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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1996.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to.
Commission File Number 0-20841
UGLY DUCKLING CORPORATION
(Exact name of registrant as specified in its charter)
DELAWARE 86-0721358
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2525 E. Camelback Road, Suite 1150
Phoenix, Arizona 85016
(Address of principal executive offices) (Zip Code)
(602) 852-6600
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Title of Class Name of each Exchange on which registered
COMMON STOCK, $.001 PAR VALUE NASDAQ NATIONAL MARKET
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 by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
At March 24, 1997, the aggregate market value of common stock held by
non-affiliates of the Registrant was approximately $233,538,099.
APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by the court. YES [ ] NO [ ]
(APPLICABLE ONLY TO CORPORATE REGISTRANTS)
Indicate the number of shares outstanding of each of the registrant's
classes of common stock, as of the latest practicable date: 18,430,776.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement relating to its
annual meeting of stockholders to be held on April 22, 1997, are incorporated
by reference in Part III hereof.
TABLE OF CONTENTS
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PART I
Item 1 Business 3
Item 2 Properties 12
Item 3 Legal Proceedings 12
Item 4 Submission Of Matters To A Vote Of Security Holders 13
PART II
Item 5 Market For The Registrant's Common Equity Securities And Related Stockholder Matters 13
Item 6 Selected Consolidated Financial Data 15
Item 7 Management's Discussion And Analysis Of Financial Condition And Results Of Operations 17
Item 8 Consolidated Financial Statements And Supplementary Data 32
Item 9 Changes In And Disagreements With Accountants On Accounting And Financial Disclosures 52
PART III
Item 10 Directors And Executive Officers Of The Registrant 52
Item 11 Executive Compensation 52
Item 12 Security Ownership Of Certain Beneficial Owners And Management 52
Item 13 Certain Relationships And Related Transactions 53
PART IV
Item 14 Exhibits, Consolidated Financial Statement Schedules, And Reports On Form 8-K 53
SIGNATURES 56
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PART I
ITEM 1 - BUSINESS
GENERAL
Ugly Duckling Corporation (the "Company") operates the largest publicly
held 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 Company Dealerships and by Third Party
Dealers located in selected markets throughout the country. As part of its
financing activities, the Company has initiated the Cygnet Dealer Program
pursuant to which it intends to provide qualified Third Party Dealers with
operating credit lines secured by the dealers' retail installment contract
portfolios. The Company targets its products and services to the sub-prime
segment of the automobile financing industry, which focuses on selling and
financing the sale of used cars to persons who have limited credit histories,
low incomes, or past credit problems ("Sub-Prime Borrowers").
The rapidly growing used car sales and finance industry achieved record
sales in 1995 of 30.5 million units, representing approximately $290.0 billion
in sales. During this same period, more than $185.0 billion in retail
installment contracts were originated through the sale of used cars. Of these
totals, approximately 11.0 million units were sold to Sub-Prime Borrowers,
generating approximately $50.0 billion in retail installment contracts.
Consistent with the industry's growth, the Company has expanded
significantly in recent periods. From 1995 to 1996, total revenues increased
by 55.2% from $48.7 million (pro forma) to $75.6 million. The Company's net
earnings grew to $5.9 million in 1996, or $0.60 per share, compared with a net
loss of $(4.0) million, or $(.67) per share in 1995. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Introduction."
The Company originated 6,929 contracts through wholly owned used car
dealership ("Company Dealerships") with an aggregate principal balance of
$49.0 million and purchased 9,825 contracts from small independent used car
dealerships ("Third Party Dealers") with an aggregate principal balance of
$56.8 million during 1996. The principal balance of the Company's total
contract portfolio serviced as of December 31, 1996, was $109.9 million,
including $51.7 million in contracts serviced under the securitization program
("Securitization Program") with SunAmerica Life Insurance Company
("SunAmerica").
OVERVIEW OF USED CAR SALES AND FINANCE INDUSTRY
Used Car Sales. Used car retail sales typically occur through franchised
new car dealerships that sell used cars or independent used car dealerships.
