<PAGE>
THIS REPORT HAS BEEN FILED WITH
THE SECURITIES AND EXCHANGE COMMISSION
VIA EDGAR
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
- -------------------------------------------------------------------------------
FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
MARCH 31, 1997
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 OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At May 13, 1996, there were 18,441,564 shares of Common Stock, $0.001 par
value, outstanding.
This document serves both as a resource for analysts, shareholders, and other
interested persons, and as the quarterly report on Form 10-Q of Ugly Duckling
Corporation (Company) to the Securities and Exchange Commission, which has
taken no action to approve or disapprove the report or pass upon its accuracy
or adequacy. Additionally, this document is to be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K, as amended, for the year ended December
31, 1996.
<PAGE>
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Part I. - FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
<S> <C>
Page
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets - March 31, 1997 and December 31,
1996 3
Condensed Consolidated Statements of Operations - Three Months Ended
March 31, 1997 and March 31, 1996 4
Condensed Consolidated Statements of Cash Flows - Three Months Ended
March 31, 1997 and March 31, 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
Part II. - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS. . . . . . . . . . . . . . . . . . . . . . 21
Item 2. CHANGES IN SECURITIES 21
Item 3. DEFAULTS UPON SENIOR SECURITIES 21
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 21
Item 5. OTHER INFORMATION 21
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 21
SIGNATURES S-1
Exhibit 11 i
Exhibit 27 ii
Exhibit 99 iii
</TABLE>
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE><CAPTION>
MARCH 31, DECEMBER 31,
1997 1996
--------- ---------
(in thousands)
ASSETS
<S> <C> <C>
Cash and Cash Equivalents $ 73,237 $ 18,455
Finance Receivables:
Held for Investment 39,790 52,188
Held for Sale 30,000 7,000
--------- ---------
Principal Balances, Net 69,790 59,188
Less: Allowance for Credit Losses (15,442) (8,125)
--------- ---------
Finance Receivables, Net 54,348 51,063
--------- ---------
Residuals in Finance Receivables Sold 16,823 9,889
Investments Held in Trust 6,339 3,479
Inventory 9,270 5,752
Property and Equipment, Net 24,996 20,652
Goodwill and Trademarks, Net 8,590 2,150
Other Assets 12,473 6,643
--------- ---------
$206,076 $118,083
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 1,858 $ 2,132
Accrued Expenses and Other Liabilities 9,575 6,728
Notes Payable 8,400 12,904
Subordinated Notes Payable 12,000 14,000
--------- ---------
Total Liabilities 31,833 35,764
--------- ---------
Stockholders' Equity:
Common Stock 171,274 82,612
Retained Earnings (Accumulated Deficit) 2,969 (293)
--------- ---------
Total Stockholders' Equity 174,243 82,319
--------- ---------
$206,076 $118,083
========= =========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
<TABLE><CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per common share - Unaudited)
Three Months Ended March 31, 1997 and 1996
1997 1996
------- -------
<S> <C> <C>
Sales of Used Cars $18,211 $15,081
Less:
Cost of Used Cars Sold 9,164 8,348
Provision for Credit Losses 3,981 2,606
------- -------
5,066 4,127
------- -------
Interest Income 6,440 3,662
Gain on Sale of Finance Receivables 4,579 539
------- -------
11,019 4,201
------- -------
Other Income 1,504 114
------- -------
Income before Operating Expenses 17,589 8,442
Operating Expenses 11,406 5,726
------- -------
Operating Income 6,183 2,716
Interest Expense 769 1,651
------- -------
Earnings before Income Taxes 5,414 1,065
Income Taxes 2,152 -
------- -------
Net Earnings $ 3,262 $ 1,065
======= =======
Earnings per Share $ 0.20 $ 0.13
======= =======
Shares Used in Computation 16,579 5,892
======= =======
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>
<TABLE><CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1997 AND 1996
1997 1996
--------- ---------
(in thousands)
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings $ 3,262 $ 1,065
Adjustments to Reconcile Net Earnings to Net
Cash Provided by Operating Activities:
Provision for Credit Losses 3,981 2,606
Gain on Sale of Finance Receivables (4,579) (539)
Finance Receivables Held for Sale (47,876) -
Proceeds from Sale of Finance Receivables 49,400 -
Decrease in Deferred Income Taxes 573 -
Depreciation and Amortization 603 332
Decrease (Increase) in Inventory (719) 124
Decrease (Increase) in Other Assets (4,294) 33
Increase in Accounts Payable, Accrued Expenses, and
Other Liabilities 1,180 1,085
Increase in Income Taxes
Receivable/Payable 1,564 417
Other, Net 1 (1)
--------- ---------
Net Cash Provided by Operating Activities 3,096 5,124
--------- ---------
Cash Flows from Investing Activities:
Increase in Finance Receivables - (23,482)
Collections of Finance Receivables 11,341 10,079
Proceeds from Sale of Finance Receivables - 9,937
Increase in Investments Held in Trust (2,861) (625)
Purchase of Property and Equipment (4,150) (533)
Payment for Purchase of Assets of Seminole Finance Co. (3,449) -
Other, Net (1,384) 26
--------- ---------
Net Cash Used in Investing Activities (503) (4,598)
--------- ---------
Cash Flows from Financing Activities:
Repayments of Notes Payable (34,404) (362)
Net Issuance (Repayment) of Subordinated Notes
Payable (2,000) (553)
Proceeds from Issuance of Common Stock 88,662 -
Other, Net (69) (366)
--------- ---------
Net Cash Provided by (Used In) Financing Activities 52,189 (1,281)
--------- ---------
Net Increase (Decrease) in Cash and Cash Equivalents 54,782 (755)
Cash and Cash Equivalents at Beginning of Period 18,455 1,419
--------- ---------
Cash and Cash Equivalents at End of Period $ 73,237 $ 664
========= =========
Supplemental Statement of Cash Flows Information:
Interest Paid $ 843 $ 1,661
========= =========
Income Taxes Paid $ 15 $ -
========= =========
Purchase of Property and Equipment with Capital Leases $ 211 $ -
========= =========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
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 and pursuant
to rules and regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for a complete financial statement
presentation. In 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, 1996 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 audited consolidated financial statements included in the
Company's Annual Report on Form 10-K, as amended, for the year ended December
31, 1996.
NOTE 2. SUMMARY OF PRINCIPAL BALANCES, NET
--------------------------------------
Following is a summary of Principal Balances, Net, as of March 31, 1997 and
December 31, 1996.
<TABLE><CAPTION>
March 31, December 31,
1997 1996
-------------- -------------
<S> <C> <C>
(000 Omitted) (000 Omitted)
Principal Balances $ 68,757 $ 58,281
Add: Accrued Interest 902 718
Loan Origination Costs 131 189
-------------- -------------
Principal Balances, Net $ 69,790 $ 59,188
============== =============
</TABLE>
NOTE 3. COMMON STOCK EQUIVALENTS
--------------------------
Net Earnings 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.
<PAGE>
NOTE 4. RECLASSIFICATIONS
-----------------
Certain reclassifications have been made to previously reported information to
conform to the current presentation.
NOTE 5. SUBSEQUENT EVENT
-----------------
On April 1, 1997, the Company purchased substantially all of the assets of a
company engaged in the business of selling and financing used motor vehicles,
including seven dealerships in San Antonio and a contract portfolio of
approximately $24.3 million. The purchase price for the acquisition was $26.3
million, subject to adjustment. The seven dealerships had sales in 1996 of
approximately $22.5 million. The assets purchased have an unaudited book
value of $28.1 million, exclusive of allowances on approximately $26.2 million
of contract receivable principal balances.
