<PAGE>1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 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 November 14, 1997, there were 18,520,916 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>2
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Part I. - FINANCIAL STATEMENTS
Page
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996 3
Condensed Consolidated Statements of Operations -Three Months and Nine
Months Ended September 30, 1997 and September 30, 1996 4
Condensed Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1997 and September 30, 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 30
Item 2. CHANGES IN SECURITIES 30
Item 3. DEFAULTS UPON SENIOR SECURITIES 30
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 30
Item 5. OTHER INFORMATION 30
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES S-1
Exhibit 10.a
Exhibit 10.b
Exhibit 10.c
Exhibit 11 i
Exhibit 27 ii
Exhibit 99 iii
<PAGE>3
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
<TABLE><CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
-------------- --------------
ASSETS
<S> <C> <C>
Cash and Cash Equivalents $ 4,401 $ 18,455
Finance Receivables Held for Sale, net 36,346 51,063
Residuals in Finance Receivables Sold 25,755 9,889
Investments Held in Trust 16,192 3,479
Notes Receivable 93,833 1,063
Income Taxes Receivable 3,760 315
Inventory 20,936 5,752
Property and Equipment, net 37,892 20,652
Goodwill and Trademarks, net 17,181 2,150
Other Assets 14,989 5,265
-------------- ---------------
$ 271,285 $ 118,083
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 3,765 $ 2,132
Accrued Expenses and Other Liabilities 19,344 6,728
Notes Payable 58,781 12,904
Subordinated Notes Payable 12,000 14,000
-------------- --------------
Total Liabilities 93,890 35,764
-------------- --------------
Stockholders' Equity:
Common Stock 171,943 82,612
Retained Earnings (Accumulated Deficit) 5,452 (293)
-------------- --------------
Total Stockholders' Equity 177,395 82,319
-------------- --------------
$ 271,285 $ 118,083
============== ==============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>4
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per common share)
<TABLE><CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
1997 1996 1997 1996
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Sales of Used Cars $ 33,530 $ 12,320 $ 79,543 $ 42,497
Cost of Used Cars Sold (18,537) (6,977) (42,537) (23,835)
Provision for Credit Losses (6,538) (2,541) (15,367) (7,713)
--------------- --------------- --------------- ---------------
8,455 2,802 21,639 10,949
--------------- --------------- --------------- ---------------
Interest Income 10,645 4,190 23,390 11,881
Gain (Loss) on Sale of Finance Receivables (2,487) 1,400 10,323 2,578
--------------- --------------- --------------- ---------------
8,158 5,590 33,713 14,459
--------------- --------------- --------------- ---------------
Other Income 3,516 349 6,953 780
--------------- --------------- --------------- ---------------
Income before Operating Expenses 20,129 8,741 62,305 26,188
Operating Expenses:
Selling and Marketing 2,887 652 6,680 2,915
General and Administrative 17,629 4,505 40,489 13,551
Depreciation and Amortization 1,001 427 2,459 1,128
--------------- --------------- --------------- ---------------
21,517 5,584 49,628 17,594
--------------- --------------- --------------- ---------------
Operating Income (Loss) (1,388) 3,157 12,677 8,594
Interest Expense 1,578 1,190 2,914 4,479
--------------- --------------- --------------- ---------------
Earnings (Loss) before Income Taxes (2,966) 1,967 9,763 4,115
Income Taxes (Benefit) (1,138) - 4,018 -
--------------- --------------- --------------- ---------------
Net Earnings (Loss) $ (1,828) $ 1,967 $ 5,745 $ 4,115
=============== =============== =============== ===============
Earnings (Loss) per Common Share ($0.10) $ 0.19 $ 0.32 $ 0.46
=============== =============== =============== ===============
Shares Used in Computation 19,000 9,205 18,200 7,230
=============== =============== =============== ===============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>5
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(IN THOUSANDS)
<TABLE><CAPTION>
1997 1996
---------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings $5,745 $4,115
Adjustments to Reconcile Net Earnings to Net
Cash Provided by Operating Activities:
Provision for Credit Losses 15,367 7,713
Gain on Sale of Finance Receivables (10,323) (2,578)
Purchase of Finance Receivables (195,127) (70,847)
Proceeds from Sale of Finance Receivables 193,823 29,029
Collections of Finance Receivables 37,157 31,107
Decrease in Deferred Income Taxes 1,500 -
Depreciation and Amortization 2,459 1,128
Decrease (Increase) in Inventory (8,869) 440
Increase in Other Assets (8,478) (584)
Increase in Accounts Payable, Accrued Expenses, and
Other Liabilities 11,497 1,430
Increase (Decrease) in Income Taxes Receivable/Payable (3,445) 684
---------- ---------
Net Cash Provided by Operating Activities 41,306 1,637
---------- ---------
Cash Flows Used In Investing Activities:
Increase in Investments Held in Trust (12,713) (8,963)
Net Decrease (Increase) in Notes Receivable (29,485) 100
Purchase of Property and Equipment (15,481) (4,013)
Payment for Acquisition of Assets (45,260) -
---------- ---------
Net Cash Used in Investing Activities (102,939) (12,876)
---------- ---------
Cash Flows from Financing Activities:
Issuance of Notes Payable, net (39,084) (2,824)
Net Repayment of Subordinated Notes Payable (2,000) (553)
Proceeds from Issuance of Common Stock 88,719 14,844
Other, Net (56) (963)
---------- ---------
Net Cash Provided by Financing Activities 47,579 10,504
---------- ---------
Net Decrease in Cash and Cash Equivalents (14,054) (735)
Cash and Cash Equivalents at Beginning of Period 18,455 1,419
---------- ---------
Cash and Cash Equivalents at End of Period $4,401 $684
========== =========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
<PAGE>6
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 reflects 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 FINANCE RECEIVABLES, NET
-----------------------------------
Following is a summary of Finance Receivables, net, as of September 30, 1997
and December 31, 1996 (in thousands):
<TABLE><CAPTION>
September 30, December 31,
1997 1996
--------------- --------------
<S> <C> <C>
Principal Balances. . . . . . . . . . . $ 41,727 $ 58,281
Add: Accrued Interest. . . . . . . . . 447 718
Loan Origination Costs . . . . . . . . 503 189
Finance Receivables . . . . . . . . . . 42,677 59,188
Less Allowance for Credit Losses. . . . (6,331) (8,125)
--------------- --------------
Finance Receivables, net. . . . . . . . $ 36,346 $ 51,063
=============== ==============
Finance Receivables Held for Sale . . . $ 42,677 $ 7,000
Finance Receivables Held for Investment - 52,188
--------------- --------------
$ 42,677 $ 59,188
=============== ==============
</TABLE>
<PAGE>7
NOTE 3. RESIDUALS IN FINANCE RECEIVABLES SOLD
-----------------------------------------
As of September 30, 1997 and December 31, 1996, the Residuals in Finance
Receivables Sold were comprised of the following (in thousands):
<TABLE><CAPTION>
September 30, December 31,
1997 1996
--------------- --------------
<S> <C> <C>
Retained interest in subordinated securities
(B Certificates) $ 41,700 $ 10,900
Net interest spreads, less present value discount 29,055 6,839
Reduction for estimated credit losses (45,000) (7,850)
--------------- --------------
Residuals in finance receivables sold $ 25,755 $ 9,889
=============== ==============
Securitized principal balances outstanding $ 228,996 $ 51,663
=============== ==============
Estimated credit losses as a % of securitized
principal balances outstanding. 19.7% 15.2%
=============== ==============
</TABLE>
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the three and nine month periods ended September
30, 1997 and 1996, respectively (in thousands).
<TABLE><CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -------------------
1997 1996 1997 1996
---------- --------- -------- ---------
<S> <C> <C> <C> <C>
Balance, Beginning of Period $ 27,441 $ 5,001 $ 9,889 $ -
Additions 12,377 2,313 34,599 7,445
Amortization (4,063) (410) (8,733) (541)
Write-down of Residual in Finance Receivables Sold (10,000) - (10,000) -
---------- --------- -------- ---------
Balance, End of Period $ 25,755 $ 6,904 $25,755 $ 6,904
========== ========= ======== =========
</TABLE>
<PAGE>8
NOTE 4. NOTES RECEIVABLE
-----------------
Following is a summary of Notes Receivable as of September 30, 1997 and
December 31, 1996 (in thousands).
<TABLE><CAPTION>
September 30, December 31,
1997 1996
-------------- -------------
<S> <C> <C>
FMAC secured debt . . . . . . . $ 63,599 $ -
FMAC debtor in possession loan 3,878 -
Cygnet Program notes receivable 23,664 -
Others. . . . . . . . . . . . . 2,692 1,063
-------------- -------------
$ 93,833 $ 1,063
============== =============
</TABLE>
NOTE 5. NOTES PAYABLE
--------------
Following is a summary of Notes Payable as of September 30, 1997 and December
31, 1996 (in thousands).
<TABLE><CAPTION>
September 30, December 31,
1997 1996
-------------- -------------
<S> <C> <C>
Revolving Facility with GE Capital $ 128
Mortgage loan with finance company 7,450 7,450
Note with Bank Group secured by FMAC secured debt 50,429 -
Other 774 852
-------------- -------------
$ 58,781 $ 12,904
============== =============
</TABLE>
NOTE 6. COMMON STOCK EQUIVALENTS
--------------------------
Net Earnings (Loss) per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding as reflected
on Exhibit 11 to this Quarterly Report on Form 10-Q.
NOTE 7. ACQUISITIONS
------------
On January 15, 1997, the Company acquired substantially all of the assets of
Seminole Finance Corporation and related companies ("Seminole"), including
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million (6,953 contracts) 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 combined net loss for the year ended December
<PAGE>9
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's results of operations in 1997 for
the assets acquired from Seminole differ materially from 1996 results because
the Company significantly altered 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 have resulted 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.
On April 1, 1997, the Company purchased substantially all of the assets of EZ
Plan, Inc. (EZ Plan), 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 (6,297 contracts) in
exchange for $26.3 million in cash. The combination of the Company's audited
consolidated statement of operations for the year ended December 31, 1996 and
EZ Plan's audited combined statement of operations for the same period (as if
the EZ Plan acquisition had taken place on January 1, 1996) results in
combined net earnings for the year ended December 31, 1996 of $5.9 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 EZ Plan acquisition occurred on January 1, 1996. In addition, the pro
forma results are not intended to be a projection of future results. The
Company's results of operations in 1997 for the assets acquired from EZ Plan
differ from 1996 results because the Company's management altered 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.
On September 19, 1997, the Company purchased substantially all of the
dealership and loan servicing assets of Kars Yes Holdings, Inc. and related
companies (Kars), a company in the business of selling and financing used
motor vehicles, including six dealerships in the Los Angeles market, two in
the Miami market, two in the Atlanta market, and two in the Dallas market in
exchange for approximately $5.5 million in cash. The combination of the
Company's audited consolidated statement of operations for the year ended
December 31, 1996 and Kars' statement of operations for the same period (as if
the Kars acquisition had taken place on January 1, 1996) results in combined
earnings for the year ended December 31, 1996 of $9.8 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 Kars
acquisition occurred on January 1, 1996. In addition, the pro forma results
are not intended to be a projection of future results. The Company does not
expect the results of operations in 1997 for the assets acquired from Kars to
have a material impact on the Company's results of operations
<PAGE>10
The following summary, prepared on a pro forma basis combines the consolidated
results of operations (unaudited) for the nine months ended September 30, 1997
as if the acquisitions had been consummated as of January 1, 1997. These
proforma results are not necessarily indicative of the future results of
operations of the Company or the results that would have been obtained had the
acquisitions taken place on January 1, 1997. Comparative information for 1996
for the acquired businesses is not available (in thousands, except per share
data).
<TABLE><CAPTION>
Nine Months Ended
September 30, 1997
--------------------
<S> <C>
Sales of Used Cars $ 179,696
Interest Income $ 25,054
Other Income $ 19,139
Total Revenues $ 223,889
Net Loss $ (2,771)
Loss per Share $ (0.15)
</TABLE>
NOTE 8. USE OF ESTIMATES
------------------
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statement and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 9. BANKRUPTCY REMOTE ENTITIES
----------------------------
Champion Receivables Corporation ("CRC") and Champion Receivables Corporation
II ("CRC II") (collectively referred to as "Securitization Subsidiaries"), are
the Company's wholly-owned special purpose "bankruptcy remote entities".
Their assets include Residuals in Finance Receivables Sold and Investments
Held In Trust, in the amounts of $25.8 million and $16.2 million,
respectively, at September 30, 1997, which amounts would not be available to
satisfy claims of creditors of the Company on a consolidated basis.
NOTE 10. RECLASSIFICATIONS
-----------------
Certain reclassifications have been made to previously reported information to
conform to the current presentation.
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,
<PAGE>11
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. 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. Statements in this Quarterly Report, including the Notes to the
Condensed Consolidated Financial Statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," describe factors,
among others, that could contribute to or cause such differences. Additional
risk factors that could cause actual results to differ materially from those
expressed in such forward looking statements are set forth in Exhibit 99 which
is attached hereto and incorporated by reference into this Quarterly Report on
Form 10-Q.
INTRODUCTION
General. Ugly Duckling Corporation ("Company") operates a chain of "buy
here-pay here" used car dealerships in the United States and underwrites,
finances, and services retail installment contracts generated from the sale of
used cars by its dealerships ("Company Dealerships") and by third party used
car dealers ("Third Party Dealers") located in selected markets throughout the
country. As part of its financing activities, the Company has initiated a
collateralized dealer financing program ("Cygnet Program") pursuant to which
it provides qualified independent used car dealers with operating lines of
credit secured by the dealers' retail installment contract portfolios and
inventory. The Company targets its products and services to the sub-prime
segment of the automobile financing industry, which focuses on selling and
financing the sale of used cars to persons who have limited credit histories,
low incomes, or past credit problems.
The Company commenced its used car sales and finance operations with the
acquisition of two Company Dealerships in 1992. During 1993, the Company
acquired three additional Company Dealerships. In 1994, the Company
constructed and opened four new Company Dealerships that were built
specifically to meet the Company's new standards of appearance, reconditioning
capabilities, size, and location. During 1994, the Company closed one Company
Dealership because the facility failed to satisfy these new standards and, at
the end of 1995, closed its Gilbert, Arizona dealership. 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 (Seminole). In
March 1997, the Company opened its first used car dealership in the Las Vegas
market. In April 1997, the Company acquired selected assets of a company in
the business of selling and financing used motor vehicles, including seven
dealerships located in the San Antonio market (EZ Plan). In addition, the
Company opened two additional dealerships in the Albuquerque market and one
additional dealership in the Phoenix market during the second quarter of 1997.
In August 1997, the Company closed a dealership in Prescott, Arizona. In
September 1997, the Company acquired selected assets of a company in the
business of selling used motor vehicles, including six dealerships in the Los
Angeles market, two in the Miami market, two in the Atlanta market and two in
the Dallas market (Kars). The Company operated 35 and 8 dealerships at
<PAGE>12
September 30, 1997 and 1996, respectively.
In 1994, the Company acquired Champion Financial Services, Inc., an
independent automobile finance company. In April 1995, the Company initiated
an aggressive plan to expand the number of contracts purchased from its Third
Party Dealer network. 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
operated 83 and 22 branch offices at September 30, 1997 and 1996,
respectively. The Company is in the process of further expanding its Third
Party Dealer operations and diversifying its earning asset base by
implementing the Cygnet Program pursuant to which the Company provides Third
Party Dealers with operating credit lines primarily secured by the dealers'
retail installment contract portfolios and inventory.
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. The registration of the resale of
the shares sold in the private placement was effective in April 1997.
First Merchants Acceptance Corporation ("FMAC") filed for reorganization under
Chapter 11 of the Federal Bankruptcy Code on July 11, 1997 ("Bankruptcy
Case"). In connection with the Bankruptcy Case, the Company, which owns
approximately 2 1/2% of FMAC's outstanding common stock with a cost basis of
approximately $1.5 million, agreed to provide up to $10 million of "debtor in
possession" financing to FMAC, of which approximately $3.8 million was
outstanding at September 30, 1997. On August 20, 1997, the Company acquired
approximately 78% of the senior secured debt ("Secured Debt") of FMAC from
certain members of the senior bank group (Bank Group) that held such debt.
The Secured Debt totaled approximately $97.8 million. The more significant
terms of the purchase of the Secured Debt included, among other things, the
(i) purchase by the Company of the debt at a 10% discount of the outstanding
principal amount; (ii) short-term financing by the Bank Group to the Company
for the purchase, with interest accruing at LIBOR plus 2% and an up-front
payment by the Company to the Bank Group equal to 20% of the purchase price;
and (iii) issuance of stock warrants to the Bank Group to purchase up to
389,800 shares of the Company's common stock at an exercise price of $20 per
share over a thirty-month term and subject to a call feature by the Company.
See Part II, Item 5, Other Information, for subsequent events which impact the
FMAC Secured Debt and debtor in possession loan.
The following discussion and analysis provides information regarding the
Company's consolidated financial position as of September 30, 1997 and
December 31, 1996, and its results of operations for the three month periods
ended September 30, 1997 and 1996, respectively, and the nine month periods
ended September 30, 1997 and 1996, respectively.
Growth in Finance Receivables. As a result of the Company's rapid expansion,
contract receivables serviced increased by 146.3% to $270.7 million at
September 30, 1997 (including $229.0 million in contracts serviced under the
Company's Securitization Program) from $109.9 million at December 31, 1996
(including $51.7 million in contracts serviced under the Company's
Securitization Program).
The following tables reflect the growth in period end balances measured in
terms of the principal amount and the number of contracts.
<PAGE>13
<TABLE><CAPTION>
TOTAL CONTRACTS OUTSTANDING:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
- -----------------------------------------------
SEPTEMBER 30, DECEMBER 31,
--------------------- --------------------
1997 1996
--------------------- --------------------
PRINCIPAL NO OF PRINCIPAL NO OF
AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- --------- --------- ---------
<S> <C> <C> <C> <C>
Company Dealerships $ 120,307 24,567 $ 49,066 9,615
Third Party Dealers 150,416 31,483 60,878 12,942
---------- --------- ---------- -------
Total Portfolio Managed 270,723 56,050 109,944 22,557
---------- --------- ---------- -------
Less Portfolios Securitized and Sold:
Company Dealerships 103,762 21,912 41,998 8,570
Third Party Dealers 125,234 25,028 9,665 2,042
---------- --------- ---------- -------
Total Portfolios Securitized and Sold 228,996 46,940 51,663 10,612
---------- --------- ---------- -------
Company Total $ 41,727 9,110 $ 58,281 11,945
========== ========= ========== =======
</TABLE>
In addition to the Company Dealership and Third Party Dealer loan portfolios
summarized above, the Company also services loan portfolios totaling approxi-
mately $162.0 million for Kars as of September 30, 1997.
The following tables reflect the growth in contract originations by Company
Dealerships and contract purchases from Third Party Dealers 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 SEPTEMBER 30,
- ------------------------------------------
1997 1996
------------------------------- ---------------------------------
PRINCIPAL NO. OF AVERAGE PRINCIPAL NO. OF AVERAGE
AMOUNT CONTRACTS PRINCIPAL AMOUNT CONTRACTS PRINCIPAL
---------- --------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Company Dealerships $ 32,147 4,389 $ 7,324 $ 11,082 1,575 $7,036
Third Party Dealers 52,588 9,236 5,694 15,716 2,678 5,869
---------- --------- --------- ---------- --------- ------
Total $ 84,735 13,625 $ 6,219 $ 26,798 4,253 $6,301
========== ========= ========= ========== ========= ======
</TABLE>
<PAGE>14
<TABLE><CAPTION>
TOTAL CONTRACTS ORIGINATED/PURCHASED:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
NINE MONTHS ENDED SEPTEMBER 30,
- ------------------------------------------
1997 1996
------------------------------- ---------------------------------
PRINCIPAL NO. OF AVERAGE PRINCIPAL NO. OF AVERAGE
AMOUNT CONTRACTS PRINCIPAL AMOUNT CONTRACTS PRINCIPAL
---------- --------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Company Dealerships $ 131,526 23,458 $ 5,607 $ 38,179 5,413 $7,053
Third Party Dealers 144,237 26,147 5,516 32,919 5,781 5,694
---------- --------- --------- ---------- --------- ----------
Total $ 275,763 49,605 $ 5,559 $ 71,098 11,194 $6,351
========== ========= ========= ========== ========= ==========
</TABLE>
Finance Receivable Principal Balances originated/purchased during the three
months ended September 30, 1997 increased by 216.2% to $84.7 million from
$26.8 million in the three month period ended September 30, 1996. For the
nine month period ended September 30, 1997, Finance Receivable Principal
Balances originated/purchased increased by 287.9% to $275.8 million, including
$55.4 million from the Seminole and EZ Plan acquisitions (13,250 contracts),
from $71.1 million in the nine month period ended September 30, 1996.
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1996
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.
Sales of Used Cars. Sales of Used Cars increased by 172.2% to $33.5 million
for the three month period ended September 30, 1997 from $12.3 million for
the three month period ended September 30, 1996. This growth reflects a
significant increase in the number of used car dealerships in operation. Units
sold increased by 156.1% to 4,523 units in the three month period ended
September 30, 1997 from 1,766 units in the three month period ended September
30, 1996. Same store sales increased by 4.3% in the three months ended
September 30, 1997 compared to the three months ended September 30, 1996.
The average sales price per car increased to $7,413 for the three month period
ended September 30, 1997 from $6,976 for the three month period ended
September 30, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased
by 165.7% to $18.5 million for the three month period ended September 30, 1997
from $7.0 million for the three month period ended September 30, 1996. On a
per unit basis, the Cost of Used Cars Sold increased by 3.7% to $4,098 for the
three month period ended September 30, 1997 from $3,951 for the three month
<PAGE>15
period ended September 30, 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 180.6% to $15.0 million for the three month period ended
September 30, 1997 from $5.3 million for the three month period ended
September 30, 1996. As a percentage of sales, the gross margin was 44.7% and
43.4% for the three month periods ended September 30, 1997 and 1996,
respectively. On a per unit basis, the gross margin per car sold was $3,315
and $3,025 for the three month periods ended September 30, 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. The Provision for Credit
Losses increased by 157.3% to $6.5 million in the three month period ended
September 30, 1997 from $2.5 million for the three month period ended
September 30, 1996. This includes an increase of $ 454,000 in the Provision
for Credit Losses in the three month period ended September 30, 1997 for Third
Party Dealer receivables and Cygnet Program dealer notes receivable over the
three month period ended September 30, 1996 when the Company recorded no such
Provision for Credit Losses. On a percentage basis, the Provision for Credit
Losses per unit originated at Company Dealerships decreased by 14.1% to $1,386
per unit in the three month period ended September 30, 1997 from $1,613 per
unit in the three month period ended September 30, 1996. As a percentage of
contract balances originated at Company Dealerships, the Provision for Credit
Losses averaged 18.2% and 22.9%, for the for the three month periods ended
September 30, 1997 and 1996, respectively. The decrease in the Provision for
Credit Losses per unit and the decrease in the Provision for Credit Losses as
a percentage of contract balances originated, is due in part to the
implementation at the Company's Arizona based dealerships in the three month
period ended September 30, 1997 of the Company's Gold Wing program which
provides the buyer with certain life and disability insurance. The Company
purchases the insurance on behalf of the buyer resulting in an increase in
cost of sales. However, as the Company expects fewer charge offs as a result
of customer death or disability, it reduced its Provision for Credit Losses by
an amount approximating the cost of the insurance coverage.
Interest Income. Interest Income consists primarily of interest on finance
receivables from Company Dealership sales, interest on Third Party Dealer
finance receivables, income from Residuals in Finance Receivables Sold, income
from the Cygnet Program, and other interest income from the FMAC Secured Debt.
Company Dealership Receivables - Interest Income increased by 67.7% to $3.7
million for the three month period ended September 30, 1997 from $2.2 million
for the three month period ended September 30, 1996. Interest Income was
reduced by sales of $155.9 million in Company Dealership contract principal
balances since inception of the Securitization Program, 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 99.7% of sales revenue and 97.0% of
the used cars sold at Company Dealerships for the three month period ended
September 30, 1997 compared to 90.0% of sales revenue and 89.2% of the used
cars sold for the three month period ended September 30, 1996. The average
amount financed increased to $7,614 for the three month period ended September
30, 1997 from $7,036 for the three month period ended September 30, 1996.
Primarily as a result of its expansion into markets with interest rate limits,
the Company's yield on its Company Dealership Receivable portfolio has trended
<PAGE>16
downward. The effective yield on Finance Receivables from Company Dealerships
was 26.0% and 29.5%, for the three month periods ended September 30, 1997 and
1996, respectively. The Company's policy is to charge 29.9% per annum on its
Company Dealership contracts. However, in those states that impose usury
limits the Company charges the maximum interest rate permitted.
Third Party Dealer Receivables - Interest Income increased by 96.4% to $3.9
million for the three month period ended September 30, 1997 from $2.0 million
in the three month period ended September 30, 1996. Interest Income was
reduced by sales of $157.9 million in Third Party Dealer contract principal
balances since inception of the Securitization Program, and will continue to
be affected in future periods by additional securitizations. Interest income
has increased in conjunction with the increases in Third Party Dealer
contracts purchased and outstanding. Primarily as a result of its expansion
into markets with interest rate limits, the Company's yield on its Third Party
Dealer portfolio has trended downward. Portfolio yield was 23.6% and 24.2%,
for the three month periods ended September 30, 1997 and 1996, respectively.
Cygnet Program and Other Interest Income - Interest income increased by
100.0% to $3.0 million for the three month period ended September 30, 1997.
This income consisted of $1.2 million in interest income from the Cygnet
Program and $1.8 million in other interest income from the FMAC Secured Debt.
Gain on Sale of Finance Receivables. Champion Receivables Corporation ("CRC")
and Champion Receivables Corporation II ("CRC II") (collectively referred to
as "Securitization Subsidiaries"), are the Company's wholly-owned special
purpose "bankruptcy remote entities". During the first quarter of 1996, the
Company initiated a Securitization Program under which CRC sold securities
backed by contracts to SunAmerica Life Insurance Company ("SunAmerica").
Beginning with the third fiscal quarter of 1997, the Company expanded the
Securitization Program to include CRC II and sales of CRC II securities
through private placement of securities to investors other than Sun America.
Under the Securitization Program, the Securitization Subsidiaries assign and
transfer the contracts to separate trusts ("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 the Securitization Subsidiaries. The Securitization Subsidiaries
then sell the Class A Certificates to unrelated investors. The transferred
contracts are serviced by Champion Acceptance Corporation ("CAC"), another
subsidiary of the Company. Prior to the Company's securitization in the three
month period ended September 30, 1997, the Company's Class A Certificates
received ratings from Standard & Poors ranging from "BBB" to "A". To obtain
these ratings from Standard & Poors, CRC was required to provide a credit
enhancement by establishing and maintaining a cash spread account for the
benefit of the certificate holders. For the securitization transaction that
was consummated during the three month period ended September 30, 1997, the
Company's Class A Certificates received a "AAA" rating from Standard & Poors,
and a "Aaa" rating from Moody's Investors Service. To obtain these ratings,
CRC II (1) obtained an insurance policy from MBIA Insurance Corporation which
unconditionally and irrevocably guaranteed full and complete payment of the
Class A guaranteed distribution (as defined), and (2) provided a credit
enhancement by establishing and maintaining a cash spread account for the
benefit of the certificate holders. The Securitization Subsidiaries make 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 Securitization Subsidiaries are also required to then make
additional deposits to the spread account from the residual cash flow (through
the trustees) as necessary to attain and maintain the spread account at a
specified percentage, ranging from 6.0% to 8.0%, of the underlying finance
<PAGE>17
receivables principal balance. Distributions are not made to the
Securitization Subsidiaries 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 September 30, 1997, CRC made initial spread
account deposits totaling $4.2 million. Additional net deposits to the spread
accounts during the three months ended September 30, 1997 totaled $2.3
million. Based upon securitizations in effect as of September 30, 1997, the
Company was required to maintain an aggregate balance in all spread accounts
of $17.8 million, a portion of which may be funded over time. As of September
30, 1997, the Company maintained a spread account balance of $15.1 million.