The market for used car sales in the United States is significant and has
steadily increased over the past five years. The Company believes that the
factors that have led to growth in this industry include substantial increases
in new car prices, which have made new cars less affordable to the average
consumer relative to used cars, the greater reliability and durability of used
cars resulting from the production of higher quality cars, and the increasing
number of vehicles coming off-lease in recent years. Many analysts expect
these trends to continue, leading to further expansion of the used car sales
market.
The used car sales industry is highly fragmented and, traditionally,
sales to customers have occurred through franchised and independent
dealerships owned by individuals, families, and small groups. According to
industry sources, there are over 23,000 franchised and 63,000 independent used
car dealership locations in the United States. Used car sales from franchised
dealerships (or affiliated used-only car lots) accounted for approximately
61.3% of used car sales during 1995, with the remaining 38.7% resulting from
sales by independent dealerships.
The Company participates in the sub-prime segment of the independent used
car sales and finance market. This segment is serviced primarily by small
independent used car dealerships that sell and finance the sale of used cars
to Sub-Prime Borrowers ("Buy Here-Pay Here dealers"). Buy Here-Pay Here
dealers typically offer their customers certain advantages over more
traditional financing sources, such as expanded credit opportunities, flexible
payment terms (including prorating customer payments due within one month into
several smaller payments and scheduling payments to coincide with a customer's
pay days), and the ability to make payments in person, an important feature to
many Sub-Prime Borrowers who may not have checking accounts or are otherwise
unable to make payments by the due date through use of the mail because of the
timing of paychecks.
Recently, the growth of the used car sales and finance market has
attracted significant attention from a number of large companies, including
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. The
Company believes that these companies are attracted by the relatively high
gross margins that can be earned in this business and the lack of
consolidation in this market. None of these companies have indicated an
intention to focus on the Buy Here-Pay Here segment.
Used Car Financing. The automobile financing industry is the
third-largest consumer finance market in the country, after mortgage debt and
credit card revolving debt, with more than $350.0 billion in contracts on new
and used cars originated in 1995. The sub-prime segment of this industry
accounted for approximately $50.0 billion of the overall market. Growth in
automobile financing has been fueled by the increasing prices of both new and
used cars, which has forced greater numbers of purchasers to seek financing
when purchasing a car. This industry is served by such traditional lending
sources as banks, savings and loans, and captive finance subsidiaries of
automobile manufacturers, as well as by independent finance companies and Buy
Here-Pay Here dealers. In general, the industry is categorized according to
the type of car sold (new versus used) and the credit characteristics of the
borrower. With respect to the borrowers, finance companies classify such
individuals according to the following generalized criteria:
- - An "A" credit or "prime" borrower is a person who has a long credit history
with no defaults, has been employed in the same job for a period of at least
18 months, and can easily finance a new car purchase through a bank, a captive
finance subsidiary of an automobile manufacturer, or an independent finance
company.
- - A "B" credit or "non-prime" borrower is a person who has a substantial
credit history that includes late payments, an inconsistent employment
history, or significant or unresolved problems with credit in the past. To
finance a used car purchase, this borrower will generally not be able to
obtain a loan from a captive finance subsidiary or a bank, and will have to
obtain financing from an independent finance company that lends into this
market category.
- - A "C" credit or "sub-prime" borrower generally has little or no credit
history or a credit history characterized by consistently late payments and
sporadic employment. Like "B" credit borrowers, "C" credit borrowers generally
are not able to obtain a loan from a captive finance subsidiary or a bank, and
have to obtain financing from an independent finance company that lends into
this market category.
- - A "D" credit borrower is also referred to as a "sub-prime" borrower. These
persons, however, in addition to having an unfavorable employment history,
have also experienced debt charge offs, foreclosures, or personal bankruptcy.
In purchasing a car, this borrower's only choice is to obtain financing from
an independent finance company or through a Buy Here-Pay Here dealer.
As with its used car sales operations, the Company's finance operations
are directed to the sub-prime segment of the market. In particular, the
finance operations of Company Dealerships are directed toward Sub-Prime
Borrowers classified in the "C" and "D" categories, while its Third Party
Dealer finance operations are generally directed to "C" credit borrowers. Many
of the traditional lending sources do not consistently provide financing to
the sub-prime consumer finance market. The Company believes traditional
lenders avoid this market because of its high credit risk and the associated
collection efforts.