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. The words "believe," "expect,"
"anticipate," "estimate," "project," and similar expressions identify forward
looking statements. 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 risk factors that
could cause actual results to differ materially from those expressed in such
forward looking statements are set forth in Exhibit 99 which is attached
hereto and incorporated by reference into this Quarterly Report of Form 10-Q.
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
<PAGE>
the end of 1995, closed its Gilbert, Arizona dealership. In January 1997, the
Company acquired selected assets of a group of companies engaged in the
business of selling and financing used motor vehicles, including four
dealerships located in the Tampa Bay/St. Petersburg market.
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 one office and 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 to expand the number
of contracts purchased from its Third Party Dealer network. By March 31, 1997,
the Company had 42 branch offices in 13 states. This expansion 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. The Company is in the process of further expanding its Third
Party Dealer operations and diversifying its earning asset base by
implementing the Cygnet Dealer Program pursuant to which the Company provides
Third Party Dealers with operating credit lines secured by the dealers' retail
installment contract portfolios.
In 1996 the Company completed an initial public offering and a secondary
offering in which it sold common stock for a total of $82.3 million. In
February 1997, the Company completed a private placement of common stock for a
total of $88.7 million, net of expenses.
On January 15, 1997, the Company acquired substantially all of the assets
of Seminole Finance Corporation and related companies ("Seminole") in exchange
for approximately $2.5 million in cash and assumption of $29.9 million in
debt. The combination of the Company's audited consolidated statement of
operations for the year ended December 31, 1996 and Seminole's audited
combined statement of operations for the same period (as if the Seminole
acquisition had taken place on January 1, 1996) results in a combined net loss
for the year ended December 31, 1996 of $(3.6) million. These pro forma
results are not necessarily indicative of the future results of operations of
the Company or the results that would have been obtained had the Seminole
acquisition occurred on January 1, 1996. In addition, the pro forma results
are not intended to be a projection of future results. The Company expects the
results of operations in 1997 for the assets acquired from Seminole to differ
materially from 1996 results because the Company's management intends to
significantly alter the type of vehicles sold at the newly acquired car
dealerships, the methodology by which the acquired operations acquire,
recondition, and market used cars, and the methodology by which the related
finance receivables are underwritten and collected, which management believes
will result in the acquired operations being profitable in 1997. Furthermore,
Seminole's audited combined statement of operations for 1996 was impacted by
several factors that are not expected to have an impact on future operations.
Such factors were related to the deterioration of its loan portfolio, which
the Company believes resulted from poor underwriting and ineffective
collection efforts. First, due to the deterioration of its loan portfolio in
1996, Seminole recorded a total of $7.1 million in provision for credit
losses. Second, the deterioration of its loan portfolio also reduced its
borrowing capacity, thereby reducing Seminole's liquidity. As a result, in
order to raise cash, Seminole sold vehicles at substantially lower margins and
sold a portfolio of notes in December 1996 for a loss of approximately $1.5
million.
<PAGE>
The following discussion and analysis provides information regarding the
Company's consolidated financial position as of March 31, 1997 and December
31, 1996, and its results of operations for the three month periods ended
March 31, 1997 and 1996.
Growth in Finance Receivables. As a result of the Company's rapid expansion,
contract receivables serviced increased by 53.9% to $169.1 million at March
31, 1997 (including $100.4 million in contracts serviced under the Company's
Securitization Program) from $109.9 million at December 31, 1996.
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.
<TABLE><CAPTION>
TOTAL CONTRACTS ORIGINATED/PURCHASED
(in thousands, except number of contracts)
THREE MONTHS ENDED MARCH 31,
---------------------------------------------
1997 1996
--------------------- ---------------------
PRINCIPAL NO. OF PRINCIPAL NO. OF
AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Company Dealerships $ 47,345 9,063 $ 13,635 1,986
Third Party Dealers 41,510 7,538 7,186 1,268
---------- --------- ---------- ---------
Total $ 88,855 16,601 $ 20,821 3,254
========== ========= ========== =========
</TABLE>
<TABLE><CAPTION>
TOTAL CONTRACTS OUTSTANDING
(in thousands, except number of contracts)
THREE MONTHS ENDED YEAR ENDED
---------------------- ---------------------
MARCH 31,1997 DECEMBER 31, 1996
--------------------- ---------------------
PRINCIPAL NO. OF PRINCIPAL NO. OF
AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- --------- ---------- ---------
<S> <C> <C> <C> <C>
Company Dealerships $ 80,749 16,125 $ 49,066 9,615
Third Party Dealers 88,385 17,797 60,878 12,942
----------- --------- ----------- --------
Total Portfolio Serviced $ 169,134 33,922 $ 109,944 22,557
----------- --------- ----------- --------
Less Portfolio Securitized
and Sold (100,377) (19,628) (51,663) (10,612)
----------- --------- ----------- --------
Company Total $ 68,757 14,294 $ 58,281 11,945
=========== ========= =========== ========
</TABLE>
<PAGE>
RESULTS OF OPERATIONS
The prices at which the Company sells its cars and the interest rates
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 interest 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 Statements of
Operations calculated as Sales of Used Cars less Cost of Used Cars Sold.
THREE MONTHS ENDED MARCH 31, 1997 COMPARED TO THREE MONTHS ENDED MARCH 31, 1996
Sales of Used Cars. Sales of Used Cars increased by 20.5% to $18.2
million for the three month period ended March 31, 1997 from $15.1 million for
the three month period ended March 31, 1996. This growth reflects increases in
the number of used car dealerships in operation, and average unit sales price.
Units sold increased by 16.7% to 2,472 units in the three month period ended
March 31, 1997 from 2,119 units in the three month period ended March 31,
1996. Same store unit sales were down by an average of 34 units per location.
This is due to the increased emphasis on underwriting at the Company
Dealerships, particularly one dealership where unit sales decreased by 310
units or 45.3% for the three month period ended March 31, 1997 compared to the
same period in 1996.
The average sales price per car increased by 3.5% to $7,367 for the three
month period ended March 31, 1997 from $7,117 for the three month period ended
March 31, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 10.8% to $9.2 million for the three month period ended March 31,
1997 from $8.3 million for the three month period ended March 31, 1996. On a
per unit basis, the Cost of Used Cars Sold decreased by 5.8% to $3,709 for the
three month period ended March 31, 1997 from $3,939 for the three month period
ended March 31, 1996. The gross margin on used car sales (Sales of Used Cars
less Cost of Used Cars Sold excluding Provision for Credit Losses) increased
by 34.3% to $9.0 million for the three month period ended March 31, 1997 from
$6.7 million for the three month period ended March 31, 1996. As a percentage
of sales, the gross margin was 49.7% and 44.7% for the three month periods
ended March 31, 1997 and 1996, respectively. On a per unit basis, the gross
margin per car sold was $3,660 and $3,178 for the for the three month periods
ended March 31, 1997 and 1996, respectively.
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. As a result, the Company recognizes a Provision for Credit Losses in
order to establish an Allowance for Credit Losses sufficient to absorb
anticipated future losses. The Provision for Credit Losses increased by 53.9%
to $4.0 million in the three month period ended March 31, 1997 over $2.6
million for the three month period ended March 31, 1996. This includes an
increase of $720,000 in the Provision for Credit Losses in the three month
period ended March 31, 1997 for third party receivables over the three month
period ended March 31, 1996 when the Company recorded no Provision for Credit
Losses for third party receivables. On a percentage basis, the Provision for
Credit Losses per unit originated at Company Dealerships increased by 17.8% to
$1,545 per unit in the three month period ended March 31, 1997 over $1,312 per
unit in the three month period ended March 31, 1996. As a percentage of
contract balances originated, the Provision for Credit Losses averaged 20.0%
and 19.1%, for the three month periods ended March 31, 1997 and 1996,
respectively.