Accordingly, an additional $2.7 million will need to be funded from future
cash flows. 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. In addition to the
spread account balance of $15.1 million, the Company had deposited a total of
$1.1 million in trust accounts in conjunction with certain other agreements.
The contracts transferred to the Trusts were purchased by the Securitization
Subsidiaries from either CAC, Champion Financial Services, Inc. ("CFS"), Ugly
Duckling Car Sales Florida, Inc. ("UDCSF"), or Ugly Duckling Cars Sales Texas,
LLP ("UDCST"), 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, CRC II, CAC, CFS, UDCSF, and UDCST.
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 plus the release of Allowance for Credit
Losses. The amount of any Gain on Sale of Loans is based upon certain
estimates, which may not subsequently be realized. The amount of Gain on Sale
of Loans recognized is a function of a number of items including, but not
limited to, the seasoning, remaining term, and weighted average net interest
rate spread of the portfolio sold, as well as the amount of Allowance for
Credit Losses available for release. The amount of Allowance for Credit
Losses available for release is evaluated in light of the adequacy of the
Allowance for Credit Losses as a percentage of retained contract principal
balances. To the extent that actual cash flows on a securitization are below
original estimates, and differ materially from the original securitization
assumptions, and in the opinion of management, those differences appear to be
other than temporary in nature, the Company would be required to revalue the
Residual in Finance Receivables Sold, and record a charge to earnings based
upon the reduction. During the three month period ended September 30, 1997,
the Company recorded a $10.0 million charge (approximately $6.0 million, net
of income taxes) to write down the retained portion of the securitization
assets.
The Company utilizes a number of estimates in arriving at the Gain on Sale of
Loans. With the exception of the Company's first two securitization
transactions which took place during the first six months of 1996, the
estimated cash flows into the Trusts were discounted with a rate of 16%. The
two securitization transactions that took place during the first six months of
1996 were discounted with a rate of 25%. For securitization transactions
between June 30, 1996 and June 30, 1997, for contracts originated at Company
Dealerships, net losses were originally estimated using total expected
cumulative net losses at loan origination of approximately 26.0%, adjusted for
actual cumulative net losses prior to securitization. For contracts purchased
<PAGE>18
from Third Party Dealers, net losses were originally estimated using total
expected cumulative net losses at loan origination of approximately 13.5%,
adjusted for actual cumulative net losses prior to securitization. Prepayment
rates were estimated to be 1.5% per month of the beginning of month balances.
The $10.0 million charge (approximately $6.0 million, net of income taxes) in
the three month period ended September 30, 1997, which resulted in a reduction
in the carrying value of the Residuals in Finance Receivables Sold, had the
effect of increasing the cumulative net loss assumption for contracts
originated at Company Dealerships to approximately 27.5%, and for contracts
purchased from Third Party Dealers to approximately 17.5% for the
securitization transactions that took place prior to the three month period
ended September 30, 1997.
For the securitization transaction that took place during the three month
period ended September 30, 1997, for contracts originated at Company
Dealerships, net losses were estimated using total expected cumulative net
losses at loan origination of approximately 27.5%, adjusted for actual
cumulative net losses prior to securitization, and for contracts purchased
from Third Party Dealers, net losses were estimated using total expected
cumulative net losses at loan origination of approximately 17.5%, adjusted for
actual cumulative net losses prior to securitization. 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. The Company classifies the
residuals as "held-to-maturity" securities in accordance with SFAS No. 115.
The Company securitized an aggregate of $103.7 million in contracts, issuing
$85.1 million in securities during the three months ended September 30, 1997.
In conjunction with this transaction, the Company reduced its Allowance for
Credit Losses by $17.7 million during the three months ended September 30,
1997 and retained a Residual in Finance Receivables Sold of $12.4 million for
a balance of $ 25.8 million at September 30, 1997. The Company recorded Loss
on Sale of Loans during the three months ended September 30, 1997 of $2.5
million, which consisted of a Gain on Sale of Loans of $7.5 million from a
securitization, net of the $10.0 million charge to revalue the Residuals in
Finance Receivables Sold from prior securitizations. The Company recognized
Gain on Sale of Loans of $1.4 million during the three month period ended
September 30, 1996. The Gain on Sale of Loans as a percentage of principal
balances securitized in the three month period ended September 30, 1997 was
8.1% and 6.4% for the Company Dealership and Third Party Dealer portfolios
securitized, respectively, compared to 8.2% for the Company Dealership
portfolio securitized in the three month period ended September 30, 1996. No
Third Party Dealer contracts were securitized in the three month period ended
September 30, 1996.
During the three month period ended September 30, 1997, the Trust issued
certificates at a yield of 6.3% resulting in net spread, before net credit
losses and after servicing, insurer, and trustee fees, of 15.0%.
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.
Champion Receivables Corporation ("CRC") and Champion Receivables Corporation
II ("CRC II") (collectively referred to as "Securitization Subsidiaries"), are
the Company's wholly-owned special purpose "bankruptcy remote entities".
Their assets include Residuals in Finance Receivables Sold and Investments
Held In Trust, in the amounts of $25.8 million and $16.2 million,
respectively, at September 30, 1997, which amounts would not be available to
<PAGE>19
satisfy claims of creditors of the Company on a consolidated basis.
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 to $3.5 million for
three months ended September 30, 1997 from $349,000 for the three months ended
September 30, 1996. The Company services the $229.0 million in securitized
contract principal balances for monthly fees ranging from .25% to .33% of the
beginning of period principal balances (3.0% to 4.0% annualized). In
addition, in conjunction with the Kars acquisition in September 1997, the
Company recognizes income from servicing the Kars portfolio at a rate of
approximately .33% (4.0% annualized) of beginning of period principal
balances. Servicing income for the three months ended September 30, 1997
increased to $2.1 million from $240,000 in the three month period ended
September 30, 1996. This increase is due to the increase in the principal
balance of contracts being serviced pursuant to the Securitization Program and
the addition of servicing of the Kars portfolio. The increase is also due to
an increase in insurance premium income of $427,000 over the same period in
the prior year when the Company recognized no insurance premium income. 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 130.3% to $20.1 million
for the three month period ended September 30, 1997 from $8.7 million for the
three month period ended September 30, 1996. Growth of Sales of Used Cars,
Interest Income on the loan portfolios and Other Income were the primary
contributors to the increase.
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
The Company has five distinct business segments. These consist of retail car
sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), activities associated with the
origination, administration and collection of finance receivables purchased
from Third Party Dealers (Third Party Dealers), financing activities related
to the collateralized dealer financing program (Cygnet), and corporate and
other operations.
A summary of Operating Expenses by business segment for the three month
periods ended September 30, 1997 and 1996, respectively, follows:
<TABLE><CAPTION>
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
1997:
Selling and Marketing . . . . $ 2,887 $ - $ - $ - $ - $ 2,887
General and Administrative. . 6,053 2,999 4,629 674 3,274 17,629
Depreciation and Amortization 426 318 101 7 149 1,001
------------ ---------- ------------ ------- -------- -------
$ 9,366 $ 3,317 $ 4,730 $ 681 $ 3,423 $21,517
============ ========== ============ ======= ======== =======
</TABLE>
<PAGE>20
<TABLE><CAPTION>
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
1996:
Selling and Marketing . . . . $ 635 $ - $ - $ - $ 17 $ 652
General and Administrative. . 2,000 339 1,260 - 906 4,505
Depreciation and Amortization 85 200 56 - 86 427
------------ ---------- ------------ ------- -------- -------
$ 2,720 $ 539 $ 1,316 $ - $ 1,009 $ 5,584
============ ========== ============ ======= ======== =======
</TABLE>
Selling and Marketing Expenses. For the three month periods ended September
30, 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 342.8% to $2.9 million
for the three month period ended September 30, 1997 from $652,000 for the
three month period ended September 30, 1996. As a percentage of Sales of Used
Cars, these expenses averaged 8.6% for the three month period ended September
30, 1997 and 5.3% for the three month period ended September 30, 1996. On a
per unit sold basis, Selling and Marketing Expenses of Company Dealerships
increased to $638 per unit for the three month period ended September 30, 1997
from $369 per unit for the three month period ended September 30, 1996. This
increase is primarily due to increased marketing production costs, and an
increase in marketing efforts in the Tampa Bay/St. Petersburg, San Antonio,
Las Vegas, and Albuquerque markets where the Company initially commenced
operations in 1997.
General and Administrative Expenses. General and Administrative Expenses
increased by 291.3% to $17.6 million for the three month period ended
September 30, 1997 from $4.5 million for the three month period ended
September 30, 1996. These expenses represented 31.9% and 24.7% of total
revenues, adjusted for the $10.0 million charge, for three month periods ended
September 30, 1997, and 1996, respectively. The increase in General and
Administrative Expenses is a result of the Company's increased number of used
car dealerships, significant expansion of its Third Party Dealer financing
operations, commencement of Cygnet operations, and 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 134.4% to $1.0 million for the three month period
ended September 30, 1997 from $427,000 for the three month period ended
September 30, 1996. The increase was due primarily to the increase in
amortization of goodwill associated with the Company's recent acquisitions,
and increased depreciation expense from the addition of used car dealerships
and Third Party Dealer Branch offices.
Interest Expense. Interest expense increased by 32.6% to $1.6 million in the
three month period ended September 30, 1997 from $1.2 million in the three
month period ended September 30, 1996. The increase in interest expense over
the prior comparable period is due in part to the debt assumed by the Company
in conjunction with the acquisition of the FMAC secured debt, which was
financed by the Company with a note payable to the FMAC senior bank group of
approximately $55.1 million and resulted in incremental interest expense of
<PAGE>21
$514,000. See Liquidity and Capital Resources-FMAC Senior Bank Group Debt.
Income Taxes. As a result of the loss incurred in the three month period
ended September 30, 1997, the Company realized an income tax benefit of $1.1
million, an effective rate of 38.4%. In the three month period ended
September 30, 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.
RESULTS OF OPERATIONS
FOR NINE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1996
Sales of Used Cars. Sales of Used Cars increased by 87.2% to $79.5 million
for the nine month period ended September 30, 1997 from $42.5 million for the
nine month period ended September 30, 1996. This growth reflects increases in
the number of used car dealerships in operation, and average unit sales price.
Units sold increased by 75.9% to 10,801 units in the nine month period ended
September 30, 1997 from 6,141 units in the nine month period ended September
30, 1996. Same store unit sales declined by 13.4% in the nine month period
ended September 30, 1997 compared to the nine month period ended September 30,
1996. This is due to the increased emphasis on underwriting at the Company
Dealerships, particularly one dealership where unit sales decreased by 619
units, which represents 77.0% of the decrease for the nine month period ended
September 30, 1997 compared to the same period in 1996.
The average sales price per car increased by 6.4% to $7,364 for the nine month
period ended September 30, 1997 from $6,920 for the nine month period ended
September 30, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased
by 78.5% to $42.5 million for the nine month period ended September 30, 1997
from $23.8 million for the nine month period ended September 30, 1996. On a
per unit basis, the Cost of Used Cars Sold increased by 1.5% to $3,938 for the
nine month period ended September 30, 1997 from $3,881 for the nine month
period ended September 30, 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 98.3% to $37.0 million for the nine month period ended September
30, 1997 from $18.7 million for the nine month period ended September 30,
1996. As a percentage of sales, the gross margin was 46.5% and 43.9% for the
nine month periods ended September 30, 1997 and 1996, respectively. On a per
unit basis, the gross margin per car sold was $3,426 and $3,039 for the nine
month periods ended September 30, 1997 and 1996, respectively.
Provision for Credit Losses. The Provision for Credit Losses increased by
99.2% to $15.4 million in the nine month period ended September 30, 1997 over
$7.7 million for the nine month period ended September 30, 1996. This includes
an increase of $1.2 million in the Provision for Credit Losses in the nine
month period month ended September 30, 1997 for third party receivables and
the Cygnet dealer notes receivable over the nine month period ended September
30, 1996 when the Company recorded no Provision for Credit losses for third
party receivables or the Cygnet dealer notes receivable. On a percentage
basis, the Provision for Credit Losses per unit originated at Company
Dealerships increased by 12.8% to $1,505 per unit in the nine month period
ended September 30, 1997 from $1,334 per unit in the nine month period ended
September 30, 1996. This increase is primarily due to an increase in the
average amount financed in the nine months ended September 30, 1997 to $7,457
per unit from $6,604 per unit in the nine month period ended September 30,
<PAGE>22
1996. As a percentage of contract balances originated, the Provision for
Credit Losses averaged 20.2% and 20.2%, for the nine month periods ended
September 30, 1997 and 1996, respectively.
Interest Income. Interest Income consists primarily of interest on finance
receivables from Company Dealership sales, interest on Third Party Dealer
finance receivables, income from Residuals in Finance Receivables Sold, income
from the Cygnet Program, and other interest income from the FMAC Secured Debt.
Company Dealership Receivables - Interest Income increased by 30.0% to $9.6
million for the nine month period ended September 30, 1997 from $7.4 million
for the nine month period ended September 30, 1996. Interest Income was
reduced by sales of $155.9 million in Company Dealership contract principal
balances since inception of the Securitization Program, including sales of
$95.7 million in Company Dealership contract principal balances in the nine
months ended September 30, 1997, and will continue to be affected in future
periods by additional securitizations. The Company financed 95.7% of sales
revenue and 94.5% of the used cars sold at Company Dealerships for the nine
month period ended September 30, 1997 compared to 89.8% of sales revenue and
94.1% of the used cars sold for the nine month period ended September 30,
1996. The average amount financed increased to $7,457 for the nine month
period ended September 30, 1997 from $6,604 for the nine month period ended
September 30, 1996. As a result of its expansion into markets with interest
rate limits, the Company's yield on its Company Dealership Receivable contract
portfolio has trended downward. The effective yield on Finance Receivables
from Company Dealerships was 27.7% and 29.2%, for the nine month periods ended
September 30, 1997 and 1996, respectively. The Company's policy is to charge
29.9% per annum on its Company Dealership contracts. However, in those states
that impose usury limits the Company charges the maximum interest rate
permitted.
Third Party Dealer Receivables - Interest Income increased by 135.5% to $10.6
million for the nine month period ended September 30, 1997 from $4.5 million
in the nine month period ended September 30, 1996. Interest Income was
reduced by sales of $157.9 million in Third Party Dealer contract principal
balances since inception of the Securitization Program, including sales of
$147.9 million in Third Party Dealer contract principal balances in the nine
months ended September 30, 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. Primarily as a result of its expansion into markets with interest
rate limits, the Company's yield on its Third Party Dealer portfolio has
trended downward. Portfolio yield was 23.2% and 24.7%, for the nine month
periods ended September 30, 1997 and 1996, respectively.
Cygnet Program and Other Interest Income - Interest income increased by
100.0% to $3.2 million for the three month period ended September 30, 1997.
This income consisted of $1.3 million in interest income from the Cygnet
Program and $1.8 million in interest income from the aforementioned FMAC
Secured Debt.
Gain on Sale of Finance Receivables. During the nine month period ended
September 30, 1997, the Company securitized an aggregate of $245.5 million in
contracts, issuing $202.0 million in securities. Pursuant to these
transactions, the Company reduced its Allowance for Credit Losses by $39.5
million during the nine month period ended September 30, 1997. The Company
recorded Gain on Sale of Loans during the nine month period ended September
30, 1997 of $10.3 million, which consisted of a Gain on Sale of Loans of $20.3
million from securitization transactions during the nine month period ended
<PAGE>23
September 30, 1997, net of the $10.0 million charge (approximately $6.0
million, net of income taxes) to revalue the Residuals in Finance Receivables
Sold. The Company recognized Gain on Sale of Loans of $2.6 million during the
nine month period ended September 30, 1996. The Gain on Sale of Loans as a
percentage of principal balances securitized was 8.6% and 8.1% respectively,
for the Company Dealership and Third Party Dealer portfolios securitized in
the nine month period ended September 30, 1997, compared to 6.2% for the
Company Dealership portfolios securitized in the nine month period ended
September 30, 1996. No Third Party Dealer contracts were securitized in the
nine month period ended September 30, 1996. The difference in the gain
percentage on the Company Dealership portfolios is due to the fact that the
portfolios securitized in the first nine months of 1996 were more seasoned,
resulting in a much shorter remaining life than the portfolios securitized in
the first nine months of 1997, and lower "A" certificate coupon rates, which
results in an increase in gain on sale, net of the impact of increasing the
cumulative net credit loss assumptions.
During the nine month period ended September 30, 1997, the Company made
initial spread account deposits totaling $7.4 million. Additional net deposits
to the spread accounts during the nine month period ended September 30, 1997
totaled $4.9 million resulting in a total balance in the spread accounts of
$15.1 million as of September 30, 1997. In addition to the spread account
balance of $15.1 million, the Company had deposited a total of $1.1 million in
trust accounts in conjunction with certain other agreements.
During the nine month period ended September 30, 1997, the Trusts issued
certificates at a weighted average yield of 7.5% with the yields ranging from
6.3% to 8.2%, resulting in net spreads, before net credit losses and after
servicing and trustee fees, ranging from 12.5% to 17.8%, and averaging 15.0%.
Other Income. Other Income which 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 increased by 791.4% to $7.0 million
for nine months ended September 30, 1997 from $780,000 for the nine month
period ended September 30, 1996. The Company services the $229.0 million in
securitized contract principal balances for monthly fees ranging from .25% to
.33% of the beginning of period principal balances (3.0% to 4.0% annualized In
addition, in conjunction with the Kars acquisition in September 1997, the
Company recognizes income from servicing the Kars portfolio at a rate of
approximately .33% (4.0% annualized) of beginning of period principal
balances. Servicing income for the nine months ended September 30, 1997
increased to $3.8 million from $487,000 in the nine month period ended
September 30, 1996. The significant increase is due to the increase in the
principal balance of contracts being serviced pursuant to the Securitization
Program and the addition of servicing of the Kars portfolio. The increase is
also due to an increase in insurance premium income of $607,000 over the same
period in the prior year when the Company recognized no insurance premium
income and an increase in earnings on investments of $1.2 million compared to
no investment earnings in the nine month period ended September 30, 1996. 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 137.9% to $62.3 million
for the nine month period ended September 30, 1997 from $26.2 million for the
nine month period ended September 30, 1996. Growth of Sales of Used Cars,
Interest Income on the loan portfolios, Gain on Sale of Loans, and Other
Income were the primary contributors to the increase.
<PAGE>24
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
The Company has five distinct business segments. These consist of retail car
sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), activities associated with the
origination, administration and collection of finance receivables purchased
from Third Party Dealers (Third Party Dealers), financing activities related
to the collateralized dealer financing program (Cygnet), and corporate and
other operations.
A summary of Operating Expenses by business segment for the nine month periods
ended September 30, 1997 and 1996, respectively, follows:
<TABLE><CAPTION>
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
1997
Selling and Marketing . . . . $ 6,670 $ - $ - $ 9 $ 1 $ 6,680
General and Administrative. . 14,196 7,563 10,076 896 7,758 40,489
Depreciation and Amortization 984 785 261 7 422 2,459
------------ ---------- ----------- -------- -------- -------
$ 21,850 $ 8,348 $ 10,337 $ 912 $ 8,181 $49,628
============ =========== ========== ======== ======== =======
</TABLE>
<TABLE><CAPTION>
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
1996:
Selling and Marketing . . . . $ 2,898 $ - $ - $ - $ 17 $ 2,915
General and Administrative. . 6,225 2,067 2,470 - 2,789 13,551
Depreciation and Amortization 235 567 131 - 195 1,128
------------ ----------- ----------- -------- -------- -------
$ 9,358 $ 2,634 $ 2,601 $ - $ 3,001 $17,594
============ =========== =========== ======== ======== =======
</TABLE>
Selling and Marketing Expenses. For the nine month periods ended September
30, 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 129.2% to $6.7 million
for the nine month period ended September 30, 1997 from $2.9 million for the
nine month period ended September 30, 1996. As a percentage of Sales of Used
Cars, these expenses averaged 8.4% and 6.9% for the nine month periods ended
September 30, 1997, and 1996, respectively. On a per unit sold basis, Selling
and Marketing Expenses of Company Dealerships increased by 30.3% to $618 per
unit for the nine month period ended September 30, 1997 from $475 per unit for
the nine month period ended September 30, 1996. This increase is primarily
due to increased marketing production costs, and an increase in marketing
efforts in the Tampa Bay/St. Petersburg, San Antonio, Las Vegas, and
<PAGE>25
Albuquerque markets where the Company initially commenced operations in 1997,
combined with a decrease in same store unit sales.
General and Administrative Expenses. General and Administrative Expenses
increased by 198.8% to $40.5 million for the nine month period ended September
30, 1997 from $13.6 million for the nine month period ended September 30,
1996. These expenses represented 33.7% and 23.5% of total revenues for nine
month periods ended September 30, 1997, and 1996, respectively. The increase
in General and Administrative Expenses is primarily 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 118.0% to $2.5 million for the nine month period
ended September 30, 1997 from $1.1 million for the nine month period ended
September 30, 1996. The increase was due primarily to the increase in
amortization of goodwill associated with the Company's recent acquisitions,
and increased depreciation expense from the addition of used car dealerships
and Third Party Dealer Branch offices
Interest Expense. Interest expense decreased by 34.9% to $2.9 million from
$4.5 million in the nine month period ended September 30, 1996. The decrease
in 1997, despite significant growth in Company assets, is primarily the result
of the two public offerings that were completed in 1996, 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 $4.0 million in the nine month period
ended September 30, 1997, an effective tax rate of 41.2%. In the nine month
period ended September 30, 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,
and through nonrefundable acquisition discounts on contracts purchased from
Third Party Dealers. The Allowance on contracts originated at Company
Dealerships decreased to 20.0% of outstanding principal balances as of
September 30, 1997 compared to 23.0% as of December 31, 1996. The Allowance as
a percentage of Third Party Dealer contracts decreased to 12.0% from 12.7%
over the same period. The Allowance as a percentage of the Company's combined
contract portfolio increased to 15.2% at September 30, 1997 from 13.9% at
December 31, 1996. The increase in the Allowance percentage is primarily due
to the composition of the total portfolio with an increase in the Company
Dealership Receivable portfolio relative to the total portfolio compared to
December 31, 1996.
<PAGE>26
The following table reflects activity in the Allowance, as well as information
regarding charge off activity, for the three month periods ended September 30,
1997 and 1996, in thousands.
<TABLE><CAPTION>
COMPANY DEALERSHIPS THIRD PARTY DEALERS
--------------------- -----------------------
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -----------------------
1997 1996 1997 1996
----------- --------- ---------- ----------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 9,929 $ 5,974 $ 4,506 $ 2,074
Provision for Credit Losses 6,084 2,541 228 -
Discount Acquired - - 6,581 1,816
Reduction Attributable to Loans Sold (10,325) (3,263) (7,354) -
Net Charge Offs (2,379) (1,681) (939) (835)
----------- ---------- ---------- ----------
Balance, End of Period $ 3,309 $ 3,571 $ 3,022 $ 3,055
=========== ========== ========== ==========
Charge off Activity:
Principal Balances:
Collateral Recovered $ (2,319) $ (1,664) $ (1,066) $ (1,003)
Collateral Not Recovered (820) (342) (198) (191)
----------- ---------- ---------- ----------
Total Principal Balances (3,139) (2,006) (1,264) (1,194)
Accrued Interest - (114) - (64)
Recoveries, Net 760 439 325 423
----------- ---------- ---------- ----------
Net Charge Offs $ (2,379) $ (1,681) $ (939) $ (835)
=========== ========== ========== ==========
Net Charge Offs as % of Average 23.8% 28.3% 17.5% 10.2%
Principal Outstanding =========== ========== ========= ===========
</TABLE>
<PAGE>27
The following table reflects activity in the Allowance, as well as information
regarding charge off activity, for the nine month periods ended September 30,
1997 and 1996, in thousands.
<TABLE><CAPTION>
COMPANY DEALERSHIPS THIRD PARTY DEALERS
--------------------- ------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------------
1997 1996 1997 1996
----------- --------- ---------- -----------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 1,625 $ 7,500 $ 6,500 $ 1,000
Provision for Credit Losses 14,193 7,713 948 -
Discount Acquired 15,309 - 17,713 3,646
Discount accreted to interest income - - (642) -
Reduction Attributable to Loans Sold (21,407) (6,187) (18,096) -
Net Charge Offs (6,411) (5,455) (3,401) (1,591)
----------- --------- --------- ------------
Balance, End of Period $ 3,309 $ 3,571 $ 3,022 $ 3,055
========== ========== ========= ============
Allowance as Percent of Period 20.0% 23.1% 12.0% 8.3%
Ended Principal Balance ========== ========== ========= ============
Charge off Activity:
Principal Balances:
Collateral Recovered $ (6,865) $ (5,260) $ (3,873) $ (2,070)
Collateral Not Recovered (1,490) (1,619) (858) (416)
----------- ---------- --------- -----------
Total Principal Balances (8,355) (6,879) (4,731) (2,486)
Accrued Interest - (486) - (123)
Recoveries, Net 1,944 1,910 1,330 1,018
---------- ----------- --------- -----------
Net Charge Offs $ (6,411) $ (5,455) $ (3,401) $ (1,591)
=========== ========== ========= ===========
Net Charge Offs as % of Average 23.9% 25.3% 15.8% 9.18%
Principal Outstanding =========== ========== ========= ===========
</TABLE>
During the nine month period ended September 30, 1997, the Company experienced
rapid growth in the number of states in which it operated Company Dealerships
and Third Party Dealer branches. As a result, the Company's loan base was
more geographically diversified throughout the country, which in turn led to
the Company repossessing significantly more vehicles throughout the country
than it historically had, in markets where it did not operate reconditioning
centers or repossession lots. The Company, therefore, relied extensively on
third parties to dispose of its repossessed collateral. This led to the
Company not realizing its expected recovery amount on the liquidation of these
repossessions. The Company has taken several actions to reverse this trend
including consolidation of auction locations through which repossessed
vehicles are liquidated, expansion of its repossession administration
department, development of an enhanced repossession tracking and monitoring
system, hiring of staff whose primary responsibility is to represent the
Company at auctions, and expansion of efforts to better recondition
repossessions prior to liquidation. The Company believes these actions will
improve recovery rates to levels it historically experienced prior to the nine
<PAGE>28
month period ended September 30, 1997. For loans originated at Company
Dealerships, recoveries as a percentage of principal balances charged off
where collateral has been recovered averaged 28.3% for the nine month period
ended September 30, 1997 compared to 36.3% for the nine month period ended
September 30, 1996. Company Dealership loan recoveries in Arizona are
positively effected by the Company's ability to receive a sales tax benefit
for charged off loans that it does not receive in other markets. As a result
of the Company's expansion outside of the Arizona market in 1997, recovery
rates for the Company Dealership loan portfolio were negatively effected. For
Third Party Dealer loans, recoveries as a percentage of principal balances
charged off where collateral has been recovered averaged 34.3% for the nine
months period ended September 30, 1997 compared to 49.2% for the nine month
period ended September 30, 1996.
