<PAGE>
THIS REPORT HAS BEEN FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION
VIA EDGAR
-----------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 1996
Commission File Number 000-20841
U G L Y D U C K L I N G C O R P O R A T I O N
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2525 E. Camelback Road,
Suite 1150
Phoenix, Arizona 85016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 852-6600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
------- -------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH CLASS OF THE ISSUER'S
CLASSES OF COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At November 12, 1996, there were 12,706,344 shares of Common Stock, $0.001 par
value, outstanding.
<PAGE> 1
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Part I. - FINANCIAL STATEMENTS
Page
Item 1 FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets - September 30, 1996 and
December 31, 1995........................................................3
Condensed Consolidated Statements of Operations - Three Months and
Nine Months Ended September 30, 1996 and September 30, 1995..............4
Condensed Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1996 and September 30, 1995................................5
Notes to Condensed Consolidated Financial Statements..........................6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS..........................9
Part II. - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS............................................26
Item 2. CHANGES IN SECURITIES........................................26
Item 3. DEFAULTS UPON SENIOR SECURITIES..............................26
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS..........26
Item 5. OTHER INFORMATION............................................26
Item 6. EXHIBITS AND REPORTS ON FORM 8-K.............................26
SIGNATURES..................................................................S-1
<PAGE> 2
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
<S> <C> <C>
September 30, December 31,
1996 1995
--------------- -------------
(Unaudited) (Note 1)
Assets
Cash and Cash Equivalents $ 684 1,419
Finance Receivables:
Principal Balances, Net 52,930 49,226
Less: Allowance for Credit Losses (6,626) (8,500)
--------------- -------------
Finance Receivables, Net 46,304 40,726
Residual in Finance Receivables Sold 6,904 -
Investments Held in Trust 2,059 -
Inventory, at Cost 5,889 6,329
Property and Equipment, Net 11,023 8,883
Deferred and Refundable Income Taxes 1,091 1,775
Other Assets 3,443 1,658
--------------- -------------
$ 77,397 60,790
=============== =============
Liabilities and Stockholders' Equity
Liabilities:
Accounts Payable and Accrued Liabilities $ 6,599 5,169
Notes Payable and Other Liabilities 30,622 33,184
Subordinated Notes Payable 14,000 17,553
--------------- -------------
Total Liabilities 51,221 55,906
Stockholders' Equity:
Preferred Stock, $.001 Par Value; Authorized
10,000,000 Shares; 1,000,000 and 1,000,000
Shares Issued and Outstanding at September 30,
1996 and December 31, 1995, respectively 10,000 10,000
Common Stock, $.001 Par Value; Authorized
20,000,000 Shares; 8,691,264 and 5,579,600
Shares Issued and Outstanding at September 30,
1996 and December 31, 1995, respectively. 18,120 127
Accumulated Deficit (1,944) (5,243)
--------------- -------------
Total Stockholders' Equity 26,176 4,884
--------------- -------------
$ 77,397 60,790
=============== =============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE> 3
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per common share - Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
<S> <C> <C> <C> <C>
1996 1995 1996 1995
---------- ---------- ---------- ----------
Dealership Revenues:
Sales of Used Cars $ 12,320 13,991 42,497 36,439
Income on Finance Receivables 2,198 2,290 7,368 5,765
Gain on Sales of Finance Receivables 1,400 - 2,578 -
---------- ---------- ---------- ----------
15,918 16,281 52,443 42,204
---------- ---------- ---------- ----------
Cost of Dealership Revenues:
Cost of Used Cars Sold 6,977 8,713 23,835 20,601
Provision for Credit Losses 2,541 2,372 7,713 6,776
---------- ---------- ---------- ----------
9,518 11,085 31,548 27,377
---------- ---------- ---------- ----------
Net Revenues from Dealership Activities 6,400 5,196 20,895 14,827
Other Income 2,341 664 5,293 1,261
---------- ---------- ---------- ----------
Income before Operating Expenses 8,741 5,860 26,188 16,088
Operating Expenses 5,584 5,368 17,594 13,984
---------- ---------- ---------- ----------
Operating Income 3,157 492 8,594 2,104
Interest Expense:
Subordinated Notes Payable 352 929 1,589 2,523
Other 838 732 2,890 1,498
---------- ---------- ---------- ----------
1,190 1,661 4,479 4,021
---------- ---------- ---------- ----------
Income (Loss) before Income Taxes 1,967 (1,169) 4,115 (1,917)
Income Tax Expense (Benefit) - - - -
---------- ---------- ---------- ----------
Net Earnings (Loss) 1,967 (1,169) 4,115 (1,917)
Preferred Stock Dividend (250) - (817) -
---------- ---------- ---------- ----------
Net Earnings (Loss) Available
to Common Shares $ 1,717 (1,169) 3,298 (1,917)
========== ========== ========== ==========
Earnings (Loss) per Common Share:
Primary $ 0.19 $ (0.20) $ 0.47 $ (0.33)
========== ========== ========== ==========
Fully Diluted $ 0.19 $ (0.20) $ 0.46 $ (0.33)
========== ========== ========== ==========
Weighted Average Common and Common
Equivalent Shares Outstanding:
Primary 9,089 5,892 7,066 5,892
========== ========== ========== ==========
Fully Diluted 9,205 5,892 7,230 5,892
========== ========== ========== ==========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE> 4
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands - Unaudited)
Nine Months Ended
September 30,
---------------------
<S> <C> <C>
1996 1995
---------- ---------
Cash Flows from Operating Activities:
Net Earnings (Loss) $ 4,115 (1,917)
Adjustments to Reconcile Net Earnings (Loss) to Net
Cash Provided by Operating Activities:
Provision for Credit Losses 7,461 6,776
Gain on Sale of Finance Receivables (2,574) -
Compensation Expense Related to Sale of Common Stock - 45
Increase in Deferred Income Taxes - (242)
Depreciation and Amortization 1,128 910
Changes in Assets and Liabilities:
Decrease (Increase) in Inventory 440 (1,750)
Increase in Other Assets (584) (390)
Increase in Accounts Payable and Accrued Expenses 1,430 626
Increase (Decrease) in Income Taxes Receivable/Payable 684 (293)
---------- ---------
Net Cash Provided by Operating Activities 12,100 3,765
---------- ---------
Cash Flows From Investing Activities:
Increase in Finance Receivables (70,599) (39,520)
Proceeds from Sales of Finance Receivables 31,107 -
Collections on Finance Receivables 29,029 13,737
Increase in Investments Arising from Finance
Receivables Sold (8,963) -
Collections on Notes Receivable 100 -
Purchases of Property and Equipment (4,013) (2,238)
---------- ---------
Net Cash Used in Investing Activities (23,339) (28,021)
---------- ---------
Cash Flows from Financing Activities:
Repayments of Obligations Under Capital Leases (146) (128)
Net Additions (Repayments) of Notes Payable (2,824) 19,723
Net Issuance (Repayments) of Subordinated Notes Payable (553) 5,391
Preferred Stock Dividends Paid (817) -
Net Proceeds from Issuance of Common Stock 14,844 5
---------- ---------
Net Cash Provided by Financing Activities 10,504 24,991
---------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents (735) 735
Cash and Cash Equivalents at Beginning of Period 1,419 168
---------- ---------
Cash and Cash Equivalents at End of Period $ 684 903
========== =========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE> 5
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Ugly
Duckling Corporation (Company) have been prepared in accordance with generally
accepted accounting principles for interim financial information, pursuant to
rules and regulations of the Securities and Exchange Commission. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for a complete financial statement
presentation. In the opinion of management, such unaudited interim
information reflect all adjustments, consisting only of normal recurring
adjustments, necessary to present the Company's financial position and results
of operations for the periods presented. The results of operations for
interim periods are not necessarily indicative of the results to be expected
for a full fiscal year. The Condensed Consolidated Balance Sheet as of
December 31, 1995 was derived from audited consolidated financial statements
as of that date but does not include all the information and footnotes
required by generally accepted accounting principles. It is suggested that
these condensed consolidated financial statements be read in conjunction with
the Company's consolidated financial statements for the year ended December
31, 1995, included in the Company's prospectus, dated October 29, 1996, filed
with the Securities and Exchange Commission pursuant to Rule 424(b) of the
Securities Act of 1933, as amended.