Many of the 63,000 independent used car dealers are not able to obtain
debt financing from traditional lending sources such as banks, credit unions,
or major finance companies. These dealers typically finance their operations
through the sale of contract receivables at a substantial discount. The
Company believes that independent dealers prefer to finance their operations
through credit facilities that enable them to retain their receivables,
thereby increasing their finance income. Accordingly, the Company believes
that there is a substantial opportunity for a company capable of serving the
needs of such dealers to make significant penetration into this underdeveloped
segment of the sub-prime market.
The industry statistical information presented herein is derived from
information provided to the Company by CNW Marketing/Research of Bandon,
Oregon.
RECENT ACQUISITIONS
In January 1997, the Company acquired selected assets of a group of
companies (the "Sellers") engaged in the business of selling and financing
used motor vehicles, including four dealerships located in the Tampa Bay/St.
Petersburg market. The acquired assets consist primarily of Sellers' inventory
of vehicles and a portfolio of installment sales contracts. The purchase price
for the assets acquired was approximately $32.4 million. In addition, the
Company leased certain facilities used in this business.
In connection with the acquisition, the Company made a commercial loan to
one of the Sellers in the amount of $891,000, secured by consumer loans and,
subject to certain conditions, committed to advance to an affiliate of Sellers
$1.5 million, secured by a second priority lien on certain real property.
These loans are guaranteed by the principal shareholders of Sellers.
On April 1, 1997, the Company purchased substantially all of the assets
of a company engaged in the business of selling and financing used motor
vehicles, including seven dealerships in San Antonio and a contract portfolio
of approximately $24.3 million. The purchase price for the acquisition was
$26.3 million, subject to adjustment. The seven dealerships had sales in 1996
of approximately $22.5 million. The assets purchased have an unaudited book
value of $28.1 million, exclusive of allowances on approximately $26.2 million
of contract receivable principal balances.
BUSINESS STRATEGY
The Company intends to leverage its management team, collection
facilities, computer networks, and capital base to grow its Company Dealership
operations, Third Party Dealer operations and Cygnet Dealer Program, both in
Arizona and in other geographic locales.
Expand Company Dealership Operations. Since commencing its used car
sales and financing operations in 1992, the Company has pursued an aggressive
growth strategy through both internal development and acquisition. As of May
12, 1997, the Company has developed or acquired twenty-one Company
Dealerships. The Company's strategy is to increase sales revenue and finance
income by acquiring or opening new dealerships and finance operations. In the
last several months, the Company has opened new Company Dealerships in
Arizona, Florida, and Nevada, has three other dealerships (one in Arizona and
two in New Mexico) currently under development, and has acquired eleven
additional Company Dealerships in Florida and Texas. The Company intends to
continue the aggressive development or acquisition of Company Dealerships
throughout the United States and in other locations where opportunities may
arise. See "- Recent Acquisitions."
The Company distinguishes its direct sales and financing operations from
typical Buy Here-Pay Here dealers by providing multiple locations, upgraded
facilities, large inventories of used automobiles, and dedication to customer
service. The Company has designed and implemented a marketing program
featuring its animated duck mascot that promotes its image as a professional,
yet approachable, operation, in contrast to the generally unfavorable public
image of many Buy Here-Pay Here dealers. In addition, the Company has
developed flexible underwriting guidelines and techniques, which combine
established underwriting criteria with managerial discretion, to facilitate
rapid credit decisions, as well as an integrated, technology-based corporate
infrastructure that enables the Company to monitor and service large volumes
of contracts.
Expand Third Party Dealer Operations. The Company has leveraged the
contract servicing experience and capabilities it acquired through its Company
Dealership activities by purchasing and servicing contracts originated by
Third Party Dealers. As of January 31, 1997, the Company had opened
thirty-nine Branch Offices in twelve states. These Branch Offices service
approximately 1,400 Third Party Dealers. The Company continually evaluates
expansion of its Third Party Dealer operations into additional geographic
areas.