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 annual percentage rate ("APR") on its
contracts less amortization of loan origination costs.
Interest Income. Interest Income consists primarily of interest on both
finance receivables from Company Dealership sales and interest on Third Party
Dealer finance receivables.
Company Dealership Receivables-Interest Income increased by 19.2% to $3.1
million for the three month period ended March 31, 1997 from $2.6 million for
the three month period ended March 31, 1996. Interest Income was affected by
sales of $73.3 million in contract principal balances pursuant to the
Securitization Program, including sales of $15.1 million in contract principal
balances in the quarter ended March 31, 1997, and will continue to be affected
in future periods by additional securitizations. 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% of sales revenue and 85.4% of the used
cars sold at Company Dealerships for the three month period ended March 31,
1997 compared to 90.4% of sales revenue and 93.7% of the used cars sold for
the three month period ended March 31, 1996. The average amount financed
increased to $7,715 for the three month period ended March 31, 1997 from
$6,866 for the three month period ended March 31, 1996. The effective yield on
Finance Receivables from Company Dealerships was 28.0%, for each of the three
month periods ended March 31, 1997 and 1996, respectively. The Company
operated 14 and 7 dealerships at March 31, 1997 and 1996, respectively.
Third Party Dealer Receivables - Interest Income increased by 200.0% to
$3.3 million for the three month period ended March 31, 1997 from $1.1 million
in the three month period ended March 31, 1996. Interest Income was affected
by sales of $55.6 million in contract principal balances pursuant to the
Securitization Program, including sales of $45.6 million in contract principal
balances in the quarter ended March 31, 1997, and will continue to be effected
in future periods by additional securitizations. Interest income has increased
in conjunction with the increases in Third Party Dealer contracts purchased
and outstanding. As noted above, the Company began to significantly expand its
Third Party Dealer branch office operations in April 1995. Further, subsequent
to June 30, 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. Portfolio yield
was 25.3%, and 26.9%, for the three month periods ended March 31, 1997 and
1996, respectively. The Company operated 42 and 10 branch offices at March 31,
1997 and 1996, respectively.
Gain on Sale of Finance Receivables. Champion Receivables Corporation
("CRC"), a "bankruptcy remote entity" is the Company's wholly-owned special
purpose securitization subsidiary. During the first quarter of 1996, the
Company initiated a Securitization Program under which CRC sells securities
backed by contracts to SunAmerica Life Insurance Company ("SunAmerica"). Under
the Securitization Program, CRC assigns and transfers the contracts to separate
trusts (the "Trusts") pursuant to Pooling and Servicing Agreements (the
"Pooling Agreements"). Pursuant to the Pooling Agreements, Class A
Certificates and subordinated Class B Certificates are issued to CRC. CRC then
sells the Class A Certificates to SunAmerica or its nominees. The transferred
contracts are serviced by Champion Acceptance Corporation ("CAC"), another
subsidiary of the Company. To obtain a "BBB" rating from Standard & Poors,
CRC is required to provide a credit enhancement by establishing and
maintaining a cash spread account for the benefit of the certificate holders.
The Company makes an initial cash deposit into the spread account, ranging
from 3% to 4% of the initial underlying finance receivables principal balance
and pledges this cash to the Trusts. The Company is also required to then make
additional deposits from the residual cash flow (through the trustees) to the
spread account as necessary to attain and maintain the spread account at a
specified percentage, ranging from 6.0% to 8.0%, of the underlying finance
receivables principal balance. Distributions are not made to CRC on the Class
B Certificates unless the spread account has the required balance, the
required periodic payments to the Class A Certificate holders are current, and
the trustee, servicer and other administrative costs are current.
During the three months ended March 31, 1997, the Company made initial spread
account deposits totaling $1,973,000. Additional net deposits through the
trustees during the three months ended March 31, 1997 totaled $610,000
resulting in a total balance in the spread accounts of $5,426,000 as of March
31, 1997. In connection therewith, the specified spread account balance, based
upon the aforementioned specified percentages of the balances of the
underlying portfolios, as of March 31, 1997 was $6,990,000, resulting in
additional funding requirements from future cash flows as of March 31, 1997 of
$1,564,000. The additional funding requirements will decline as the trustees
deposit additional cash flows into the spread account and as the principal
balance of the underlying finance receivables declines.
The contracts transferred to the Trusts were purchased by CRC from either CAC
or Champion Financial Services ("CFS"), another subsidiary of the Company in
"true sale" transactions pursuant to separate purchase agreements. The
obligations of CAC, as servicer, pursuant to the Pooling Agreements are
guaranteed by the Company and certain other subsidiaries of the Company, other
than CRC, CAC, and CFS.
The Company recognizes a Gain on Sale of Finance Receivables equal to the
difference between the yield earned on the contract portfolio securitized and
the return on the securities sold. The amount of any Gain on Sale of Loans 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 securitization which it retains, and record a charge to earnings based
upon the reduction. The Company classifies the residuals as "held-to-maturity"
securities in accordance with SFAS No. 115.
The Company utilizes a number of estimates in arriving at the Gain on Sale of
Loans. The estimated cash flows into the Trusts were discounted with rates
ranging from 16% to 25%. For contracts originated at Company Dealerships, net
losses were estimated using total expected cumulative net losses at loan
origination of approximately 25.0%, adjusted for actual cumulative net losses
prior to securitization. For contracts purchased from Third Party Dealers, net
losses were estimated using total expected cumulative net losses at loan
origination of approximately 13.5%, adjusted for actual cumulative net losses
prior to securitization. Losses are discounted at an assumed risk free rate.
Prepayment rates were estimated to be 1.5% per month of the beginning of month
balance. The assumptions utilized in prior securitizations may not necessarily
be the same as those utilized in future securitizations, if any.
Through March 31, 1997, the Company had securitized an aggregate of $128.9
million in contracts, issuing $105.2 million in securities to SunAmerica.
Pursuant to these transactions, the Company reduced its Allowance for Credit
Losses by $7.3 million during the three months ended March 31, 1997 and
retained a residual in the contracts sold of $16.8 million at March 31, 1997.
The Company also recorded Gain on Sale of Loans during the three months ended
March 31, 1997 of $4.6 million, net of expenses, compared to $539,000 for the
same period in 1996. The gain on sale of loans as a percentage of principal
balance securitized was 7.5% for both the Company Dealership portfolio
securitized and for the Third Party Dealer portfolio securitized in the three
month period ended March 31, 1997 compared to 4.1% for the Company Dealership
portfolio securitized in the three month period ended March 31, 1996.
During the three months ended March 31, 1997, the Trusts issued certificates
to Sun America at a weighted average yield of 8.18% with the yields ranging
from 8.16% to 8.27%, resulting in net spreads, after servicing and trustee
fees, ranging from 12.5% to 17.2%, and averaging 13.5%.
The Company's net earnings may fluctuate from quarter to quarter in the future
as a result of the timing and size of its securitizations.
Other Income. Other Income consists primarily of servicing income, insurance
premiums earned on force placed insurance policies, earnings on investments
from the Company's cash and cash equivalents, and franchise fees from the
Company's rent-a-car franchisees. This income increased by 1,216% to $1.5
million for three months ended March 31, 1997 from $114,000 for the three
months ended March 31, 1996. The Company services the $128.9 million in
contracts sold in the securitization for monthly fees ranging from .33% to
.42% of beginning of period principal balances (4% to 5% annualized).