NOTE 2. SUMMARY OF PRINCIPAL BALANCES, NET
Following is a summary of Principal Balances, Net, as of September 30, 1996
and December 31, 1995.
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
--------------- -------------
<S> <C> <C>
(000 Omitted) (000 Omitted)
Contractually Scheduled Payments $ 72,349 66,425
Less: Unearned Finance Charges (20,205) (18,394)
--------------- -------------
Principal Balances 52,144 48,031
Add: Accrued Interest 580 613
Loan Origination Costs 206 582
--------------- -------------
Principal Balances, Net $ 52,930 49,226
=============== =============
</TABLE>
NOTE 3. PRESENTATION OF DEALERSHIP REVENUES AND COST OF REVENUES
Revenues from Company Dealership operations consist of Sales of Used Cars,
Income on Finance Receivables, including income on Residual in Finance
Receivables Sold and Gain on Sale of Finance Receivables. Cost of Revenues of
Dealership operations is comprised of Cost of Used Cars Sold and the Provision
for Credit Losses.
<PAGE> 6
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 profit/margin in its Statement of Operations
calculated as Sales of Used Cars less Cost of Used Cars Sold.
NOTE 4. PUBLIC OFFERING
On June 21, 1996, the Company completed its initial public offering of
2,300,000 shares of its Common Stock. Further, on June 28, 1996, the
underwriters of the offering exercised their over-allotment option to purchase
an additional 345,000 shares of the Company's Common Stock. The net proceeds
from the offering (approximately $14.9 million) were used to reduce borrowings
under the Company's revolving credit facility.
Effective upon the closing of the initial public offering, SunAmerica Life
Insurance Company ("SunAmerica") converted $3.0 million of subordinated debt
into Common Stock at the initial public offering price. SunAmerica received
444,444 shares of Common Stock in the Company. The 12.5% subordinated note
was originated in August of 1995.
Effective upon the closing of the initial public offering, Verde Investments,
Inc.(Verde), an affiliate of the Company whose sole shareholder is also the
Chairman, Chief Executive Officer, and majority stockholder of the Company,
lowered the rental rates on eleven properties leased to the Company by Verde.
Verde also granted the Company the right to purchase nine properties owned by
Verde and assigned to the Company its leasehold interests in the two
properties it subleases to the Company. In addition, the interest rate on
$14.0 million of subordinated debt payable to Verde was lowered from 18% to
10%.
On June 21, 1996, prior to the closing of the initial public offering, the
Board of Directors declared a dividend on the Company's Preferred Stock at an
annualized rate of 12% in the amount of $267,000 covering the period from
April 1, 1996 through June 21, 1996. Effective upon completion of the
offering, the dividend rate on $10.0 million of Preferred Stock held by Verde
was lowered to 10% through the end of 1997. See Note 7, below.
NOTE 5. COMMON STOCK EQUIVALENTS
Net Earnings (Loss) per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding as reflected
on Exhibit 11 to this Quarterly Report on Form 10-Q.
NOTE 6. RECLASSIFICATIONS
Certain reclassifications have been made to previously reported information to
conform with classifications made as of September 30, 1996 and for the three
and nine month periods then ended.
<PAGE> 7
NOTE 7. SUBSEQUENT EVENT
Subsequent to September 30, 1996, the Company completed a public offering of
4,000,000 shares of its Common Stock (not including 600,000 additional shares
which are subject to the underwriters' over-allotment option). The net
proceeds from the offering (approximately $56 million) were used to redeem the
Company's outstanding 10% cumulative Preferred Stock, to reduce borrowings
under the Company's revolving credit facility, and provide working capital for
general corporate purposes.
<PAGE> 8
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q contains forward looking statements.
Additional written or oral forward looking statements may be made by the
Company from time to time in filings with the Securities and Exchange
Commission or otherwise. Such forward looking statements are within the
meaning of that term in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Such
statements may include, but not be limited to, projections of revenues,
income, or loss, capital expenditures, plans for future operations, financing
needs or plans, and plans relating to products or services of the Company, as
well as assumptions relating to the foregoing.
Forward looking statements are inherently subject to risks and uncertainties,
some of which cannot be predicted or quantified. Future events and actual
results could differ materially from those set forth in, contemplated by, or
underlying the forward looking statements. Statements in this Quarterly
Report, including the Notes to the Condensed Consolidated Financial Statements
and "Management's Discussion and Analysis of Financial Condition and Results
of Operations," describe factors, among others, that could contribute to or
cause such differences. Additional factors that could cause actual results to
differ materially from those expressed in such forward looking statements are
set forth in Exhibit 99 to this Quarterly Report on Form 10-Q.
INTRODUCTION
Ugly Duckling Corporation (the "Company") operates one of the largest chains
of Buy Here-Pay Here used car dealerships in the United States and
underwrites, finances, and services retail installment contracts generated
from the sale of used cars by its dealerships ("Company Dealerships") and
third party used car dealers ("Third Party Dealers") located in selected
markets throughout the country. The Company targets its products and services
to the sub-prime segment of the automobile financing industry, which focuses
on selling and financing the sale of used cars to persons who have limited
credit histories, low incomes, or past credit problems ("Sub-Prime
Borrowers").
BUSINESS OPERATIONS 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"). In July 1996, the Company's Prescott, Arizona dealership
commenced operations.
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
<PAGE> 9
was unable to leverage across its other operations. Accordingly, the Company
terminated this program in December, 1995, and sold the land, dealership
building, and other assets to a third party. During the three months ended
September 30, 1995, the Gilbert Dealership produced sales of $3.5 million
(average of $9,732 per car sold) and gross profits (Sales of Used Cars less
Cost of Used Cars Sold) of $631,000 (average of $1,764 per car sold), and the
Company incurred selling and marketing expenses of $233,000 (average of $650
per car sold). During the nine months ended September 30, 1995, the Gilbert
Dealership produced sales of $7.1 million (average of $8,882 per car sold) and
gross profits of $1.8 million (average of $2,221 per car sold), and the
Company incurred selling and marketing expenses of $450,000 (average of $563
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 $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 September 30, 1996 had opened
twenty-two Third Party Dealer contract buying offices ("Branch Offices") in
seven states serving approximately 800 Third Party Dealers. Further, the
Company intends to open at least eight additional branches during the fourth
quarter of 1996 and at least 15 additional branches during 1997.
INITIAL PUBLIC OFFERING AND RECAPITALIZATION TRANSACTIONS On June 21, 1996,
the Company completed its initial public offering of 2,300,000 shares of
Common Stock. On June 28, 1996, the underwriters of the offering exercised
their overallotment option to purchase an additional 345,000 shares of the
Company's Common Stock. The net proceeds from the offering (approximately
$14.9 million) were used to reduce borrowings under the Company's revolving
credit facility ("Revolving Facility") with General Electric Capital
Corporation ("GE Capital").
Effective upon the closing of the initial public offering, Verde Investments,
Inc. ("Verde"), an affiliate of the Company whose sole stockholder is the
Chairman, Chief Executive Officer, and majority stockholder of the Company,
agreed to sell to the Company, subject to financing, nine properties owned by
Verde 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, subject to cost of living adjustments if the sale does not take place.
