Not to Compete, Principally Due
to Amortization......................... (63,000) -- --
Software Development Costs................. (83,000) (96,000) (137,000)
Loan Origination Fees...................... -- (198,000) (143,000)
Basis Adjustment Related to the Acquisition
of CFS.................................. (32,000) -- --
Inventory, Principally Related to
Repossessed Vehicles.................... (193,000) (213,000) (195,000)
---------- ----------- -----------
Total Gross Deferred Tax Liabilities.... (371,000) (507,000) (628,000)
---------- ----------- -----------
Net Deferred Tax Asset............. $1,374,000 $ 925,000 $ 925,000
========= ========== ==========
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1994 and
1995 was $897,000 and $2,315,000, respectively and $1,633,000 (unaudited) at
March 31, 1996. The net change in the total valuation allowance for the years
ended December 31, 1994 and 1995 was an increase of $897,000 and $1,418,000,
respectively and a decrease of $682,000 (unaudited) for the period ended March
31, 1996. In assessing the realizability of deferred tax assets, management
considers whether it is more likely than not that some portion or all of the
deferred tax assets will not be realized. The ultimate realization of deferred
tax assets is dependent upon generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of deferred tax liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projections for future taxable
income over the periods in which the deferred tax assets are deductible,
management believes it is more likely than not that the Company will realize the
benefits of these deductible differences, net of the existing valuation
allowance at March 31, 1996.
At December 31, 1995, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $632,000, which, subject to annual
limitations, are available to offset future taxable income, if any, through 2006
and net operating loss carryforwards for state income tax purposes of
$1,464,000, which are available to offset future taxable income through 2000.
F-19
<PAGE> 80
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At March 31, 1996, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $633,000 (unaudited), which,
subject to annual limitations, are available to offset future taxable income, if
any, through 2006 and net operating loss carryforwards for state income tax
purposes of $1,887,000 (unaudited), which are available to offset future taxable
income through 2000.
(15) RENTAL CAR FRANCHISING ACTIVITY
The Company sold twenty-nine and four additional franchises and recognized
initial franchise fee revenue totaling $148,358 and $17,711 during 1993 and
1994, respectively. No rental car franchises were sold during the year ended
December 31, 1995 or the period ended March 31, 1996 (unaudited). Additionally,
ongoing rental Franchise Fees from franchises average 6% of the franchisees'
gross revenue and totaled $408,344, $404,083 and $299,062 for the years ended
December 31, 1993, 1994, and 1995, respectively. Franchise fees totaled $58,424
(unaudited) for the period ended March 31, 1996.
The Company terminated agreements with twenty-four, fifty, twenty-eight and
five (unaudited) franchisees during the years ended December 31, 1993, 1994, and
1995 and the period ended March 31, 1996, respectively. Costs associated with
these terminations are not material. As of March 31, 1996, the Company retains
agreements with approximately forty-nine (unaudited) franchises with the related
agreements extending over periods ranging from five to ten years.
(16) LEASE COMMITMENTS
As of December 31, 1995, the Company leases seven car lots, a vehicle
reconditioning center, and two office buildings from Verde under operating
leases, with one lease expiring July 1998, and the remaining leases expiring
December 2008. Verde's leases with the Company require base monthly rent
payments aggregating approximately $123,000, contain provisions for additional
contingent rents, and have renewal options for periods ranging from one to ten
years. The Company is also responsible for occupancy and maintenance costs,
including real estate taxes, insurance, and utilities. The leases contain rent
escalation provisions where annual rents will increase with the increase in the
Consumer Price Index. In connection with these leases, the Company has paid
security deposits to Verde totaling $334,000 and $364,000 and $364,000
(unaudited) which are included in Other Assets in the accompanying Consolidated
Balance Sheets as of December 31, 1994, 1995 and March 31, 1996 (unaudited),
respectively.
As of March 31, 1996 (unaudited), the Company leases an additional
operating facility and fourteen offices from unrelated entities under operating
leases which expire through April 2000. The leases require monthly rental
payments aggregating approximately $37,000 and contain various renewal options
from one to ten years. The Company is also responsible for occupancy and
maintenance costs, including real estate taxes, insurance, and utility costs.
As of March 31, 1996 (unaudited), the Company leases a vehicle, and certain
office equipment from unrelated entities under operating leases which expire
through September 1998. The leases require monthly rental payments aggregating
approximately $5,600.
Rent expense for the year ended December 31, 1993 totaled $488,400, of
which $235,000 was paid to Verde. There were no contingent rents paid in 1993.