Servicing Income for the three months ended March 31, 1997 increased to
$598,000 from $54,000 in the three month period ended March 31, 1996. The
significant increase is due to the increase in the principal balance of
contracts being serviced pursuant to the Securitization Program. The increase
is also due to the increase in insurance premium income of $127,000 and an
increase in earnings on investments of $435,000. The Company no longer
actively engages in the rent-a-car franchise business.
Income before Operating Expenses. As a result of the Company's continued
expansion, Income before Operating Expenses grew by 109.5% to $17.6 million
for the three month period ended March 31, 1997 from $8.4 million for the
three month period ended March 31, 1996. Interest Income on the loan
portfolios and Gain on Sale of Loans were the primary contributors to the
increase. The increase also reflects the growth of Sales of Used Cars.
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
Selling and Marketing Expenses. For the three month periods ended March 31,
1997 and 1996, Selling and Marketing Expenses were comprised almost entirely
of advertising costs and commissions relating to Company Dealership
operations. Selling and Marketing Expenses increased by 50.0% to $1.5 million
for the three month period ended March 31, 1997 from $1.0 million for the
three month period ended March 31, 1996. As a percentage of Sales of Used
Cars, these expenses averaged 8.4% and 6.9% for the three month periods ended
March 31, 1997, and 1996, respectively. On a per unit sold basis, Selling and
Marketing Expenses of Company Dealerships increased by 26.4% to $621 per unit
for the three month period ended March 31, 1997 from $491 per unit for the
three month period ended March 31, 1996. This increase is primarily due to
increased marketing production costs, and an increase in marketing in the
Tampa Bay/St. Petersburg market where the Company initially commenced
operations in the three month period ended March 31, 1997, combined with a
decrease in same store unit sales.
General and Administrative Expenses. General and Administrative Expenses
increased by 111.4% to $9.3 million for the three month period ended March 31,
1997 from $4.4 million for the three month period ended March 31, 1996. These
expenses represented 30.2%,and 22.4% of total revenues for three month periods
ended March 31, 1997, and 1996, respectively. For the three month period ended
March 31, 1997 approximately 34.9% of General and Administrative Expenses were
attributable to Company Dealership sales, approximately 17.1% to the Company
Dealership Receivables' financing activities, approximately 24.9% to Third
Party Dealer activities, and approximately 23.1% to corporate overhead. For
the three month period ended March 31, 1996, approximately 48.8% of General
and Administrative Expenses were attributable to Company Dealership sales,
approximately 18.2% to the Company Dealership Receivables' financing
activities, approximately 13.0% to Third Party Dealer activities, and
approximately 20.0% to corporate overhead. The increase in General and
Administrative Expenses is a result of the Company's increased number of used
car dealerships, and significant expansion of its Third Party Dealer financing
operations as well as continued expansion of infrastructure to administer
growth.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on the Company's property and equipment and
amortization of the Company's goodwill and trademarks. Depreciation and
amortization increased by 81.6% to $603,000 for the three month period ended
March 31, 1997 from $332,000 for the three month period ended March 31, 1996.
The increase was due primarily to the increase in depreciation expense for the
Company's Third Party Dealer Branch offices. For the three month period ended
March 31, 1997, approximately 33.2% of these expenses were attributable to
Company Dealership sales, approximately 34.2% to the Company Dealership
receivables' financing activities, approximately 12.1% to Third Party Dealer
activities, and approximately 20.5% to corporate overhead. For the three month
period ended March 31, 1996, approximately 22.6% of these expenses were
attributable to Company Dealership sales, approximately 53.3% to the Company
Dealership receivables' financing activities, approximately 9.9% to Third
Party Dealer activities, and approximately 14.2% to corporate overhead.
Interest Expense. Interest expense decreased by 54.8% to $769,000 in the
three month period ended March 31, 1997 from $1.7 million in the three month
period ended March 31, 1996. The decrease in 1997, despite significant growth
in Company assets, is the direct result of the two public offerings that were
completed in 1996, and a private placement that was completed in February of
1997 which generated, in the aggregate, approximately $168.1 million in cash,
and the Company's Securitization Program which generated cash from the sale of
Finance Receivables which the Company utilized to pay down debt. Further,
concurrent with the Company's initial public offering on June 21, 1996, the
Company restructured its Subordinated Notes Payable reducing the borrowing
rate on that debt from 18% to 10% per annum.
Income Taxes. Income taxes totaled $2.2 million in the three month period
ended March 31, 1997, an effective rate of 39.8%. In the three month period
ended March 31, 1996, no income tax was incurred due to income tax benefits
realized from the Company's reduction in its valuation allowance for deferred
income tax assets.
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 and Provision for Credit Losses on contracts purchased
from Third Party Dealers. The Allowance on contracts originated at Company
Dealerships increased to 28.4% of outstanding principal balances as of March
31, 1997 compared to 23.0% as of December 31, 1996. The Allowance as a
percentage of Third Party Dealer contracts increased to 17.1% from 12.7% over
the same period. The Allowance as a percentage of the Company's combined
contract portfolio increased to 22.1% at March 31, 1997 from 13.7% at December
31, 1996. The increase in reserves is primarily due to the acquisition of the
portfolio in the Company's Florida acquisition and a bulk purchase of finance
receivables at a discount.
The following table reflects activity in the Allowance, as well as information
regarding charge off activity, for the three month periods ended March 31,
1997 and 1996, in thousands.
<TABLE>
<CAPTION>
COMPANY DEALERSHIPS THIRD PARTY DEALERS
-------------------- -------------------
THREE MONTHS ENDED THREE MONTHS ENDED
MARCH 31, MARCH 31,
-------------------- -----------------
1997 1996 1997 1996
--------- --------- -------- -------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 1,626 $ 7,500 $ 5,434 $1,000
Provision for Credit Losses 3,261 2,606 720 -
Discount Acquired 9,033 - 6,418 721
Discount accreted to interest income - - (642) -
Reduction Attributable to Loans Sold (3,100) (1,658) (4,235) -
Net Charge Offs (1,597) (2,048) (1,476) (371)
--------- --------- -------- -------
Balance, End of Period $ 9,223 $ 6,400 $ 6,219 $1,350
========= ========= ======== =======
Allowance as Percent of Period
Ended Principal Balance 28.4% 23.0% 17.1% 7.3%
========= ========= ======== =======
Charge off Activity:
Principal Balances:
Collateral Recovered $ 2,140 $ 2,252 $ 1,597 $ 542
Collateral Not Recovered 123 462 464 91
--------- --------- -------- -------
Total Principal Balances 2,263 2,714 2,061 633
Accrued Interest - 167 - 30
Recoveries, Net (666) (833) (585) (292)
--------- --------- -------- -------
Net Charge Offs $ 1,597 $ 2,048 $ 1,476 $ 371
========= ========= ======== =======
Net Charge Offs as % of Average
Principal Outstanding 5.0% 5.8% 2.9% 2.2%
========= ========= ======== =======
</TABLE>
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.
Net Charge Offs - Company Dealerships. Net Charge Offs for contracts
originated at Company dealerships in the three month period ended March 31,
1997 were 5.0% of the average principal balance outstanding compared to 5.8%
in the three month period ended March 31, 1996.
Recoveries averaged 29.4% of principal balances charged off in the three month
period ended March 31, 1997 compared to 30.7% in the three month period ended
March 31, 1996.
The Company's net charge offs on contracts generated through certain of the
Company Dealerships are favorably affected by a reduction in sales tax
liability as a result of loan defaults.