The Company's Net Charge Offs on its Third Party Dealer contract portfolio are
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.
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 modified its methodology to reflect
additional historical experience in computing "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, but 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 not be material.
<PAGE>29
CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS
The following table sets forth the cumulative net charge offs as a percentage
of original contract cumulative (pool) balances, based on the quarter of
origination and segmented by the number of monthly payments completed by
customer before charge off. Additionally, set forth is the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
<TABLE><CAPTION>
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF PERCENT
----------------------------------------------------------------
0 3 6 12 18 24 TLI REDUCED
----- ----- ----- ----- ----- ----- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1993:
1st Quarter 6.9% 18.7% 26.5% 31.8% 33.9% 35.1% 35.4% 100.0%
2nd Quarter 7.2% 18.9% 25.1% 29.4% 31.7% 32.1% 32.4% 100.0%
3rd Quarter 8.6% 19.6% 23.7% 28.5% 30.7% 31.6% 31.9% 100.0%
4th Quarter 6.3% 16.1% 21.6% 27.0% 28.9% 29.5% 29.6% 100.0%
1994:
1st Quarter 3.4% 10.0% 13.4% 18.1% 20.5% 21.2% 21.3% 100.0%
2nd Quarter 2.8% 10.5% 14.2% 19.7% 21.9% 22.4% 22.5% 100.0%
3rd Quarter 2.8% 8.2% 12.2% 16.5% 18.6% 19.5% 19.6% 100.0%
4th Quarter 2.4% 7.7% 11.3% 16.9% 20.0% 21.0% 21.1% 100.0%
1995:
1st Quarter 1.1% 7.4% 12.5% 17.8% 20.3% 21.3% 21.5% 97.6%
2nd Quarter 1.7% 7.1% 12.1% 16.7% 19.6% 21.1% 21.1% 93.0%
3rd Quarter 2.0% 7.0% 11.1% 18.1% 21.7% x 22.8% 86.6%
4th Quarter 1.2% 5.7% 10.8% 17.8% 22.3% - 22.6% 81.7%
1996:
1st Quarter 1.4% 7.6% 13.2% 20.6% x - 23.6% 74.4%
2nd Quarter 2.2% 9.2% 14.1% 22.6% - - 23.1% 64.4%
3rd Quarter 1.6% 7.2% 12.9% x - - 18.9% 53.1%
4th Quarter 1.6% 8.7% 16.0% - - - 17.6% 44.5%
1997:
1st Quarter 2.5% 10.4% x - - - 12.7% 34.0%
2nd Quarter 1.8% x - - - - 4.7% 15.4%
3rd Quarter x - - - - - 0.2% 1.8%
</TABLE>
Trends set forth in the table above indicate a deterioration in the
performance of the associated loan portfolio. Management believes the
deterioration is primarily attributable to less effective collection
procedures resulting from a loan servicing and collection data processing
system conversion in the first and second quarters of 1997 rather than from
any fundamental change in loan quality or underwriting. As a result of this
trend, the Company recorded a charge against its Residuals in Finance
Receivables Sold during the three month period ended September 30, 1997.
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
Company Dealership contract principal balances.
<PAGE>30
<TABLE><CAPTION>
Retained Securitized Managed
--------- ------------ --------
<S> <C> <C> <C>
September 30,1997:
31 to 60 days 1.5% 3.9% 3.6%
61 to 90 days 2.8% 1.4% 1.6%
December 31,1996:
31 to 60 days 2.3% 5.4% 5.0%
61 to 90 days 0.6% 1.9% 1.7%
</TABLE>
In accordance with the Company's charge off policy, there are no accounts more
than 90 days delinquent as of September 30, 1997 and December 31, 1996.
CONTRACTS PURCHASED FROM THIRD PARTY DEALERS
Non-refundable acquisition discount ("Discount") acquired totaled $6.6 million
and $1.8 million for the three month periods ended September 30, 1997 and
1996, respectively. The Discount, attributable to Third Party Dealer
purchases, averaged approximately 12.5% as a percentage of principal balances
purchased in the three month period ended September 30, 1997, compared to
11.6% in the three month period ended September 30, 1996. For the nine month
period ended September 30, 1997 and 1996, Discount acquired totaled $17.7
million and $3.6 million, respectively. As a percentage of contracts
purchased, Discount averaged 12.2% and 11.1% during the same periods,
respectively.
The following table sets forth the cumulative net charge offs as a percentage
of original contract cumulative (pool) balances, based on the quarter of
origination and segmented by the number of monthly payments completed by
customer before charge off. Additionally, set forth is the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
<TABLE><CAPTION>
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF PERCENT
----------------------------------------------------------------
0 3 6 12 18 24 TLI REDUCED
----- ----- ------ ----- ----- ------ ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
1995:
2nd Quarter 0.9% 4.1% 5.7% 7.7% 9.4% 10.6% 10.6% 90.1%
3rd Quarter 1.2% 3.7% 4.6% 6.3% 7.5% x 8.1% 82.4%
4th Quarter 1.0% 4.3% 6.7% 9.3% 11.0% - 11.2% 82.5%
1996:
1st Quarter 0.8% 3.7% 6.9% 10.8% x - 12.1% 74.5%
2nd Quarter 1.6% 6.2% 9.7% 13.6% - - 13.6% 67.8%
3rd Quarter 1.3% 6.0% 9.2% x - - 14.7% 56.2%
4th Quarter 1.4% 7.4% 12.0% - - - 15.2% 45.6%
1997:
1st Quarter 1.4% 7.6% x - - - 8.2% 30.9%
2nd Quarter 1.5% x - - - - 2.4% 14.3%
3rd Quarter x - - - - - 0.1% 2.6%
</TABLE>
<PAGE>31
Trends set forth in the table above indicate a deterioration in the
performance of the associated loan portfolio. Management believes the
deterioration is primarily attributable to less effective collection
procedures resulting from a loan servicing and collection data processing
system conversion in the first and second quarters of 1997 rather than from
any fundamental change in loan quality or underwriting. As a result of this
trend, the Company recorded a charge against its Residuals in Finance
Receivables Sold during the three month period ended September 30, 1997.
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 which are paid
in full. Therefore, 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.
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
Third Party Dealer contract principal
<TABLE><CAPTION>
Retained Securitized Managed
--------- ------------ --------
<S> <C> <C> <C>
September 30, 1997:
31 to 60 days . . . 1.7% 4.7% 4.2%
61 to 90 days . . . 2.5% 1.6% 1.8%
December 31, 1996:
31 to 60 days . . . 3.1% 4.3% 3.3%
61 to 90 days . . . 1.1% 1.0% 1.1%
</TABLE>
In accordance with the Company's charge off policy there are no Third Party
Dealer contracts more than 90 days delinquent as of September 30, 1997 and
December 31, 1996.
During 1996 and continuing throughout 1997, 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 as
expected.
RESIDUALS IN FINANCE RECEIVABLES SOLD
Residuals in Finance Receivables Sold represent the Company's retained potion
of the securitization assets. The Company utilizes a number of estimates in
arriving at the initial valuation of the Residuals in Finance Receivables
Sold, which represent the expected present value of net cash flows into the
trust in excess of those required to pay principal and interest on the Class A
certificates. The present value of expected cash flows are a function of a
number of items including, but not limited to, charge off rates, repossession
<PAGE>32
recovery rates, portfolio delinquency, prepayment rates, and trust expenses.
Subsequent to the initial recording of the Residuals in Finance Receivables
Sold, the carrying value is adjusted for the actual cash flows into the
respective trusts in order to maintain a carrying value which approximates the
present value of the expected net cash flows into the trust in excess of those
required to pay all obligations of the respective trust other than the
obligations to the Class B certificates. To the extent that actual cash flows
on a securitization are below original estimates, and differ materially from
the original securitization assumptions, and in the opinion of management,
those differences appear to be other than temporary in nature, 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.
During the three month period ended September 30, 1997, the Company recorded
a $10.0 million charge (approximately $6.0 million, net of income taxes) to
write down the Residuals in Finance Receivables Sold. The Company determined
a write down in the Residuals in Finance Receivables Sold was necessary due to
an increase in net losses in the securitized loan portfolio, particularly the
Third Party Dealer portfolio. For securitization transactions between June 30,
1996 and June 30, 1997, for contracts originated at Company Dealerships, net
losses were originally estimated using total expected cumulative net losses at
loan origination of approximately 26.0%, adjusted for actual cumulative net
losses prior to securitization. For contracts purchased from Third Party
Dealers, net losses were originally estimated using total expected cumulative
net losses at loan origination of approximately 13.5%, adjusted for actual
cumulative net losses prior to securitization. Prepayment rates were estimated
to be 1.5% per month of the beginning of month balance. The $10.0 million
charge (approximately $6.0 million, net of income taxes) in the three month
period ended September 30, 1997 which resulted in a reduction in the carrying
value of the Company's Residuals in Finance Receivables Sold had the effect of
increasing the cumulative net loss assumption for contracts originated at
Company Dealerships to approximately 27.5%, and for contracts purchased from
Third Party Dealers to approximately 17.5% for the securitization transactions
that took place prior to the three month period ended September 30, 1997. As
a result of this charge, the remaining allowance for credit losses inherent in
the securitization assumptions as a percentage of the remaining principal
balances of securitized contracts was approximately 19.7% as of September 30,
1997, compared to 15.2% as of December 31, 1996. There can be no assurance
that the charge taken by the Company is sufficient and that the Company will
not record additional charges in the future in order to write down the
Residuals in Finance Receivables Sold.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support increases in its contract portfolio,
expansion of Company Dealerships, Branch Offices, the Cygnet Program, 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 increased by $39.7
million to $41.3 million for the nine month period ended September 30, 1997
from $1.6 million in the nine month period ended September 30, 1996. The
increase was primarily due to an increase in proceeds from sales of finance
receivables, provision for credit losses, and increases in Accounts Payable,
Accrued Liabilities and Other Liabilities offset by increases in Finance
Receivables Held for Sale, Gain on Sale of Finance Receivables, and increases
in Inventory and Other Assets.
<PAGE>33
The Net Cash Used in Investing Activities increased by $90.1 million to $103.0
million in the nine months ended September 30, 1997 from $12.9 million in the
nine months ended September 30, 1996. The increase was due to an increase in
notes receivable of $29.6 million, an increase in the purchase of property and
equipment of $11.5 million, and the purchase of the assets of Seminole, EZ
Plan, and Kars, for $45.3 million.
The Company's Net Cash Provided by Financing Activities increased by $37.1
million to $47.6 million in the nine month period ended September 30, 1997
from $10.5 million in the nine month period ended September 30, 1996. This
increase was primarily the result of the $88.7 million in proceeds from the
Company's sale of common stock, net of the $39.1 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 $100.0 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 86.0% of the principal balance
of eligible Third Party Dealer contracts. The Revolving Facility expires in
December 1998. The facility is secured by substantially all of the Company's
assets. As of September 30, 1997, the Company's borrowing capacity under the
Revolving Facility was $19.0 million, the aggregate principal amount
outstanding under the Revolving Facility was approximately $128,000, and the
amount available to be borrowed under the facility was $18.9 million. The
Revolving Facility bears interest at the 30-day LIBOR plus 3.15%, payable
daily (total rate of 8.8% as of September 30, 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, 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 2.1 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.
FMAC Senior Bank Group Debt. In conjunction with the acquisition of the
Secured Debt from the Bank Group, the Company executed a note payable of
approximately $55.1 million payable to the Bank Group with a balance at
September 30, 1997 at approximately $50.4 million. The note payable, which is
due in full in February 1998, bears interest at 30-day LIBOR plus 2.0% (7.65%
at September 30, 1997), and is payable daily.
Subordinated Indebtedness and Preferred Stock. Prior to its public offering
in June 1996, the Company 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 million and $14.0
<PAGE>34
million as of September 30, 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. In July 1997, the Company's Board of
Directors approved the prepayment of the $12.0 million in subordinated debt
subject to various conditions including the Company's completion of a debt
offering. No such prepayment has been made as of the date of filing of this
Form 10-Q.
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 nine month period ended
September 30, 1996, the Company paid a total of $817,000 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. Pursuant to the Company's Securitization Program, the
Company and SunAmerica entered into an agreement under which SunAmerica would
purchase $175.0 million of certificates secured by contracts. As of June 30,
1997, the Company had substantially utilized its maximum commitment from, and
does not expect to complete any further securitizations with SunAmerica under
the existing Securitization Program. The Securitization Program has provided
the Company with a source of funding in addition to the Revolving Facility. At
the closing of each securitization, the Securitization Subsidiaries receive
payment 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 primarily from the
difference between the payments received from customers on the contracts and
the payments paid on the Class A Certificates. In addition, securitization
allows the Company to fix its cost of funds for a given contract portfolio,
and broadens the Company's capital source alternatives. The Company sold its
securitization that was consummated during the three month period ended
September 30, 1997 to private investors. Failure to periodically engage in
securitization transactions will adversely affect the Company.
In connection with its securitization transactions, the Securitization
Subsidiaries are 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 cash flows due to the B
Certificates first are deposited into 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 Securitization Subsidiaries from the pledged spread account.
<PAGE>35
Debt Shelf Registration. On July 18, 1997, the Company filed a Form S-3
registration statement for the purpose of registering up to $200 million of
its debt securities in one or more series at prices and on terms to be
determined at the time of sale. The registration statement has been declared
effective by the Securities and Exchange Commission and is available for
future debt offerings.
Transactions regarding First Merchants Acceptance Corporation. First Merchants
Acceptance Corporation ("FMAC") filed for reorganization under Chapter 11 of
the Federal Bankruptcy Code on July 11, 1997 ("Bankruptcy Case"). In
connection with the Bankruptcy Case, the Company, which owns approximately 2
1/2% of FMAC's outstanding common stock with a cost basis of approximately
$1.5 million, agreed to provide up to $10 million of "debtor in possession"
financing to FMAC, of which approximately $3.8 million was outstanding at
September 30, 1997. On August 20, 1997, the Company acquired approximately 78%
of the senior secured debt ("Secured Debt") of FMAC from certain members of
the senior bank group (Bank Group) that held such debt. The Secured Debt
totaled approximately $97.8 million. The more significant terms of the
purchase of the Secured Debt included, among other things, the (i) purchase by
the Company of the debt at a 10% discount of the outstanding principal amount;
(ii) short-term financing by the Bank Group to the Company for the purchase,
with interest accruing at LIBOR plus 2% and an up-front payment by the Company
to the Bank Group equal to 20% of the purchase price; and (iii) issuance of
stock warrants to the Bank Group to purchase up to 389,800 shares of the
Company's common stock at an exercise price of $20 per share over a
thirty-month term and subject to a call feature by the Company.
Subsequent to September 30, 1997, the Company entered into a contract to
acquire, subject to various conditions that have not yet been satisfied, the
remaining approximately 22% of the Secured Debt from two (2) unrelated third
parties (the "Sellers"). The more significant terms of the purchase include,
among other things, (i) the Company's right to purchase by an exercise of a
call right that expires on February 20, 1998 (the "Call Period"), and which is
followed by a put right by the Sellers that expires on March 15, 1998 (the
"Put Period"); (ii) a purchase price equal to ninety-five percent (95%) during
the Call Period (and one hundred percent (100%) during the Put Period) of the
outstanding principal balance of the purchased Secured Debt, plus interest on
such purchase price from November 12, 1997 through the closing date of such
purchase at approximately 8.0% per annum, less all payments received by the
Sellers with respect to the purchased Secured Debt through the date of
closing; and (iii) the issuance of stock warrants to the Sellers to purchase
up to 110,200 shares of the Company's common stock at an exercise price of
$20.00 per share over a 36 month term and subject to a call feature of the
Company.
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 opened two new dealerships in
Phoenix, Arizona and two new dealerships in Albuquerque, New Mexico. In
addition, the Company has two dealerships in Phoenix, Arizona, one in San
Antonio, two in Dallas, one in Miami and one in Tampa currently under
development. Further, the Company opened 11 new Branch Offices during the
three month period ended September 30, 1997, and recently completed expansion
of its contract servicing and collection facility.
On September 19, 1997, the Company purchased substantially all of the
dealership and loan servicing assets of Kars Yes Holdings, Inc. (Kars), a
Company in the business of selling and financing used motor vehicles,
<PAGE>36
including six dealerships in the Los Angeles market, two in the Miami market,
two in the Atlanta market, and two in the Dallas market in exchange for $5.5
million in cash. In addition, the Company intends to open 2 or more new
Branch Offices and six 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). Further, on July 11, 1997,
the Company entered into an agreement to provide "debtor in possession"
financing to First Merchants Acceptance Corporation in an amount up to $10.0
million. The Company had advanced $3.8 million against this commitment as of
September 30, 1997. The Company intends to finance these expenditures through
operating cash flows and supplemental borrowings, including amounts available
under the Revolving Facility and the Securitization Program, if any.
Common Stock Repurchase Program. In October 1997 the Company's Board of
Directors authorized a stock repurchase program by which the Company may
acquire up to one million shares of its common stock from time to time on the
open market. Under the program, purchases may be made depending on market
conditions, share price and other factors. The stock repurchase program will
terminate on December 31, 1998, unless extended by the Company's Board of
Directors, and may be discontinued at any time. As of the date of filing of
this Form 10-Q, the Company had not repurchased any shares of common stock.
Year 2000. The Company has commenced a study of its computer systems in order
to assess its exposure to year 2000 issues. The Company expects to make the
necessary modifications or changes to its computer information systems to
enable proper processing of transactions relating to the year 2000 and beyond.
The Company will evaluate appropriate courses of action, including replacement
of certain systems whose associated costs would be recorded as assets and
subsequently amortized. However, there can be no assurance that year 2000
costs and expenses will not have a material adverse affect on the Company.
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
<PAGE>37
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.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130). This statement is effective for interim and fiscal periods
beginning after December 15, 1997, and requires the Company to classify items
of other comprehensive income by their nature in a financial statement, and to
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
statement of financial position. Management of the Company does not expect
that the adoption of SFAS No. 130 will have a material impact on the Company.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131). This statement is
effective for fiscal years beginning after December 15, 1997, and requires the
Company to report information about operating segments in its annual financial
statements and further requires the Company to disclose selected information
about operating segments in interim reports to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Management of the Company does not
expect that the adoption of SFAS No. 131 will have a material impact on the
Company.
The Securities and Exchange Commission has approved rule amendments to clarify
and expand existing disclosure requirements for derivative financial
instruments. The amendments require enhanced disclosure of accounting
policies for derivative financial instruments in the footnotes to the
financial statements. In addition, the amendments expand existing disclosure
requirements to include quantitative and qualitative information about market
risk inherent in market risk sensitive instruments. The required quantitative
and qualitative information are to be disclosed outside the financial
statements and related notes thereto. The enhanced accounting policy
disclosure requirements are effective for the quarter ended June 30, 1997. As
the Company believe that the derivative financial instrument disclosure
contained within the notes to the financial statements of its 1996 Form 10-K
substantially conform with the accounting policy requirements of these
amendments, no further interim period disclosure has been provided. The rule
amendments that require expanded disclosure of quantitative and qualitative
information about market risk are effective with the 1998 Form 10-K.
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
<PAGE>38
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 as a defendant in civil suits
filed by customers in state, local, or small claims courts. Additionally, in
the ordinary course of business, the Company is a defendant in various other
types of legal proceedings. There can be no assurance that the Company will
not be a target of similar claims and legal proceedings 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 adverse effect on
the Company.
Item 2. Changes in Securities and Use of Proceeds.
Warrants to purchase 389,800 shares of common stock of the Company were
issued in a private placement under Section 4(2) of the Securities Act of 1933
to a group of banks in connection with the acquisition of senior Secured Debt
of First Merchants Acceptance Corporation from such banks. See a description
of the transaction herein under "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Introduction."
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
Subsequent to September 30, 1997, the Company entered into a contract to
acquire, subject to various conditions that have not yet been satisfied, the
remaining approximately 22% of the Secured Debt from two (2) unrelated third
parties (the "Sellers"). The more significant terms of the purchase include,
among other things, (i) the Company's right to purchase by an exercise of a
call right that expires on February 20, 1998 (the "Call Period"), and which is
followed by a put right by the Sellers that expires on March 15, 1998 (the
"Put Period"); (ii) a purchase price equal to ninety-five percent (95%) during
the Call Period (and one hundred percent (100%) during the Put Period) of the
outstanding principal balance of the purchased Secured Debt, plus interest on
such purchase price from November 12, 1997 through the closing date of such
purchase at approximately 8.0% per annum, less all payments received by the
Sellers with respect to the purchased Secured Debt through the date of
closing; and (iii) the issuance of stock warrants to the Sellers to purchase
up to 110,200 shares of the Company's common stock at an exercise price of
$20.00 per share over a 36 month term and subject to a call feature of the
Company.
<PAGE>39
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.a - Amended and Restated Motor Vehicle Installment
Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation
Exhibit 10.b - Employment Agreement between Registrant and Steven A.
Tesdahl*
Exhibit 10.c - Amended and Restated Employment Agreement between
Registrant and Donald L. Addink*
Exhibit 11 - Statement Regarding Computation of Earnings Per Share
Exhibit 27 - Financial Data Schedule
Exhibit 99 - Cautionary Statement Regarding Forward Looking
Statements and Risk Factors
____________________________
*- Denotes a management contract or compensatory plan, contract, or
arrangement.
(b) Reports on Form 8-K.
During the third quarter of 1997, the Company filed two reports on Form
8-K. The first report on Form 8-K, dated July 17, 1997 and filed July
18,1997, pursuant to Items 5 and 7, filed a copy of the Company's press
release entitled "Ugly Duckling Corporation to Purchase Secured Bank Debt of
First Merchants Acceptance Corporation." The second report on Form 8-K, dated
August 21, 1997 and filed September 5, 1997, pursuant to Items 2, 5, and 7,
reported (1) the purchase by the Company of approximately 78% of the FMAC
senior bank debt, (2) the expected recording of a third quarter charge to net
earnings of between $4 million to $6 million (after taxes), and (3)
negotiations between the Company and Kars to acquire certain dealership and
servicing assets of Kars. After the third quarter 1997, the Company filed one
Form 8-K. This Form 8-K, dated September 19, 1997 and filed October 5, 1997
pursuant to Items 2, 5, and 7, reported (1) the completion of the acquisition
by the Company of certain assets of Kars, and (2) the securitization of
approximately $104 million of vehicle receivables by CRC II.
<PAGE>40
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ugly Duckling Corporation
Date: November 14, 1997
-------------------
/s/ Steven T. Darak
- ----------------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
S-1
===
<PAGE>41
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.a - Amended and Restated Motor Vehicle Installment Contract Loan and
Security Agreement between Registrant and General Electric Capital
Corporation
10.b - Employment Agreement between Registrant and Steven A. Tesdahl*
10.c - Amended and Restated Employment Agreement between Registrant and
Donald L. Addink*
11 - Statement Regarding Computation of Earnings Per Share
27 - Financial Data Schedule
99 - Cautionary Statement Regarding Forward Looking Statements and Risk
Factors
AMENDED AND RESTATED MOTOR VEHICLE INSTALLMENT CONTRACT
LOAN AND SECURITY AGREEMENT
This Amended and Restated Loan and Security Agreement ("Agreement") is
entered into by and between Ugly Duckling Corporation successor in interest to
Ugly Duckling Holdings, Inc. ("Ugly Duckling") a Delaware corporation, Duck
Ventures, Inc. ("Ventures"), Champion Acceptance Corporation ("CAC")formerly
known as Ugly Duckling Credit Corporation , Ugly Duckling Car Sales, Inc.
("Sales"), and Champion Financial Services, Inc. ("Champion"), all Arizona
corporations, and Ugly Duckling Car Sales Florida, Inc. ("Car Sales Florida")
a Florida corporation and Ugly Duckling Car Sales Texas, L.L.P. ("Car Sales
Texas"), an Arizona limited liability partnership, and Ugly Duckling Car Sales
New Mexico, Inc. ("Car Sales New Mexico"), a New Mexico corporation (Ugly
Duckling, Ventures, Credit, Sales, Champion, Car Sales Florida, Car Sales
Texas, and Car Sales New Mexico, collectively called (hereinafter referred to
as "Borrower"), and General Electric Capital Corporation, a New York
corporation (hereinafter referred to as "Lender"). The obligations of
Borrower to Lender under this Agreement are the joint and several liability of
each Borrower. The maximum Borrowing Base set forth herein is an aggregate
combined total for Borrower. In consideration of the mutual covenants and
agreements contained herein, Borrower and Lender agree as follows:
RECITALS
A. Borrower and GE Capital are parties to that certain Motor Vehicle
Installment Contract Loan and Security Agreement dated as of June 1, 1994 as
amended (the "Original Agreement") pursuant to which GE Capital made certain
loans to Borrower which loans were secured by, among other things, Borrower's
motor vehicle installment contracts;
B. Borrower and Lender have agreed to enter into this Agreement in order
to amend and restate the Original Agreement in its entirety; and document such
other changes in the lending relationship between the parties as have occurred
since the Original Agreement.
C. It is the intent of Borrower and Lender that the execution and delivery
of this amendment and restatement of the Original Agreement shall not
effectuate a novation of the indebtedness outstanding under the Original
Agreement, but rather as it pertains to the indebtedness outstanding under the
Original Agreement, shall constitute a substitution of certain of the terms
governing the payment and performance of such indebtedness.
ARTICLE I. - DEFINITIONS.
Section 1.0 DEFINITIONS. Capitalized terms used in this Agreement shall
have the meanings given to such terms in Section 16 of this Agreement. When
such defined terms are used in this Agreement in the plural, the terms shall
have the plural of such meanings. All other terms contained in this Agreement
shall, unless the context indicates otherwise, have the meanings provided for
by the UCC to the extent the same are defined therein.
ARTICLE II. - LOAN: GENERAL TERMS
Section 2.0. REVOLVING CREDIT; LOAN AMOUNT. Subject to all of the terms
and conditions of this Agreement, Lender agrees to loan funds to Borrower
against Eligible Contracts from time to time in a series of Advances during
<PAGE>43
the term of this Agreement. Funds may be borrowed, repaid and reborrowed on a
revolving basis subject to the terms and conditions set forth in this
Agreement, provided that the Loan shall not at any time exceed the Borrowing
Base. Borrower's obligation to pay the Loan is evidenced by this Agreement.
Borrower shall pay Lender when due all Obligations in accordance with the
terms of this Agreement whether or not Borrower has executed a promissory
note. The actual amount Borrower is obligated to pay Lender hereunder shall
be determined by this Agreement and the records of Lender, regardless of the
terms of any promissory note. Any promissory note executed in connection with
the Indebtedness need not be amended to reflect changes made to this
Agreement.
Section 2.1. SINGLE LOAN. All Advances by Lender to Borrower shall
constitute one loan and all indebtedness and obligations of Borrower to Lender
under the Loan Documents shall constitute an obligation secured by Lender's
security interest in all of the Collateral.