The Company believes the reduced rental rates approximate the financing costs
to be incurred in connection with the purchase of such properties. In
addition, Verde assigned to the Company its leasehold interests in two
properties it previously subleased to the Company, lowered the interest rate
on $14 million of subordinated debt payable to Verde from 18% to 10% per
annum, and lowered the dividend rate on $10 million of Preferred Stock held by
Verde (which previously accrued a dividend of 12% annually, increasing one
percent annually to a maximum of 18%) to 10% through 1997. Also effective
upon the closing of the offering, SunAmerica Life Insurance Company
("SunAmerica"), a significant funding source of the Company, converted $3.0
million of subordinated debt into Common Stock at the public offering price.
<PAGE> 10
RECENT DEVELOPMENTS Since its initial public offering in June 1996, the
Company has opened one new Company Dealership in Arizona and has acquired the
leasehold rights to an existing dealership in Las Vegas, Nevada. In addition,
the Company has three other dealerships (one in Phoenix, Arizona and two in
Albuquerque, New Mexico) and a used car reconditioning facility (in
Albuquerque, New Mexico) currently under development. Also since June 1996,
the Company has opened nine Third Party Dealer contract purchasing offices
("Branch Offices") in various states and intends to open eight more Branch
Offices during the fourth quarter of 1996. The Company intends to continue
its aggressive growth strategy, developing or acquiring additional Company
Dealerships and opening fifteen or more Branch Offices in 1997.
The Company is in the process of expanding its Third Party Dealer operations
by implementing a collateralized dealer financing program (the "Cygnet Dealer
Program"), pursuant to which it will provide operating credit lines to
qualified Third Party Dealers. The Company anticipates that it will begin
testing this program with selected Third Party Dealers during the fourth
quarter of 1996 and will begin full-scale marketing of the program during the
first quarter of 1997.
The Company has also established insurance operations directed to the
sub-prime market. Its initial activities in this area have focused on force
placing casualty insurance on its Third Party Dealer contracts. In an effort
to expand its services, the Company entered into a letter of intent In October
1996 to acquire the capital stock of an insurance agency that provides
insurance services to the sub-prime market. The Company does not believe that
this transaction will be consummated.
GROWTH IN FINANCE RECEIVABLES Total assets of the Company grew from $60.8
million at December 31, 1995 to $77.4 million at September 30, 1996 primarily
as a result of growth in finance receivable related assets. This growth
excludes $32.6 million in principal balances outstanding and serviced by the
Company under securitization sales agreements at September 30, 1996, all of
which were sold during 1996.
The following table reflects finance receivables principal balances for both
managed and owned contracts as of September 30, 1996 and December 31, 1995.
<TABLE>
<CAPTION>
FINANCE RECEIVABLES PRINCIPAL BALANCES
September 30, 1996 December 31, 1995
------------------------------- -----------------------------
<S> <C> <C> <C> <C>
Principal Number Principal Number
--------------- -------------- -------------- -------------
(000 Omitted) (Actual) (000 Omitted) (Actual)
SOURCE OF CONTRACTS:
Originated at Company Dealerships $ 48,066 9,632 $ 34,226 8,049
Less Balances on Portfolio Securitized
and Sold (32,633) (7,226) - -
--------------- -------------- -------------- -------------
Originated at Company Dealerships, Net 15,433 2,406 34,226 8,049
Purchased From Third Party Dealers 36,711 8,041 13,805 2,733
--------------- -------------- -------------- -------------
Company Total $ 52,144 10,447 $ 48,031 10,782
=============== ============== ============== =============
Total Managed Portfolio $ 84,777 17,673 $ 48,031 10,782
=============== ============== ============== =============
</TABLE>
<PAGE> 11
The following tables detail finance receivables activity for contracts
originated at Company Dealerships and purchased from Third Party Dealers for
the three and nine months ended September 30, 1996 and 1995.
<TABLE>
<CAPTION>
FINANCE RECEIVABLE PRINCIPAL BALANCES ORIGINATED/PURCHASED
Three Months Ended Three Months Ended
September 30, 1996 September 30, 1995
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Principal Number Principal Number
--------------- -------------- --------------- --------------
(000 Omitted) (Actual) (000 Omitted) (Actual)
SOURCE OF CONTRACTS:
Originated at Company Dealerships $ 11,082 1,575 $ 10,083 1,624
Purchased From Third Party Dealers 15,716 2,678 5,416 850
--------------- -------------- --------------- --------------
$ 26,798 4,253 $ 15,499 2,474
=============== ============== =============== ==============
</TABLE>
<TABLE>
<CAPTION>
FINANCE RECEIVABLE PRINCIPAL BALANCES ORIGINATED/PURCHASED
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
------------------------------- -------------------------------
<S> <C> <C> <C> <C>
Principal Number Principal Number
--------------- -------------- --------------- --------------
(000 Omitted) (Actual) (000 Omitted) (Actual)
SOURCE OF CONTRACTS:
Originated at Company Dealerships $ 38,179 5,413 $ 28,085 4,780
Purchased From Third Party Dealers 32,919 5,781 10,921 2,094
--------------- -------------- --------------- --------------
$ 71,098 11,194 $ 39,006 6,874
=============== ============== =============== ==============
</TABLE>
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED SEPTEMBER 30, 1996
COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1995
DEALERSHIP REVENUES
SALES OF USED CARS - Sales of Used Cars during the three months ended
September 30, 1996, were $12.3 million versus sales of $10.5 million (pro
forma) for the comparable three month period in 1995, reflecting an increase
of 17.1%. During the three months ended September 30, 1996, 1,766 used cars
were sold with an average sales price of $6,976. For the three months ended
September 30, 1995, 1,705 (pro forma) used cars were sold with an average
sales price of $6,162 (pro forma). The increase in revenue is attributable
both to management's decision to sell higher quality vehicles, resulting in a
higher average sales price, and the increase in the number of cars sold which
is attributed to the success of the Company's business strategy. The revenue
<PAGE> 12
figures, however, also reflect the decrease in the level of sales the Company
typically experiences in the third quarter as compared to the first half of
the year, which is attributable to the seasonal buying patterns of the
Company's Company Dealership customers as well as management's decision to
slow its advertising expenditures in preparation for a new advertising
campaign.
The Company's sales strategy is to provide financing to customers with poor
credit histories or who are unable to obtain financing through traditional
sources. The Company Dealerships financed approximately 90.0% of sales
revenue and 88.7% of the units sold for the three month period ended September
30, 1996 compared to 92.7% (pro forma) of sales revenue and 91.7% (pro forma)
of the units sold for the comparable period in 1995.
INCOME ON FINANCE RECEIVABLES - Income on Finance Receivables from Company
Dealership sales was $2.2 million for the three months ended September 30,
1996 versus $2.3 million for the comparable three month period in 1995, a
decrease of 4.3%. The decrease in income was primarily due to the decrease in
average contract principal balances outstanding during the period ended
September 30, 1996, reflecting the Company's sales of $17.1 million in
receivables in September, 1996. The Company Dealership portfolio of contracts
for the three month periods ending September 30, 1996 and September 30, 1995
had an effective yield of 29.5% and 28.9%, respectively.
GAIN ON SALES OF FINANCE RECEIVABLES - For the three months ended September
30, 1996, the Company recorded a Gain on Sale of Finance Receivables of $1.4
million. The Company completed its third securitization in September 1996.
The Company reduced its Allowance for Credit Losses (Allowance) by $3.3
million and retained a residual interest in the contracts sold of $3.1
million. The Company plans to undertake a securitization transaction
approximately every three to four months. Future securitizations may include
the sale of receivables acquired from Third Party Dealers. The Company's net
income may fluctuate from quarter to quarter in the future as a result of the
timing and size of its securitizations.