Net Charge Offs - Third Party Dealers. Net Charge Offs for contracts
purchased from Third Party Dealers in the three month period ended March 31,
1997 were 2.9% of the average principal balance outstanding compared to 2.2%
in the three month period ended March 31, 1996. 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%. In April 1995 the Company significantly
revised and expanded its Third Party Dealer program. Under the current
program, which is aimed at more creditworthy borrowers, it purchases from
Third Party Dealers, at discounts averaging approximately 11.0%, contracts
with average principal balances of approximately $5,800 and bearing an average
APR of 24.5%.
Recoveries averaged 28.4% of principal balances charged off on contracts
purchased from Third Party Dealers in the three month period ended March 31,
1997 compared to 46.1% for the three month period ended March 31, 1996. The
decrease is primarily due to the increase in the charge off of principal
balances where no collateral has been recovered. The percentage of principal
charged off with no recovery of collateral increased to 22.5% in the three
months ended March 31, 997 from 14.4% in the comparable period in 1996.
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 relationship of the average amount
financed to the underlying collateral's wholesale value and to a lesser degree
the generally more creditworthy customers served by Third Party Dealers. In
its Third Party Dealer portfolio, the Company generally limits the amount
financed to not more than 120.0% of the wholesale value of the underlying car,
although the Company will make exceptions on a case-by-case basis.
Net Charge Off percentage trends for the respective portfolios are considered
by management in determining the adequacy of the Allowance as a percentage of
contract principal balances outstanding.
Static Pool Analysis. To monitor contract performance, beginning in June
1995, the Company implemented "static pool" analysis for 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. The table below 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. For periods denoted by "x", the
pools have not seasoned sufficiently to allow for computation of cumulative
losses. For periods denoted by "-", the pools have not yet attained the
indicated cumulative age. While the Company monitors its static pools on a
monthly basis, for presentation purposes the information in the tables are
presented on a quarterly basis.
Effective January 1, 1997, the Company retroactively implemented methodology
to more reasonably compute "Monthly Payments Completed by Customer Before
Charge Off" as it relates to loan balances charged off after final insurance
settlements and on loans modified from their original terms. Resulting
adjustments affect the timing of previously reported interim cumulative losses
and do not impact ending cumulative losses. For loan balances charged off
after insurance settlement principal reductions, the revised calculation
method only gives credit for payments actually made by the customer and
excludes credit for reductions arising from insurance proceeds. For modified
loans, completed payments now reflect customer payments made both before and
after the loan was modified. The numbers presented below reflect the adoption
of the revised calculation method.
Currently reported cumulative losses may also vary from those previously
reported due to ongoing collection efforts on charged off accounts and the
difference between final proceeds on the liquidation of repossessed collateral
versus original accounting estimates. Management believes that such variation
will be insignificant.
CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS
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>
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 6.9% 18.7% 26.5% 31.8% 33.9% 35.1%
2nd Quarter 7.2% 18.9% 25.1% 29.4% 31.7% 32.1%
3rd Quarter 8.6% 19.5% 23.7% 28.5% 30.7% 31.6%
4th Quarter 6.3% 16.1% 21.6% 27.0% 28.9% 29.5%
1994:
1st Quarter 3.4% 10.0% 13.4% 18.1% 20.5% 21.2%
2nd Quarter 2.8% 10.5% 14.3% 19.8% 22.0% 22.5%
3rd Quarter 2.9% 8.2% 12.3% 16.6% 18.8% 19.7%
4th Quarter 2.4% 7.7% 11.3% 17.0% 20.0% 21.0%
1995:
1st Quarter 1.1% 7.4% 12.5% 17.8% 20.5% x
2nd Quarter 1.7% 7.1% 12.2% 16.9% 19.8% -
3rd Quarter 2.0% 7.1% 11.1% 18.1% x -
4th Quarter 1.2% 5.7% 10.9% 17.8% - -
1996:
1st Quarter 1.4% 7.5% 13.1% x - -
2nd Quarter 2.2% 9.2% 14.0% - - -
3rd Quarter 1.5% 7.3% x - - -
4th Quarter 1.6% x - - - -
1997:
1st Quarter x - - - - -
</TABLE>
<PAGE>
Analysis of portfolio delinquencies is also considered in evaluating the
adequacy of the Allowance. Principal balances 31 to 60 days delinquent as a
percentage of total outstanding contract principal balances totaled 2.3% as of
March 31, 1997 and December 31, 1996. Principal balances 61 to 90 days
delinquent as a percentage of total outstanding contract principal balances
totaled 1.7% and 0.6% as of March 31, 1997 and December 31, 1996,
respectively. In accordance with the Company's charge off policy, there are no
accounts more than 90 days delinquent as of March 31, 1997 and December 31,
1996.
CONTRACTS PURCHASED FROM THIRD PARTY DEALERS
Non-refundable acquisition discount ("Discount") acquired totaled $6.4 million
and $721,000 for the three month periods ended March 31, 1997 and 1996,
respectively. The Discount, attributable to Third Party Dealer branch
purchases, averaged 15.5% as a percentage of principal balances purchased in
the three month period ended March 31, 1997, compared to 10.0% in the three
month period ended March 31, 1996. Beginning in 1996, the Company expanded
into markets with interest rate limits. While contractual interest rates on
these contracts are limited by law, the Company has been able to purchase
these contracts at a reasonably consistent effective yield and therefore
Discounts have trended upward. The increase in the Discount as a percent of
purchased contracts was due in large part to a bulk purchase of contracts in
March 1997. The Discount for purchased contracts excluding bulk purchases
totaled 11.6% in the three month period ended March 31, 1997.
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>
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 0.9% 4.1% 5.7% 7.7% 9.4% x
3rd Quarter 1.4% 3.9% 5.1% 6.9% - -
4th Quarter 1.0% 4.3% 6.8% 9.6% x -
1996:
1st Quarter 0.8% 3.7% 6.9% x - -
2nd Quarter 1.6% 6.3% 9.7% - - -
3rd Quarter 1.3% 6.1% x - - -
4th Quarter 1.3% x - - - -
1997:
1st Quarter x - - - - -
</TABLE>
Beginning April 1, 1995, the Company initiated a new purchasing program
for Third Party Dealer contracts which included an emphasis on 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 an
immaterial remaining balance as of March 31, 1997. Static pool results under
the prior program are not a material consideration for management evaluation
of the current Third Party Dealer portfolio and thus, contract performance
under this prior program has been excluded from the table above.
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.
Analysis of portfolio delinquencies is also considered in evaluating the
adequacy of the Allowance. Principal balances 31 to 60 days delinquent as a
percentage of total outstanding contract principal balances totaled 3.5% and
3.1% as of March 31, 1997 and December 31, 1996, respectively. Principal
balances 61 to 90 days delinquent as a percentage of total outstanding
contract principal balances totaled 1.9% and 1.1% as March 31, 1997 and
December 31, 1996, respectively. In accordance with the Company's charge off
policy there are no Third Party Dealer contracts more than 90 days delinquent
as of March 31, 1997 and December 31, 1996.
During 1996, the Company 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 a result of this
revised repossession policy, delinquencies increased slightly, as expected.
Further, the Company underwent a conversion of its loan servicing system on
February 1, 1997. In the opinion of management, delinquency was adversely
effected by the conversion process due to the need for employees to completely
acquaint themselves with the Company's new systems.
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 Company funds its capital
requirements through equity offerings, operating cash flow, the sale of
finance receivables, and supplemental borrowings.