Section 2.2. GENERAL INTEREST RATE AND FEES. (A) Except as modified by
Sections 2.4 and 15.1, the average daily balance of the Loan shall bear
interest, calculated daily on the basis of a 365-day year, at a per annum rate
equal to Three Hundred Fifteen (315) basis points plus the LIBOR Rate.
(B) Borrower shall pay to Lender the Line Fee on the date hereof and
each anniversary thereof.
(C) Borrower shall pay to Lender the Underutilization Fee within ten
(10) days after the end of an Accounting Period for which an Underutilization
Fee is due.
Section 2.3. LOAN TERM; RIGHT TO TERMINATE. Unless sooner terminated as
hereinafter provided, this Agreement shall terminate on December 31, 1998 and
may be renewed by agreement of the parties for one additional year. Both
Lender and Borrower have the right to terminate this Agreement as of the end
of the term hereof upon at least ninety (90) days prior written notice to the
other. If an Event of Default has occurred, Lender may without prior notice
to Borrower, immediately terminate this Agreement. A prepayment in full of
the Loan shall be a termination of this Agreement. Notwithstanding
termination of this Agreement in any manner, the Indebtedness shall be payable
in accordance with this Agreement, and all rights and remedies granted to
Lender hereunder or pursuant to applicable law shall continue until all
obligations of Borrower to Lender have been fully paid and performed.
Section 2.4. MAXIMUM LAWFUL RATE.
(A) INTEREST RATE. Notwithstanding any provision in this
Agreement, or in any other document, if at any time before the payment in full
of the Indebtedness, any of the rates of interest specified in this Agreement
(the "Stated Rates") exceeds the highest rate of interest permissible under
any law which a court of competent jurisdiction shall, in a final
determination, deem applicable hereto (the "Maximum Lawful Rate"), then in
such event and so long as the Maximum Lawful Rate would be so exceeded, the
rate of interest payable shall be equal to the Maximum Lawful Rate; provided,
however, that if at any time thereafter the Stated Rates shall be less than
the Maximum Lawful Rate, then, subject to (B) below, Borrower shall continue
to pay interest at the Maximum Lawful Rate until such time as the total
interest received by Lender is equal to the total interest which Lender would
have received had the Stated Rates been (but for the operation of this Section
2.4(A)) the interest rates payable; thereafter, the interest rates payable
shall be the Stated Rates unless and until any of the Stated Rates shall again
<PAGE>44
exceed the Maximum Lawful Rate, in which event this Section 2.4(A) shall again
apply. In the event interest payable hereunder is calculated at the Maximum
Lawful Rate, such interest shall be calculated at a daily rate equal to the
Maximum Lawful Rate divided by the number of days in the year in which such
calculation is made.
(B) AMOUNT OF INTEREST. In no event shall the total interest
contracted for, charged, received or owed pursuant to the terms of this
Agreement exceed the amount which Lender may lawfully receive. In the event
that a court of competent jurisdiction, notwithstanding the provisions of this
Section 2.4, shall make a final determination that Lender has received,
charged, collected, or contracted for interest hereunder in excess of the
amount which Lender could lawfully have, Lender shall, to the extent permitted
by law, promptly apply such excess first to any interest due (calculated at
the Maximum Lawful Rate if applicable) and not yet paid, then to the
prepayment of principal, and any excess remaining thereafter and after
application to any other amounts Borrower owes Lender shall be refunded to
Borrower. In determining whether the interest exceeds the Maximum Lawful Rate
or the maximum amount which Lender could lawfully have received, the total
amount of interest shall, to the extent allowed by law, be spread over the
term of the Loan. Any provisions of this Agreement regarding the time during
which interest accrues on Advances are only elements of the formula for
calculating interest on the total Loan and are not intended to cause interest
to be applied to specific Advances for usury determination purposes.
ARTICLE III - LOAN DISBURSEMENTS
Section 3.0. LOAN - BORROWING BASE. Provided that there does not then
exist an Event of Default or a Pre-Default Event, and provided that Lender has
not taken over all or some of the administration of the Contracts, Lender
shall, upon written request of Borrower and subject to all of the terms and
conditions of this Agreement, make Advances to Borrower pursuant to Section
3.2.
Section 3.1. ELIGIBLE CONTRACTS. Borrower shall from time to time
deliver to Lender Eligible Contracts which Borrower desires to be included in
the Borrowing Base. Along with the Contracts Borrower shall also deliver a
List of Contracts. An Eligible Contract shall be included in the Borrowing
Base only when and for so long as, in Lender's sole determination, each of the
requirements in the definition of Eligible Contracts continues to be
satisfied. If a Contract is determined by Lender to be, or is treated by
Lender as, an Eligible Contract, Lender reserves the right to change its
determination or treatment and to remove the Contract from the Borrowing Base
if it later determines that the Contract is not or was not an Eligible
Contract. A determination by Lender that a Contract is an Eligible Contract
is not a waiver by Lender of, or an admission by Lender of the truth of, any
of Borrower's representations and warranties in this Agreement.
Section 3.2. PROCEDURE FOR BORROWING. (A) The first Advance shall not
exceed the Borrowing Base. Subsequent Advances shall not be made more
frequently than daily. Each subsequent Advance shall not exceed the Loan
Availability determined at Lender's election either as of the end of the most
recent Accounting Period for which Lender has received the monthly reports
required by Section 5.1 (C), or, as of such other date thereafter designated
by Lender. Lender is not obligated to make an Advance if the amount available
or requested is less than Twenty-Five Thousand Dollars ($25,000.00). Lender
is not obligated to make an Advance unless Borrower provides Lender with
sufficient information to calculate the Loan Availability. Lender's use of
the information provided by Borrower to determine the amount available for
<PAGE>45
Advances is not an admission by Lender as to the accuracy of the information,
and Lender reserves the right to verify the information and redetermine the
amount available for Advances.
(B) Lender shall disburse each Advance requested by Borrower
within one (1) Business Day after receipt of Borrower's written request for
the Advance. Lender shall disburse each Advance requested by Borrower by
means of a draft, or, upon the request of and at the expense of Borrower,
Lender shall wire transfer the funds to Borrower.
ARTICLE IV - LOANS: PAYMENTS
Section 4.0. PAYMENTS BY BORROWER. (A) All payments by Borrower to
Lender shall be deposited in the Depository Account; or shall be sent to such
other location that Lender notifies Borrower to send payments to.
(B) Upon the effective date of termination of this Agreement,
Borrower shall pay to Lender the entire Indebtedness. If there is an Event of
Default, Borrower shall pay the entire Indebtedness on demand if the
Indebtedness is accelerated pursuant to Section 15.2.
(C) Interest shall accrue on the Loan daily and be paid from the
Remittances as provided in Section 4.2. If at the end of an Accounting Period
there is more than one Business Day of accrued unpaid interest, Borrower shall
pay the more-than- one-day accrued interest to Lender within one (1) Business
Day after the end of the Accounting Period. Accrued interest shall not be
added to the Loan balance and bear interest, unless the interest is past due
and paid with an Advance requested by Borrower and approved by Lender;
provided that, such an approval by Lender shall not constitute a waiver of the
Event of Default consisting of the failure to pay the interest except to the
extent provided in Section 16.9.
(D) Whenever Lender shall notify Borrower, with a Statement of
Borrowing Base or otherwise, that the Loan exceeds the Borrowing Base,
Borrower shall within one (1) Business Day after receipt of such notice,
either pay down the Loan by the amount of such excess, or, if Lender consents,
deliver additional Eligible Contracts to Lender which are sufficient to
increase the Borrowing Base above the Loan.
(E) The payment of all elements of the Indebtedness not covered
by Subsections (B), (C), or (D) shall be payable by Borrower to Lender as and
when provided in the Loan Documents, and, if not specified, then on demand.
(F) Borrower has the right to prepay the Loan in full or in part
at any time without penalty.
(G) If the Loan is less than One Million Dollars
($1,000,000.00), Borrower is not required to forward cash deposits to Lender,
unless otherwise directed by Lender.
Section 4.1. CONTRACT PAYMENTS. Borrower shall direct all Contract
Debtors for Pledged Contracts, and all other Persons (including Contract
Rights Payors) who make payments to Borrower relating to Pledged Contracts, to
make, when paying by mail, all payments directly to the Post Office Box. In
the event Borrower receives any Remittances, Borrower shall, as soon as
possible but no later than the two (2) Business Days following receipt,
deposit the Remittances in kind in the Depository Account. Borrower shall
hold Remittances in trust for Lender until delivery to Lender or deposit in
the Depository Account. Borrower shall pay all expenses associated with the
Post Office Box.
Section 4.2. APPLICATION OF PAYMENTS. All Remittances received by Lender
shall be applied by Lender to the Indebtedness within one two (2) Business
Days after the Remittance has been deposited in Lender's account. No
Remittance other than cash shall be treated as a final payment to Lender
unless and until such item has actually been collected by Lender's bank and
such collection has been finally credited to Lender's account; provided,
further that if a Remittance applied to the Indebtedness is charged back to
Lender's bank, Lender can retroactively remove the application of the
Remittance to the Indebtedness and accrue any interest not accrued because of
the application of the Remittance to the Indebtedness. Each Remittance shall
be applied by Lender to the Indebtedness (i) first to accrued interest, and,
if sufficient to pay accrued interest, (ii) then to the Indebtedness, other
than the Advances, and (iii) then to the Loan. Lender reserves the right to
use a different order of application if there is an Event of Default or
Pre-Default Event, or Lender has given prior written notice to Borrower of a
different order. All Remittances received by Lender may be applied to the
Indebtedness even though no portion of the Indebtedness is otherwise then due
and even though Lender has not sent Borrower a demand, notice or request for
payment of the Indebtedness. Payments shall be deemed to be due by Borrower
when received by Lender unless they are due sooner by the terms of the Loan
Documents.
ARTICLE V - CONTRACT ADMINISTRATION
Section 5.0. LENDER ADMINISTRATION. (A) Lender shall have no liability
to Borrower with respect to Remittances received by Lender, the Post Office
Box, or the Depository Account, other than to: (i) apply the Remittances
pursuant to Section 4.2 of this Agreement and (ii) upon termination of this
Agreement and Borrower's satisfaction of all of its obligations under this
Agreement, to assign the Post Office Box and its contents to Borrower. Lender
shall have no liability to Borrower with respect to any interest or other
earnings which are earned, or could have been earned, on the Remittances while
they are in the Post Office Box, the Depository Account, or otherwise.
Section 5.1. BORROWER ADMINISTRATION. (A) Borrower shall perform all
aspects of servicing, administering, collecting, liquidating, accounting for
and managing (collectively, "administering", "administer", or
"administration") the Pledged Contracts it customarily performs in accordance
with Borrower's current practices for contract administration, which practices
are in accordance with applicable law and have been disclosed to Lender prior
to the date hereof. Borrower shall provide such administration in a
reasonable and prudent way that does not, in Lender's determination, adversely
affect the value of the Collateral to Lender. If in Lender's opinion,
Borrower fails to administer the Pledged Contracts in accordance with
Borrower's practices disclosed to Lender prior to the date hereof, Lender
shall notify Borrower of the deficiencies in Borrower's administration and
Borrower shall have ten (10) Business Days to cure any such deficiencies. If
Borrower fails to cure such deficiency within such ten (10) Business Day
period, Lender may thereafter, in its sole discretion, take over all or part
of the administration of the Pledged Contracts. The administration provided
by Borrower shall include but not be limited to all servicing currently
provided by Borrower, and Financed Vehicle titling and lien perfection,
customer service, insurance claim tracking and collection, insurance
maintenance, Contract enforcement, Contract billing, payment processing,
portfolio and Contract accounting, portfolio management, delinquency
collection, repossession, foreclosure, resale, and maintaining current
Contract Debtor and Financed Vehicle location information (name, address and
phone number). Borrower shall maintain current, accurate, and complete
records of activity and comments regarding collection, insurance, payments,
<PAGE>47
and other material events. The records regarding collection history,
payments, Contract accounting, customer service notes, Contract Debtor names
and addresses and Outstanding Principal Balance shall be computerized.
Borrower shall require Contract Debtors to maintain Required Contract Debtor
Insurance. Borrower shall administer and otherwise deal with the Contracts in
compliance with all applicable laws. Borrower shall conduct foreclosure sales
in a commercially reasonable manner and take the steps necessary to preserve
the deficiency liability of the Contract Debtors.
(B) Borrower shall administer the Pledged Contracts at its
existing service centers in Arizona, Florida and Texas or at such other
locations that Borrower provides prior notice of to Lender and Lender approves
for Contract administration.
(C) Borrower shall furnish to Lender such reports in such form
that Lender determines are necessary for it to track and monitor the Pledged
Contracts, Remittances, Financed Vehicles, and insurance. Such reports shall
be in a format and on a medium readable by Lender's computer software, or such
other format or medium acceptable to Lender. The reports shall include but
not be limited to those reports set forth on Exhibit 5.1(C) attached hereto
and made a part hereof, and shall be delivered to Lender in accordance with
such Exhibit.
(D) Notwithstanding anything herein to the contrary, (i)
Borrower shall remain liable under all Contracts, and any other contracts and
agreements with Contract Rights Payors or otherwise included in or related to
the Collateral, to the extent set forth therein to perform all of its duties
and obligations thereunder to the same extent as if this Agreement had not
been executed, and (ii) the exercise by Lender of any rights under any of the
Loan Documents shall not release Borrower from any of its duties or
obligations under the Contracts, or the other contracts and agreements, and
(iii) Lender shall not have any obligation or liability under the Contracts,
or the other contracts and agreements, nor shall Lender be obligated to
perform any of the obligations or duties of Borrower thereunder or to take any
action to collect or enforce any rights thereunder.
(E) Borrower shall administer the Contracts at its own expense.
In the event that Borrower fails to administer the Contracts in accordance
with Section 5.1(A) or there is an Event of Default or a Pre-Default Event,
Lender may in Lender's or Borrower's name take over all or part of the
Contract administration Borrower is required by this Agreement to perform. If
Lender takes over all or part of such administration, Borrower shall pay to
Lender on demand all out-of-pocket costs incurred by Lender in the performance
of Borrower's administration obligations, and Borrower shall pay Lender for
the administration performed by Lender an administration fee (exclusive of
out-of-pocket costs) established by Lender consistent with generally
prevailing fees charged by servicers of contracts of similar credit quality,
and until so paid such costs and fee shall be part of the Loan.
ARTICLE VI - COLLATERAL: GENERAL TERMS
Section 6.0. SECURITY INTEREST. To secure the performance and payment of
the Indebtedness and all of Borrowers existing and future obligations to
Lender whether arising under or related to this Agreement or otherwise,
Borrower hereby grants to Lender a continuing security interest in and to all
of the following property of Borrower, whether now owned or existing or
hereafter arising or acquired and regardless of where located:
<PAGE>48
Contracts; Contract Debtor Documents; Contract Rights; payments from
Contract Debtor bank accounts; chattel paper; leases; installment sale
contracts; installment loan contracts; payments from chattel paper obligors;
security deposits; Motor Vehicles (including but not limited to cars, trucks
and motorcycles); certificates of title; contract purchase discounts;
accounts; general intangibles; security interests; collateral securing chattel
paper; dealer agreements; dealer reserves and rate participation; rights of
Debtor related to chattel paper, installment contracts, motor vehicles, and
collateral securing chattel paper; documents; instruments; deposit accounts;
electronic funds transfers; equipment; inventory; parts and accessories for
motor vehicles; payments from account debtor bank accounts; reserve accounts;
insurance policies, and benefits and rights under insurance policies, which
Borrower is solely or jointly the owner of, insured under, the lienholder or
loss payee under, or the beneficiary of; and all payments and property of any
kind, now or at any time or times hereafter, in the possession or under the
control of Secured Party, or a bailee of Secured Party;
accessions to, substitutions for and all replacements, products and
proceeds of, any of the foregoing property; and
books and records (including, without limitation, financial statements,
accounting records, customer lists, credit files, computer programs,
electronic data, print-outs and other computer materials and records) of
Borrower pertaining to any of the foregoing property.
Section 6.1. DISCLOSURE OF SECURITY INTEREST. Borrower shall make
appropriate entries upon its financial statements and its books and records
disclosing Lender's security interest in the Collateral. Borrower shall stamp
all original, duplicates and reproductions of Pledged Contracts with an
assignment to Lender.
Section 6.2. ADDITIONAL ACTS. Borrower shall perform all other acts
requested by Lender for the purpose of perfecting, protecting, maintaining and
enforcing Lender's security interest in the Collateral and the priority of
such security interest. Borrower agrees that a carbon, photographic,
photostatic, or other reproduction of this Agreement or of a financing
statement is sufficient as a financing statement. Borrower, upon request of
Lender, shall either pay or reimburse Lender for all costs, filing fees, and
taxes associated with the perfection of Lender's security interest.
Section 6.3. INSPECTION AND ACCESS. Lender and its agents shall have the
right, at any time, to (i) during Borrower's usual business hours, inspect the
Collateral and the premises upon which any of the Collateral is located; (ii)
during Borrower's usual business hours, inspect, audit and make copies or
extracts from any of Borrower's records, computer systems, files, and books of
account; (iii) during Borrower's usual business hours, monitor Borrower's
performance of its obligations with respect to this Agreement; and (iv) obtain
information about Borrower's affairs and finances from any Person; and (v)
verify, in Lender's name or in the name of Borrower, the validity, amount,
quality, quantity, value and condition of, or any other matter relating to,
the Collateral including but not limited to verifying Contract information
with Contract Debtors. Borrower shall, upon Lender's request from time to
time, instruct its vendors, banking and other financial institutions and its
accountants to make available to Lender and discuss with Lender such
information and records as Lender may request. Borrower authorizes Lender, if
requested by a Person other than a credit reporting agency and without request
if the Person is a credit reporting agency, to provide that Person with
information about the Indebtedness, Collateral and Borrower's performance of
this Agreement. If Borrower maintains or stores any data with respect to
<PAGE>49
Collateral on a computer data system, Borrower shall upon request of Lender
provide Lender with (a) on-line access to such computer data system or (b)
deliver to Lender duplicate copies of the requested data in machine readable
form acceptable to Lender along with a printout or other hard copy of such
data. Borrower shall, on request of Lender, provide to Lender (at the
location designated by Lender) the Contract Debtor Documents. If at any time
during the Agreement, Lender establishes on-line access to Borrower's computer
system, Lender shall exercise such care as it exercises with respect to its
own computer systems regarding the integrity and confidentiality of Borrower's
information therein and Lender shall observe all reasonable security
requirements relating to Borrower's computer system as Lender is advised of by
Borrower, provided however, that such observance shall in no way prevent
Lender from accessing Borrower's information.
Section 6.4. RIGHT TO NOTIFY AND ENDORSE. Borrower hereby irrevocably
authorizes Lender to notify any or all Contract Debtors and Contract Rights
Payors that Lender has a security interest in Contracts, Contract Rights, and
other items of Collateral at any time (i) prior to the occurrence of an Event
of Default, in the name of Borrower, and (ii) after the occurrence of an Event
of Default, in Lender's or Borrower's name. Any such notice shall, at
Lender's election, be signed by Borrower and may be sent on Borrower's
stationery.
Section 6.5. LENDER APPOINTED ATTORNEY-IN-FACT. Borrower hereby
irrevocably appoints Lender (and all Persons designated by Lender for that
purpose) as Borrower's true and lawful attorney-in-fact to act in Borrower's
place in Borrower's or Lender's name (i) to endorse Borrower's name on any
Remittance; (ii) to sign Borrower's name on any assignment or termination of a
security interest in a Financed Vehicle, on any application for a Certificate
of Title for a Financed Vehicle, or on any UCC financing statement related the
Collateral, and on any other public records regarding the Collateral; (iii) to
send requests for verification to Contract Debtors and (iv) to execute an
assignment to Lender of any Pledged Contract for which Lender has made an
Advance which was delivered to Lender without such assignment. Borrower
ratifies and approves all acts of Lender as Borrower's attorney-in-fact.
Lender shall not, when acting as attorney-in-fact, be liable for any acts or
omissions as or for any error of judgment or mistake of fact or law, except
for actions taken in bad faith or resulting from Lender's gross negligence or
willful misconduct. This power, being coupled with an interest, is
irrevocable until all payment and performance obligations of Borrower to
Lender have been fully satisfied. Borrower shall upon request of Lender
execute powers of attorney to separately evidence the foregoing powers granted
to Lender. After an Event of Default or Pre-Default Event has occurred, all
costs, fees and expenses thereafter incurred by Lender, or for which Lender
becomes obligated, in connection with exercising any of the foregoing powers
shall be payable to Lender by Borrower on demand by Lender and until paid
shall be part of the Loan.
Section 6.6. CHANGE OF COLLATERAL, LOCATION, OFFICE OR STRUCTURE.
Borrower shall keep the Collateral, other than Collateral delivered to Lender
and Financed Vehicles, at Borrower's address set forth in Section 16.1 or its
service center(s) listed in Section 5.1. Borrower shall not change its name,
tradename, principal place of business and chief executive office or the
location of any service center, unless Borrower gives Lender at least sixty
(60) days prior written notice of such change and prior thereto has taken all
action Lender requires to maintain the priority and perfection of its security
interest in, and access to, the Collateral.
<PAGE>50
Section 6.7. LENDER'S PAYMENT OF CLAIMS ASSERTED AGAINST BORROWER.
Lender may, at any time, in its sole discretion and without obligation to do
so and without waiving or releasing any obligation, liability or duty of
Borrower under the Loan Documents or any Event of Default, pay, acquire or
accept an assignment of any security interest, lien, claim or encumbrance
asserted by any Person against the Collateral; provided that Lender shall
first give Borrower writ-ten notice of its intent to do the same, and Borrower
does not, within five (5) days of such notice, pay such claim and/or obtain to
Lender's reasonable satisfaction the release of the security interests, liens,
claims or encumbrances to which such notice relates. All sums paid by Lender
in respect thereof and all costs, fees and expenses, including reasonable
attorneys' fees, court costs, expenses and other charges relating thereto,
which are incurred by Lender on account thereof, shall be payable by Borrower
to Lender on demand by Lender and until paid shall be part of the Loan.
Section 6.8. TERMINATION OF SECURITY INTEREST. Lender's security
interest in the Collateral shall continue until performance and payment in
full of all of Borrower's obligations to Lender in accordance with the terms
of agreements creating such obligations; and if, at any time, all or part of a
payment or transfer made by Borrower or any other Person and applied by Lender
to Borrower's obligations to Lender is rescinded or otherwise must be returned
by Lender for any reason whatsoever (including, without limitation, the
insolvency, bankruptcy or reorganization of Borrower or such other Person),
the security interest granted hereunder or under any other present or future
agreement between Borrower and Lender, and all rights of Lender, shall be
reinstated as to the obligations which were satisfied by the payment or
transfer rescinded or returned, all as though such payment or transfer had not
been made, and Borrower shall take the action requested by Lender to reperfect
all terminated security interests and to reinstate all satisfied obligations.
Lender shall release its security interest in Contracts which are sold or
pledged to other Persons in accordance with Section 14.8.
Section 6.9. RETURN OF CONTRACT DELIVERY DOCUMENTS. Lender shall return
to Borrower within Two (2) Business Days of Borrower's request any Contract
Delivery Document originals for Contracts paid in full. In addition, provided
that there is no Event of Default or Pre-Default Event and the removal of the
Contract will not result in the Loan exceeding the Borrowing Base, Lender
shall return Contract Delivery Document originals for other Contracts
requested by Borrower for the time and to the extent necessary for Borrower to
make corrections or to enforce the Contracts or the obligations of the
Contracts Rights Payors. Whenever Borrower is in possession or control of
Contract Delivery Documents for Contracts not paid in full, Borrower shall
hold them in trust for Lender.
ARTICLE VII - COLLATERAL: CONTRACTS
Section 7.0. NOTICE REGARDING CONTRACTS. (A) In the event any amounts
due and owing in excess of Five Thousand Dollars ($5,000) on a Pledged
Contract become disputed between the Contract Debtor and Borrower, or in the
event a Contract Debtor for a Pledged Contract asserts a claim, offset, or
defense, or in the event a Person other than Borrower or a Contract Debtor
makes a claim of ownership or other interest in a Financed Vehicle or
Contract, then Borrower shall provide Lender with written notice thereof
within three (3) Business Days of learning of the same, explaining in detail
the nature of the matter and the amount in controversy. Borrower shall
promptly, but in no event later than three (3) Business Days after learning
thereof, inform Lender of all material adverse information relating to the
financial condition of any Contract Debtor, or the value of any Pledged
Contract or Financed Vehicle.
<PAGE>51
(B) After an Eligible Contract is included in the Borrowing Base,
in the event that Borrower becomes aware that one of the requirements in the
definition of Eligible Contracts or one of the conditions in Section 9.0 are
no longer being satisfied with respect to the Contract, Borrower shall provide
Lender with written notice thereof within five (5) Business Days of Borrower
becoming aware, explaining in detail the timing and reasons why the
requirement or condition is not satisfied.
(C) Upon request of Lender, Borrower shall to the extent authorized
by law obtain current credit bureau reports on Contract Debtors.
ARTICLE VIII - COLLATERAL: REMITTANCES AND INSURANCE
Section 8.0. ASSIGNMENT OF LIEN IN FINANCED VEHICLES. In addition to the
security interest granted in Section 6.0, Borrower hereby assigns absolutely
to Lender Borrower's rights of foreclosure as lienholder of the Financed
Vehicles for Contracts delivered to Lender. This assignment is solely for the
purpose of Lender foreclosing on the liens following an Event of Default.
Until an Event of Default, Borrower has the right to foreclose on a Financed
Vehicle. In the event Lender exercises the right to foreclose, Lender shall
be the owner of the foreclosure sale proceeds and shall apply them to the
Indebtedness.
Section 8.1. ABSOLUTE ASSIGNMENT OF REMITTANCES. In addition to the
security interest granted in Section 6.0, Borrower hereby absolutely assigns
to Lender Borrower's interest in and right to all Remittances arising on or
after the date of this Agreement, and such Remittances shall be the property
solely of Lender.
Section 8.2. INSURANCE. In addition to the security interest granted in
Section 6.0, Borrower hereby assigns absolutely to Lender Borrower's right to
refunds and benefits under Required Contract Debtor Insurance, and Optional
Contract Debtor Insurance for Pledged Contracts. This assignment is evidenced
by Exhibit 8.2. In the event Lender uses this assignment to collect insurance
benefits or refunds, Lender shall be the owner of the benefits and refunds and
shall apply them to the Indebtedness.