Rent expense for the year ended December 31, 1994 totaled $1,399,851. Rents
paid to Verde totaled $1,220,703, including contingent rents of $310,102, and
$127,000 of rent capitalized during the construction period of two used car
dealership facilities. Accrued rent payable to Verde totaled $63,142 at December
31, 1994 and is included in Accrued Expenses on the accompanying Consolidated
Balance Sheets.
Rent expense for the year ended December 31, 1995 totaled $2,376,802. Rents
paid to Verde totaled $1,889,007, including contingent rents of $465,000, and
$112,943 of rent capitalized during the construction period of a facility.
Accrued rent payable to Verde totaled $100,805 at December 31, 1995 and is
included in Accrued Expenses on the accompanying Consolidated Balance Sheets.
F-20
<PAGE> 81
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Rent expense for the period ended March 31, 1996 totaled $736,008
(unaudited). Rents paid to Verde totaled $582,244 (unaudited) including
contingent rents of $241,632 (unaudited). Accrued rent payable to Verde totaled
$326,437 (unaudited) at March 31, 1996 and is included in Accrued Expenses on
the accompanying Consolidated Balance Sheets.
A summary of future minimum lease payments required under noncancelable
operating leases with remaining lease terms in excess of one year as of March
31, 1996 (unaudited) follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1995 MARCH 31, 1996 (UNAUDITED)
---------------------------------------- -----------------------------------------
UNRELATED RELATED PARTY UNRELATED RELATED PARTY
PARTIES LEASES TOTAL PARTIES LEASES TOTAL
---------- ------------- ----------- ---------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C>
1996.......... $ 487,832 $ 1,245,254 $ 1,733,086 $ 476,239 $ 1,254,719 $1,730,958
1997.......... 481,827 1,217,532 1,699,359 478,322 1,251,558 1,729,880
1998.......... 320,222 1,140,526 1,460,748 280,936 1,125,138 1,406,074
1999.......... 181,026 1,032,717 1,213,743 156,952 1,061,928 1,218,880
2000.......... 48,162 1,032,717 1,080,879 21,220 1,061,928 1,083,148
Thereafter.... -- 8,261,734 8,261,734 -- 8,229,942 8,229,942
----------- ---------- ------------ ----------- ------------ ------------
$1,519,069 $ 13,930,480 $15,449,549 $1,413,669 $ 13,985,213 $15,398,882
=========== ========== ============ =========== ============ ============
</TABLE>
(17) STOCKHOLDERS' EQUITY
On January 1, 1994, the Company had a 4,000-for-1 stock split with the
1,000 shares of common stock outstanding on December 31, 1993 being exchanged
for 4,000,000 shares. There were no changes in the stock's par value (no par) or
the 10,000,000 shares authorized. Further, as described in Note 23, on April 24,
1996, the Company effectuated a 1.16-to-1 common stock split. The effect of
these stock splits have been reflected in the Consolidated Financial Statements.
In February 1994, the Company issued 174,000 shares of common stock in
connection with the purchase of CFS. The common stock was recorded at $15,000,
which in the opinion of management approximated the fair market value of the
stock on the date of issuance.
In May 1994, the Company issued 707,600 shares of common stock to employees
for $61,000 in cash, which in the opinion of management approximated the fair
market value of the stock on the date of issuance.
In March 1995, the Company issued 58,000 shares of common stock to an
employee for $5,000 in cash. The Company recorded compensation expense of
$45,000 in 1995 related to this sale of common stock.
On June 30, 1995, the Company adopted a long-term incentive plan (stock
option plan). The stock option plan, as amended, set aside 800,000 shares of
common stock to be granted to employees at a price not less than fair market
value of the stock at the date of grant. Options are to vest over a period to be
determined by the Board of Directors upon grant and will generally expire ten
years after the date of grant. Concurrent with the adoption of the stock option
plan, the Company granted options to certain employees to purchase a total of
294,060 shares of common stock. The options generally vest over a period of five
years.