The Company's Net Cash Provided by Operating Activities decreased by
39.2% to $3.1 million for the three month period ended March 31, 1997 from
$5.1 in the three month period ended March 31, 1996. The decrease was
primarily due to an increase in Other Assets, the Gain on Sale of Finance
Receivables, and an increase in Finance Receivables Held for Sale offset by
increases in Net Earnings, the Provision for Credit Losses, and proceeds from
sale of finance receivables.
The Net Cash Used in Investing Activities decreased by 89.1% to $503,000
in the three months ended March 31, 1997 from $4.6 million in the three months
ended March 31, 1996. The decrease was due to a net increase in Finance
Receivable activity of $14.8 million net of an increase in investments held in
trust of $2.2 million, an increase in the purchase of property and equipment
of $3.6 million, and the purchase of the assets of Seminole. Gross deposits
into the spread account by the trustees were $2.8 million and $625,000 while
gross disbursements from the spread account totaled $265,000 during the three
months ended March 31, 1997. There were no disbursements from the spread
account during the three months ended March 31, 1996.
The Company's Net Cash Provided by / Used in Financing Activities
increased to $52.2 million in the three months ended March 31, 1997 from
($1.3) million in the three months ended March 31, 1996. This increase was the
result of the $88.7 million in proceeds from the Company's sale of common
stock, net of the $34.4 million of repayment of Notes Payable and the
repayment of subordinated notes payable of $2.0 million.
Revolving Facility. The Company maintains a Revolving Facility with GE
Capital that 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, 1997,
the Company's borrowing capacity under the Revolving Facility was $50.0
million, the aggregate principal amount outstanding under the Revolving
Facility was $100,000, and the amount available to be borrowed under the
facility was $49.9 million. The Revolving Facility bears interest at the
30-day LIBOR plus 3.60%, payable daily (total rate of 9.0% as of March 31,
1997).
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) make unsecured loans or other advances of money to
officers, directors, employees, stockholders or affiliates in excess of
$25,000 in total; (iii) engage in securitization transactions (other than the
Securitization Program with Sun America, for which GE Capital has consented);
(iv) 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; (v) make any change in its
capital structure; (vi) declare or pay dividends except in accordance with all
applicable laws and not in excess of fifteen percent (15%) of each year's net
earnings available for distribution; (vii) make certain investments and
capital expenditures; and (viii) engage in certain transactions with
affiliates. These covenants also require the Company to maintain specified
financial ratios, including a debt ratio of 2.0 to 1 and a net worth of at
least $75,000,000, and to comply with all laws relating to the Company's
business. The Revolving Facility also provides that a transfer of ownership of
the Company that results in less than 15.0% of the Company's voting stock
being owned by Mr. Ernest C. Garcia II, will result in an event of default
under the Revolving Facility.
The Company recently completed negotiations to modify the terms of
its Revolving Facility, and expects to execute a definitive agreement in the
near future. Under the modified terms of the agreement, the commitment will
be raised from $50 million to $100 million, the Company may borrow up to 65.0%
of the principal balance of eligible Company Dealership contracts and up to
86.0% of the principal balance of eligible Third Party Dealer contracts, the
interest rate will be reduced to 30-day LIBOR plus 3.15%, payable daily, and
the Revolving Facility will expire in December 1998, at which time the Company
will have the option to renew the Revolving Facility for one additional year.
The definitive agreement will be subject to the approval of the Board of
Directors of the Company. Also, certain of the definitive terms may vary from
those set forth herein. No assurance can be given that definitive agreements
will ultimately be executed.
Subordinated Indebtedness and Preferred Stock. The Company has
historically borrowed substantial amounts from Verde Investments Inc.
("Verde"), an affiliate of the Company. The Subordinated Notes Payable
balances outstanding to Verde totaled $12.0 and $14.0 million as of March 31,
1997 and December 31, 1996, respectively. 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 and the Company may suspend interest and
principal payments in the event it is in default on obligations to any other
creditors.
On December 31, 1995, Verde 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 from 12.0% to 10.0%. During the three month period ended March
31, 1996, the Company paid a total of $300,000 in dividends to Verde on the
Preferred Stock which was redeemed in November 1996. As the preferred stock
was redeemed in 1996, there were no dividends paid in 1997.
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
provides the Company with a source of funding in addition 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. 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.
In connection with its securitization transactions, 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 balances 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.
Capital Expenditures and Commitments. The Company is pursuing an
aggressive growth strategy. In the fourth quarter of 1996, the Company
acquired the leasehold rights to an existing dealership in Las Vegas, Nevada,
which commenced operations in March 1997, and has three other dealerships (one
in Phoenix, Arizona and two in Albuquerque, New Mexico) currently under
development. In addition, the Company opened seven new Branch Offices during
the first quarter of 1997, and recently completed expansion of its contract
servicing and collection facility.
On April 1, 1997, the Company purchased substantially all of the assets
of a Company engaged in the business of selling and financing used motor
vehicles, including seven dealerships in San Antonio and a contract portfolio
of approximately $24.3 million. The purchase price for the acquisition was
$26.3 million, subject to adjustment. The seven dealerships had sales in 1996
of approximately $22.5 million. The assets purchased have an unaudited book
value of $28.1 million, exclusive of reserves on approximately $26.2 million
of contract receivable principal balances. In addition to the facilities
currently under development, the Company intends to open 15 or more new Branch
Offices and three or more Company Dealerships through the end of 1997. The
Company believes that it will expend approximately $50,000 to establish each
new Branch Office. New Company Dealerships cost approximately $1.5 to $1.7
million to construct (excluding inventory). The Company intends to finance
these expenditures through operating cash flows and supplemental borrowings,
including amounts available under the Revolving Facility and Securitization
Program.
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
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.
ACCOUNTING MATTERS
In February 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
(SFAS No. 128). This statement is effective for both interim and annual
periods ending after December 15, 1997, and replaces the presentation of
"primary" earnings per share with "basic" earnings per share and the
presentation of "fully diluted" earnings per share with "diluted" earnings per
share. Earlier application is not permitted. When adopted, all previously
reported earnings per common share amounts must be restated based upon the
provisions of the new standard. Management of the Company does not expect
that adoption of SFAS No. 128 will have a material impact on the Company.
<PAGE>
PART II. OTHER INFORMATION
Item 1. 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 applicable state, federal and other laws and regulations,
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 and are
subsequently resolved, the Company is named occasionally as a defendant in
civil suits filed by customers in state, local, or small claims courts. There
can be no assurance that the Company will not be a target of similar claims in
the future. The Company, believes that the ultimate disposition of these
matters on a cumulative basis will not have a material adverse effect on the
Company. However, there can be no assurance in this regard.
In connection with the Seminole acquisition, a purported creditor of the
sellers filed, on January 21, 1997, to enjoin the sale as a fraudulent
conveyance. Alternatively, the suit seeks to void any transfer of the assets
that has already occurred, to attach the assets that have been transferred, or
to appoint a receiver to take charge of the assets transferred. The Company
has not been named in this action, has received a specific indemnity from the
sellers relating to this action, and has been advised by the sellers that, in
their view, the claim is without merit. The Company believes that the
ultimate disposition of this matter will not have a material effect on the
Company.
Item 2. Changes in Securities.
None.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
Set forth below is information concerning each matter submitted to a vote at
the Company's Annual Meeting of Shareholders on April 22, 1997:
Directors: Each of the following persons was elected as a director of the
Company to hold office until the 1998 Annual Meeting of Shareholders or until
earlier retirement, resignation or removal: Robert J. Abrahams, Ernest C.
Garcia II, Christopher D. Jennings, John N. MacDonough, Arturo R. Moreno and
Frank P. Willey. Each of these persons received 14,501,946 votes "for"
reelection and 51,579 votes "withheld."