ARTICLE IX - CONDITIONS TO ADVANCES
Section 9.0. CONDITIONS TO EACH ADVANCE. Notwithstanding any other
provision of this Agreement and without affecting in any manner the rights of
Lender hereunder, Lender shall not be obligated to make any Advances
(including the initial Advance) unless at the time of the Advance, all of the
following conditions shall, in Lender's sole determination, be satisfied:
(A) For each Eligible Contract, Borrower shall have included the
Eligible Contract on a List of Contracts delivered to Lender and shall have
delivered to Lender the Contract Delivery Documents; except that, if a
Certificate of Title has not been issued and Borrower has provided Lender with
proof acceptable to Lender that a Certificate of Title has been applied for,
then the Certificate of Title must be delivered to Lender within ninety (90)
days of the Contract date;
(B) All of the representations and warranties of Borrower in all
of the Loan Documents shall be true and correct on and as of the date of such
Advance as though they were made on and as of such date and Borrower shall
have performed all of its obligations contained in the Loan Documents required
to be performed as of such date;
<PAGE>52
(C) The making of the Advance will not constitute an Event of
Default or Pre-Default Event;
(D) There shall have been no material adverse change in the
financial condition of Borrower, the Validity of Collateral Guarantor, or
Guarantor, after March 31, 1997;
(E) No claim has been asserted or proceeding commenced
challenging this Agreement or Lender's rights under this Agreement, and no
claim has been asserted which if true would be a breach of a representation
and warranty in the Loan Documents;
(F) No Event of Default shall have occurred, and no Pre-Default
Event shall have occurred and still be in existence;
(G) Lender has a first priority perfected security interest in
the Collateral except to the extent otherwise allowed by this Agreement or
Lender in writing;
(H) An event has not occurred which entitles Lender pursuant to
Section 5.1 (E) to take over administration of the Contracts;
(I) Lender's most recent inspection of the Collateral or
Borrower's records or operations has been satisfactory to Lender;
(J) Borrower shall have provided such additional information and
documents as Lender may reasonably request; and
(K) None of the actions taken or supplemental documents executed
listed on Exhibit 9.0 attached hereto and made a part hereof have been
revoked, rescinded, terminated, or canceled without Lender's prior consent.
ARTICLE X - REPRESENTATIONS AND WARRANTIES OF BORROWER
Section 10.0. REPRESENTATIONS OF BORROWER. Borrower hereby makes the
following representations and warranties. The representations and warranties
are made as of the execution and delivery of the Agreement, and each time
Borrower delivers Contracts to Lender or requests an Advance the
representations and warranties are deemed to be made again at that time.
Lender's knowledge of any breach of the representations and warranties
contained herein shall not void any of the representations or warranties or
affect Lender's rights with respect to the breach.
(a) ORGANIZATION, GOOD STANDING, NAME, AND LOCATION. Borrower is a
corporation duly organized, validly existing and in good standing under the
laws of the States where it conducts business, with power and authority to own
its properties and to conduct its business, and, at all relevant times, has
the power, authority and legal right to acquire, own, and pledge the Pledged
Contracts. Borrower has, is in good standing under, and is in compliance
with, all governmental approvals, licenses, permits, certificates,
inspections, consents and franchises necessary to conduct its business, to
enter into and perform this Agreement, and to own and operate its business.
Borrower's principal place of business and chief executive office is the
Borrower address set forth in Section 16.1. During the preceding five (5)
years, Borrower has not, been known by or used any other corporate, trade or
fictitious name, except as disclosed in Exhibit 10(a). Ugly Duckling is the
sole shareholder of Ventures; Ventures is the sole shareholder of CAC, Sales
CAC is the sole shareholder of Champion Financial Services, Inc. Sales is the
sole shareholder of Car Sales Florida and Car Sales New Mexico and is the
general partner of Car Sales Texas.
(b) DUE QUALIFICATION. Borrower has, and is in good standing
under, all licenses, permits, and approvals in all jurisdictions which are
required for Borrower's initial acquisition of the Pledged Contracts and for
Borrower's performance of this Agreement.
(c) POWER AND AUTHORITY. Borrower has the power and authority to
execute this Agreement and carry out its terms, and the execution and
performance of the Agreement have been duly authorized by all necessary
corporate action. The execution and performance of this Agreement by Borrower
does not require the consent or approval of any Person.
(d) VALID AND BINDING OBLIGATIONS. The Agreement constitutes a
valid loan obligation of Borrower and a valid granting of a security interest
in the Collateral to Lender, enforceable against creditors of and purchasers
from Borrower; and is a legal, valid and binding obligation of Borrower
enforceable in accordance with its terms. The Guaranty and the Validity of
Collateral Guaranty are valid and binding obligations of the Validity of
Collateral Guarantor and Guarantor enforceable according to their terms.
Borrower's use of the Advances is a legal and proper corporate use. Borrower
has not used Advances to give any preference to any creditor or to make a
fraudulent transfer.
(e) NO VIOLATION. Borrower's execution and performance of this
Agreement does not conflict with, result in any breach of, nor constitute
(with or without notice or lapse of time) a default under, (i) the articles of
incorporation or bylaws of Borrower, or (ii) any indenture, instrument,
agreement, or court order by which it is bound, or (iii) nor does it result in
the creation or imposition of any lien upon any of Borrower's properties other
than that granted to Lender.
(f) NO PROCEEDINGS. There are no proceedings or investigations
pending, or to the best of Borrower's knowledge, threatened, before any court,
regulatory body, administrative agency, or other governmental instrumentality
having jurisdiction over Borrower or its properties, which (i) assert the
invalidity of the Agreement, (ii) seek to prevent the consummation of any of
the transactions contemplated by the Agreement, (iii) seek any determination
or ruling that, if determined adversely to Borrower, would materially and
adversely affect the Collateral, Borrower's ability to perform its obligations
under the Agreement, the validity or enforceability of the Agreement, Lender's
rights under the Agreement, or Borrower's financial condition or business, or
(iv) allege that Borrower is in violation of any statute, regulation, rule or
ordinance of any governmental entity, including, without limitation, the
United States of America, any state, city, town, municipality, county or of
any other jurisdiction, or of any agency thereof except in connection with
complaints of Contract Debtors made in the normal course of Borrower's
business and not of a material nature.
(g) COLLATERAL. Borrower has good and marketable ownership of the
Collateral, and the Collateral is free and clear of all liens, claims,
charges, defenses, counterclaims, offsets, encumbrances and security interests
of any kind or nature, except the Permitted Liens. The security interests
granted to Lender pursuant hereto are perfected first priority security
interests, assuming delivery to Lender of any Collateral as to which
possession is the only method of perfecting a security interest and assuming
the filing of a UCC financing statement with the collateral description in
Exhibit G with the office of Secretary of State of Arizona; Florida, Nevada,
Texas and New Mexico and no claim of ownership or other interest has been
asserted which would be a breach of this Section 10.0(g).
<PAGE>54
(h) TAXES. All required federal, state and local tax returns of
Borrower have been accurately prepared and duly and timely filed (within the
initial or extended time period allowed therefor) and all federal, state and
local taxes required to be paid with respect to the periods covered by such
returns have been paid. Borrower has not been delinquent in the payment of
any tax, assessment or other governmental charge which could adversely affect
in any way the Collateral.
(i) BROKERS. Except as otherwise disclosed on Exhibit 10(i)
attached hereto, no person has, or as a result of the transactions
contemplated hereby will have by reason of any Borrower conduct or any
agreement to which Borrower is a party, any right, interest or claim against
Borrower, Lender or the Collateral for any commission, fee or other
compensation as a finder or broker or in any similar capacity.
(j) STATUS AND CONDITION. Borrower is solvent, in stable financial
condition and is able to and does pay its liabilities as they mature. Except
as otherwise disclosed on Exhibit 10(j) attached hereto, Borrower is not a
party to any labor dispute or any collective bargaining contract.
(k) DISCLOSURE. There is no fact known to Borrower which Borrower
has not disclosed to Lender in writing with respect to the Collateral or the
assets, liabilities, financial condition or activities of Borrower or its
Affiliates which would or may be likely to have a material adverse effect upon
the Collateral or Borrower's ability to perform its obligations under the
Agreement. All information and documents prepared by Borrower and provided to
Lender at any time are true and accurate at the time of delivery. Borrower
does not have knowledge that any information or documents, not prepared by
Borrower but delivered by Borrower to Lender were not true and accurate at the
time of delivery.
(l) ARTICLES OF INCORPORATION AND CERTIFICATES OF GOOD STANDING.
The Borrower's Articles of Incorporation received by Lender pursuant to
Section 9.0 have not been modified. Borrower has not taken or allowed any
action which would result in it not being in good standing. Borrower has not
received notice of any actual or threatened action to revoke its articles of
incorporation or good standing.
(m) FINANCIAL STATEMENTS. All financial statements of Borrower,
Affiliates, Validity of Collateral Guarantor, and Guarantor delivered to
Lender fairly present the assets, liabilities and financial condition and
income as of the dates thereof. There are no material omissions from the
financial statements and there has been no adverse change in the assets,
liabilities or financial condition since the date of the most recently
delivered financial statements. There exists no equity or long-term
investments in, or outstanding advances to, or guaranties of, any Person
except such equity, investment, advances, or guaranties disclosed in the
financial statements. The financial statements accurately disclose all
transactions with Affiliates.
(n) CONDITIONS. Each time Borrower requests an Advance, the
Conditions in Section 9.0 have been met.
(o) CHARACTERISTICS OF CONTRACTS. Each Pledged Contract delivered
to Lender as an Eligible Contract meets all of the requirements listed in the
definition of Eligible Contract, except that Borrower makes no representation
or warranty as to whether (i) the Contract meets such requirements to Lender's
satisfaction, or (ii) the Contract presents a credit, collateral, or
documentation risk unacceptable to Lender. No selection procedures adverse to
<PAGE>55
Lender have been utilized in selecting the Eligible Contracts delivered to
Lender.
(p) NO DEFAULTS. No event has occurred and no condition exists
which would, upon the execution and delivery of this Agreement or Borrower's
performance hereunder, constitute an Event of Default. Borrower is not in
default, and no event has occurred and no condition exists which constitutes,
or with the passage of time or the giving of notice or both, would constitute,
a default under any material agreement between Borrower and any Person,
including the payment of any debt or other obligation permitted under this
Agreement to any Person for borrowed funds, or any obligation relating to the
securitization of any assets of Borrower or any Affiliate of Borrower.
ARTICLE XI - REPRESENTATIONS AND WARRANTIES OF THE LENDER
Section 11.0. REPRESENTATIONS OF LENDER. The Lender hereby makes the
following representations and warranties:
(a) DUE ORGANIZATION. The Lender is a corporation, duly organized,
validly existing and in good standing under the laws of the State of New York,
and has the power to own its assets and to transact the business in which it
is presently engaged with regard to this Agreement;
(b) REQUISITE POWER. The Lender has the power to execute, deliver
and perform this Agreement, and has taken all necessary action to authorize
the execution, delivery and performance of this Agreement; and
(c) BINDING AGREEMENT. This Agreement has been duly executed and
delivered by the Lender and constitutes the legal, valid and binding
obligation of the Lender, enforceable in accordance with its terms.
ARTICLE XII - INDEMNITIES
Section 12.0. INDEMNITY. Borrower shall indemnify and hold Lender
harmless from any and all losses, claims, damages, costs, good faith
settlements, expenses, taxes, reasonable attorneys' fees or other liabilities,
including but not limited to costs of investigation, litigation fees and
expenses, and costs in successfully asserting the right to indemnification
hereunder, (collectively, "Losses") incurred by Lender at any time and
pertaining to (i) facts which are, or allegations which if true would be, a
breach of any representation, warranty, obligation, agreement or covenant of
Borrower contained in the Loan Documents, or (ii) Lender entering into the
Loan Documents or making Advances or handling Remittances or administering
Pledged Contracts, (iii) an Event of Default or a Pre-Default Event, or (iv)
activities, operations or conduct of Borrower, Validity of Collateral
Guarantor or Guarantor, or Affiliates.
ARTICLE XIII - AFFIRMATIVE COVENANTS
The following covenants shall remain in effect until the full payment and
performance of all of Borrower's obligations to Lender:
Section 13.0. FINANCING STATEMENTS. At the request of Lender, Borrower
shall execute such financing statements as Lender determines may be required
by law to perfect, maintain and protect the interest of Lender in the
Collateral and in the proceeds thereof.
Section 13.1. BOOKS AND RECORDS. Borrower shall maintain accurate and
complete books and records with respect to the Collateral, Borrower's
<PAGE>56
business, and Borrower's administration of the Pledged Contracts. All
accounting books and records shall be maintained in accordance with generally
accepted accounting principles consistently applied.
Section 13.2. PAYMENT OF FEES AND EXPENSES. Borrower shall pay to
Lender, on demand, any and all fees, costs or expenses which Lender pays to a
bank or other similar institution arising out of or in connection with (i) the
forwarding to Borrower, or any other Person on behalf of Borrower, by Lender
of Advances pursuant to this Agreement and (ii) the return of payments
deposited for collection by Lender, including but not limited to payments by
Borrower and payments by Contract Debtors.
Section 13.3. CONTINUITY OF BUSINESS AND COMPLIANCE WITH AGREEMENT.
Borrower shall continue in business in a prudent, reasonable and lawful manner
with all necessary licenses, permits, and qualifications necessary to perform
this Agreement. Borrower shall regularly and properly train its employees to
comply with all applicable laws governing the administration and purchase of
Contracts. Borrower shall take the steps necessary for the representations
and warranties in Article X to be true at all times. In the event that
Borrower learns that a representation and warranty in Article X is no longer
true, it shall notify Lender within one (1) Business Days after learning
thereof.
Section 13.4. FINANCIAL STATEMENTS AND ACCESS TO RECORDS. Borrower shall
provide Lender with quarterly UNAUDITED CONSOLIDATED financial statements
within forty-five (45) days of the end of each of Borrower's fiscal quarters,
and with audited annual CONSOLIDATED financial statements within one hundred
and twenty (120) days of Borrower's fiscal year-end audited by an independent
certified public accounting firm acceptable to Lender. Upon request of
Lender, Borrower shall provide Lender with unaudited (or audited if Borrower
so chooses) consolidated and consolidating monthly financial statements.
Borrower shall deliver to Lender with each financial statement a certificate
by Borrower's chief financial officer in the form of Exhibit 13.4. Borrower
shall provide Lender with audited or unaudited annual financial statements of
the Validity of Collateral Guarantor and Guarantor within sixty (60) days
after the end of each calendar year, and for such other periods as Lender may
request but no more frequently than every six (6) months.
Section 13.5. SUBSEQUENT ACTIONS. At the request of Lender, Borrower
shall execute and deliver to Lender after execution of this Agreement such
documents or take such action as Lender deems necessary to carry out the
Agreement.
Section 13.6. FINANCIAL CONDITION. Borrower shall not allow its Debt
Ratio to exceed 2.1:1. Borrower shall maintain a Net Worth of at least
Seventy-Five Million Dollars ($75,000,000.00). If Borrower is in default of
any securitized tranche/trust, the Net Worth will be reduced by the residual
value associated with that securitization. Borrower shall maintain Interest
Coverage of at least 1.5. Borrower shall notify Lender in writing, promptly
upon its learning thereof of any material adverse change in the financial
condition of Borrower, Validity of Collateral Guarantor, or Guarantor.
Borrower's Rolling Average Delinquency shall not exceed 8.5%. Borrower's
Average Charged-Off Losses shall not exceed 1.75%. Lender may, in its sole
discretion, amend the Rolling Average Delinquency on an annual basis.
Section 13.7. LITIGATION MATTERS. Borrower shall notify Lender in
writing, promptly upon its learning thereof, of any litigation, arbitration or
administrative proceeding which may materially and adversely affect the
operations, financial condition or business of Borrower or Borrower's ability
<PAGE>57
to perform this Agreement or which in any way involve Lender's security
interest in the Collateral or other rights under the Loan Documents.
Section 13.8. VALUE OF COLLATERAL. If in Lender's judgment the
Collateral has materially decreased in value, other than the ordinary
depreciation of Financed Vehicles, Borrower shall either provide enough
additional Collateral to satisfy Lender or reduce the Loan by an amount
sufficient to satisfy Lender.
Section 13.9 PAYMENT OF OBLIGATIONS. Borrower shall pay and perform, as
and when due, all of its obligations, including, without limitation, all of
its obligations to Lender.
Section 13.10. BORROWER INSURANCE. Borrower shall maintain customary
amounts of insurance covering, without limitation, fire, theft, burglary,
public liability, property damage, product liability, workers' compensation,
and liability arising from Borrower's collection of Contracts and sale of
motor vehicles. Borrower shall pay all insurance premiums payable for such
coverage and shall upon request of Lender deliver a copy of the policies of
such insurance to Lender, together with evidence of payment of all premiums
therefor.
Section 13.11. CERTIFICATES OF TITLE. Borrower shall promptly apply for
and obtain Certificates of Title for all Financed Vehicles. Borrower shall
promptly deliver to Lender all Certificates of Title it receives for Financed
Vehicles for Pledged Contracts.
Section 13.12. INTEREST RATE CAP. Borrower shall purchase an Interest
Rate Cap issued by a financial institution acceptable to Lender, if payment to
Borrower of an interest rate differential equal to the amount by which the
average annual percentage rate of the Pledged Contracts is less than (i) the
applicable interest rate under this Agreement plus (ii) fourteen percent (14%)
Section 13.13. UNENCUMBERED INVENTORY. Sales shall at all times
maintain an inventory of Motor Vehicles held for sale which are free and clear
of all liens, security interests and encumbrances and valued at not less than
Five Million Seven Hundred Thousand Dollars ($5,700,000.00) in the aggregate.
Section 13.14. LOSS RESERVE. Borrower shall at all times maintain a
funded loss reserve equal to not less than such percentage of the net
Outstanding Principal Balance of each Pledged Contract owned by Borrower as
Borrower's independent certified public accountants require to issue
unqualified financial statements for Borrower at any time from and after the
date hereof.
Section 13.15. CYGNET FINANCE, INC. Borrower pledges to Lender a
security interest in the stock and all proceeds thereof in Cygnet Finance,
Inc. Borrower shall not invest more than Twenty Million Dollars
($20,000,000.00) in Cygnet Finance, Inc. Cygnet Finance, Inc. shall guaranty
the obligations of Borrower and shall execute a guaranty that conforms to
Exhibit 9.0(B), attached hereto (the "Guaranty").
ARTICLE XIV - NEGATIVE COVENANTS
Borrower covenants and agrees that hereafter, without Lender's prior
written consent, which Lender may or may not give, in its sole discretion,
until all of Borrower's obligations to Lender with respect to this Agreement
are performed and paid in full:
<PAGE>58
Section 14.0. MERGERS, ETC. Borrower shall not merge with, consolidate
with, acquire or otherwise combine with any Person, transfer any division or
segment of its operations to any Person or form any subsidiary.
Section 14.1. INVESTMENTS. Borrower shall not make any investment in any
Person through the direct or indirect holding of securities or otherwise.
Section 14.2. DIVIDENDS. Borrower shall not declare or pay dividends
except in accordance with all applicable laws and any dividends declared or
paid shall not exceed, in the aggregate, fifteen percent (15%) of each year's
net income available for distribution.
Section 14.3. LOANS AND ADVANCES. Except for routine and customary
salary advances, Borrower shall not make any unsecured loans or other advances
of money to officers, directors, employees, stockholders or Affiliates in
excess of Twenty-Five Thousand Dollars ($25,000.00) in total. Borrower shall
not incur any long term or working capital debt (other than the Indebtedness)
secured by Contracts, and shall not create, incur, assume or suffer to exist
any short term indebtedness which is not Subordinated Debt.
Section 14.4. CAPITAL STRUCTURE. Borrower shall not (i) redeem, retire,
purchase or otherwise acquire, directly or indirectly, any of Borrower's
stock, or (ii) make any change in Borrower's capital structure, or (iii) make
any change in any of its business objectives, purposes and operations which
might in any way adversely affect the payment or performance of, or Borrower's
ability to pay and perform, its obligations to Lender with respect to this
Agreement. Borrower shall not allow a transfer of ownership of Borrower which
results in less than fifteen percent (15%) of the voting stock of Borrower
being owned by Ernest C. Garcia, II. Notwithstanding the foregoing, Borrower
may issue up to 2,000,000 shares of common stock in connection with Borrower's
acquisition of businesses or assets in one or more transactions, In addition,
Borrower may issue up to $200,000,000 in debt securities that are subordinate
to the Loan in one or more transactions provided such subordination shall be
in a form and substance approved by Lender.
Section 14.5. TRANSACTIONS WITH AFFILIATE. Borrower shall not enter
into, or be a party to, any transaction with any Affiliate, or stockholder of
Borrower, except, consistent with Borrower's practice before entering into
this Agreement, in the ordinary course of, and pursuant to the reasonable
requirements of, Borrower's business and upon fair and reasonable terms which
are fully disclosed to Lender and are no less favorable to Lender than would
obtain in a comparable arm's length transaction with a Person not an Affiliate
or stockholder of Borrower.
Section 14.6. ADVERSE TRANSACTIONS. Borrower shall not enter into any
transaction which adversely affects the Collateral or Borrower's ability to
perform this Agreement or Lender's rights under the Loan Documents; or permit
or agree to any extension, compromise or settlement or make any change or
modification of any kind or nature with respect to any Pledged Contract,
including any of the terms thereof or the amounts due thereunder except for
customary payment extensions of Pledged Contracts done, in accordance with
Borrower's policies and routines in existence on the Closing Date, no more
frequently than once every twelve (12) months but not to exceed two (2)
extensions over the life of the Contract, for a period of no more than thirty
(30) days for each extension. In the event a Contract exceeds two extensions,
Borrower must notify Lender and provide a list of such Contracts for
exclusion from Eligible Contracts.
Section 14.7. GUARANTIES. Borrower shall not guaranty or otherwise in
<PAGE>59
any way, become liable with respect to the obligations or liabilities of any
other Person except (i) the Affiliates' obligations to Lender, and (ii) by
customary endorsement of instruments or items of payment for deposit to the
general account of Borrower or for delivery to Lender.
Section 14.8. COLLATERAL. Except as otherwise expressly permitted in the
Loan Documents, Borrower shall not convey or allow any ownership, security, or
other, interest in the Collateral other than Borrower's ownership interest and
Lender's security interest. Borrower shall not interfere with or countermand
Lender's instructions to any Person to send Remittances to the Post Office
Box, the Depository Account or Lender. Borrower can sell or pledge Contracts
which are not Eligible Contracts provided that the sale or loan proceeds are
delivered to Lender for application to the Indebtedness Borrower can grant
purchase money security interests in its equipment to Persons other than
Lender. Borrower can lease, as lessee, equipment it uses.
ARTICLE XV - EVENTS OF DEFAULT
Section 15.0. EVENTS OF DEFAULT. An Event of Default means the
occurrence or existence of one or more of the following events or conditions
(whatever the reason for the Event of Default and whether voluntary,
involuntary or caused by operation of law) which is not waived in writing by
Lender or cured to the extent a cure is applicable:
(A) A breach by Borrower of any representation, warranty or
obligation contained herein or in the other Loan Documents or in any other
agreement with Lender.
(B) A breach by a Validity of Collateral Guarantor, Guarantor, or
an Affiliate of any representation, warranty, or obligation contained in a
Guaranty or a Validity of Collateral Guaranty, or any other agreement with
Lender.
(C) Any default by Borrower or any Affiliate of Borrower (including
but not limited to a default due to non-payment, or a default relating to the
securitization of any assets of Borrower or any Affiliate of Borrower) under
any material agreement, document or instrument to which it is a party or by
which any of its property is bound, creating or relating to any debt or other
obligation (other than the Loan hereunder), if the payment or maturity of such
debt or obligation is accelerated as a consequence of such default or demand
for payment thereof is made.
(D) The Collateral or any other of Borrower's or a Validity of
Collateral Guarantor's or Guarantor's or an Affiliate's assets are attached,
seized, levied upon or subjected to a writ or distress warrant, or come within
the possession of any receiver, trustee, custodian or assignee for the benefit
of creditors and the same is not dissolved within thirty (30) days thereafter;
an application is made by any Person other than Borrower for the appointment
of a receiver, trustee, or custodian for the Collateral or any other of
Borrower's or Validity of Collateral Guarantor's or Guarantor's or an
Affiliate's assets and the same is not dismissed within thirty (30) days after
the application therefor; or Borrower or a Validity of Collateral Guarantor or
Guarantor or an Affiliate shall have concealed, removed or permitted to be
concealed or removed, any part of its property, with intent to hinder, delay
or defraud its creditors or made or suffered a transfer of any of its property
which may be fraudulent under any bankruptcy, fraudulent conveyance or other
similar law.
<PAGE>60
(E) An application is made by Borrower or a Validity of
Collateral Guarantor or Guarantor or an Affiliate for the appointment of a
receiver, trustee or custodian for the Collateral or any other of Borrower's
or a Validity of Collateral Guarantor's or Guarantor's or an Affiliate's
assets; a petition under any section or chapter of the Bankruptcy Code or any
similar federal or state law or regulation shall be filed by Borrower or a
Validity of Collateral Guarantor or Guarantor or an Affiliate; Borrower,
Validity of Collateral Guarantor, or Guarantor or an Affiliate shall make an
assignment for the benefit of its creditors or any case or proceeding is filed
by Borrower, or a Validity of Collateral Guarantor or Guarantor or an
Affiliate for its dissolution, liquidation, or termination; Borrower ceases to
conduct its Contract purchase and servicing business.
(F) Borrower is enjoined, restrained or in any way prevented by
court order from conducting all or any material part of its business affairs,
or a petition under any section or chapter of the Bankruptcy Code or any
similar federal or state law or regulation is filed against Borrower or a
Validity of Collateral Guarantor or Guarantor or an Affiliate, or any case or
proceeding is filed against Borrower or a Validity of Collateral Guarantor or
Guarantor or an Affiliate for its dissolution or liquidation, and such
injunction, restraint, petition, case or proceeding is not dismissed within
thirty (30) days after the entry or filing thereof.
(G) A notice of lien, levy or assessment is filed of record with
respect to all or any of Borrower's or a Validity of Collateral Guarantor's or
Guarantor's or an Affiliate's assets by the United States, or any department,
agency or instrumentality thereof, or by any state, county, municipal or other
governmental agency and it is not released within thirty (30) days after the
filing; or if any taxes or debts become a lien or encumbrance upon the
Collateral or any other of Borrower's or a Validity of Collateral Guarantor's
or Guarantor's or an Affiliate's assets, and the same is not released within
thirty (30) days after the same becomes a lien or encumbrance.
(H) Borrower or a Validity of Collateral Guarantor or Guarantor
or an Affiliate becomes insolvent or admits in writing to its inability to pay
its debts as they mature.
(I) An event has occurred which entitles Lender pursuant to Section
5.1(E) to take over administration of the Contracts.
(J) There occurs or exists any situation which leads Lender to
believe, in good faith, that Borrower may not, or may be unable to, pay in the
normal course one or more payment obligations to Lender, and Lender has given
Borrower at least ten (10) days' notice thereof.
(K) A financial statement of Borrower or an Affiliate or a
Validity of Collateral Guarantor or Guarantor reveals that its financial
condition has materially adversely deteriorated after the execution of this
Agreement.
(L) An audited financial statement of Borrower is not
unqualified.
(M) Any other event occurs which will, in Lender's reasonable
opinion, have a material adverse effect on the Collateral, Lender's rights
under the Loan Agreements, or on Borrower's financial or business condition,
operations or prospects, including, without limitation, any change in the due
diligence procedures used by Borrower to qualify Contract Debtors for
Contracts, and Lender has given Borrower at least ten (10) days' notice
thereof.
(N) Validity of Collateral Guarantor or Guarantor fails to make
payment pursuant to the terms of the Validity of Collateral Guaranty or
Guaranty.
(O) Any Validity of Collateral Guarantor or Guarantor shall
revoke or attempt to revoke its Validity of Collateral Guaranty or Guaranty,
or shall repudiate its liability thereunder or be in default of the terms of
such Validity of Collateral Guaranty or Guaranty.
Section 15.1. DEFAULT RATE OF INTEREST. Upon and after an Event of
Default and subject to Section 2.5, Borrower's obligations to Lender shall
continue to bear interest, calculated daily on the basis of a 365-day year at
the per annum rate set forth in Section 2.3, plus additional post-default
interest of two percent (2%) per annum until paid in full.