F-21
<PAGE> 82
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the aforementioned stock plan follows:
<TABLE>
<CAPTION>
PRICE PER SHARE
-------------------------
WEIGHTED
NUMBER RANGE AVERAGE
------- ------------ --------
<S> <C> <C> <C>
Balance, December 31,1994........................ -- -- --
Granted.......................................... 458,780 $0.86 - 2.59 $ 1.72
Forfeited........................................ (17,400) 2.16 - 2.16 2.16
Exercised........................................ -- -- --
------- ------------ -----
Balance, December 31,1995........................ 441,380 $0.86 - 2.59 $ 1.70
------- ------------ -----
Granted.......................................... 2,900 $3.45 - 3.45 3.45
Forfeited........................................ (1,160) 2.59 - 2.59 2.59
Exercised........................................ -- -- --
------- ------------ -----
Balance, March 31,1996 (unaudited)............... 443,120 $0.86 - 3.45 $ 1.70
======= ============ =====
</TABLE>
There were 32,480 shares subject to unexercised options that were
exercisable as of March 31, 1996 (unaudited).
The Company's stockholders have executed a stockholder agreement
(agreement) which places certain restrictions on the sale of the Company's
common stock by the stockholders. The Company retains a right of first refusal
to purchase the common stock from any selling stockholder. The agreement defines
procedures to be followed in the event a stockholder wishes to sell their stock
and the method for determining the selling price and payment term. The agreement
terminates upon the closing of the Company's anticipated public offering (note
23).
On December 31, 1995, the Company exchanged 1,000,000 shares of Series A
preferred stock for $10,000,000 of subordinated notes payable with Verde. The
preferred stock is redeemable at any time at the option of the Company.
Cumulative dividends are initially payable at a rate of 12% per annum increasing
one-percent each year through 2002 at which point they reach their maximum rate
of 18% per annum. The dividends are payable quarterly upon declaration by the
Company's Board of Directors. In the event that dividends are not declared or
paid, the Company is restricted from issuing dividends on common stock, and from
purchasing outstanding common stock, except as required by the Company's
stockholder agreement, until all undeclared and unpaid dividends have been
declared and paid. Further, in the event that dividends have not been declared
and paid for an entire calendar year, the Series A stockholders shall be
entitled to vote in the election of the Company's Board of Directors with each
share of Series A preferred stock equivalent to ten shares of common stock.
Additionally, in the event of liquidation, the holders of Series A preferred
stock shall be entitled to receive, prior and in preference to any distribution
of any of the assets of the Company, an amount equal to the issuance price paid
for each share plus all dividends due and unpaid.
On March 31, 1996, the Company's Board of Directors declared a quarterly
dividend of $300,000 (unaudited) which was paid in full on that date. There were
no cumulative unpaid dividends at March 31, 1996 (unaudited).
(18) COMMITMENTS AND CONTINGENCIES
The Company has executed an agreement to sell up to $50,000,000 in
receivable backed certificates through December 31, 1996 to an insurance
company. In addition, the purchaser has the right of first refusal to purchase
up to an additional $125,000,000 of finance receivables through December 31,
1998. The Company completed the sale of $10 million (unaudited) in receivable
backed certificates during the first fiscal quarter of 1996.
F-22
<PAGE> 83
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company is involved in various claims and actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a materially adverse effect on the
Company's financial position.
(19) PENSION PLAN
During 1995, the Company established a qualified 401(k) retirement plan
(defined contribution plan) which became effective on October 1, 1995. The plan
covers substantially all employees having no less than one year of service, have
attained the age of 21, and work at least 1,000 hours per year. Participants may
voluntarily contribute to the plan up to the maximum limits established by
Internal Revenue Service regulations. The Company will match 10% of the
participants' contributions. Participants are immediately vested in the amount
of their direct contributions and vest over a five-year period, as defined by
the plan, with respect to the Company's contribution. Pension expense totaled
$5,282 and $7,576 (unaudited) during the year ended December 31, 1995 and the
period ended March 31, 1996, respectively.
(20) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires that the Company disclose
estimated fair values for its financial instruments. The following summary
presents a description of the methodologies and assumptions used to determine
such amounts.
Limitations
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve uncertainties, matters of judgment and,
therefore, cannot be determined with precision. These estimates do not reflect
any premium or discount that could result from offering for sale at one time the
Company's entire holdings of a particular instrument. Changes in assumptions
could significantly affect these estimates.
Since the fair value is estimated as of December 31, 1995, the amounts that
will actually be realized or paid in settlement of the instruments could be
significantly different.
Cash and Cash Equivalents and Investments Held in Trust
The carrying amount is assumed to be the fair value because of the
liquidity of these instruments.
Finance Receivables, Net
The carrying amount is assumed to be the fair value because of the short
maturity of the portfolio due to paydown and charge-offs.
Accounts Payable, Accrued Expenses, and Note Payable
The carrying amount approximates fair value because of the short maturity
of these instruments.