COST OF DEALERSHIP REVENUES
COST OF USED CARS SOLD - Cost of Used Cars Sold were $7.0 million for the
three month period ended September 30, 1996 versus $5.9 million (pro forma)
for the comparable three month period in 1995, an increase of 18.6% (pro
forma). This increase is attributable to both the increase in the number of
used cars sold and an increase in, on a percentage basis, the average cost of
the used cars purchased for resale. On a percentage basis, Cost of Used Cars
Sold increased from 55.8% (pro forma) of sales for the three month period
ended September 30, 1995 to 56.6% of sales for the comparable period in 1996.
In 1996, management continued its strategy to increase the quality, and
therefore the cost, of cars sold while targeting a consistent dollar gross
margin. For the three months ended September 30, 1996, on a per car sold
basis, the average gross margin was $3,025 versus $2,725 (pro forma) for the
same period in 1995.
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 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 (Provision) was
<PAGE> 13
$2.5 million for the three months ended September 30, 1996 versus $2.3 million
(pro forma) in the comparable three month period in 1995, an decrease of 8.7%.
This increase is attributable to the increases in both the number of
contracts originated as well as the average amount financed in the three month
period ending September 30, 1996. As a percentage of sales financed, the
Provision averaged 22.9% for the three months ended September 30, 1996 versus
23.6% (pro forma) for the comparable three month period in 1995. The decrease
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. Also see the
discussion of the "Allowance for Credit Losses" below.
OTHER INCOME
Other Income, which consists primarily of income on Third Party Dealer finance
receivables, increased by 246% to $2.3 million for the three months ended
September 30, 1996 from $664,000 for the three months ended September 30,
1995. The increase reflects the substantial growth in the Company's Third
Party Dealer contract portfolio. Subsequent to April 1995, as a result of its
migration to higher quality contracts and expansion into markets with interest
rate limits, the Company's yield on its Third Party Dealer contract portfolio
has trended downward. The Third Party Dealer portfolio had an average balance
of $32.8 million for the three month period ending September 30, 1996, with an
effective yield for the three month period of 24.2%. This portfolio averaged
$8.8 million for the three months ended September 30, 1995, with an effective
yield of 27.3%.
INCOME BEFORE OPERATING EXPENSES
As a result of the Company's continued expansion, Income before Operating
Expenses grew to $8.7 million for the three months ended September 30, 1996
versus $5.3 million (pro forma) for the three months ended September 30, 1995.
Finance Income on third party contracts was the primary contributor to the
increase. Net Revenue from Dealership Activity also contributed to the
increase.
OPERATING EXPENSES
Operating Expenses consist of selling and marketing expenses, general and
administrative expenses and depreciation and amortization. Operating Expenses
were $5.6 million for the three months ended September 30, 1996 versus $4.8
million (pro forma) for the three months ended September 30, 1995, an increase
of 16.7%. The increase reflects additional expenses attributable to increased
Company Dealership activity, continued development of corporate
infrastructure, and the expansion of the Third Party Dealer network from one
branch office at March 31, 1995 to twenty-two as of September 30, 1996.
Operating Expenses represented 30.6% of total revenues for the three months
ended September 30, 1996 and 31.7% of total revenue for the three months ended
September 30, 1995.
INTEREST EXPENSE
SUBORDINATED NOTES PAYABLE - Interest expense on Subordinated Notes Payable
totaled $352,000 for the three months ended September 30, 1996 versus $929,000
for the comparable three month period in 1995. The decrease was due to a
decrease in the average Subordinated Note balance from $20.7 million for the
<PAGE> 14
three months ended September 30, 1995 to $14 million for the three months
ended September 30, 1996. In addition, the interest rate on the Subordinated
Notes, which was originally 18%, was reduced to 10% effective June 21, 1996.
Had the rate decrease been effective for the three month period ended
September 30, 1995, interest expense would have been reduced by $412,000.
INTEREST, OTHER - Interest, Other consisted primarily of the cost of borrowing
under the Company's revolving credit facility ("Revolving Facility") with GE
Capital. Interest, Other totaled $838,000 for the three months ended
September 30, 1996 versus $732,000 for the comparable three month period in
1995. For the three month period ended September 30, 1996, the amount
outstanding under the Revolving Facility averaged $29.6 million with an
average borrowing cost of 9.7%. For the three month period ended September
30, 1995, the amount outstanding under the Revolving Facility averaged $25.2
million with an average borrowing rate of 10.7%.
RESULTS OF OPERATIONS
FOR NINE MONTHS ENDED SEPTEMBER 30, 1996
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1995
DEALERSHIP REVENUES
SALES OF USED CARS - Sales of Used Cars during the nine months ended September
30, 1996, were $42.5 million versus sales of $29.3 million (pro forma) for the
comparable nine month period in 1995, reflecting an increase in same store
sales of over 45.1%. During the nine months ended September 30, 1996, 6,141
used cars were sold with an average sales price of $6,920. For the nine
months ended September 30, 1995, 4,875 (pro forma) used cars were sold with an
average sales price of $6,019 (pro forma). The increase in revenue is
attributable both to Management's decision to sell higher quality vehicles,
resulting in a higher average sales price, and the increase in the number of
cars sold during the first six months of the year, which is attributed to the
success of the Company's business strategy, most notably its advertising and
marketing programs.
The Company Dealerships financed approximately 89.8% of sales revenue and
88.1% of the units sold for the nine month period ended September 30, 1996
compared to 89.2% (pro forma) of sales revenue and 91.5% (pro forma) of the
units sold for the comparable period in 1995.
INCOME ON FINANCE RECEIVABLES - Income on Finance Receivables from Company
Dealership sales was $7.4 million for the nine months ended September 30, 1996
versus $5.8 million for the nine month period ended September 30, 1995, an
increase of 27.6%. The increase in income was primarily due to the increase
in average contract principal balances outstanding during the nine months
ended September 30, 1996 as impacted by the Company's sale of $41.3 million in
finance receivables in 1996. Additionally, Income on Finance Receivables for
the nine month period in 1996 includes $725,000 in income on Residual in
Finance Receivables Sold. There was no corresponding income in 1995. The
Company Dealership portfolio of contracts for the nine month periods ending
September 30, 1996 and September 30, 1995 had an effective yield of 29.2% and
29.3%, respectively.
<PAGE> 15
GAIN ON SALES OF FINANCE RECEIVABLES - The Company completed the
securitization and sale of approximately $41.3 million in contracts originated
at its Company Dealerships during the nine month period ended September 1996
from which the Company recognized gains on sales of $2.6 million. The
Company's net income may fluctuate from quarter to quarter in the future as a
result of the timing and size of its securitizations.
COST OF DEALERSHIP REVENUES
COST OF USED CARS SOLD - Cost of Used Cars Sold was $23.8 million for the nine
month period ended September 30, 1996 versus $15.3 million (pro forma) for the
comparable nine month period in 1995, an increase of 55.6%. This increase is
attributable to both the increase in the number of used cars sold and an
increase in, on a percentage basis, the average purchase price of the used
cars sold. On a percentage basis, Cost of Used Cars Sold increased from 52.1%
(pro forma) of sales for the nine month period ended September 30, 1995 to
56.1% of sales for the comparable period in 1996. In 1996, Management
continued its strategy to increase the quality, and therefore the cost, of
cars sold while targeting a consistent dollar gross margin. For the nine
months ended September 30, 1996, on a per car sold basis, the average gross
margin was $3,039 versus $2,885 (pro forma) for the same period in 1995.