Section 15.2. LENDER'S REMEDIES. Whenever a Pre-Default Event or an
Event of Default has occurred and whenever Lender is entitled to take over
Contract administration, Lender may without prior notice immediately suspend
making Advances. Upon and after an Event of Default, Lender shall have the
following rights and remedies. The rights and remedies shall be cumulative,
and none exclusive, except to the extent required by law. Lender's exercise
of any right, remedy, or attorney-in-fact appointment shall not relieve
Borrower of any of its obligations to Lender.
(A) The right, at Lender's discretion and without notice, (i) to
immediately cease further Advances and/or terminate this Agreement, and (ii)
to declare Borrower's obligations to Lender immediately due and payable,
whereupon Borrower's obligations shall become and be due and payable, without
presentment, demand, protest or further notice or process of any kind, all of
which are expressly waived by Borrower. Borrower's obligations to Lender
shall be immediately due and payable without declaration by Lender if the
Event of Default consists of a petition filed under the Bankruptcy Code or any
similar federal or state law.
(B) All of the rights and remedies of a secured party under the
UCC and other applicable laws, including the right to appoint a receiver.
(C) The right at any time to (i) enter through self-help and
without judicial process, upon the premises of Borrower, without any
obligation to pay rent to Borrower, or to enter any other place or places
where the Collateral is located and kept, and remove the Collateral or remain
on and use the premises for the purpose of collecting or disposing of the
Collateral, and (ii) require Borrower to assemble the Collateral and make it
available to Lender at a place to be designated by Lender.
(D) The right to sell or otherwise dispose of all or any of the
Collateral at public or private sale, as Lender in its sole discretion may
deem advisable, with such notice as may be required by law; and such sales may
be adjourned from time to time with or without notice. Lender shall have the
right to conduct such sales on Borrower's premises without charge for such
time and Collateral as Lender may see fit. Lender is hereby granted a license
or other applicable right to use, without charge, Borrower's labels, patents,
copyrights, rights of use of any name, trade secrets, trade names, trademarks
and advertising matter, or any property of a similar nature, as it pertains to
the Collateral, in advertising for sale and selling any Collateral and
Borrower's rights under all licenses and all franchise agreements shall inure
to Lender's benefit for this purpose. Lender shall have the right to sell,
lease or otherwise dispose of the Collateral, or any part thereof, for cash,
credit or any combination thereof, and Lender may purchase all or any part of
<PAGE>62
the Collateral at public or, if permitted by law, private sale and, in lieu of
actual payment of such purchase price, may set off the amount of such price
against Borrower's obligations to Lender. Without excluding other methods of
disposition which may be commercially reasonable, it shall be a commercially
reasonable disposition of the Pledged Contracts and Contract Rights for Lender
to collect and enforce the Contracts and Contract Rights in the same manner
that it collects and enforces similar Contracts and Contract Rights for its
own account or for the account of other Persons. If any deficiency shall
arise from the disposition of Collateral, Borrower shall remain liable to
Lender therefor.
(E) The right at any time and from time to time thereafter, at
Lender's sole discretion and without notice to Borrower, (i) to enforce
payment of the Contract Debtor's and Contract Rights Payor's obligations, and
to collect and foreclose, by legal proceedings or otherwise, the Collateral in
the name of Lender or Borrower and (ii) to take control, in any manner, of any
item of payment for or proceeds of the Collateral. Lender is not obligated to
pursue the Collateral or the Guarantor or the Validity of Collateral Guarantor
or any other Person in order to enforce Borrower's obligations to Lender.
(F) The right to take over in Lender's or Borrower's name all or
part of the administration of the Contracts.
(G) The right to carry out the actions within the scope of
Borrower's appointment of Lender as attorney-in-fact.
(H) The right to offset or apply the funds in the Depository
Account.
Section 15.3. INJUNCTIVE RELIEF. Borrower recognizes that if there is an
Event of Default then, depending on the nature of the Event of Default, it may
be that no remedy at law will provide complete or adequate relief to Lender,
and Lender shall be entitled to temporary and permanent injunctive relief in
any such case without the necessity of proving actual damages. The injunctive
relief shall not be a waiver of Lender's rights to other relief and remedies.
Section 15.4. NOTICE. Any notice required to be given by Lender of a
sale, lease, or other disposition of the Collateral which is given pursuant to
Section 16.1 at least five (5) days prior to such proposed action, shall
constitute commercially reasonable and fair notice thereof to Borrower.
Notice of less duration shall not be presumed to be commercially unreasonable
or unfair.
Section 15.5. APPOINTMENT OF LENDER AS BORROWER'S LAWFUL ATTORNEY.
Borrower irrevocably appoints Lender (and all persons designated by Lender) as
Borrower's true and lawful attorney-in- fact to act in Borrower's place in
Borrower's or Lender's name to: (i) demand payment of the Pledged Contracts,
other Collateral consisting of payment obligations and Contract Rights; (ii)
enforce payment of the Pledged Contracts, other Collateral consisting of
payment obligations and Contract Rights, by legal proceedings or otherwise;
(iii) exercise all of Borrower's rights and remedies with respect to the
collection and enforcement of the Pledged Contracts, other Collateral
consisting of payment obligations, and Contract Rights; (iv) settle, adjust,
compromise, discharge, release, extend or renew the Pledged Contracts, other
Collateral consisting of payment obligations, and Contract Rights; (v) if
permitted by applicable law, sell or assign the Collateral upon such terms,
for such amounts and at such time or times as Lender deems advisable; (vi)
take control, in any manner, of any item of payment or proceeds with respect
to the Collateral; (vii) prepare, file and sign Borrower's name on any proof
<PAGE>63
of claim in Bankruptcy or similar document against any Contract Debtor or
Contract Rights Payor; (ix) prepare, file and sign Borrower's name on any
notice of lien, assignment or satisfaction of lien or similar document in
connection with the Collateral; (x) do all acts and things necessary, in
Lender's sole discretion, to exercise Lender's rights granted in or referred
to in Section 15.2 of this Agreement; (xi) endorse the name of Borrower upon
any item of payment or proceeds consisting of or relating to the Collateral
and deposit the same to the account of Lender for application to the
Indebtedness; (xii) use the information recorded on or contained in any data
processing equipment and computer hardware and software relating to the
Collateral to which Borrower has access; (xiii) open Borrower's mail to
collect Collateral and direct the Post Office to deliver Borrower's mail to an
address designated by Lender; and (xiv) do all things necessary to carry out
and enforce this Agreement which Borrower has failed to do. Borrower ratifies
and approves all acts of Lender as Borrower's attorney-in-fact. Lender shall
not, when acting as attorney-in-fact, be liable for any acts or omissions as
or for any error of judgment or mistake of fact or law, except for actions
taken in bad faith or resulting from Lender's gross negligence or willful
misconduct. This power, being coupled with an interest, is irrevocable until
all payment and performance obligations of Borrower to Lender have been fully
satisfied. Borrower shall upon request of Lender execute powers of attorney
to separately evidence the foregoing powers granted to Lender. All costs,
fees and expenses incurred by Lender, or for which Lender becomes obligated,
in connection with exercising any of the foregoing powers shall be payable to
Lender by Borrower on demand by Lender and until paid shall be part of the
Loan.
Section 15.6. LENDER'S DEFAULT. In the event of any default of the Loan
Documents by Lender or any claim by Borrower related to the Loan Documents,
Borrower's sole and exclusive remedy against Lender shall be a cause of action
sounding in contract with damages limited to actual and direct damages
incurred. Lender shall in no event be liable for ordinary negligence, delay
in performance or any consequential, special, punitive, incidental or indirect
damages, including without limitation, loss of profit or goodwill. Lender
shall in no event be liable for any loss or damage directly or indirectly
resulting from the furnishing of services or reports under this Agreement.
With respect to any goods and services provided by Lender, LENDER MAKES NO
warranties, whether expressed or implied, including, without limitation,
implied WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE.
Borrower shall have no cause of action against Lender for a default of the
Loan Documents unless Borrower first notices Lender of the default and allows
Lender a reasonable time of at least thirty (30) Business Days to cure the
default and Lender fails to cure the default.
Section 15.7. BORROWER'S RIGHT TO CURE. In the event of an unintentional
Pre-Default Event by Borrower with respect to payment obligations or the
delivery of Contract Delivery Documents or Remittances, Borrower shall have
three (3) Business Days to cure the Pre-Default Event before Lender exercises
its right to sue Borrower or repossess the Collateral. In the event of any
other type of unintentional default by Borrower, Borrower shall have thirty
(30) calendar days to cure the default before Lender exercises its right to
sue Borrower or repossess the Collateral. Regardless of whether Borrower
cures a default, Lender shall be entitled to indemnification pursuant to
Article XII with respect to any Losses arising from claims asserted against
Lender.
<PAGE>64
ARTICLE XVI - DEFINITIONS
Section 16.0 DEFINED TERMS. Whenever used in this Agreement with such
upper case letters as are shown below, the following terms shall have the
respective meanings set forth below. When the terms are used in the plural,
the plural forms of the meanings shall apply.
ACCOUNTING DATE: the last day of an Accounting Period.
ACCOUNTING PERIOD: a calendar month, beginning with the month during
which this Agreement is executed and ending with the calendar month during
which the Indebtedness has been paid in full following termination of this
Agreement.
ADVANCE: each of the Loan advances described in Article III of this
Agreement.
AFFILIATE: Guarantors, and any Person, now or in the future (i) directly
or indirectly owned or controlled in whole or in part by Borrower or a
Guarantor, or (ii) under common ownership or control with Borrower. For the
purpose of this definition, "control" shall mean the power to direct, or
cause the direction of, management or policies, whether through the ownership
of voting securities, by contract or otherwise. For the purpose of this
definition, "owned" shall mean at least 10% ownership.
AVERAGE CHARGED-OFF LOSSES: the Accounting Period average of the
Charged-Off Losses for any six consecutive Accounting Periods; provided that,
until the first six Accounting Periods have expired, the Average Charged-Off
Losses shall be the Accounting Period average of the Charged-Off Losses for
the Accounting Periods which have expired.
BORROWING BASE: the amount equal to the lesser of (i) One Hundred
Million Dollars ($100,000,000.00), or (ii) (A) sixty five percent (65%) of the
Outstanding Principal Balance of all Eligible Contracts during the time they
are included in the Borrowing Base pursuant to Section 3.1, which Eligible
Contracts are originated by any Affiliate of Borrower which is a captive
Dealer to Borrower, or (B) eighty-six percent (86%) of the Outstanding
Principal Balance of all Eligible Contracts not to exceed one hundred seven
percent (107%) of wholesale Kelly Blue Book for all such Eligible Contracts in
the aggregate during the time they are included in the Borrowing Base pursuant
to Section 3.1 which Eligible Contracts are purchased by Borrower from Dealers
who are not Affiliates of Borrower through Champion Financial Services, Inc.,
(C) seventy-five percent (75%) of the Outstanding Principal Balance of all
Eligible Contracts during the time they are included in the Borrowing Base
pursuant to Section 3.1, which Eligible Contracts were purchased from Seminole
Finance, or (D) a percentage, as determined by Lender in its sole discretion
and not to exceed ninety-eight percent (98%) of Borrower's Net Investment of
Bulk Purchase Contracts, excluding any premium or goodwill paid by Borrower.
BULK PURCHASE CONTRACT: a Contract acquired on a group basis through
purchase of a Dealer's portfolio of existing installment sales contracts.
BUSINESS DAY: any day other than (i) a Saturday or Sunday, or (ii) a day
on which banking institutions in the States of Arizona, Florida and Texas are
required by law to be closed.
CERTIFICATE OF TITLE: with respect to each Financed Vehicle, the
certificate of title (or other evidence of ownership) issued by the department
<PAGE>65
of motor vehicles, or other appropriate governmental body, of the state in
which the Financed Vehicle is to be registered showing the Contract Debtor as
owner, with either notation of the Borrower's first lien or such other status
indicated thereon which is necessary to perfect Borrower's security interest
in the Financed Vehicle as a first priority interest, and showing no other
actual or possible lien interest in the Financed Vehicle.
CHARGED-OFF CONTRACT: a Pledged Contract (i) for which all or part of
the Scheduled Payments are due and unpaid, ninety (90) days after the due date
for such Scheduled Payments, (ii) for which the Financed Vehicle has been
surrendered, repossessed, or unable to be located, or (iii) which has been
settled for less than the Outstanding Principal Balance.
CHARGED-OFF LOSSES: as of the end of an Accounting Period, the
Outstanding Principal Balance of Charged-Off Contracts which become
Charged-Off Contracts during the Accounting Period minus amounts received by
Borrower during the Accounting Period and applied to Charged-Off Contracts
which became Charged-Off Contracts during a previous Accounting Period,
divided by the Outstanding Principal Balance of all Contracts owned by
Borrower which are not Charged-Off Contracts; expressed as a percentage.
CLOSING DATE: the date of execution of this Agreement.
COLLATERAL: any and all real and personal, tangible and intangible,
property in which Lender is granted a security interest now or hereafter, in
this Agreement or otherwise, to secure Borrower's obligations to Lender.
CONTRACT: an installment or conditional sale contract, with any
amendments, owned or acquired by Borrower pursuant to which a Contract Debtor
has: (i) purchased a new or used Motor Vehicle, (ii) granted a security
interest in the Motor Vehicle to secure the Contract Debtor's payment
obligations, and (iii) agreed to pay the unpaid purchase price and a finance
charge in periodic installments no less frequently than monthly.
CONTRACT DEBTOR: the Person that has executed a Contract as a purchaser,
and any guarantor, co-signer or other Person obligated to make payments under
the Contract.
CONTRACT DEBTOR DOCUMENTS: those documents as are identified on the
attached Exhibit 6.3 attached hereto and made apart hereof.
CONTRACT DELIVERY DOCUMENTS: the original Certificate of Title, and the
original executed Contract with original Contract Debtor and Dealer signatures
and bearing on its front or back surface an assignment to Lender.
CONTRACT RIGHTS: with respect to Pledged Contracts, (i) Borrower's
interest in the Financed Vehicle; (ii) all rights of Borrower regarding the
Contract and Financed Vehicle, including but not limited to rights to
electronic funds transfers and rights under all dealer agreements and purchase
agreements pursuant to which the Contract was acquired by Borrower; (iii) all
rights of Borrower with respect to Optional Contract Debtor Insurance,
Required Contract Debtor Insurance, and any other policies of fire, theft or
comprehensive insurance, collision insurance, public liability insurance or
property damage insurance maintained with respect to the Financed Vehicle, the
Contract, or the Contract Debtor; (iv) all rights of Borrower, if any, to
prepaid dealer rate participation in connection with the Contract; (v)
Remittances, and (vi) all rights of Borrower to the originals of all books,
records (including electronic data), reports, files, and documents relating to
the Contracts, including, but not limited to, Contract Debtor Documents,
<PAGE>66
financial statements of Contract Debtors, and all payment reports or records
relating to the Contracts.
CONTRACT RIGHTS PAYORS: Persons, other than Contract Debtors, against
whom Contract Rights can be asserted.
CREDIT LINE: the dollar component in the definition of Borrowing Base
which is One Hundred Million Dollars ($100,000,000.00)
DEALER: the seller of the Financed Vehicle to the Contract Debtor.
DEALER INVOICE: as to new Financed Vehicles, the invoice prepared by the
manufacturer showing the net cost; and, as to used Financed Vehicles, the
Kelly Blue Book value.
DEBT RATIO: the debt-to-equity ratio of Borrower, calculated in
accordance with generally accepted accounting principles, by comparing total
liabilities, other than Subordinated Debt, to Net Worth.
DELINQUENCY MEASUREMENT: as of the end of an Accounting Period, the sum
of the Outstanding Principal Balances of all Delinquency Measurement Contracts
which have Scheduled Payments which are due and partially or completely unpaid
more than thirty (30) days from the due date of such Scheduled Payments,
divided by the sum of the Outstanding Principal Balances of all Delinquency
Measurement Contracts; expressed as a percentage.
DELINQUENCY MEASUREMENT CONTRACTS: all Pledged Contracts which do not
constitute Charged-Off Losses.
DEPOSITORY ACCOUNT: a bank account owned by Lender at a bank designated
by Lender for the purpose of receiving Remittances made payable to it or
Borrower.
ELIGIBLE CONTRACT: each Contract delivered by Borrower to Lender which
is listed on a List of Contracts delivered to Lender at the same time, and
which in Lender's sole determination satisfies each of the requirements set
forth on Exhibit 3.1 at the time of delivery and thereafter except to the
extent expressly stated in Exhibit 3.1 to apply only at delivery or only
thereafter.
EVENT OF DEFAULT: this term has the meaning provided in Section 15.0 of
this Agreement.
FINANCED VEHICLE: the new or used Motor Vehicle purchased by a Contract
Debtor pursuant to a Contract, or any substituted vehicle which is properly
documented and approved by Lender.
GUARANTOR: Cygnet Finance, Inc.
INDEBTEDNESS: the Loan and all other amounts, including but not limited
to interest, that Borrower owes Lender in connection with this Agreement.
INTEREST COVERAGE: the sum of Borrower's year-to-date pre-tax income
plus Borrower's year to date interest expense, compared to Borrower's
year-to-date interest expense.
LIBOR RATE: the average of the "one month" London Interbank Offered
Rates ("LIBOR") published in the Money Rates column of the Wall Street Journal
during the calendar month immediately preceding the calendar month for which
<PAGE>67
interest is being calculated, or published in such other publication as Lender
may designate.
LINE FEE: the fee payable annually by Borrower to Lender equal to one
quarter of one percent (.25%) times the Credit Line.
LIST OF CONTRACTS: the list delivered to Lender by Borrower with each
Contract or group of Contracts which: (i) identifies each Contract being
delivered by account number, the name of the Contract Debtor, the Outstanding
Principal Balance, and the year, make, model, and VIN of the Financed Vehicle,
and (ii) shows the total number of Contracts and the total of the Outstanding
Principal Balances.
LOAN: the outstanding principal amount of the Advances, plus all other
amounts advanced, expended or applied by Lender under this Agreement to or for
the benefit of Borrower or to perform or enforce Borrower's covenants in this
Agreement.
LOAN AVAILABILITY: the amount by which the Borrowing Base exceeds the
Loan.
LOAN DOCUMENTS: this Agreement, the Note, the guaranties signed by the
Guarantors, and the Supplemental Documentation.
MOTOR VEHICLE: A passenger motor vehicle, van, or light duty truck which
is not manufactured for a particular commercial purpose and which can be
registered for use on public highways and is not a "grey market" vehicle.
NET INVESTMENT: The gross finance receivable from a Contract owned by a
Borrower minus unearned interest income minus unamortized discounts and minus
any refundable reserves.
NET WORTH: the total of shareholders' equity (including capital stock,
additional paid-in capital, and retained earnings) plus Subordinated Debt,
less (i) the total amount of loans and debts due from Affiliates,
shareholders, officers, or employees, and (ii) the total amount of any
intangible assets, including without limitation unamortized discounts,
deferred charges, and goodwill.
OPTIONAL CONTRACT DEBTOR INSURANCE: any insurance, other than Required
Contract Debtor Insurance which insures a Financed Vehicle or a Contract
Debtor's obligations under a Contract, including but not limited to credit
life, credit health, credit disability, unemployment insurance; and any
service contract, mechanical breakdown coverage, warranty, or extended
warranty for a Financed Vehicle.
OUTSTANDING PRINCIPAL BALANCE: the outstanding principal balance of a
Contract calculated by subtracting the unearned finance charge (determined by
the finance charged refund method applicable to the Contract) from the sum of
the unpaid Scheduled Payments.
PERMITTED LIEN: (i) any security interest or lien at any time granted in
favor of Lender; (ii) liens securing claims of materialmen, mechanics,
carriers, warehousemen, landlords and other similar Persons for labor,
materials, supplies or rentals incurred in the ordinary course of Borrower's
business; and (iii) liens resulting from deposits made in the ordinary course
of business in connection with workers compensation, unemployment insurance,
social security and other similar laws.
<PAGE>68
PERSON: any individual, sole proprietorship, partnership, joint venture,
trust, unincorporated organization, association, corporation, institution,
entity, party, or government (including, any instrumentality or division
thereof).
POST OFFICE BOX: the post office box owned by Lender into which Borrower
shall receive all Remittances.
PLEDGED CONTRACT: a Contract owned on the Closing Date or in the future
by Borrower.
PRE-DEFAULT EVENT: an event which with the passage of time, the giving
of notice, or both, would constitute an Event of Default if Lender gave any
notice required by this Agreement for the event to be an Event of Default, or
if the event continued past the end of any period specifically allowed by this
Agreement for the event to continue before it becomes an Event of Default.
REMITTANCES: all payments made with respect to Pledged Contracts,
including, but not limited to, Scheduled Payments, full and partial
prepayments, liquidation proceeds, insurance proceeds and refunds, late
charges, fees (including but not limited to NSF fees and extension fees), and
payments from Contract Rights Payors.
REQUIRED CONTRACT DEBTOR INSURANCE: (i) the liability insurance coverage
required by law and (ii) at such time as Borrower experiences losses at any
time equal to or in excess of one percent (l.0%) of the Loan which are
attributable to a lack of insurance covering physical damage to, and theft or
loss of a Financed Vehicle, insurance for physical damage to, and theft or
loss of, the Financed Vehicle, having a deductible no higher than $500 and
providing coverage at least equal to the actual cash value of the Financed
Vehicle for all Vehicles with an actual cost to Borrower of $3500.00 or more.
ROLLING AVERAGE DELINQUENCY: the average of the Delinquency Measurements
for any six (6) consecutive Accounting Periods; provided that, until the first
six (6) Accounting Periods have expired, the Rolling Average Delinquency shall
be the average of the Delinquency Measurements for the Accounting Periods
which have expired.
SCHEDULE OF PAYMENTS: the schedule of payments disclosed on a Contract.
SCHEDULED PAYMENT: the periodic installment payment amount disclosed in
the Schedule of Payments for the Contract.
SKIP LOSS INVESTIGATION: an investigation initiated by Borrower of the
whereabouts of a Financed Vehicle or a Contract Debtor.
STATEMENT OF BORROWING BASE: a statement issued by Lender which contains
the amount of the Borrowing Base, the amount of the Loan or Indebtedness, and
either the amount available for Advances or the amount by which the Loan or
Indebtedness exceeds the Borrowing Base.
SUBORDINATED DEBT: a debt obligation of Borrower which is subordinated to
Lender pursuant to a subordination agreement which is in the form of Exhibit
16 or pursuant to some other agreement approved in writing by Lender.
SUPPLEMENTAL DOCUMENTATION: all agreements, instruments, documents,
certificates of title, financing statements, notices of assignment, Lists of
Contracts, chattel mortgages, powers of attorney, subordination agreements,
and other written matter necessary or reasonably requested by Lender to
<PAGE>69
perfect and maintain perfected Lender's security interest in the Collateral or
to consummate the transactions contemplated by this Agreement.
UCC: Uniform Commercial Code.
UNDERUTILIZATION FEE: the fee payable by Borrower to Lender equal to
thirty-five basis points (0.35%) on an annualized basis or .000959% times the
unused portion of the Credit Line below Forty Million Dollars
($40,000,000.00), with the unused portion being equal to the difference
between Forty Million Dollars ($40,000,000.00) and the actual daily balance of
the outstanding Advance. This fee will be due monthly for the previous month
and will be billed immediately following the month end.
VALIDITY OF COLLATERAL GUARANTOR: Ernest C. Garcia, II
Section 16.1 OTHER TERMS: All other terms contained in this Agreement
shall, unless the context indicates otherwise, have the meanings provided in
the UCC to the extent the same are defined therein.
Section 16.2 ACCOUNTING TERMS. Any accounting terms used in this
Agreement which are not specifically defined shall have the meanings
customarily given them in accordance with generally accepted accounting
principles.
ARTICLE XVII - GENERAL TERMS AND CONDITIONS
Section 17.0. APPLICABLE LAW. This Agreement shall be governed and
construed in accordance with the laws of the State of Arizona.
Section 17.1. NOTICES. Any notice, request, demand, instruction or other
communication to be given any party hereto in writing shall be effective upon
delivery during regular business hours at the offices of Borrower and Lender
hereinafter set forth or at such other offices that either party notifies the
other of in writing. The failure to deliver a copy as set forth below shall
not affect the validity of the notice to the Borrower or Lender. Such
communications shall be given by telecopy, commercial delivery service, or
sent by certified mail, postage prepaid and return receipt requested, as
follows:
If to Borrower: Ugly Duckling Corporation
2525 East Camelback Road, Suite 1150
Phoenix, Arizona 85016
Electronic FAX (602) 852-6696
ATTN: Steven P. Johnson
If to Lender: General Electric Capital Corporation
1000 Hart Road
Barrington, IL 60010
Electronic FAX (847) 304-3456
Attention: Manager, Asset Based Financing
with a copy to: General Electric Capital Corporation
600 Hart Road
Barrington, IL 60010
Electronic FAX (847) 304-3444
Attention: Counsel -Auto Financial Services
Section 17.2. HEADINGS. Paragraph headings have been inserted in this
Agreement as a matter of convenience for reference only. The paragraph
headings shall not be used in the interpretation of this Agreement.
<PAGE>70
Section 17.3. SEVERABILITY. If any one or more of the provisions of this
Agreement are held to be invalid, illegal or unenforceable in any respect for
any reason, the validity, legality and enforceability of any such provision or
provision in every other respect and of the remaining provisions of this
Agreement shall not be in any way impaired.
Section 17.4. OFFSET. Lender has the right to offset, apply, or recoup
any obligation of Borrower to Lender, arising under the Loan Documents or
otherwise, against any obligations or payments Lender owes to Borrower,
arising under the Loan Documents or otherwise, or against any property of
Borrower held by Lender. Borrower waives any right to offset, apply, or
recoup against any obligation it owes to Lender. Lender is not obligated to
collect any of the Contracts or pursue any of the other Collateral or any of
Lender's rights at any time as a condition to payment and performance by
Borrower.
Section 17.5. INDEPENDENT CONTRACTOR. Borrower is an independent
contractor in all matters relating to this Agreement and the Collateral and is
not an agent or representative of Lender. Borrower has no authority to act on
behalf of or bind Lender.
Section 17.6. EXPENSES. Each party shall bear the expenses of its own
performance of this Agreement.
Section 17.7. MODIFICATION OF LOAN DOCUMENTS; SALE OF INTEREST. This
Agreement may not be modified, altered or amended, except by an agreement in
writing signed by Borrower and Lender. The rights of Lender granted in or
referred to in this Agreement shall apply to any modification of or supplement
to the Loan Documents. Borrower may not without Lender's prior written
permission sell, assign or transfer any of the Loan Documents, or any portion
thereof, including, without limitation, Borrower's rights, title, interests,
remedies, powers and duties thereunder. Any sale, assignment, or transfer by
Borrower without Lender's permission shall be void ab initio. Borrower hereby
consents to Lender's participation, sale, assignment, transfer or other
disposition, at any time or times hereafter, of any of the Loan Documents, or
of any portion thereof, including, without limitation, Lender's rights, title,
interests, remedies, powers and duties thereunder. The Loan Documents shall
be binding upon and inure to the benefit of the permitted successors and
assigns of Borrower and Lender.