Amendment of Certificate of Incorporation: The shareholders approved an
amendment of the Company's Certificate of Incorporation to increase the
authorized number of shares of common stock from 20,000,000 to 100,000,000.
<TABLE><CAPTION>
<S> <C> <C> <C> <C>
For Against Abstentions Broker Nonvotes
---------- ------- ----------- ---------------
Amendment of Certificate
of Incorporation 13,589,384 937,886 26,255 --
</TABLE>
Amendment of Long-Term Incentive Plan: The shareholders approved the
management proposal to amend the Company's Long-Term Incentive Plan to
increase the number of shares authorized for issuance thereunder from 800,000
to 1,800,000.
<TABLE><CAPTION>
<S> <C> <C> <C> <C>
For Against Abstentions Broker Nonvotes
---------- ------- ----------- ---------------
Amendment of Long-Term
Incentive Plan 12,414,030 441,481 30,355 1,667,659
</TABLE>
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
Exhibit 99 - Cautionary Statement Regarding Forward Looking
Statements
(b) Reports on Form 8-K.
During the first quarter of 1997, the Company filed three reports on
Form 8-K, two of which were subsequently amended. The first report on Form
8-K, dated January 15, 1997, and filed January 30, 1997, reported the closing
of the acquisition of certain assets from third parties (referred to as
Seminole) and included a copy of the agreement of purchase and sale of assets
for the acquisition. On March 31, 1997, the Company filed a Form 8-K/A1
reporting certain financial statements related to the Seminole acquisition.
Those financial statements were subsequently revised pursuant to From 8-K/A2
filed May 14, 1997. The second report on Form 8-K, dated February 3, 1997 and
filed February 4, 1997, reported the undertaking of a private placement by the
Company of certain of its common stock and included the Company's audited
financial statements as of and for the year ended December 31, 1996, and a
copy of the Company's press release titled "Ugly Duckling Corporation
Announces Intention to Sell Up to 5,000,000 Shares of Common Stock to
Institutional Investors." The third report on Form 8-K, dated February 11,
1997 and filed February 12, 1997, reported the completion of the private
placement of approximately 5,000,000 shares of its common stock and included a
copy of the Company's press release titled "Ugly Duckling Corporation
Completes Private Placement of 5,000,000 Shares of Common Stock to
Institutional Investors." The third report on Form 8-K was amended on
February 12, 1997 and February 27, 1997 to disclose certain additional
information in connection with the private placement of the 5,000,000 shares
of the Company's common stock. After the first quarter 1997, the Company
filed two reports on Form 8-K. The first report on Form 8-K,dated April 1,
1997 and filed April 15, 1997 reported the closing of the acquisition of
certain assets from third parties (referred to as E-Z Plan), indicated that
financial information in connection with the E-Z Plan acquisition will be
filed later when it is available and incorporated by reference the previously
filed agreement of purchase and sale of assets for the acquisition. The
second report on Form 8-K dated April 21, 1997 and filed April 22, 1997,
reported that the Company's registration statement relating to the resale of
the common stock acquired pursuant to the private placement had been declared
effective.
<PAGE>
SIGNATURE
---------
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: May 15, 1997
--------------
/s/ Steven T. Darak
- ----------------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
S-1
EXHIBIT 11
UGLY DUCKLING CORPORATION
SCHEDULE OF COMPUTATION OF EARNINGS PER COMMON SHARE
(in thousands, except per share amounts)
<TABLE><CAPTION>
Three Months ended March 31,
---------------------------------------------
1997 1996
--------------------- ----------------------
<S> <C> <C> <C> <C>
Fully Fully
Primary Diluted Primary Diluted
---------- --------- ---------- ----------
Net earnings $ 3,262 3,262 1,065 1,065
Preferred dividends -- -- (300) (300)
---------- --------- ---------- ----------
Net earnings available to common
shares $ 3,262 3,262 765 765
========== ========= ========== ==========
Earnings per common share $ 0.20 0.20 0.13 0.13
========== ========= ========== ==========
Weighted average common shares outstanding 15,904 15,904 5,522 5,522
Common equivalent shares outstanding
using the treasury stock method 675 675 370 370
---------- --------- ---------- ----------
Weighted average common and common
equivalent shares outstanding 16,579 16,579 5,892 5,892
========== ========= ========== ==========
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This financial data schedule on form 10-Q for the quarter ended March 31, 1997
contains summary financial information which is incorporated by reference from
the 1997 quarterly report and extracted from the Condensed Consolidated
Balance Sheets, Condensed Consolidated Statements of Operations, and Condensed
Consolidated Statements of Cash Flows, and is qualified in its entirety by
reference to the financial statement within the report on form 10-Q filing.
Any item provided in the schedule, in accordance with the rules governing the
schedule, will not be subject to liability under the federal securities laws,
except to the extent that the financial statements and other information from
which the data were extracted violate the federal securities laws. Also,
pursuant to item 601(c)(1)(iv) of Regulation S-K promulgated by the Securities
and Exchange Commission (SEC), the schedule shall not be deemed filed for
purposes of Section 11 of the Securities Act of 1933, Section 18 of the
Exchange Act of 1934 and Section 323 of the Trust Indenture Act, or otherwise
be subject to the liabilities of such sections, nor shall it be deemed a part
of any registration statement to which it relates.
<CAPTION>
<S> <C>
</LEGEND>
<CIK> 0001012704
<NAME> UGLY DUCKLING CORP
<MULTIPLIER> 1,000
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> MAR-31-1997
<CASH> 73,237
<SECURITIES> 23,162
<RECEIVABLES> 69,790
<ALLOWANCES> 15,442
<INVENTORY> 9,270
<CURRENT-ASSETS> 0<F1>
<PP&E> 28,471
<DEPRECIATION> 3,475
<TOTAL-ASSETS> 206,076
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 171,274
<OTHER-SE> 2,969
<TOTAL-LIABILITY-AND-EQUITY> 174,243
<SALES> 18,211
<TOTAL-REVENUES> 29,230
<CGS> 9,164
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 11,406
<LOSS-PROVISION> 3,981
<INTEREST-EXPENSE> 769
<INCOME-PRETAX> 5,414
<INCOME-TAX> 2,152
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,262
<EPS-PRIMARY> .20
<EPS-DILUTED> .20
<FN>
<F1>UNCLASSIFIEDBALANCESHEET
</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
- -------------
Investing in the stock of the Company involves certain risks. In addition to
the other information included elsewhere in this From 10-Q, investors should
give careful consideration to the following risk factors which may impact the
Company's performance and the price of its stock.
NO ASSURANCE OF CONTINUED PROFITABILITY; FLUCTUATIONS IN OPERATING RESULTS
- ------------------------------------------------------------------------------
The Company began operations in 1992 and incurred significant losses in 1994
and 1995. In 1996, however, the Company achieved profitability with net
earnings of approximately $5.9 million (including $4.4 million of gains
recognized from the sale of contract receivables pursuant to the
Securitization Program) on total revenues of $75.6 million. There can be no
assurance that the Company will remain profitable. See Part 1, Item 2.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<PAGE>
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 its
Securitization Program, which the Company expects to continue for the
foreseeable future. Consequently, the Company's net earnings 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 securities markets generally, conditions in the asset-backed
securities markets specifically, and the credit quality of the Company's
portfolio. The amount of any gain on sale 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 securitization 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. See Part
1, Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
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 fixed
interest rates ranging from 21.0% to 29.9% on contracts originated at Company
Dealerships, while rates range from 17.6% 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 13.9% of contract principal
balances for 1995 and 1996, respectively, to cover anticipated credit losses
on the contracts currently in its portfolio. At December 31, 1995 and 1996,
the principal balance of delinquent contracts as a percentage of total
outstanding contract principal balances was 4.2% and 3.7%, respectively. The
Company's net charge offs as a percentage of average principal outstanding for
the years ended December 31, 1995 and 1996 were 21.7% and 16.7%, respectively.