Implement New Products and Services. The Company is in the process of
expanding its Third Party Dealer operations by implementing the Cygnet Dealer
Program. The Company believes that providing operating credit lines to
qualified Third Party Dealers will give such dealers a unique opportunity to
obtain the debt financing necessary to expand their businesses while enabling
the Company to earn additional finance income and diversify its earning asset
base. The Company also believes that the relationships established with these
dealers will provide it with a preferred position to acquire retail
installment contracts from them. Such contract purchases would provide these
dealers with an additional source of financing and enable the Company to
further expand its contract portfolio. The Company began full-scale marketing
of the program during the first quarter of 1997.
The Company also intends to expand its insurance operations, which to
date consist of force placing casualty insurance on its Third Party Dealer
contracts. Among other things, the Company is evaluating the sale of other
insurance products to its customer base. See "- Third Party Dealer
Operations."
COMPANY DEALERSHIP OPERATIONS
Company Dealership operations include the retail sale of used cars and
the underwriting, financing, and servicing of contracts originated from such
sales. The Company's total revenues from its Company Dealership operations
were $32.5 million, $56.1 million ($46.6 million excluding sales at the
Gilbert Dealership), and $67.0 million for fiscal years 1994, 1995, and 1996,
respectively. See Note 20 to the Consolidated Financial Statements and Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Introduction."
Retail Car Sales. The Company distinguishes its Company Dealership
operations from those of typical Buy Here-Pay Here dealers through its network
of multiple locations, upgraded facilities, large inventories of used cars,
centralized purchasing, value-added marketing programs, and dedication to
customer service. All Company Dealerships are located in high visibility, high
traffic commercial areas, and generally are newer and cleaner in appearance
than other Buy Here-Pay Here dealers, which helps promote the Company's image
as a friendly and reputable business. The Company believes that these factors,
coupled with its widespread brand name recognition (achieved through extensive
promotion of its duck mascot and logo), enable it to attract customers who
might otherwise visit another Buy Here-Pay Here dealer.
Company Dealerships generally maintain an average inventory of 100 to 300
used cars and feature a wide selection of makes and models (with ages
generally ranging from 5 to 10 years) and a range of sale prices, all of which
enables the Company to meet the tastes and budgets of a broad range of
potential customers. The Company acquires its inventory from new or late-model
used car dealers, used car wholesalers, used car auctions, and customer
trade-ins, as well as from repossessions. The Company's size enables it to cut
inventory costs by making volume purchases for all Company Dealerships. In
making its purchases, the Company takes into account each car's retail value
and the costs of buying, reconditioning, and delivering the car for resale.
After purchase, cars are delivered to the individual dealerships, where they
are inspected and reconditioned for sale. Although the prices of used cars are
subject to market variance, the Company does not believe that it will
encounter significant difficulty in maintaining its current inventory levels.
The average sales price per car at Company Dealerships was $7,107 for the
fiscal year ended December 31, 1996, and $6,065 for the fiscal year ended
December 31, 1995 (exclusive of sales at the Company's Gilbert Dealership).
Company Dealerships use a standardized sales contract that typically provides
for down payments of approximately 10.0% to 15.0% of the purchase price with
the balance of the purchase price financed at fixed interest rates ranging
from 21.0% to 29.9% over periods ranging from 12 to 48 months. The Company
sells cars on an "as is" basis, and requires its customers to sign an
agreement at the date of sale releasing the Company from any obligation with
respect to vehicle-related problems that subsequently occur. See Item 3.
"Legal Proceedings."
Used Car Financing. The Company finances approximately 90.0% of the used
car sales at its Company Dealerships through retail installment contracts that
the Company services. Subject to the discretion of its sales managers,
potential customers must meet the Company's underwriting guidelines, referred
to as minimum deal standards, before the Company will agree to finance the
purchase of a car. The Company created these minimum deal standards to control
its exposure to credit risk while providing its sales managers with sufficient
flexibility to consummate sales when appropriate. In connection with each
sale, customers are required to complete a credit application. Company
personnel analyze and verify customer application information, which contains
employment and residence histories, income information, and references, as
well as the customer's personal cash flow statement (taking into account the
completion of the sale), credit bureau reports, and other information
regarding the customer's credit history.