Convertible Note Payable and Subordinated Notes Payable
The terms of the Company's convertible note payable and subordinated notes
payable approximate the terms in the market place at which they could be
replaced. Therefore, the fair value approximates the carrying value of these
financial instruments.
(21) BUSINESS SEGMENTS
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended December 31, 1993, 1994,
and 1995. Total revenue by business segment includes sales of vehicles, finance
income and other income as reported in the Company's Consolidated Financial
Statements. Operating profit is total revenue less cost of sales, where
appropriate, and other
F-23
<PAGE> 84
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operating expenses. In computing operating profit by business segment, the
following items were considered in the Corporate and Other category: portions of
administrative expenses, interest expense and other items not considered direct
operating expenses. Identifiable assets by business segment are those assets
used in each segment of Company operations.
<TABLE>
<CAPTION>
CORPORATE
COMPANY THIRD AND
DEALERSHIPS PARTY OTHER TOTAL
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
December 31, 1993:
Total Revenue....................... $15,597,915 $ -- $ 878,663 $16,476,578
=========== =========== ========== ===========
Cost of Sales....................... $ 6,089,098 $ -- $ -- $ 6,089,093
=========== =========== ========== ===========
Provision for Credit Losses......... $ 3,291,620 $ -- $ -- $ 3,291,620
=========== =========== ========== ===========
Selling and Marketing............... $ 880,460 $ -- $ 412,313 $ 1,292,773
General and Administrative.......... 2,699,638 -- 860,888 3,560,526
Depreciation and Amortization....... 186,353 -- 4,958 191,311
Amortization of Covenants........... -- -- 365,911 365,911
----------- ----------- ---------- -----------
Operating Expenses.................. $ 3,766,451 $ -- $ 1,644,070 $ 5,410,521
=========== =========== ========== ===========
Operating Income (Loss)............. $ 2,450,752 $ -- $ (765,408) $ 1,685,344
=========== =========== ========== ===========
Capital Expenditures................ $ 216,645 $ -- $ 54,056 $ 270,701
=========== =========== ========== ===========
Identifiable Assets................. $10,070,055 $ -- $ 1,866,293 $11,936,348
=========== =========== ========== ===========
December 31, 1994:
Total Revenue....................... $32,507,443 $ 709,710 $ 556,509 $33,773,662
=========== =========== ========== ===========
Cost of Sales....................... $12,577,696 $ -- $ -- $12,577,696
=========== =========== ========== ===========
Provision for Credit Losses......... $ 8,023,576 $ 116,215 $ -- $ 8,139,791
=========== =========== ========== ===========
Selling and Marketing............... $ 2,262,990 $ -- $ 139,008 $ 2,401,998
General and Administrative.......... 6,529,991 239,981 2,200,951 8,970,923
Depreciation and Amortization....... 290,239 64,309 126,604 481,152
Amortization of Covenants........... -- -- 296,232 296,232
----------- ----------- ---------- -----------
Operating Expenses.................. $ 9,083,220 $ 304,290 $ 2,762,795 $12,150,305
=========== =========== ========== ===========
Operating Income (Loss)............. $ 2,822,950 $ 289,205 $(2,206,286) $ 905,870
=========== =========== ========== ===========
Capital Expenditures................ $ 4,662,055 $ 301,728 $ 370,014 $ 5,333,797
=========== =========== ========== ===========
Identifiable Assets................. $25,551,669 $ 1,558,086 $ 2,600,970 $29,710,725
=========== =========== ========== ===========
</TABLE>
F-24
<PAGE> 85
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
CORPORATE
COMPANY THIRD AND
DEALERSHIPS PARTY OTHER TOTAL
----------- ----------- ---------- -----------
<S> <C> <C> <C> <C>
December 31, 1995:
Total Revenue....................... $56,051,434 $ 1,844,577 $ 307,741 $58,203,752
=========== =========== ========== ===========
Cost of Sales....................... $27,964,258 $ -- $ -- $27,964,258
=========== =========== ========== ===========
Provision for Credit Losses......... $ 8,359,585 $ -- $ -- $ 8,359,585
=========== =========== ========== ===========
Selling and Marketing............... $ 3,855,771 $ -- $ -- $ 3,855,771
General and Administrative.......... 10,594,519 1,162,449 2,672,957 14,429,925
Depreciation and Amortization....... 758,054 89,304 170,689 1,018,047
Amortization of Covenants........... -- -- 296,231 296,231
----------- ----------- ---------- -----------
Operating Expenses.................. $15,208,344 $ 1,251,753 $ 3,139,877 $19,599,974
=========== =========== ========== ===========
Operating Income (Loss)............. $ 4,519,247 $ 592,824 $(2,832,136) $ 2,279,935
=========== =========== ========== ===========