PROVISION FOR CREDIT LOSSES - The Provision was $7.7 million for the nine
months ended September 30, 1996 versus $6.3 million (pro forma) in the
comparable nine months in 1995, an increase of 22.2%. This increase is
attributable to the increases in both the number of contracts originated as
well as the average amount financed in the nine month period ending September
30, 1996. As a percentage of sales financed, the Provision averaged 20.2% for
the nine months ended September 30, 1996 versus 24.1% (pro forma) for the
comparable nine month period in 1995. The decrease 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. Also see the discussion of the "Allowance for
Credit Losses" below.
OTHER INCOME - Other Income, which consists primarily of income on Third
Party Dealer finance receivables, increased to $5.3 million for the nine
months ended September 30, 1996 from $1.3 million for the nine months ended
September 30, 1995, an increase of 307%. Subsequent to April, 1995, as a
result of its migration to higher quality contracts and expansion into markets
with interest rate limits, the Company's yield on its Third Party Dealer
contract portfolio has trended downward. The Third Party Dealer portfolio of
contracts had an average balance of $24.1 million for the nine month period
ended September 30, 1996, with an effective yield for the nine month period of
24.7%. This portfolio averaged $5.0 million for the nine months ended
September 30, 1995, with an effective yield for the period of 26.5%.
INCOME BEFORE OPERATING EXPENSES
As a result of the Company's continued expansion, Income before Operating
Expenses grew to $26.2 million for the nine months ended September 30, 1996,
versus $14.8 million (pro forma) for the nine months ended September 30, 1995.
Net Revenue from Dealership Activity, and growth of the Company's Third Party
Dealer operations were the primary contributors to the increase.
<PAGE> 16
OPERATING EXPENSES
Operating Expenses consist of selling and marketing expenses, general and
administrative expenses and depreciation and amortization. Operating Expenses
were $17.6 million for the nine months ended September 30, 1996, versus $14.0
million for the nine months ended September 30, 1995, an increase of 25.7%.
The increase reflects additional expenses attributable to the expansion of the
Third Party Dealer network from one branch office at March 31, 1995, to
twenty-two as of September 30, 1996. The increase also reflects the continued
development of corporate infrastructure, including the implementation of
contract servicing facilities and systems, to accommodate anticipated future
growth. Expenses attributable to the Company Dealership sales and financing
activities, including real property rent expense, also increased
proportionately to the Company Dealership revenue growth. Until June 21,
1996, the Company Dealerships paid rents to Verde based on a percentage of
Company Dealership total revenues. Effective June 21, 1996, these rents have
been reduced to a fixed amount. Had the new fixed rents been in place for the
nine months ended September 30, 1996 and 1995, rent expense for the nine month
periods would have been reduced by $961,000 and $1 million (pro forma),
respectively. The Company also continues to expand its advertising and
marketing efforts.
Operating Expenses represented 30.5% of total revenues for the nine months
ended September 30, 1996 and 32.2% of total revenue for the nine months ended
September 30, 1995.
INTEREST EXPENSE
SUBORDINATED NOTES PAYABLE - Interest expense on Subordinated Notes Payable
totaled $1.6 million for the nine months ended September 30, 1996 versus $2.5
million for the comparable nine month period in 1995. The decrease was due to
a decrease in the average Subordinated Note balance from $18.9 million for the
nine months ended September 30, 1995 to $14.0 million for the nine months
ended September 30, 1996. In addition, effective June 21, 1996 the interest
rate on the Subordinated Note was decreased from 18% to 10%. Had the interest
rate decrease been effective for the nine month periods ended September 30,
1996 and 1995, interest expense would have been reduced $500,000 and $1.1
million, respectively.
INTEREST, OTHERS - Interest, Others consisted primarily of the cost of
borrowing under the Revolving Facility with GE Capital. Interest, Others
totaled $2.9 million for the nine months ended September 30, 1996 versus $1.5
million for the comparable nine month period in 1995. For the nine month
period ended September 30, 1996 the amount outstanding under the Revolving
Facility averaged $31.9 million with an average borrowing rate of 9.8%. For
the nine month period ended September 30, 1995, the amount outstanding under
the Revolving Facility averaged $18.4 million with an average borrowing rate
of 10.7%.
ALLOWANCE FOR CREDIT LOSSES
The Company has established an Allowance for Credit Losses (Allowance) 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
Allowance as a percentage of Company Dealership contracts increased from 21.9%
at December 31, 1995 to 23.1% at September 30, 1996, and the Allowance as a
<PAGE> 17
percentage of Third Party Dealer contracts increased from 7.2% to 8.3% over
the same period. However, the Allowance as a percentage of the Company's
combined contract portfolio decreased from 17.7% at December 1995 to 12.7% at
September 30, 1996 due to the relative increase in the combined contract
portfolio represented by contracts purchased from Third Party Dealers, for
which a lower level of Allowance is required.
STATIC POOL ANALYSIS, GENERAL - To monitor contract 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 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.
Management has factored the trends indicated by its static pool analysis into
its determination of the adequacy of the Allowance for both its Company
Dealership and Third Party Dealer portfolio.
The Company monitors all its static pools on a monthly basis; however for
presentation purposes the information in static pool tables for the Allowance
attributable to Company Dealerships and the Allowance attributable to Third
Party Dealers is presented on a quarterly basis. 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 cumulative age.
ALLOWANCE ATTRIBUTABLE TO COMPANY DEALERSHIP CONTRACTS - The Allowance on
contracts originated at Company Dealerships increased to 23.1% of outstanding
principal balance as of September 30, 1996 compared to 21.9% as of December
31, 1995. The following table reflects activity in the Allowance, as well as
information regarding charge off activity, on contracts originated at Company
Dealerships for the three and nine month periods ended September 30, 1996 and
1995.
<PAGE> 18
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
<S> <C> <C> <C> <C>
1996 1995 1996 1995
--------------- -------------- -------------- --------------
(000 Omitted) (000 Omitted) (000 Omitted) (000 Omitted)
ALLOWANCE ACTIVITY:
Balance, beginning of period $ 5,974 7,875 7,500 6,050
Provision for credit losses 2,541 2,372 7,713 6,776
Reduction attributable to
loans sold (3,263) - (6,187) -
Net Charge offs (1,681) (1,983) (5,455) (4,562)
--------------- -------------- -------------- --------------
Balance, end of period $ 3,571 8,264 3,571 8,264
=============== ============== ============== ==============
CHARGE OFF ACTIVITY:
Principal Balances:
Collateral Repossessed $ (1,664) (1,729) (5,260) (4,227)
Other (342) (785) (1,619) (1,693)
--------------- -------------- -------------- --------------
Total Principal Balances (2,006) (2,514) (6,879) (5,920)
Accrued interest (114) (191) (486) (434)
Recoveries, net 439 722 1,910 1,792
--------------- -------------- -------------- --------------
Net Charge Offs $ (1,681) (1,983) (5,455) (4,562)
=============== ============== ============== ==============
</TABLE>
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 due to the factors discussed above. See
"--Results of Operations-- Provision for Credit Losses."
Since many of the Company's customers use income tax refunds as a source of
down payments, Company Dealerships generally experience increased car sales
and contract originations during the first six months of a fiscal year. See
"--Seasonality." Accordingly, the increase in the Allowance at September 30,
1996 over December 31, 1995 is primarily a timing difference, reflecting the
fact that such increased sales and contract originations (and the associated
Provision for Credit Losses taken on each contract at the time of sale)
immediately increase the Allowance while charge offs related to such contracts
may occur later.
<PAGE>
STATIC POOL ANALYSIS, COMPANY DEALERSHIP CONTRACTS - The following table 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 monthly payments made prior to charge off.