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 its Allowance for Credit Losses 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 Part 1, Item 2. "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Allowance for Credit Losses."
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
Dealerships and 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 upon its
ability to: (i) expand its revenue generating operations while not
<PAGE>
proportionately 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
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.
The Company has initiated its Cygnet Dealer Program, pursuant to which the
Company provides 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 the financing
necessary to fully implement the Cygnet Dealer Program. In addition, there can
be no assurance that the Company will be successful in its efforts to expand
its insurance services.
NO ASSURANCE OF SUCCESSFUL ACQUISITIONS
- -------------------------------------------
The Company has recently completed two acquisitions and intends to consider
acquisitions of and alliances with other companies that could complement the
Company's existing business. There can be no assurance that suitable
acquisition or joint venture candidates can be identified, or that, if
identified, any such transactions will be consummated. Furthermore, there can
be no assurance that the Company will be able to integrate successfully such
acquired businesses including those recently acquired into its existing
operations, which could increase the Company's operating expenses in the
short-term and materially and adversely affect the Company's results of
operations. Moreover, any acquisition by the Company may result in
potentially dilutive issuances of equity securities, the incurrance of
additional debt, and amortization of expenses related to goodwill and
intangible assets, all of which could adversely affect the Company's
profitability. Acquisitions involve numerous risks, such as the diversion of
the attention of the Company's management from other business concerns, the
entrance of the Company into markets in which it has had no or only limited
experience, and the potential loss of key employees of the acquired company,
all of which could have a material adverse effect on the Company's business,
financial condition, and results of 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 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
<PAGE>
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 highly
fragmented and very competitive. In recent years, 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.
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
decreased sales of used cars and increased delinquencies, repossessions, and
credit losses that could hinder the Company's business. Because of the
Company's focus on the sub-prime segment of the automobile financing industry,
its actual rate of delinquencies, repossessions, and credit losses could be
higher under adverse conditions than those experienced in the used car sales
and finance industry in general.
INDUSTRY CONSIDERATIONS AND LEGAL CONTINGENCIES
- ---------------------------------------------------
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation and other events. In addition, one of these
companies has filed for bankruptcy protection. These announcements have had
and may continue to have a disruptive effect on the market for securities of
sub-prime automobile finance companies, are expected to result in a tightening
of credit to the sub-prime markets and could lead to enhanced regulatory
<PAGE>
oversight. Furthermore, companies in the used car financing market have been
subject to an increasing number of class action lawsuits brought by customers
and third party dealers alleging violations of various federal and state
credit and similar laws and regulations, breach of contract and other claims.
Although the Company is not currently subject to any such lawsuits, no
assurance can be given that such claims will not be asserted against the
Company in the future or that the Company's operations will not be subject to
enhanced regulatory oversight.
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 enters 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
- -------------------------
Company Dealership operations are currently concentrated in Arizona, Florida,
Nevada, and Texas. In addition, a majority of the Company's Branch Offices are
located in Arizona, Indiana, Florida, and Texas. 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 the Company's
primary markets
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. 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,
and also requires the Company to meet certain financial tests. As of March 31,
1997, the aggregate principal amount outstanding under the Revolving Facility
was $100,000, and the amount available to be borrowed was $49.9 million.
Although the Company believes it is currently in compliance with the terms and
conditions of the Revolving Facility, there can be no assurance that the
<PAGE>
Company will be able to continue to satisfy such terms and conditions or that
the Revolving Facility will be extended beyond its current expiration date.
For a discussion of certain possible amendments to the Revolving Facility, see
Part 1, Item 2. "Management's Discussion and Analysis of Financial Condition
and Results of Operations - Liquidity and Capital Resources - Revolving
Facility." In addition, the Company and SunAmerica have entered into the
Securitization Program pursuant to which SunAmerica may purchase up to $175.0
million of the Company's asset-backed securities. 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. As of
March 31, 1997, the Company had securitized an aggregate of $68.2 million in
contracts originated through Company Dealerships and $60.7 million in loans
originated at Third Party Dealers and purchased by the Company, and had issued
$105.2 million in asset-backed securities to SunAmerica in since inception of
the Securitization Program. There can be no assurance, however, that any
further securitizations will be completed or that the Company will be able to
secure additional financing, including the financing necessary to fully
implement the Cygnet Dealer Program, when and as needed in the future, or on
terms acceptable to the Company. See Part 1, Item 2. "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Liquidity and
Capital Resources."
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 on 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 fixed interest rates ranging from 21.0% to 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, a
significant portion of the Company's used car sales activities are conducted
in, and a significant portion of the contracts the Company services are
originated in, Arizona, which does not impose limits on the interest rate that
a lender may charge. However, the Company has expanded, and will continue to
expand, its operations into states that impose usury limits, such as Florida
and Texas. The Company attempts to mitigate these rate restrictions by
purchasing contracts from Third Party Dealers originated in these states at a
higher discount, or by obtaining higher gross margins on vehicles sold and
financed at Company Dealerships. The Company's inability to achieve adequate
discounts, or gross margins in states imposing usury limits would adversely
affect the Company's planned expansion and its results of operations. There
can be no assurance that the usury limitations to which the Company is or may
become subject or that additional laws, rules, and regulations that may be
adopted in the future will not adversely affect the Company's business.
<PAGE>
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.
CONTROL BY PRINCIPAL STOCKHOLDER
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Mr. Ernest C. Garcia, II, the Company's Chairman, Chief Executive Officer, and
principal stockholder, holds 25.1% 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.
POTENTIAL ANTI-TAKEOVER EFFECT OF PREFERRED STOCK
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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.
REGULATION, SUPERVISION, AND LICENSING
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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
<PAGE>
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.
SHARES ELIGIBLE FOR FUTURE SALE
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Approximately 5,122,456 shares of Common Stock outstanding as of the date of
this Quarterly Report are "restricted securities," as that term is defined
under Rule 144 promulgated under the Securities Act. In general, under Rule
144 as currently in effect, subject to the satisfaction of certain other
conditions, if one year has elapsed since the later of the date of acquisition
of restricted shares from an issuer or an affiliate of an issuer, the acquiror
or subsequent holder is entitled to sell in the open market, within any
three-month period, a number of shares that does not exceed the greater of one
percent of the outstanding shares of the same class or the average weekly
trading volume during the four calendar weeks preceding the filing of the
required notice of sale. (A person who has not been an affiliate of the
Company for at least the three months immediately preceding the sale and who
has beneficially owned shares of Common Stock as described above for at least
two years is entitled to sell such shares under Rule 144 without regard to any
of the limitations described above.) Of the "restricted securities"
outstanding, substantially all of these shares have been held for the one-year
holding period required under Rule 144. In addition, 5,413,144 shares of
Common Stock were recently registered for resale under the Securities Act of
1933, as amended (the "Securities Act"). No predictions can be made with
respect to the effect, if any, that sales of the Common Stock in the market or
the availability of shares of Common Stock for sale under Rule 144 will have
on the market price of Common Stock prevailing from time to time.
Nevertheless, the possibility that substantial amounts of Common Stock may be
sold in the public market may adversely affect prevailing market prices for
the Common Stock.
POSSIBLE VOLATILITY OF STOCK PRICE
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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.