Capital Expenditures................ $ 2,756,474 $ 215,539 $ 222,759 $ 3,194,772
=========== =========== ========== ===========
Identifiable Assets................. $43,638,872 $13,419,461 $ 3,731,888 $60,790,221
=========== =========== ========== ===========
March 31, 1995 (unaudited):
Total Revenue....................... $11,247,550 $ 216,723 $ 82,111 $15,546,384
=========== =========== ========== ===========
Cost of Sales....................... $ 4,857,746 $ -- $ -- $ 4,857,746
=========== =========== ========== ===========
Provision for Credit Losses......... $ 2,060,271 $ -- $ -- $ 2,060,271
=========== =========== ========== ===========
Selling and Marketing............... $ 750,630 $ -- $ -- $ 750,630
General and Administrative.......... 2,256,480 90,606 588,120 2,935,206
Depreciation and Amortization....... 134,680 18,319 33,520 186,519
Amortization of Covenants........... -- -- 74,058 74,058
----------- ----------- ---------- -----------
Operating Expenses.................. $ 3,141,790 $ 108,925 $ 695,698 $ 3,946,413
=========== =========== ========== ===========
Operating Income (Loss)............. $ 1,187,743 $ 107,798 $ (613,587) $ 681,954
=========== =========== ========== ===========
Capital Expenditures................ $ 897,796 $ -- $ 3,828 $ 901,624
=========== =========== ========== ===========
Identifiable Assets................. $28,860,621 $ 1,835,509 $ 3,025,553 $33,721,683
=========== =========== ========== ===========
March 31, 1996 (unaudited):
Total Revenue....................... $18,267,508 $ 1,068,695 $ 60,099 $19,396,302
=========== =========== ========== ===========
Cost of Sales....................... $ 8,347,707 $ -- $ -- $ 8,347,707
=========== =========== ========== ===========
Provision for Credit Losses......... $ 2,606,112 $ -- $ -- $ 2,606,112
=========== =========== ========== ===========
Selling and Marketing............... $ 1,041,004 $ -- $ -- $ 1,041,004
General and Administrative.......... 2,895,247 560,157 866,041 4,321,445
Depreciation and Amortization....... 250,774 33,542 47,298 331,614
Amortization of Covenants........... -- -- -- --
----------- ----------- ---------- -----------
Operating Expenses.................. $ 4,187,025 $ 593,699 $ 913,339 $ 5,694,063
=========== =========== ========== ===========
Operating Income (Loss)............. $ 3,126,664 $ 474,996 $ (853,240) $ 2,748,420
=========== =========== ========== ===========
Capital Expenditures................ $ 375,116 $ 89,238 $ 68,428 $ 532,782
=========== =========== ========== ===========
Identifiable Assets................. $41,392,533 $17,425,382 $ 2,841,483 $61,659,398
=========== =========== ========== ===========
</TABLE>
F-25
<PAGE> 86
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(22) QUARTERLY FINANCIAL DATA -- UNAUDITED
A summary of the quarterly data for the years ended December 31, 1994 and
1995 follows:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS OF DOLLARS)
<S> <C> <C> <C> <C>
1994:
Total Revenues............................ $ 8,378 $ 8,128 $ 8,956 $ 8,312
======= ======= ======= =======
Income before Operating Expenses.......... $ 3,411 $ 3,410 $ 2,961 $ 3,274
======= ======= ======= =======
Operating Expenses........................ $ 2,225 $ 2,759 $ 3,410 $ 3,756
======= ======= ======= =======
Operating Income.......................... $ 1,186 $ 651 $ (449) $ (482)
======= ======= ======= =======
Net Earnings (Loss)....................... $ 679 $ (58) $(1,485) $(1,103)
======= ======= ======= =======
1995:
Total Revenues............................ $11,546 $14,975 $16,944 $14,739
======= ======= ======= =======
Income before Operating Expenses.......... $ 4,628 $ 5,601 $ 5,858 $ 5,793
======= ======= ======= =======
Operating Expenses........................ $ 3,946 $ 4,614 $ 5,359 $ 5,682
======= ======= ======= =======
Operating Income.......................... $ 682 $ 987 $ 500 $ 111
======= ======= ======= =======
Net Loss.................................. $ (465) $ (283) $(1,169) $(2,055)
======= ======= ======= =======
</TABLE>
(23) PUBLIC OFFERING
On April 24, 1996, the Company reincorporated from Arizona to Delaware by
way of a merger in which the Company, an Arizona corporation, merged with and
into a newly created Delaware subsidiary of the Company. In the merger, each
share of the Arizona corporation's issued and outstanding common stock was
exchanged for 1.16 shares of the Delaware corporation's common stock and each
option to purchase shares of the Arizona corporation's common stock was
exchanged for 1.16 options to purchase shares of the Delaware corporation's
common stock. All share and per share information in these Consolidated
Financial Statements have been adjusted to give effect to the terms of the
reincorporation.