<TABLE>
<CAPTION>
<PAGE> 19
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF
POOL'S ORIGINAL AGGREGATE PRINCIPAL BALANCE
Monthly Payments Completed by Customer Before Charge Off
0 3 6 12 18 24
---- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
1993:
1st Quarter 6.6% 18.3% 26.6% 33.2% 35.1% 35.3%
2nd Quarter 7.7% 18.4% 26.2% 30.6% 32.1% 32.3%
3rd Quarter 8.5% 19.9% 25.2% 30.4% 31.5% 31.7%
4th Quarter 7.1% 16.9% 23.4% 27.7% 28.9% 29.5%
1994:
1st Quarter 3.5% 10.8% 14.3% 17.7% 19.3% 21.4%
2nd Quarter 3.7% 11.3% 15.3% 19.7% 21.7% x
3rd Quarter 3.5% 8.5% 12.9% 17.0% 19.4% -
4th Quarter 2.9% 9.1% 13.3% 18.0% x -
1995:
1st Quarter 1.6% 8.3% 13.8% 18.2% - -
2nd Quarter 2.5% 7.9% 12.7% x - -
3rd Quarter 1.9% 6.5% 11.3% - - -
4th Quarter 1.1% 5.8% x - - -
1996:
1st Quarter 1.4% x - - - -
</TABLE>
The following table reflects the principal balances of delinquent Company
Dealership contracts as a percentage of total outstanding contract principal
balances of the Company Dealership portfolio as of September 30, 1996 and
December 31, 1995.
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
-------------- -------------
<S> <C> <C>
DELINQUENCY PERCENTAGES:
Principal balances current 95.4% 94.7%
Principal balances 31 to 60 days 3.1% 4.2%
Principal balances over 60 days 1.5% 1.1%
</TABLE>
At December 31, 1995 the average number of days a customer was delinquent when
repossession took place was under 30 days for both contracts originated at
Company Dealerships and those purchased from Third Party Dealers. In 1996,
the Company has elected to extend the time period before repossession is
ordered with respect to those customers who exhibit a willingness and capacity
to bring their contracts current. As this modification to its repossession
policy is implemented, delinquencies are expected to adjust accordingly.
ALLOWANCE ATTRIBUTABLE TO THIRD PARTY DEALER CONTRACTS - The Allowance on
contracts purchased from Third Party Dealers increased to 8.3% of the
outstanding principal balance as of September 30, 1996 from 7.2% as of
December 31, 1995. For these contracts, the Company continues to credit all
Discount acquired with the purchase of contracts from Third Party Dealers to
the Allowance.
<PAGE> 20
Following are tables reflecting activity in the Allowance, as well as
information regarding charge off activity, on contracts purchased from Third
Party Dealers for the three and nine month periods ended September 30, 1996
and 1995.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- ------------------------------
<S> <C> <C> <C> <C>
1996 1995 1996 1995
--------------- -------------- -------------- --------------
(000 Omitted) (000 Omitted) (000 Omitted) (000 Omitted)
ALLOWANCE ACTIVITY:
Balances at beginning of period $ 2,074 650 1,000 160
Provision for credit losses - - - -
Discount acquired 1,816 428 3,646 1,109
Net Charge offs (835) (194) (1,591) (385)
Balances at end of period $ 3,055 884 3,055 884
=============== ============== ============== ==============
CHARGE OFF ACTIVITY:
Principal Balances:
Collateral Repossessed $ (1,003) (213) (2,070) (335)
Other (191) (81) (416) (134)
--------------- -------------- -------------- --------------
Total Principal Balances (1,194) (294) (2,486) (469)
Accrued interest (64) (13) (123) (29)
Recoveries, net 423 113 1,018 113
--------------- -------------- -------------- --------------
Net Charge Offs $ (835) (194) (1,591) (385)
=============== ============== ============== ==============
</TABLE>
Discount acquired totaled $1.8 million and $3.6 million for the three months
and nine months ended September 30, 1996, respectively. Discount acquired
totaled $428,000 and $1.1 million for the three months and nine months ended
September 30, 1995, respectively. In 1996, as a percentage of principal
balances purchased, the Discount averaged 11.6% for the three months ended
September 30, 1996 and 11.1% for the nine months then ended. Beginning in
1996 the Company expanded into markets with interest rate limits. While
contractual interest rates on these contracts are limited, the Company has
been able to purchase these contracts at a reasonably consistent effective
yield and therefore Discounts have trended upward. In 1995, as a percentage
of contracts purchased, Discount averaged 11.1% and 10.2% for the three months
and nine months ended September 30, 1995, respectively. In the nine months
ended September 30, 1995, the Company had just begun its expansion of the
Third Party Dealer branch network and significantly curtailed the purchase of
lesser quality contracts, which were purchased at a higher discounts.
Accordingly, the lower percentage level of Discount for the three month verses
the nine month period is attributable to this transition to higher quality
contracts, purchased at lower discounts. The Company continues to allocate
all Discount acquired to the Allowance for Credit Losses.
STATIC POOL ANALYSIS, THIRD PARTY DEALERS - The following table 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
monthly payments made prior to charge off.
<PAGE> 21
<TABLE>
<CAPTION>
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF
POOL'S ORIGINAL AGGREGATE PRINCIPAL BALANCE
Monthly Payments Completed by Customer Before Charge Off
0 3 6 12 18 24
----- ------ ------ ----- ----- -----
<S> <C> <C> <C> <C> <C> <C>
1995:
2nd Quarter .9% 4.1% 5.8% x - -
3rd Quarter 1.4% 4.0% x - - -
4th Quarter 1.0% x - - - -
1996:
1st Quarter .8% - - - - -
</TABLE>
While the static pool information is developing, management augments its
evaluation of the adequacy of the Allowance for Third Party Dealers through
comparisons in the characteristics of collateral ratios and borrowers on Third
Party Dealer contracts versus those of the Company Dealership contracts, as
well as through comparisons of portfolio delinquency, actual contract
performance and, to the extent information is available, industry statistics.
Beginning April 1, 1995, the Company initiated a new purchasing program for
Third Party Dealer contracts which included a rapid migration to higher
quality contracts. As of March 31, 1995, the Third Party Dealer portfolio
originated under the prior program had a principal balance of $2.0 million and
has a remaining balance of $246,000 as of September 30, 1996. Static pool
results under the prior program are not a material consideration for
management evaluation of the current Third Party Dealer portfolio and contract
performance under this prior program have been excluded from the table above.
Analysis of portfolio delinquencies is also considered in evaluating the
adequacy of the Allowance. The following table reflects the principal balance
of delinquent Third Party Dealer contracts as a percentage of total
outstanding contract principal balances of the Third Party Dealer portfolio as
of September 30, 1996 and December 31, 1995.
<TABLE>
<CAPTION>
September 30, December 31,
1996 1995
-------------- -------------
<S> <C> <C>
DELINQUENCY PERCENTAGES:
Principal balances current 96.9% 98.4%
Principal balances 31 to 60 days 2.5% 1.2%
Principal balances over 60 days 0.6% 0.4%
</TABLE>
See the discussion above regarding the Company's repossession policy and its
impact on delinquencies.
<PAGE> 22
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, proceeds from the sale of finance receivables,
and supplemental borrowings. The Company's Net Cash Provided by Operating
Activities increased by 218% from $3.8 million for the nine months ended
September 30, 1995 to $12.1 million for the nine months ended September 30,
1996. The increase was primarily due to increases in Net Earnings, Provision
for Credit Losses, Accounts Payable and Accrued Expenses, and Other
Liabilities and a decrease in Refundable Income Taxes offset by the Gain on
Sale of Finance Receivables.
The Net Cash Used in Investing Activities decreased by 16.8% from $28.0
million in the nine months ended September 30, 1995 to $23.3 million in the
nine months ended September 30, 1996. The $31.1 million provided by the sale
of finance receivables and the $29.0 million provided by collections on
finance receivables were offset by the $70.6 million used in the increase in
finance receivables, $9.0 million used for the increase in Investments Arising
from Finance Receivables Sold, and $4.0 million used for the purchases of
property and equipment.