The Company's credit underwriting process takes into account the ability
of its managers and other sales employees, who have extensive experience, to
make sound judgments regarding the extension of credit to Sub-Prime Borrowers
and to personalize financing terms to meet the needs of individual customers.
For example, contract payments may be scheduled to coincide with the customer's
pay days, whether weekly, biweekly, semi-monthly, or monthly. In addition,
each manager makes credit approvals only after a "face-to-face" interview with
the potential customer in which the manager gains firsthand information
regarding the customer's financial situation, sources of income, and past
credit problems. The Company believes that its customers value the expanded
credit opportunities that such flexibility provides and, consequently, will
pay a higher price for their cars. The Company believes that the higher prices
it charges are necessary to fund the high rate of credit losses incurred as a
result of financing Sub-Prime Borrowers. To the extent the Company is unable
to charge such higher prices or otherwise obtain acceptable margins, its
results of operations will be adversely affected.
Subsequent to each sale, all finance transactions are "audited" by the
Company's portfolio manager and reviewed for compliance with the Company's
underwriting standards. To the extent such audits reveal non-compliance, such
non-compliance is discussed with dealership management and, where appropriate,
remedial action is taken against the responsible manager, ranging from oral or
written reprimands to termination.
The Company's use of wide area and local area networks enables it to
service large volumes of contracts from its centralized servicing facilities
while allowing the customer the flexibility to make payments at and otherwise
deal with the individual dealerships. In addition, the Company has developed
comprehensive databases and sophisticated management tools, including static
pool analysis, to analyze customer payment history and contract performance
and to monitor underwriting effectiveness.
Advertising and Marketing. The Company believes that it maintains the
largest advertising budget of any Buy Here-Pay Here dealer in Arizona. In
general, the Company's advertising campaigns emphasize its multiple locations,
wide selection of quality used cars, and ability to provide financing to most
Sub-Prime Borrowers. The Company's advertising campaign revolves around a
series of television commercials that feature the Company's animated duck
mascot, as well as complementary radio, billboard, and print advertisements.
The Company believes that its marketing approach creates brand name
recognition and promotes its image as a professional, yet approachable,
business, in contrast to the lack of name recognition and generally
unfavorable public image of many Buy Here-Pay Here dealers. The Company
believes that its advertising has helped establish it as the most widely
recognized Buy Here-Pay Here dealership network in Arizona.
A primary focus of the Company's marketing strategy is its ability to
finance consumers with poor credit histories. Under the slogan "Ugly Duckling
Car Sales - Putting You on the Road to Good Credit," the Company has initiated
innovative marketing programs designed to attract Sub-Prime Borrowers, assist
such customers in reestablishing their credit, reward those customers who pay
on time, develop customer loyalty, and increase referral and repeat business.
Among these programs are:
- - The Down Payment Back Program. This program encourages customers to make
timely payments on their contracts by enabling them to receive a refund of
their initial down payment (typically representing 10.0%-15.0% of the initial
purchase price of the car) at the end of the contract term if all payments
have been made by the scheduled due date.
- - The Income Tax Refund Program. During the first quarter of each year, the
Company offers assistance to customers in the preparation of their income tax
returns, including forwarding customers' tax information to a designated
preparer, paying the preparation fee, and, if there is a forthcoming tax
refund, crediting such refund toward the required down payment. This program
enables customers to purchase cars without having to wait to receive their
income tax refund.
- - Secured $250 Visa Card Program. Pursuant to this program, the Company
arranges for qualified applicants to obtain a Visa credit card secured by a
nonrefundable $250 payment made by the Company to the credit card company.
This program offers otherwise unqualified customers the chance to obtain the
convenience of a credit card and rebuild their credit records.
The Company also utilizes various telemarketing programs. For example,
potential customers are contacted within several days of their visit to a
Company Dealership to follow up on leads and obtain information regarding
their experience while at a Company Dealership. In addition, customers with
satisfactory payment histories are contacted several months before contract
maturity and are offered an opportunity to purchase another vehicle with a
nominal down payment requirement. The Company also maintains a loan-by-phone
program utilizing its toll-free telephone number of 1-800-THE-DUCK.