Contingent upon closing of the public offering, Verde has agreed to lower
the interest rate on its subordinated debt, lower the dividend rate on its
preferred stock and agreed to sell certain property owned by it to the Company,
and, pending such sale, to lower the rental rates on properties leased to the
Company. In addition, the party holding the $3,000,000 convertible note has
agreed to convert the note to common stock at the initial public offering price.
F-26
<PAGE> 87
======================================================
NO DEALER, SALESPERSON, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY, ANY OF THE UNDERWRITERS, OR ANY OTHER
PERSON. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE
INFORMATION CONTAINED HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE
HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF ANY SECURITIES OTHER
THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A SOLICITATION OF AN
OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN OFFER OR
SOLICITATION WOULD BE UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary......................... 3
Risk Factors............................... 8
The Company................................ 13
Use of Proceeds............................ 13
Dividend Policy............................ 14
Recapitalization and Related
Transactions............................. 14
Capitalization............................. 15
Dilution................................... 16
Selected Consolidated Financial Data....... 17
Management's Discussion and Analysis of
Financial Condition and Results of
Operations............................... 20
Business................................... 35
Management................................. 46
Principal Stockholders..................... 52
Certain Relationships and Related
Transactions............................. 53
Description of Capital Stock............... 54
Shares Eligible for Future Sale............ 57
Underwriting............................... 58
Legal Matters.............................. 59
Experts.................................... 59
Additional Information..................... 60
Index to Consolidated Financial
Statements............................... F-1
Report of Independent Auditors............. F-2
Consolidated Financial Statements.......... F-3
</TABLE>
------------------------
UNTIL JULY 12, 1996 (25 CALENDAR DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING
IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY
REQUIREMENT IS IN ADDITION TO THE OBLIGATIONS OF THE DEALERS TO DELIVER A
PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR ALLOTMENTS OR
SUBSCRIPTIONS.
======================================================
======================================================
2,300,000 Shares
LOGO
Common Stock
-----------------------
PROSPECTUS
-----------------------
CRUTTENDEN ROTH
INCORPORATED
June 17, 1996
======================================================
<PAGE> 88
APPENDIX A
DESCRIPTION OF GRAPHIC AND IMAGE MATERIAL
1. Location: Outside Front and Back Covers of Prospectus
Item: Ugly Duckling Corporation Logo
Description: The logo consists of a duck next to the words "Ugly Duckling
Corporation".
2. Location: Inside Front Cover Page of Prospectus
Item: Photograph
Description: The photograph shows the Company's dealership in Glendale,
Arizona. There is no caption under the photograph.
3. Location: Inside Gatefold Page (Left Side)
Item: Map
Description: This page contains a map of the United States indicating the
location of each of the Company's Dealerships and Branch
Offices. The map also indicates the locations where the
Company plans to open new Company Dealerships and Branch
Offices and indicates them as "proposed" locations.
4. Location: Inside Gatefold Page (Right Side)
Item: Photographs
Description: The following photographs appear on the right side of the
inside of the gatefold page: (i) Photograph of a Company
Dealership located in Tucson, Arizona; (ii) photograph of the
interior of the Company's credit collection facility in
Gilbert, Arizona; and (iii) photograph of the exterior of the
Company's credit collection facility in Gilbert, Arizona.
There are no captions under these photographs.
5. Location: Inside Back Cover Page of Prospectus
Item: Samples of the Company's Advertising
Description: The inside back cover page of the Prospectus shows various
samples of some of the Company's advertising. The page
contains the following caption: "Samples of the Company's
print advertising and storyboards from two of the Company's
animated television advertising for the Company Dealership
operations." The advertisements depict various programs of
the Company including the Company's Visa card program and
the use of tax refunds to make down payments. The
advertisements display the Company's logo and its toll free
number 1-800-THE-DUCK.