The Company's Net Cash Provided by Financing Activities decreased by 58.0%
from $25.0 million in the nine months ended September 30, 1995 to $10.5
million in the nine months ended September 30, 1996. The primary financing
activities in the first nine months of 1996 were the $14.8 million in proceeds
from the issuance of common stock and corresponding $2.8 million reduction of
the Revolving Facility with GE Capital.
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 September 30, 1996, the Company's borrowing capacity
under the Revolving Facility was approximately $41.3 million, the aggregate
principal amount outstanding under the Revolving Facility was $28.0 million,
and the amount available to be borrowed under the facility was $13.3 million.
The Revolving Facility bears interest at the 30-day LIBOR plus 4.25%, payable
daily (total rate of 9.7% as of September 30, 1996). The rate was
subsequently reduced to 30-day LIBOR plus 3.60% in October 1996.
SUBORDINATED NOTES PAYABLE - The Company has historically borrowed
substantial amounts from Verde, an affiliate of the Company. The subordinated
notes payable balances outstanding to Verde totaled $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 September 30,
1996. Prior to June 21, 1996, these borrowings accrued interest at an annual
rate of 18.0%. Effective June 21, 1996 the annual interest rate on these
borrowings was reduced to 10.0%. The Company is required to make monthly
payments of interest and annual payments of principal in the amount of $2.0
million. This debt is 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.
<PAGE> 23
PREFERRED STOCK - On December 31, 1995, Verde Investments converted $10.0
million of subordinated debt to Preferred Stock of the Company. Prior to June
21, 1996, the Preferred Stock accrued a dividend of 12.0% annually, increasing
one percent per year up to a maximum of 18.0%. Effective June 21, 1996 the
dividend on the Preferred Stock was decreased to 10.0% through December 31,
1997, at which time the rate was scheduled to be raised to, and remain at,
12.0%. The Preferred Stock was retired in November 1996.
CONVERTIBLE NOTE - In August 1995, the Company entered into a note purchase
agreement with SunAmerica pursuant to which SunAmerica purchased a $3.0
million convertible subordinated note. Effective June 21, 1996, SunAmerica
exercised its conversion rights. In return for the early exercise of its
conversion rights, the Company granted SunAmerica a ten-year warrant to
purchase 116,000 shares of Common Stock at $6.75 per share, the initial public
offering price, and paid fees to SunAmerica totaling $150,000.
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.
CAPITAL EXPENDITURES AND COMMITMENTS - The Company has acquired the
leasehold rights to an existing dealership in Las Vegas, Nevada, has three
other dealerships (one in Phoenix, Arizona and two in Albuquerque, New Mexico)
and a reconditioning facility (in Albuquerque, New Mexico) currently under
development, and has begun an expansion of its contract servicing and
collection facility. In addition, the Company intends to open eight new
Branch Offices during the fourth quarter of 1996. The Company intends to
continue its aggressive growth strategy, developing or acquiring additional
Company Dealerships and opening 15 or more new Branch Offices through the end
of 1997. The Company believes that it will expend an average of approximately
$1.5 million to $1.7 million (excluding inventory) to develop each new Company
Dealership and $50,000 to establish each new Branch Office. The Company
intends to finance these expenditures through operating cash flows,
supplemental borrowings, (including under the Revolving Facility), and as
discussed below, the proceeds of the October 29, 1996 offering.
SEASONALITY
Historically, the Company has experienced higher revenues in the first two
quarters 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
<PAGE> 24
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 interest rate. To date, inflation has not
had a significant impact on the Company's operations.
SECONDARY PUBLIC OFFERING
On October 29, 1996 the Company completed a secondary public offering of
4,000,000 shares of Common Stock. Approximately $49.0 million of the net
proceeds of the offering (approximately $56.0 million) were used to pay down
the Revolving Facility and to retire the $10.0 million in Preferred Stock.
Remaining net proceeds of approximately $7.0 million were added to working
capital for general corporate purposes.
The underwriters of the offering have a 30-day option to purchase an
additional 600,000 shares of the Common Stock at a price of $15 per share.
Should the underwriters elect to exercise their option, the net proceeds
(approximately $8.5 million) will be added to working capital for general
corporate purposes.
<PAGE> 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The registrant and its subsidiaries are not the subject of legal
proceedings which, in the opinion of management, will have a
material effect on the financial position of the registrant or its
results of operations.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
None.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 11 - Statement regarding Computation of Earnings per Share
Exhibit 27 - Financial Data Schedule - Regulation S-X Article 5
Exhibit 99 - Statement regarding Forward-looking Information
(b) Reports on Form 8-K.
No reports on Form 8-K have been filed during the quarter for which
this report is filed.
<PAGE> 26
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ugly Duckling Corporation
Date: November 14, 1996
-----------------
/s/ Steven T. Darak
-----------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
S-1
EXHIBIT 11
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION
SCHEDULE OF COMPUTATION OF EARNINGS PER COMMON SHARE
Three Months Ended Three Months Ended
September 30, 1996 September 30, 1995
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Fully Fully
Primary Diluted Primary Diluted
-------------- ------------- ------------- -------------
Net earnings (loss) $ 1,967 1,967 (1,169) (1,169)
Preferred dividends (250) (250) - -
-------------- ------------- ------------- -------------
Net earnings (loss)available to common
shares $ 1,717 1,717 (1,169) (1,169)
============== ============= ============= =============
Earnings (loss) per common share $ 0.19 0.19 (0.20) (0.20)
============== ============= ============= =============
Weighted average common shares outstanding 8,633 8,633 5,522 5,522
Common equivalent shares outstanding
using the treasury stock method 456 572 370 370
-------------- ------------- ------------- -------------
Weighted average common and common
equivalent shares outstanding 9,089 9,205 5,892 5,892
============== ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
Nine Months Ended Nine Months Ended
September 30, 1996 September 30, 1995
---------------------------- ----------------------------
<S> <C> <C> <C> <C>
Fully Fully
Primary Diluted Primary Diluted
-------------- ------------- ------------- -------------
Net earnings (loss) $ 4,115 4,115 (1,917) (1,917)
Preferred dividends (817) (817) - -
-------------- ------------- ------------- -------------
Net earnings (loss)available to common
shares 3,298 3,298 (1,917) (1,917)
============== ============= ============= =============
Earnings (loss) common per share $ 0.47 0.46 (0.33) (0.33)
============== ============= ============= =============
Weighted average common shares outstanding 6,659 6,659 5,522 5,522
Common equivalent shares outstanding
using the treasury stock method 407 572 370 370
-------------- ------------- ------------- -------------
Weighted average common and common
equivalent shares outstanding 7,066 7,230 5,892 5,892
============== ============= ============= =============
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's unaudited financial statements as of and for the three months
and nine months ended September 30, 1996, and is qualified in its entirety
by reference to such statements.