Section 17.8. ATTORNEYS' FEES AND LENDER'S EXPENSES. If, following an
Event of Default, Lender shall in good faith employ counsel for advice or
other representation or shall incur other costs and expenses in connection
with (A) any litigation, contest, dispute, suit, proceeding or action (whether
instituted by Lender, Borrower or any other Person) in any way relating to the
Collateral, any of the Loan Documents or any other agreements executed or
delivered in connection herewith, (B) any attempt to enforce, or enforcement
of, any rights of Lender against Borrower or any other Person, including,
without limitation, Contract Debtors, that may be obligated to Lender by
virtue of any of the Loan Documents, or (C) any actual or attempted
inspection, audit, monitoring, verification, protection, collection, sale,
liquidation or other disposition of the Collateral; then, in any such event,
the attorneys' fees arising from such services and all expenses, costs,
charges and other fees (including expert's fees) incurred by Lender in any way
arising from or relating to any of the events or actions described in this
Section shall be payable to Lender by Borrower on demand by Lender and until
paid shall be part of the Loan.
<PAGE>71
Section 17.9. WAIVER BY LENDER. Lender's failure, at any time or times
hereafter, to require strict performance by Borrower of any provision of this
Agreement or any of the other Loan Documents shall not waive, affect or
diminish any right of Lender thereafter to demand strict performance
therewith. Any suspension or waiver by Lender of an Event of Default by
Borrower under the Loan Documents shall not suspend, waive or affect any other
Event of Default by Borrower under the Loan Documents, whether the same is
prior or subsequent thereto and whether of the same or of a different type.
None of the undertakings, agreements, warranties, covenants and
representations of Borrower contained in the Loan Documents and no Event of
Default by the Borrower under the Loan Documents shall be deemed to have been
suspended or waived by Lender unless such suspension or waiver is by an
instrument in writing signed by a manager of Lender and identifies the matter
waived or suspended. Any consent or approval by Lender pursuant to this
Agreement is not a waiver by Lender of, or an admission by Lender of the truth
of, any of Borrower's representations and warranties in this Agreement.
Section 17.10. WAIVERS BY BORROWER. Except as otherwise provided for in
this Agreement, Borrower waives (i) notice and consummation of presentment,
demand, protest, dishonor, intent to accelerate, acceleration; (ii) all rights
to notice and a hearing prior to taking possession or control of, or Lender's
replevy, attachment or levy upon, the Collateral; (iii) any bond or security
in a judicial proceeding as a condition to Lender exercising any of Lender's
remedies; (iv) the benefit of all valuation, appraisement and exemption laws,
and (v) TRIAL BY JURY in any dispute with Lender arising out of or related to
any of the Loan Documents. The failure or delay of Borrower to strictly
enforce the terms of this Agreement shall not be a waiver of Borrower's right
to do so.
Section 17.11. COUNTERPARTS. This Agreement may be executed in two or
more counterparts, with the same effect as if all parties had signed the same
document. All such counterparts shall be deemed an original, shall be
construed together and shall constitute one and the same instrument.
Section 17.12. ENTIRE AGREEMENT. This Agreement contains the entire
agreement among the parties regarding the loan by Lender to Borrower based on
Contracts and supersedes all prior agreements, whether written or oral, with
respect thereto.
Section 17.13. STATEMENTS OF ACCOUNT. Each report, billing statement,
Statement of Borrowing Base, and payment transcript which is prepared by
Lender shall, except for manifest errors, be deemed final, binding and
conclusive upon Borrower in all respects as to all matters reflected therein,
and shall constitute an account stated between Borrower and Lender, unless
thereafter waived in writing by Lender or unless, within thirty (30) days
after Borrower's receipt of such document, Borrower delivers to Lender notice
of a written objection thereto specifying the claimed error. In the event of
such an error, only those items expressly objected to in such notice shall be
deemed to be disputed by Borrower and Lender's only liability to Borrower
shall be to issue a corrected document.
Section 17.14. PUBLICITY. Borrower shall not (i) issue any press release
or make any public announcement or otherwise publicize the consummation of
this Agreement with Lender, or (ii) make a public disclosure of any kind
regarding the subject matter hereof, or (iii) make use of Lender's name,
tradename, logo or trademark without the express written consent of Lender,
except that Borrower may publicly disclose information relating to this
Agreement if Borrower gives Lender 48 hours advance written notice prior to
releasing any disclosure required by law or in connection with its
<PAGE>72
registration of securities with the U.S. Securities and Exchange Commission or
any state securities commission, or in connection with a filing pursuant to
Borrower's listing with a national securities exchange or governmental entity.
Section 17.15. CONTRACT DOCUMENTS. After Lender reviews a Contract form
or any other form used in connection with a Contract (collectively, the
"Form") Lender may inform Borrower that the Form may not comply with certain
laws or that the Form is not acceptable to Lender as an Eligible Contract form
unless certain changes are made. Borrower is responsible for its use of the
Forms and for any changes Borrower makes to the Forms in response to Lender's
comments. Lender shall have no liability to Borrower arising from Borrower's
use of, or changes to, any Form regardless of whether Lender approved the Form
or the changes or whether Lender conditioned the use of the Form as an
Eligible Contract form upon the changes being made. Regardless of Lender's
approval of a Form or Lender's comments regarding a Form, Borrower remains
obligated to Lender to conduct its business in a lawful manner, including the
use of Forms which comply with applicable laws.
Section 17.16. FAXED DOCUMENTS. In order to expedite the acceptance and
execution of this Agreement and any of the Supplemental Documents, each of the
parties hereto agrees that a faxed copy of any original executed document
shall have the same binding effect on the party so executing the faxed
document as an original handwritten executed copy thereof.
Entered into as of: _________________, 1997
<TABLE><CAPTION>
<S> <C>
GENERAL ELECTRIC CAPITAL CORPORATION UGLY DUCKLING CAR SALES, INC.
Its: General Partner
By: ________________________________ By: ______________________________
Title: ____________________________ Title: ___________________________
UGLY DUCKLING CORPORATION UGLY DUCKLING CAR SALES NEW MEXICO, INC.
By: ________________________________ By: ______________________________
Title: ____________________________ Title: ___________________________
DUCK VENTURES, INC. CHAMPION FINANCIAL SERVICES, INC.
By: ________________________________ By: ______________________________
Title: ____________________________ Title: ___________________________
Signatures Continued on Following Page
CHAMPION ACCEPTANCE UGLY DUCKLING CAR SALES FLORIDA,
CORPORATION formerly known as UGLY INC.
DUCKLING CREDIT CORPORATION By: _______________________________
Title: ____________________________
By: ________________________________
Title: ____________________________
UGLY DUCKLING CAR SALES TEXAS,
L.L.P.
By: Ugly Duckling Car Sales, Inc.
Its: General Partner
By: ________________________________
Title: _____________________________
<PAGE>73
LOAN AND SECURITY AGREEMENT BETWEEN UGLY DUCKLING
CORPORATION, ETAL. AND GENERAL ELECTRIC CAPITAL CORPORATION
LIST OF EXHIBITS
EXHIBIT 3.1 ELIGIBILITY REQUIREMENTS
EXHIBIT 3.1(A) CONTRACT FORM
EXHIBIT 3.1(B) CREDIT AND ADVANCE CRITERIA
EXHIBIT 5.1(C) REPORTS
EXHIBIT 5.1(C)(1) SERVICING REPORT CERTIFICATE
EXHIBIT 6.3 CONTRACT DEBTOR DOCUMENTS
EXHIBIT 8.2 ASSIGNMENT
EXHIBIT 8.3 ASSIGNMENT OF BORROWER'S RIGHTS TO DIRECT
DEBIT
EXHIBIT 9.0 SUPPLEMENTAL DOCUMENTS
EXHIBIT 9.0(A) VALIDITY OF COLLATERAL GUARANTY
EXHIBIT 9.0(B) GUARANTY FOR CYGNET FINANCE INC.
EXHIBIT 9.0(G) OPINION OF COUNSEL
EXHIBIT 9.0(L) OFFICER'S CERTIFICATE
EXHIBIT 9.0(P) CORPORATE RESOLUTION OF EACH BORROWER
EXHIBIT 9.0(Q) POWER OF ATTORNEY
EXHIBIT 9.0(V) LANDLORD LIEN WAIVER
EXHIBIT 10.0(a) BORROWERS' NAMES, LOCATIONS AND SUBSIDIARIES
EXHIBIT 10.0(g) UCC LANGUAGE
EXHIBIT 10.0(i) BROKER DISCLOSURE
EXHIBIT 10.0(j) LABOR DISCLOSURE
EXHIBIT 13.4 FINANCIAL STATEMENT CERTIFICATE
EXHIBIT 16.0 DEBT SUBORDINATION AGREEMENT
[NOTE: ALL EXHIBITS NOT INCLUDED WITH UGLY DUCKLING CORPORATION'S SEC FILING.
HOWEVER, EXHIBITS ARE AVAILABLE UPON AN APPROPRIATE REQUEST.]
</TABLE>
August 6, 1997
Mr. Steven A. Tesdahl
9501 North 46th Place
Phoenix, Arizona 85028
Re: Terms of Employment
Dear Steve:
I am pleased that you have accepted the offer of employment made by Ugly
Duckling Corporation ("Ugly Duckling"). The purpose of this letter is to
confirm the terms and conditions under which you will be employed.
POSITION: You will serve as Senior Vice President - Chief Information
Officer of Ugly Duckling. You will be a member of the executive management
group of Ugly Duckling and will report to the Chief Executive Officer. You
will be employed on a full-time basis and will devote all of your working time
and efforts exclusively to Ugly Duckling.
LOCATION: Your office will be located at 2525 East Camelback Road,
Phoenix, Arizona 85016. The location of your office may be changed from time
to time. Also, you may be required to provide services from time to time at
other Ugly Duckling locations. You may also be required to travel in the
performance of services.
SALARY: You will receive a salary at the rate of $175,000.00 per year. On
each anniversary of commencement of employment your salary will be increased
by a minimum of ten percent.
BENEFITS: Enclosed is a summary of Ugly Duckling's employee benefits. You
will be entitled to these benefits as an employee of Ugly Duckling. However,
in lieu of standard vacation leave, you will be entitled to four weeks (20
business days) of paid vacation leave each year during the term of your
employment, prorated for any partial year.
<PAGE>
STOCK OPTIONS: You will receive a nonqualified option to purchase 100,000
shares of common stock of Ugly Duckling on September 1, 1997 (the "Stock
Options"). The Stock Options are granted to provide you an incentive to work
in a manner that adds as much value as possible to Ugly Duckling. However,
Ugly Duckling makes no representations or warranties as to, and, shall have no
liability for, the value of the Stock Options or the price of common stock of
Ugly Duckling at any time. You acknowledge that the issuance and/or exercise
of the Stock Options may constitute compensation to you and you shall be
responsible for paying all income taxes assessed on said compensation. The
Stock Options are granted pursuant to the Ugly Duckling Long Term Incentive
Plan (the "Incentive Plan") and a Nonqualified Stock Option Agreement (the
"Option Agreement"). A copy of the Incentive Plan and Option Agreement are
enclosed with this letter. The Stock Options will vest over five years from
the date of grant and be subject to other terms and conditions of the
Incentive Plan and Option Agreement.
<PAGE>75
STOCK GRANT: As a signing bonus, you will receive on January 15, 1998 that
number of shares of common stock of Ugly Duckling at the closing market price
on September 1, 1997 equal to $100,000 (the "Restricted Stock"). The
Restricted Stock is granted to induce you to bear all risk of terminating your
current employment with Andersen Consulting, L.L.P. and accepting employment
with Ugly Duckling under the terms of this letter. However, Ugly Duckling
makes no representations or warranties as to, and, shall have no liability
for, the value or price of the Restricted Stock at any time. You acknowledge
that the issuance of the Restricted Stock will constitute compensation for you
and you shall be responsible for paying all income taxes assessed on said
compensation. You authorize Ugly Duckling to withhold from the Restricted
Stock at the time of issuance that number of shares with a value equal to the
withholdings required by applicable law. If any withholdings are required
prior to the issuance of the Restricted Stock you authorize Ugly Duckling to
make the withholdings from your Salary. The Restricted Stock will not be
registered under the Securities Act of 1933 and will be subject to transfer
restrictions under Rule 144 of the Securities Act of 1933.
TERM: Your employment will commence on or before September 1, 1997. There
is no minimum term for your employment. You are employed at will and your
employment may be terminated at any time for any lawful reason, all at the
discretion and will of Ugly Duckling. However, if your employment is
terminated by Ugly Duckling without cause prior to September 1, 1998, then
your Salary, but not any other benefits, will be continued for 12 months. If
your employment is terminated by Ugly Duckling without cause after September
1, 1998 and prior to September 1, 1999, then your Salary, but not any other
benefits, will be continued for 9 months. If your employment is terminated by
Ugly Duckling without cause after September 1, 1999 and prior to September 1,
2000, then your Salary, but not any other benefits, will be continued for 6
months. If your employment is terminated (a) by Ugly Duckling without cause
after September 1, 2000; (b) by Ugly Duckling at any time for cause; or (c) by
you at any time, then your Salary will not be continued after the termination.
The continuation of your Salary, if required, will be a severance benefit (the
"Severance Benefit") and the Severance Benefit will be your exclusive benefit
and remedy for the termination of your employment by Ugly Duckling without
cause. For purposes of this letter and the termination of your employment by
Ugly Duckling without cause, "without cause" shall mean termination for any
reason other than your (a) illegal conduct; (b) gross misconduct; or (c)
willful failure to perform your duties after receipt of written demand for
performance of your duties.
CHANGE OF CONTROL: If a change in control of Ugly Duckling occurs during
the term of your employment and your employment by Ugly Duckling is either (a)
terminated by you within 12 months after the change of control; or (b)
terminated by Ugly Duckling without cause within 90 days prior to the change
of control or within 12 months after the change of control, then in either
event you will receive a termination fee equal to 200% of your then current
salary (the "Termination Fee"). If your employment is terminated without cause
more than 90 days prior to a change of control or with cause at any time, then
no Termination Fee shall be payable to you. If you are entitled to the
Termination Fee, then you shall not be entitled to the Severance Benefit. In
addition, at the time of any change of control all Stock Options granted to
you pursuant to this letter that are not yet vested at the time of the change
of control shall automatically be fully vested without any further action or
authority of the Board of Directors of Ugly Duckling. The vesting of all Stock
Options in connection with a change in control shall be included in the Option
Agreement. For purposes of this letter, change of control shall be defined by
the Plan but shall include the removal and/or resignation of Ernest C. Garcia
II as the Chairman of the Board of Directors and Chief Executive Officer of
Ugly Duckling.
OTHER TERMS: There are no material terms and conditions of your employment
other than as stated in this letter. This letter and the agreements enclosed
with this letter constitute legally binding and enforceable contracts under
Arizona law. You acknowledge that you have received the advice of independent
legal counsel prior to you signing this letter and the enclosed agreements.
If these terms and conditions of employment are acceptable to you, then
please acknowledge your acceptance by signing this letter and the enclosed
agreements and returning them to me. If you have any questions or comments
regarding these terms and conditions of your employment, please contact me or
Ernie Garcia.
I look forward to working with you.
Cordially,
/s/ Steven P. Johnson
Steven P. Johnson
General Counsel
SPJ:ag
Accepted this 6th day of August, 1997.
/s/ Steven A. Tesdahl
Steven A. Tesdahl
Social Security No. ###-##-####
DV.PM:TESDAHL.DOC
AMENDED AND RESTATED
EMPLOYMENT AGREEMENT
<TABLE>
<CAPTION>
<S> <C>
AGREEMENT DATE: AUGUST 1, 1997
DV: DUCK VENTURES, INC.
AN ARIZONA CORPORATION
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
ADDINK: DONALD L. ADDINK
2833 EAST HILLARY DRIVE
PHOENIX, ARIZONA 85032
SOCIAL SECURITY NO. ###-##-####
</TABLE>
RECITALS
--------
The parties acknowledge that the following recitals are true, correct and
a material part of this Amended and Restated Employment Agreement (this
"Agreement"):
1. DV is an Arizona corporation wholly owned by Ugly Duckling
Corporation ("UDC").
2. DV owns companies engaged in sales and financing of used vehicles
(the "Vehicle Businesses").
3. One or more affiliates of UDC ("Affiliates") may engage in other
businesses from time to time affiliated with the Vehicle Business (the
"Affiliate Businesses").
4. Addink has professional expertise and experience in financial
analysis, financial investments, business operations, insurance and other
commercial activities and seeks to use his professional expertise and
experience as a full-time employee of DV for the benefit of the Vehicle
Businesses and the Affiliate Businesses.
5. This Agreement amends and restates the Employment Agreement
between DV and Addink dated June 1, 1995 (the "Prior Agreement").
NOW, THEREFORE, in consideration of the covenants, representations and
warranties of the parties stated herein, the performances of the parties
required hereby and the benefits to be obtained by the parties herefrom, DV
and Addink mutually agree and expressly intend to be legally bound as follows:
<PAGE>78
SECTION 1. EMPLOYMENT.
- -------------------------
Commencing as of the Agreement Date, DV shall employ Addink on a
full-time basis to render the services required by this Agreement (the
"Services"). Addink shall render the Services on a full-time basis faithfully,
promptly and professionally as a full-time employee of DV. All Services
rendered by Addink as a full-time employee of DV shall be rendered for the
benefit of DV, the Insurance Business and Vehicle Businesses. Addink
represents and warrants unto DV that he has not entered into any agreement
that would prohibit or prevent Addink from rendering the Services.
SECTION 2. OBLIGATIONS OF ADDINK.
- --------------------------------------
2.1 SERVICES. The Services rendered by Addink shall be rendered to
--------
the best of Addink's ability, utilizing all of his experience, knowledge,
talents and ingenuity. All Services shall be rendered in compliance with all
applicable laws, the highest standards of ethics and the instructions of the
board of directors of DV or UDC and or officers of DV or UDC (collectively,
the "Board"). The Services to be rendered by Addink include, but may not be
limited to, the following:
2.1.1 OFFICES. Addink shall serve as the Vice President-Senior
-------
Analyst of UDC and shall serve as an officer of the Affiliates from time to
time as requested by the Board.
2.1.2 VEHICLE BUSINESSES. Addink shall perform and provide financial
------------------
analysis, investment and operations advice and other assistance to the Vehicle
Businesses. Addink shall advise the Board on actions that can be taken to
improve the profitability of the Vehicle Businesses. Addink shall execute and
perform all directives and orders of the Board regarding the Vehicle
Businesses.
2.1.3 AFFILIATE BUSINESSES. Addink shall perform and provide
---------------------
financial analysis, investment and operations advice and other assistance to
the Affiliate Businesses. Addink shall advise the Board and or the owners of
the Affiliates, on actions that can be taken to improve the profitability of
the Affiliate Businesses.
2.1.4 OTHER. Addink shall perform and provide all other services and
-----
duties customarily performed and provided by an executive of a commercial
enterprise and all other services and duties required by the Board.
2.2 RESTRICTIONS. Addink acknowledges that as an executive officer
------------
of the Insurance Business he shall have the authority to act on behalf of DV
and to thereby incur obligations, debts and liabilities on behalf of DV.
Notwithstanding such authority, Addink shall not execute any contract, incur
any debt or incur any other liability on behalf of DV unless the same is
either in the ordinary course of the Insurance Business or is first authorized
by the Board. Addink shall not make any misrepresentations to any person or
entity regarding DV, UDC, the Insurance Business, the Vehicle Businesses or
Addink's authority. Addink acknowledges that the Board may from time to time
establish budgets, policies and other regulations regarding the Insurance
Business and Vehicle Businesses. Addink shall at all times perform the
Services in compliance with such budgets, policies and regulations established
by the Board.
SECTION 3. DV OBLIGATIONS.
- -------------------------------
DV shall provide the following to Addink for use and utilization by
Addink in connection with, in support of, and for the benefit of, the Services
of Addink.
3.1 OFFICE. DV shall maintain an office in the Phoenix metropolitan
------
area and all equipment, supplies, furniture and fixtures as may be reasonably
required by Addink to perform the Services (the "Office").
3.2 PERSONNEL. DV shall employ or retain such personnel as may be
---------
reasonably required by Addink to perform the Services and shall be responsible
for the compensation thereof (the "Personnel").
3.3 INSURANCE. DV shall maintain such general liability and casualty
---------
insurance as may be reasonably required by and available to the Insurance
Business and Vehicle Businesses. DV shall also maintain insurance coverage for
the errors and omissions of the directors and officers of DV or any of its
affiliates. DV shall indemnify Addink for liabilities incurred by Addink as an
officer or employee in accordance with the Articles and Bylaws of DV.
3.4 OTHER. DV shall provide other items and services that may be
-----
requested by Addink and that are reasonably required by Addink to perform the
Services.
SECTION 4. COMPENSATION.
- ---------------------------
During the term of this Agreement and not thereafter, DV shall compensate
Addink for the Services rendered by Addink pursuant to this Agreement by
paying and providing to Addink the following:
4.1 SALARY. Addink shall receive an annual salary of One Hundred
------
Sixty Five Thousand Dollars ($165,000.00) (the "Salary"). The Salary shall be
payable in arrears in regularly scheduled installments commencing on the first
regular payday after the Agreement Date. The Salary shall be payable only as
it is earned and upon termination or expiration of this Agreement no Salary
shall be payable thereafter.
4.2 BONUS. On the Agreement Date Addink shall receive a bonus of Ten
-----
Thousand Dollars ($10,000.00) (the "Bonus").
4.3 INSURANCE BENEFITS. On the Commencement Date, Addink shall be
------------------
insured by and included in the group medical insurance policy maintained by DV
for its full time employees (the "Insurance Benefits"). All Insurance Benefits
shall be provided under the terms and conditions stated in the policies
therefor and all deductibles, co-payments and other charges payable by
<PAGE>80
employees insured thereunder shall be paid by Addink without reimbursement by
DV.
4.4 VACATION DAYS. Addink may be absent from the Offices and not
-------------
perform Services for fifteen (15) business days during 1997 and each calendar
year thereafter, whether said absence is for vacation, personal business or
any other purposes ("Vacation Days"). Vacation Days not taken in one calendar
year shall not accumulate and shall not be taken in a subsequent calendar year
and no compensation shall be payable to Addink at any time for Vacation Days
not taken.
4.5 EXPENSES. DV shall reimburse Addink for reasonable and necessary
--------
expenses incurred by Addink in performing the Services, including payment of
professional organization membership dues and the cost of the attending
meetings of such organizations as required to maintain Addink's continuing
education requirements, knowledge and expertise in the insurance industry. All
such expenses shall be reimbursed in accordance with DV's expense
reimbursement policies.
4.6 WITHHOLDINGS. All installments of the Salary and all other funds
------------
paid to Addink pursuant to this Section 4, shall have withheld therefrom all
federal and state income taxes and all other amounts that DV is required by
law to withhold.
4.7 UDC OPTIONS. Addink was granted and Addink now holds options to
-----------
acquire 100,000 shares of common stock of UDC (the "UDC Options") pursuant to
UDC's long term incentive stock option plan (the "Plan"). The UDC Options were
granted on the following dates, in the following amounts and for the following
exercise prices:
<TABLE><CAPTION>
<S> <C> <C>
June, 1995 . . 58,000 shares $ 1.72/share
June, 1996 . . 25,000 shares $ 6.75/share
December, 1996 17,000 shares $17.69/share
</TABLE>
As an additional benefit to Addink pursuant to this Agreement, the terms of
the award to Addink of the UDC Options are hereby amended to provide that the
UDC Options shall be fully vested on the following dates:
June, 1995 UDC Options vest on Agreement Date
June, 1996 UDC Options vest on January 15, 1998
December, 1996 UDC Options vest on Agreement Date
The foregoing shall not effect any other options to acquire any securities of
UDC now held by Addink or hereafter acquired by Addink. Neither DV nor UDC nor
any of their respective shareholders, directors, officers or employees make
any representation or warranty of any kind regarding the value of the UDC
Options or the value of the common stock of UDC that may be acquired by
exercise of the UDC Options.
<PAGE>81
SECTION 5. TERM AND TERMINATION.
- -------------------------------------
5.1 TERM. This Agreement shall commence as of the Agreement Date and
----
shall expire on May 31, 2000 (the "Expiration Date"), unless terminated prior
thereto. Neither party has any obligation to extend this Agreement upon its
expiration. If a party does not intend to extend this Agreement beyond the
Expiration Date, then said party shall notify the other of its intention not
to extend by delivery of written notice thereof thirty (30) or more days prior
to the Expiration Date. If neither party gives written notice of its intention
not to extend this Agreement, then this Agreement shall automatically be
extended and continued on a month-to-month basis and may be terminated by
either party at any time effective thirty (30) days after delivery of written
notice of termination.
5.2 TERMINATION BY ADDINK. Addink may terminate this Agreement at
---------------------
any time, with or without cause, by delivery of written notice of termination
to DV thirty (30) or more days prior to the effective date of the termination.
DV shall continue to pay the Salary and provide Insurance Benefits during said
thirty (30) day period but may suspend Addink from his position at any time
during said thirty (30) day period. If Addink terminates this Agreement all
of Addink's rights under this Agreement shall terminate except for the right
to receive the Salary and Insurance Benefits during said thirty (30) day
period and Addink shall not receive nor be entitled to receive any additional
or other benefits after Addink's delivery of written notice of termination.
5.3 TERMINATION BY DV. DV may terminate this Agreement as follows:
-----------------
5.3.1 TERMINATION WITHOUT CAUSE. DV may terminate this Agreement
-------------------------
immediately or at any time, and without cause, by delivery of written notice
to Addink on, or at any time prior to, the effective date of the termination.
If DV terminates this Agreement without cause, then DV shall continue to pay
the Salary to Addink for twelve (12) months after the termination of this
Agreement, but not beyond the Expiration Date. The continuation of the Salary
for a limited time after termination of this Agreement pursuant to this
Section 5.3.1 shall constitute a severance or termination fee (the
"Termination Fee") and shall be the exclusive remedy of Addink for the
termination of the Agreement by DV without cause. In the event of termination
of this Agreement pursuant to this Section 5.3.1, Addink shall not receive nor
be entitled to any additional benefits from and after the effective date of
termination of this Agreement. No Termination Fee shall be payable to Addink
in the event of the expiration or termination of this Agreement pursuant to
Section 5.1, the termination of this Agreement by Addink pursuant to Section
5.2 or in the event of termination of this Agreement by DV pursuant to Section
5.3.2 or 5.3.3.
5.3.2 TERMINATION WITH CAUSE. Notwithstanding any other provision of
----------------------
this Agreement, if any of the following events or actions occur, DV may
immediately terminate this Agreement by delivery of written notice of
termination to Addink and no Termination Fee shall be payable in the event of
termination pursuant to this Section 5.3.2:
5.3.2.1 Addink commits any fraud, embezzlement or other act of
dishonesty, commits any criminal act, makes any material misrepresentation
<PAGE>82
regarding DV, UDC, the Vehicle Businesses or the Affiliate Businesses.
5.3.2.2 Addink knowingly violates any laws, rules or regulations
applicable to the Vehicle Businesses or Affiliate Businesses.
5.3.2.3 Addink engages in any conduct or action that materially and
personally harms or threatens to materially and personally harm any employee
or customer of DV, UDC or their affiliates, the Vehicle Businesses, the
Affiliate Businesses or any person with whom DV, UDC or their affiliates, the
Vehicle Businesses or the Affiliate Businesses is involved with.
5.3.2.4 Addink breaches any of the covenants made in Section 6 hereof
and DV, UDC, the Vehicle Businesses or the Affiliate Businesses are materially
harmed or damaged as a result of Addink's breach.
5.3.2.5 The death of Addink.
5.3.3 DISABILITY. If Addink is unable to perform the Services on a
----------
full-time basis for sixty (60) days, whether due to illness, injury or any
other physical or mental condition, then Addink shall be deemed disabled. In
such event, DV may then reduce the Salary to Five Thousand Dollars ($5,000.00)
per month until Addink is able to perform the Services on a full-time basis in
the same manner as prior to being disabled. If Addink remains disabled for
sixty (60) days such that Addink has not fully performed the Services on a
full-time basis for a total of one hundred twenty (120) days, then DV may at
any time terminate this Agreement and no Termination Fee shall be payable in
the event of termination pursuant to this Section 5.3.3. This Section 5.3.3
is not intended to effect any disability benefits that Addink may be entitled
to under any governmental or private disability benefits program but DV does
not make any representations or warranties regarding the effect of this
Section 5.3.3 on any governmental or private disability benefits program.
5.4 EFFECT OF TERMINATION. If this Agreement is terminated, DV shall
---------------------
have no obligation to Addink except for the payment of Salary and Insurance
Benefits earned prior to the effective date of the termination and payment of
the Termination Fee, if a Termination Fee is payable in connection with the
termination. If this Agreement is terminated, Addink shall not be entitled to
any additional Salary, Insurance Benefits, Vacation Days or other amounts or
benefits other than those earned and received by Addink prior to the effective
date of the termination, and the Termination Fee if a Termination Fee is
payable in connection with the termination. Notwithstanding any other
provision of this Agreement, upon termination of this Agreement by Addink
pursuant to Section 5.2 or by DV pursuant to Sections 5.3.1 or 5.3.3, and upon
the death of Addink, any UDC Options not then fully vested shall automatically
be fully vested and may be exercised by Addink or his heirs at any time within
fifteen (15) months following the termination or death.
SECTION 6. CONFIDENTIALITY, BUSINESS PROPERTY AND NON-COMPETITION.
- -------------------------------------------------------------------------
6.1 CONFIDENTIALITY. Addink acknowledges that certain information
---------------
regarding DV, UDC and their affiliates, the Vehicle Businesses and Affiliate
Businesses may be business secrets and that the confidentiality thereof is a
valuable right of DV. At all times during and after the term of this
Agreement, Addink shall use his best efforts to maintain the confidentiality
of such information. At all times during and after the term of this Agreement
<PAGE>83
Addink shall not knowingly or intentionally disclose such information to
persons not authorized to receive such information without the prior written
consent of the Board, unless the disclosure is either required by law or is
made in the ordinary course of business.
6.2 BUSINESS PROPERTY. Addink acknowledges that all tangible and
-----------------
intangible property of DV, UDC and their affiliates and the Vehicle
Businesses, including, but not limited to, records, files, data, contracts and
information regarding employees and customers belong exclusively to DV and
Addink shall not own nor acquire any interest therein. Upon expiration or
termination of this Agreement, all such property in the possession of Addink
shall be immediately surrendered and returned to the Office.
6.3 NON-COMPETITION.
---------------
6.3.1 DURING AGREEMENT. During the term of this Agreement Addink
----------------
shall not render any services to any person or entity in any business that
competes with DV, UDC or their affiliates, the Vehicle Businesses or the
Affiliate Businesses without the prior written consent of the Board. During
the term of this Agreement Addink shall not engage in any activity that
conflicts or interferes with, impedes or hampers Addink's performance of the
Services required by this Agreement on a full-time basis or that is
prejudicial or harmful to DV, UDC or their affiliates, the Vehicle Businesses
or the Affiliate Businesses.
6.3.2 AFTER AGREEMENT. For thirty (30) days after the expiration or
----------------
termination of this Agreement, Addink shall not, directly or indirectly, be
employed by, provide any services to, or hold any interest in, any business
that competes with the Vehicle Businesses or Affiliate Businesses. For twelve
(12) months after the expiration or termination of this Agreement, Addink
shall not communicate with the owners, operators, employees or customers of
DV, UDC or their affiliates, the Vehicle Businesses or the Affiliate
Businesses for the purpose of inducing such persons to terminate or not renew
their relations with DV, UDC or their affiliates, the Vehicle Businesses or
the Affiliate Businesses. Addink acknowledges that the covenants of Addink
stated in this Section 6.3.2 are fair, reasonable and appropriate.
6.4 ENFORCEMENT. Addink acknowledges that DV will incur substantial,
-----------
irreparable, immediate and continuing harm if any of the covenants of Addink
stated in this Section 6 are violated and that monetary awards will not be
adequate remedies for the violations. Therefore, Addink acknowledges and
agrees that equitable remedies may be sought and obtained by DV including, but
not limited to, temporary and permanent restraining orders and injunctions.
SECTION 7. GENERAL PROVISIONS.
- --------------------------------
7.1 NOTICES. All notices and communications hereunder shall be in
-------
writing and shall be given by personal delivery or mailed first class,
registered or certified mail, postage prepaid, and shall be deemed received
upon the earlier of actual delivery or three (3) business days after deposit
in the United States Mail. Notices to the parties shall be delivered or
mailed to the addresses set forth in this Agreement.
7.2 TIME. Time is of the essence of this Agreement. However, if any
----
action is required to be taken on a Saturday, Sunday or legal holiday, the
action shall be deemed timely taken if it is taken on the next regular
business day.
7.3 LAW. This Agreement shall be governed by and construed in
---
accordance with the laws of the State of Arizona. Any action brought in
connection with this Agreement shall be brought and prosecuted in a federal or
state court of competent jurisdiction in Arizona.
7.4 LIABILITY OF AFFILIATES. The parties acknowledge that this
------------------------
Agreement is made exclusively between DV and Addink and that neither the
shareholders, directors, officers, employees or agents of DV, UDC or their
affiliates, shall have any liability under this Agreement of any kind at any
time.
7.5 NEGOTIATIONS AND INTEGRATION. The terms and provisions of this
----------------------------
Agreement represent the results of extensive negotiations between the parties.
Each party has obtained, or had the opportunity to obtain, the advice of
independent legal counsel. The terms and provisions of this Agreement shall be
interpreted and construed in accordance with their usual and customary
meanings. All understandings and agreements between the parties are merged in
this Agreement which alone fully and completely expresses their agreement.
This Agreement is entered into after full investigation, neither party relying
upon any statements or representations made by the other not embodied in this
Agreement. This Agreement supersedes all prior employment between DV and
Addink and all personnel policies of DV.
7.6 ASSIGNMENT AND MODIFICATION. This Agreement may not be assigned,
---------------------------
delegated or subcontracted at any time. DV shall not merge, liquidate or
distribute substantially all of its assets without the prior written consent
of Addink, which consent will not be unreasonably withheld. This Agreement may
not be changed orally, but only by an agreement in writing, signed by the
parties. The parties shall execute all amendments and restatements of this
Agreement recommended by counsel to DV, provided such amendments and
restatements do not substantially modify nor adversely affect any of the
material provisions of this Agreement.
7.7 SEVERANCE. If any provision of this Agreement or the application
---------
of such provision to any person or circumstance shall be held invalid, the
remainder of this Agreement, or the application of such provision to persons
or circumstances other than those to which it was held invalid, shall not be
effected thereby.
7.8 SUCCESSORS AND ASSIGNS. This Agreement shall be binding upon the
----------------------
parties hereto, their successors and assigns. However, nothing herein shall be
deemed to permit assignment except in strict accordance with the provisions of
this Agreement.
7.9 COUNTERPARTS. This Agreement may be executed in counterparts,
------------
each of which shall be deemed an original, but all of which together shall
constitute one and the same Agreement.
IN WITNESS WHEREOF, the parties hereby acknowledge their receipt, review,
understanding and acceptance of every provision of this Agreement as of the
dates stated below, effective as of the Agreement Date.
DV: Duck Ventures, Inc.,
an Arizona corporation
By: /s/ Ernest C. Garcia II
Name: Ernest C. Garcia II
Its: President
Date: August 1, 1997
UDC: In approval of Section 4.6,
Ugly Duckling Corporation,
a Delaware corporation
By: /s/ Ernest C. Garcia II
Name: Ernest C. Garcia II
Its: CEO
Date: August 1, 1997
Addink: /s/ Donald L. Addink
Donald L. Addink
Date: August 1, 1997
DV.PM:ADDINK.DOC
<TABLE><CAPTION>
UGLY DUCKLING CORPORATION
SCHEDULE OF COMPUTATION OF EARNINGS PER COMMON SHARE
Three Months Ended Three Months Ended
September 30, 1997 September 30, 1996
---------------------- --------------------
Fully Fully
Primary Diluted Primary Diluted
---------- ---------- --------- ---------
<S> <C> <C> <C> <C>
Net earnings (loss) $ (1,828) $ (1,828) $ 1,967 1,967
Preferred dividends - - (250) (250)
Net earnings (loss) available to common shares $ (1,828) $ (1,828) $ 1,717 1,717
========== ========== ========= =========
Earnings (loss) per share $ (0.10) $ (0.10) $ 0.19 $ 0.19
========== ========== ========= =========
Weighted average common shares outstanding 18,455 18,455 8,633 8,633
Common equivalent shares outstanding 545 545 456 572
using the treasury stock method
Weighted average common and common
equivalent shares outstanding 19,000 19,000 9,089 9,205
========== ========== ========= =========
Nine Months Ended Nine Months Ended
September 30, 1997 September 30, 1996
---------------------- --------------------
Fully Fully
Primary Diluted Primary Diluted
---------- ---------- --------- ---------
Net earnings $ 5,745 $ 5,745 $ 4,115 4,115
Preferred dividends - - (817) (817)
Net earnings available to common shares $ 5,745 $ 5,745 3,298 3,298
========== ========== ========= =========
Earnings per share $ 0.32 $ 0.32 $ 0.47 $ 0.46
========== ========== ========= =========
Weighted average common shares 17,600 17,600 6,659 6,658
outstanding
Common equivalent shares outstanding 600 600 407 572
using the treasury stock method
Weighted average common and common
equivalent shares outstanding 18,200 18,200 7,066 7,230
========== ========== ========= =========
<TABLE> <S> <C>
<ARTICLE>5
<LEGEND>
This financial data schedule on form 10-Q for the quarter ended September 30,
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.
<CIK> 0001012704
<NAME> UGLY DUCKLING CORP
<MULTIPLIER> 1,000
<PERIOD-TYPE> 3-MOS 9-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996
<PERIOD-END> SEP-30-1997 SEP-30-1997
<CASH> 4,401 4,401
<SECURITIES> 41,947 41,947
<RECEIVABLES> 42,677 42,677
<ALLOWANCES> 6,331 6,331
<INVENTORY> 20,936 20,936
<CURRENT-ASSETS> 0<F1> 0<F1>
<PP&E> 42,669 42,669
<DEPRECIATION> (4,777) (4,777)
<TOTAL-ASSETS> 271,285 271,285
<CURRENT-LIABILITIES> 0<F1> 0<F1>
<BONDS> 0 0
0 0
0 0
<COMMON> 171,943 171,943
<OTHER-SE> 5,452 5,452
<TOTAL-LIABILITY-AND-EQUITY> 271,285 271,285
<SALES> 33,530 79,543
<TOTAL-REVENUES> 45,204 120,209
<CGS> 18,537 42,537
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 21,517 49,628
<LOSS-PROVISION> 6,538 15,367
<INTEREST-EXPENSE> 1,578 2,914
<INCOME-PRETAX> (2,966) 9,763
<INCOME-TAX> (1,138) 4,018
<INCOME-CONTINUING> (1,828) 5,745
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> (1,828) 5,745
<EPS-PRIMARY> (.10) .32
<EPS-DILUTED> (.10) .32
<FN>
<F1>UNCLASSIFIED BALANCE SHEET
</FN>
</TABLE>
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS AND RISK FACTORS
The Company wishes to take advantage of the "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, Form 10-K/A, this Form 10-Q, any other Form 10-Q, any Form 8-K, Form
8-K/A, other SEC filings, 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," "intend,"
"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 securities of the Company involves certain risks. In addition
to the other information included elsewhere in this Form 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 PROFITABILITY
The Company began operations in 1992 and incurred significant operating losses
in 1994 and 1995. The Company experienced net earnings of $5.9 million in 1996
and net earnings for the nine month period ended September 30, 1997 of $5.7
million. However, the Company realized a net loss for the three month period
ended September 30, 1997 due in large part to a charge of $10.0 million
(approximately $6.0 million, net of income taxes) against the Residuals in
Finance Receivables Sold. There can be no assurance that the Company will
regain profitability in the next fiscal quarter or in future periods. See Part
1, Item 2. "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
<PAGE>90
LIQUIDITY
The Company's cash and cash equivalents have decreased from $18.5 million at
December 31, 1996 to $4.4 million at September 30, 1997. This decrease is due
in large part to the Company's FMAC Secured Debt purchase and debtor in
possession loans, as well as the growth of the Cygnet Program loan portfolio.
The Company is currently in negotiations with a finance company to provide
financing for the Cygnet program and is in the process of evaluating its
alternatives for the financing of the FMAC Secured Debt and debtor in
possession loans.
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. To date, substantially all of the Company's
securitization transactions have been completed under a Securitization Program
with SunAmerica. Under this program, SunAmerica was granted the right to
purchase $175.0 million of Certificates. As of June 30, 1997, the Company had
substantially utilized its maximum commitment from SunAmerica under the
Securitization Program. Beginning with the third fiscal quarter of 1997, the
Company expanded the Securitization Program to include CRC II (defined below)
and sales of CRC II securities through private placement of securities to
investors other than Sun America. The Company is actively seeking to identify
alternative securitization participants. Failure to identify new
securitization participants and to periodically engage in securitization
transactions will adversely affect the Company's cash flows and net earnings.
The Company's ability to successfully complete securitizations in the future
may also 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. In addition,
with respect to securitization transactions that have closed in the past, the
amount of any gain on sale is based upon certain estimates and assumptions,
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 subordinate certificate 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
subordinate certificate portion. The income recorded on the subordinate
certificate portion will vary from quarter to quarter based upon cash flows
received in a given period. To the extent that cash flows are deficient,
charge-offs of finance receivables exceed original estimates, or assumptions
that were applied at the time of the securitization to the underlying
portfolio are not realized, the Company is required to revalue the residual
portion of the securitization which it retains, and record a charge to
operations. During the three month period ended September 30, 1997, the
Company recorded a charge of $10.0 million ($6.0 million, net of income taxes)
against the carrying value of the retained portion of its securitization. The
charge resulted from an upward revision in the Company's net loss assumptions
related to the underlying contract portfolios supporting the Company's
retained securitization assets. Although the Company believes the charge is
adequate to adjust the assumptions to a level which will more closely
approximate future net losses in the underlying contract portfolio, there can
be no assurance in that regard. To the extent that cash flows are deficient,
charge-offs of finance receivables exceed the revised estimates, or the
revised assumptions that were applied to the underlying portfolio are not
realized, the Company is required to revalue the residual portion of the
securitization which it retains, and record a charge to operations. Champion
Receivables Corporation ("CRC") and Champion Receivables Corporation II ("CRC
<PAGE>91
II") (collectively referred to as "Securitization Subsidiaries"), are the
Company's wholly-owned special purpose "bankruptcy remote entities". Their
assets include residuals in finance receivables and investments held in trust,
in the amounts of $25.8 million and $15.1 million, respectively, at September
30, 1997, which amounts would not be available to satisfy claims of creditors
of the Company on a consolidated basis. See Part 1, Item 2. "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
DEPENDENCE ON EXTERNAL FINANCING AND SECURITIZATION PROGRAM
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 $100.0 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 86.0% of the principal balance of eligible Third Party
Dealer contracts. The Revolving Facility expires in December 1998. 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. 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 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. In addition, the
Company has established a Securitization Program pursuant to which the Company
is subject to numerous terms and conditions. Pursuant to the Securitization
Program, the Company and SunAmerica entered into an agreement under which
SunAmerica would purchase $175.0 million of certificates secured by contracts.
As of June 30, 1997, the Company had securitized an aggregate of $210.0
million in contracts, and SunAmerica had purchased $170.4 million in Class A
Certificates, thereby substantially utilizing the maximum commitment from
SunAmerica. During the three month period ended September 30, 1997, the
Company completed a securitization transaction with private investors. There
can be no assurance that any further securitizations will be completed or that
the Company will be able to secure additional financing, including the
financing necessary to pay in full the FMAC Bank Group (defined below) note
payable of approximately $55.1 million, or to fully implement the Cygnet
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."
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 and/or low incomes,
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 approximately 21.0% to
29.9% on contracts originated at Company Dealerships, while rates range from
approximately 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 13.9% and 17.7% of contract principal balances as of December 31,
1996 and 1995, respectively, and 15.2% of contract principal balances as of
September 30, 1997, to cover anticipated credit losses on the contracts
<PAGE>92
currently in its portfolio. At December 31, 1996 and 1995, the principal
balance of delinquent contracts as a percentage of total outstanding contract
principal balances was 3.7% and 4.2%, respectively. The principal balance of
delinquent contracts as a percentage of total outstanding contract principal
balances at September 30, 1997 was 5.6%. The Company's net charge offs as a
percentage of average principal outstanding for the years ended December 31,
1996 and 1995 were 16.7% and 21.7%, respectively. The Company's annualized net
charge offs as a percentage of average principal outstanding for the nine
months ended September 30, 1997 were 19.7%. The Company believes its current
Allowance for Credit Losses is adequate to absorb anticipated credit losses.
However, no assurance can be given that the Company has adequately provided
for, or will adequately provide for, such credit risks or that credit losses
in excess of 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. 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 primarily
upon its ability to: (i) expand its revenue generating operations while not
proportionately increasing its administrative overhead; (ii) originate and
purchase contracts with an acceptable level of credit risk; (iii) 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.
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 and/or
inventory. 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, similar to 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
or pay in full the Bank Group debt which matures in February 1998. 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 three significant acquisitions (Seminole,
EZ Plan, and Kars) and intends to consider additional acquisitions, alliances
<PAGE>93
and transactions involving other companies that could complement the Company's
existing business. There can be no assurance that suitable acquisition
parties, joint venture candidates, or transaction counterparties can be
identified, or that, if identified, any such transactions will be consummated
on terms favorable to the Company, or at all. 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, these types of transactions by the Company may result in
potentially dilutive issuances of equity securities, the incurrence of
additional debt, and amortization of expenses related to goodwill and
intangible assets, all of which could adversely affect the Company's
profitability. As of September 30, 1997, the Company had Goodwill totaling
approximately $17.2 million, the components of which will be amortized over a
period of 15 to 20 years. These transactions 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.
HIGHLY COMPETITIVE INDUSTRY
Although the used car sales industry has historically been highly fragmented,
it has attracted significant attention 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
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.
<PAGE>94
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, certain of these
companies have filed for bankruptcy protection. These announcements have had a
disruptive effect on the market for securities of sub-prime automobile finance
companies, to result in a tightening of credit to the sub-prime markets, and
could lead to enhanced regulatory oversight. Furthermore, companies in the
used vehicle financing market have been named as a defendant in an increasing
number of class action lawsuits brought by customers alleging violations of
various federal and state consumer credit and similar laws and regulations.
Although the Company is not currently a named defendant in 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 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 Program.
GEOGRAPHIC CONCENTRATION
Company Dealership operations are currently located in Arizona, Georgia,
California, Texas, Florida, Nevada, and New Mexico. In addition, a majority of
the Company's Branch Offices are located in Arizona, Texas, Florida, and
Indiana. 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.
<PAGE>95
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 owns 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 approximately
21.0% to 29.9% on the contracts originated at Company Dealerships, while rates
range from approximately 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 raising the retail prices of its used cars or purchasing
contracts originated in these states at a higher discount. The Company's
inability to achieve higher sales prices or adequate discounts in states
imposing usury limits would adversely affect the Company's planned expansion
and its results of operations. There can be no assurance that 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.
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. The Company does not
currently maintain any key person life insurance on any of its executive
officers.
CONTROL BY PRINCIPAL STOCKHOLDER
Mr. Ernest C. Garcia, II, the Company's Chairman, Chief Executive Officer, and
principal stockholder, holds approximately 25.1% of the outstanding Common
Stock, including 136,000 shares held by The Garcia Family Foundation, Inc., an
Arizona non-profit corporation. As a result, Mr. Garcia has 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.
<PAGE>96
POTENTIAL ANTI-TAKEOVER EFFECT OF PREFERRED STOCK
The Company's Certificate of Incorporation authorizes the Company to issue
"blank check" Preferred Stock, the designation, number, voting powers,
preferences, and rights of which may be fixed or altered from time to time by
the Board of Directors. Accordingly, the Board of Directors has the authority,
without stockholder approval, to issue Preferred Stock with dividend,
conversion, redemption, liquidation, sinking fund, voting, and other rights
that could adversely affect the voting power or other rights of the holders of
the Common Stock. The Preferred Stock could be utilized, under certain
circumstances, to discourage, delay, or prevent a merger, tender offer, or
change in control of the Company that a stockholder might consider to be in
its best interests. Although the Company has no present intention of issuing
any additional shares of its authorized Preferred Stock, there can be no
assurance that the Company will not do so in the future.
REGULATION, SUPERVISION, AND LICENSING
The Company's operations are subject to ongoing regulation, supervision, and
licensing under various federal, state, and local statutes, ordinances, and
regulations. Among other things, these laws require that the Company obtain
and maintain certain licenses and qualifications, limit or prescribe terms of
the contracts that the Company originates and/or purchases, require specified
disclosures to customers, limit the Company's right to repossess and sell
collateral, and prohibit the Company from discriminating against certain
customers. The Company is also subject to federal and state franchising and
insurance laws.
The Company believes that it is currently in substantial compliance with all
applicable material 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 result in fines or
interruption or cessation of certain of the business activities of the Company
and could have a material adverse effect on the operations of the Company. In
addition, the adoption of additional statutes and regulations, changes in the
interpretation of existing statutes and regulations, or the Company's entrance
into jurisdictions with more stringent regulatory requirements could have a
material adverse effect on the Company.
SHARES ELIGIBLE FOR FUTURE SALE
Approximately 5.0 million 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, approximately 3.4 million
shares of common stock were recently registered for resale under the
<PAGE>97
Securities Act of 1933, as amended (the "Securities Act"). 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
The market price of the common stock has been and may continue to be volatile
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.
TRANSACTIONS WITH FIRST MERCHANTS ACCEPTANCE CORPORATION
First Merchants Acceptance Corporation ("FMAC") filed for reorganization under
Chapter 11 of the Federal Bankruptcy Code on July 11, 1997 ("Bankruptcy
Case"). In connection with the Bankruptcy Case, the Company, which owns
approximately 2 1/2% of FMAC's outstanding common stock with a cost basis of
approximately $1.5 million, agreed to provide up to $10 million of "debtor in
possession" financing to FMAC, of which approximately $3.8 million was
outstanding at September 30, 1997. On August 20, 1997, the Company acquired
approximately 78% of the senior secured debt ("Secured Debt") of FMAC from
certain members of the senior bank group (Bank Group) that held such debt.
The Senior Debt totaled approximately $97.8 million. The more significant
terms of the purchase of the Senior Debt included, among other things, the (i)
purchase by the Company of the debt at a 10% discount of the outstanding
principal amount; (ii) short-term financing by the Bank Group to the Company
for the purchase, with interest accruing at LIBOR plus 2% and an up-front
payment by the Company to the Bank Group equal to 20% of the purchase price;
and (iii) issuance of stock warrants to the Bank Group to purchase up to
389,800 shares of the Company's common stock at an exercise price of $20 per
share over a thirty-month term and subject to a call feature by the Company.
Subsequent to September 30, 1997, the Company entered into a contract to
acquire, subject to various conditions that have not yet been satisfied, the
remaining approximately 22% of the Secured Debt from two (2) unrelated third
parties (the "Sellers"). The more significant terms of the purchase include,
among other things, (i) the Company's right to purchase by an exercise of a
call right that expires on February 20, 1998 (the "Call Period"), and which is
followed by a put right by the Sellers that expires on March 15, 1998 (the
"Put Period"); (ii) a purchase price equal to ninety-five percent (95%) during
the Call Period (and one hundred percent (100%) during the Put Period) of the
outstanding principal balance of the purchased Secured Debt, plus interest on
such purchase price from November 12, 1997 through the closing date of such
purchase at approximately 8.0% per annum, less all payments received by the
Sellers with respect to the purchased Secured Debt through the date of
closing; and (iii) the issuance of stock warrants to the Sellers to purchase
up to 110,200 shares of the Company's common stock at an exercise price of
$20.00 per share over a 36 month term and subject to a call feature of the
Company.
DATA PROCESSING AND TECHNOLOGY AND YEAR 2000
The Company has dedicated significant resources to data processing and related
technologies, which management expects will enhance the Company's ability to
service loan portfolios, meet the Company's operational requirements, and
eventually reduce costs. The Company believes that its continuing investment
in data processing and technology will allow it to remain competitive in the
industry. The success of any participant in the Sub-Prime industry, including
<PAGE>98
the Company, depends in part on its ability to continue to adapt its
technology, on a timely and cost-effective basis, to meet changing customer
and industry standards and requirements. Related to the preceding, the Company
recently converted to a new loan servicing and collection data processing
system at its Gilbert, Arizona facility which services the Company's Arizona,
Nevada, and New Mexico Company Dealership loan portfolios as well as the Third
Party Dealer loan portfolio. The system became operational in the first
quarter of 1997; however, although conditions have improved, the Company
continues to confront various implementation and integration issues for the
new loan servicing and collection data processing system, which management
believes have resulted in increases in both contract delinquencies and charge
offs. Delay or failure to fully resolve these issues could have a material
adverse affect on the Company.
The Company also services its loan portfolios on loan servicing and collection
data processing systems in Tampa/St. Petersburg, San Antonio, and Dallas which
are different from the loan servicing and collection data processing system
utilized at the Gilbert , Arizona facility. The Company expects to migrate and
convert all of its loan servicing and collection data processing to a single
loan servicing and collection data processing system which has yet to be
identified. Failure to identify and successfully migrate and convert to a
single loan servicing and data processing system could have a material adverse
affect on the Company.
The Company has commenced a study of its computer systems in order to assess
its exposure to year 2000 issues. The Company expects to make the necessary
modifications or changes to its computer information systems to enable proper
processing of transactions relating to the year 2000 and beyond. The Company
will evaluate appropriate courses of action, including replacement of certain
systems whose associated costs would be recorded as assets and subsequently
amortized. However, there can be no assurance that year 2000 costs and
expenses will not have a material adverse impact on the Company.
The Company is dependent on its main processing facilities as well as long-
distance and local telecommunications access in order to transmit and process
information among its various facilities. The Company maintains a disaster
response plan, but a natural disaster, calamity or other significant event
that causes long-term damage to any of these facilities or that interrupts its
telecommunications networks could have a material adverse effect on the
Company. See Part 1, Item 2. "Management's Discussion and Analysis of
Financial Condition and Results of Operations": "Allowance for Credit Losses -
Net Charge Offs - Company Dealerships", "Net Charge Offs - Third Party
Dealerships", and "Static Pool Analysis", "Contracts Originated at Company
Dealerships", and "Contracts Purchased From Third Party Dealers."