</LEGEND>
<CIK> 0001012704
<NAME> UGLY DUCKLING CORP
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-END> SEP-30-1996 SEP-30-1996
<CASH> 684 684
<SECURITIES> 8,963 8,963
<RECEIVABLES> 52,930 52,930
<ALLOWANCES> 6,626 6,626
<INVENTORY> 5,889 5,889
<CURRENT-ASSETS> 0<F1> 0<F1>
<PP&E> 13,528 13,528
<DEPRECIATION> (2,505) (2,505)
<TOTAL-ASSETS> 77,397 77,397
<CURRENT-LIABILITIES> 0<F1> 0<F1>
<BONDS> 0 0
0 0
10,000 10,000
<COMMON> 18,120 18,120
<OTHER-SE> (1,944) (1,944)
<TOTAL-LIABILITY-AND-EQUITY> 77,397 77,397
<SALES> 12,320 42,497
<TOTAL-REVENUES> 18,259 57,736
<CGS> 6,977 23,835
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 5,584 17,594
<LOSS-PROVISION> 2,541 7,713
<INTEREST-EXPENSE> 1,190 4,479
<INCOME-PRETAX> 1,967 4,115
<INCOME-TAX> 0 0
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 1,967 4,115
<EPS-PRIMARY> .19 .47
<EPS-DILUTED> .19 .46
<FN>
<F1>UNCLASSIFIED BALANCE SHEET
</FN>
</TABLE>
EXHIBIT 99
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The Company wishes to take advantage of the new "safe harbor" provisions of
the Private Securities Litigation Reform Act of 1995 and is filing this
cautionary statement in connection with such safe harbor legislation. The
Company's Form 10-K, this Form 10-Q, any other Form 10-Q, any Form 8-K, or any
other written or oral statements made by or on behalf of the Company may
include forward looking statements which reflect the Company's current views
with respect to future events and financial performance. The words "believe,"
"expect," "anticipate," "intends," "forecast," "project," and similar
expressions identify forward looking statements.
The Company wishes to caution investors that any forward looking statements
made by or on behalf of the Company are subject to uncertainties and other
factors that could cause actual results to differ materially from such
statements. These uncertainties and other factors include, but are not
limited to, the Risk Factors listed below (many of which have been discussed
in prior SEC filings by the Company). Though the Company has attempted to
list comprehensively these important factors, the Company wishes to caution
investors that other factors may in the future prove to be important in
affecting the Company's results of operations. New factors emerge from time
to time and it is not possible for management to predict all of such factors,
nor can it assess the impact of each such factor on the business or the extent
to which any factor, or combination of factors, may cause actual results to
differ materially from forward looking statements.
Investors are further cautioned not to place undue reliance on such forward
looking statements as they speak only of the Company's views as of the date
the statement was made. The Company undertakes no obligation to publicly
update or revise any forward looking statements, whether as a result of new
information, future events, or otherwise.
RISK FACTORS
NO ASSURANCE OF CONTINUED PROFITABILITY;
FLUCTUATIONS IN OPERATING RESULTS
The Company began operations in 1992 and incurred significant losses in 1994
and 1995. For the nine months ended September 30, 1996 the Company achieved
profitability with net earnings of approximately $4.1 million (including $2.6
million from the sale of contract receivables pursuant to the Company's
securitization program) on total revenues of $57.7 million. There can be no
assurance that the Company will remain profitable. Historically, the Company
has experienced higher revenues in the first two quarters 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 part of the year, which
are a primary source of down payments on used car purchases.
<PAGE> 1
DEPENDENCE ON SECURITIZATIONS
In recent periods, a significant portion of the Company's net earnings have
been attributable to gains on sales of contract receivables under the
Company's securitization program with SunAmerica Life Insurance Company, which
program the Company expects to continue for the foreseeable future.
Consequently, the Company's net income may fluctuate from quarter to quarter
as a result of the timing and size of its securitizations. The Company's
ability to successfully complete securitizations in the future may be affected
by several factors, including the condition of the securities markets
generally, conditions in the asset-backed securities markets specifically, and
the credit quality of the Company's servicing portfolio. The amount of gain
on sales is based upon certain estimates, which may not subsequently be
realized. To the extent that actual cash flows on a securitization are
materially below estimates, the Company would be required to revalue the
residual portion of the securitizations which it retains, and record a charge
to earnings based upon the reduction. In addition, the Company records
ongoing income based upon the cash flows on its residual portion. The income
recorded on the residual portion will vary from quarter to quarter based upon
cash flows received in a given period.
POOR CREDITWORTHINESS OF BORROWERS;
HIGH RISK OF CREDIT LOSSES
Substantially all of the contracts that the Company originates, acquires, or
services are with customers with limited credit histories, low incomes, or
past credit problems ("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 its wholly owned dealerships ("Company Dealerships") while rates
generally range from 21.0% to 29.9% on the contracts it purchases from third
party dealers ("Third Party Dealers"). In addition, the Company has
established an Allowance for Credit Losses to cover anticipated credit losses
on the contracts currently in its portfolio. 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.
RISKS ASSOCIATED WITH GROWTH STRATEGY AND NEW PRODUCT OFFERINGS
The Company's business strategy calls for aggressive growth in its sales and
financing activities through the development and acquisition of new Company
owned dealerships ("Company Dealerships") and Third Party Dealer contract
buying offices ("Branch Offices") and the expansion of its existing operations
to include additional financing and insurance services. The Company's ability
to remain profitable as it pursues this business strategy will depend on its
ability to: (i) expand its revenue generating operations while not
proportionally increasing its administrative overhead; (ii) originate and
purchase contracts with an acceptable level of credit risk; (iii) effectively
collect payments due on the contracts in its portfolio; (iv) locate sufficient
financing, with acceptable terms, to fund the expansion of used car sales and
the origination and purchase of additional contracts; and (v) adapt to the
<PAGE> 2
increasingly competitive market in which it operates. 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.
The Company has initiated a collateralized dealer financing program ("Cygnet
Dealer Program"), pursuant to which the Company intends to provide qualified
Third Party Dealers with operating lines of credit secured by such dealers'
retail installment contract portfolios. While the Company will require Third
Party Dealers to meet certain minimum net worth and operating history criteria
to be considered for inclusion in the Cygnet Dealer Program, the Company will
nevertheless, be extending credit to dealers who are not otherwise able to
obtain debt financing from traditional lending institutions such as banks,
credit unions, and major finance companies. Consequently, as with its other
financing activities, the Company will be subject to a high risk of credit
losses that could have a material adverse effect on the Company's financial
condition and results of operations and on the Company's ability to meet its
own financing obligations. Further, there can be no assurance that the
Company will be able to obtain financing necessary to fully implement the
Cygnet Dealer Program. In addition, there can be no assurance the Company
will be successful in its efforts to expand its insurance operations.
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., and Driver's
Mart, 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.
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.
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.
<PAGE> 3
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.
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. Pursuant to the Cygnet Dealer Program, the
Company will also enter into financing agreements with qualified Third Party
Dealers. 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,
that such dealers will continue to generate a volume of contracts comparable
to the volume of contracts historically generated by such dealers, or that any
such dealers will become involved in the Cygnet Dealer Program.
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 September 30, 1996, five of the Company's twenty-two Branch
Offices were located in Arizona. A substantial majority of the contracts
owned by the Company at September 30, 1996 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.
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 a revolving credit facility (the "Revolving Facility") with
General Electric Capital Corporation, 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. In addition, the
Revolving Facility contains numerous 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, and also requires
the Company to meet certain financial tests. There can be no assurance that
<PAGE> 4
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
Life Insurance Company ("SunAmerica") pursuant to which SunAmerica may
purchase up to $175.0 million of the Company's asset-backed securities created
pursuant to the terms of a 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. There can
be no assurance that any further securitizations will be completed or that the
Company will be able to secure additional financing, including the financing
necessary to implement the Cygnet Dealer Program, when and as needed in the
future, or on terms acceptable to the Company.
SENSITIVITY TO INTEREST RATES
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.
IMPACT OF USURY LAWS
The Company typically charges a fixed interest rate of 29.9% on the contracts
originated at Company Dealerships, while rates range from 17.6% 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.
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
limited non-competition provisions) with certain of its officers.
<PAGE> 5
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 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.
POSSIBLE VOLATILITY OF STOCK PRICES
The market price of the Common Stock could 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.
<PAGE> 6