Sales Personnel and Compensation. Each Company Dealership is run by a
general manager who has complete responsibility for the operations of the
dealership facility, including final approval of sales and contract
originations, inventory maintenance, the appearance and condition of the
facility, and the hiring, training, and performance of Company Dealership
employees. In addition to the general manager, the Company typically staffs
each dealership with, among others, up to three sales managers, an office
manager, a lot supervisor, five to twelve salespersons, and several mechanics.
The Company trains its managers to be contract underwriters. The Company
pays its managers a base salary and allows them to earn bonuses based upon a
variety of factors, including the overall performance of the contract
portfolio originated. Although sales persons are paid on commission, each sale
must be underwritten and approved by a manager. By giving its managers a
strong incentive to underwrite quality contracts, the Company believes that it
can maintain its current level of credit losses while continuing to achieve
significant growth in sales revenue.
THIRD PARTY DEALER OPERATIONS
Contract Purchasing. In 1994, the Company acquired Champion Financial
Services, Inc., an independent automobile finance company, primarily for its
management expertise and contract servicing software and systems. Champion had
a portfolio of approximately $1.9 million in sub-prime contracts averaging
approximately $2,000 in principal amount. For the balance of 1994, the Company
purchased an additional $1.7 million in contracts.
In April 1995, the Company initiated an aggressive plan for purchasing
contracts from Third Party Dealers and by January 31, 1997 had opened
thirty-nine Branch Offices in twelve different states throughout the country
and entered into contract purchasing agreements with approximately 1,400 Third
Party Dealers. The Company has hired experienced branch managers having
existing relationships with Third Party Dealers and opened Branch Offices near
its Third Party Dealers to better service their needs. The Company services
the Third Party Dealer contract portfolio from its centralized collection and
servicing centers. The expansion of its Third Party Dealer network enabled the
Company to leverage its existing infrastructure and increase its contract
portfolio much more quickly than it could through the planned expansion of its
Company Dealerships. The Company was also able to increase the socioeconomic
and geographic diversity of its contract portfolio by purchasing higher
quality contracts and contracts from areas where there are no Company
Dealerships.
The Company generally purchases contracts from Third Party Dealers that
are originated with customers possessing financial characteristics superior to
those of Company Dealership customers and that reflect principal amounts
closer to the actual wholesale value of the underlying car. Consequently, its
Third Party Dealer contracts generally present a reduced credit and collateral
risk. The Company's total revenues from its Third Party Dealer operations were
$1.8 million and $7.8 million in fiscal years 1995 and 1996, respectively. See
Note 20 to the Consolidated Financial Statements.
The Company purchases contracts from Third Party Dealers at a
nonrefundable acquisition discount from the principal amount of the contract
that generally ranges from 5.0% to 20.0%, and averages approximately 11.0%.
The Company determines the appropriate discount needed to cover estimated
losses on a contract-by-contract basis, taking into account, among other
things, the principal amount of the contract in relation to the wholesale
value of the underlying car and the credit risk presented by the particular
customer. The Company generally will not purchase a contract from a Third
Party Dealer if the discounted price exceeds 120.0% of the Kelly Blue Book
wholesale value of the underlying car plus license and tax, although it will
make exceptions on a contract-by-contract basis. If the Company cannot
negotiate an appropriate discount, it will not purchase the contract.
When opening a new office, the Company hires experienced branch managers
having existing relationships with Third Party Dealers. The Company's branch
managers have an average of approximately nine years of experience in the
sub-prime automobile finance industry. Upon the execution of a dealer
agreement with a Third Party Dealer, Branch Office employees will introduce
the dealer to the Company's systems and procedures. The Company provides
uniform contract buying criteria as well as expedient application processing
and funding. The Company expects its Branch Office employees to develop and
maintain excellent relationships with its Third Party Dealers.
Branch Office employees monitor and evaluate Third Party Dealer contracts
for conformity to established policies and procedures. Selected finance
transactions are examined each month and a written report on each Branch
Office is prepared. Included in the report is an evaluation of Branch Office
decisions and practices as well as the portfolio performance of individual
Third Party Dealers. Branch Office management is notified and counseled with
respect to variances from underwriting standards that are found. Branch Office
management monitors the first six months of contract performance. Substandard
contract performance during this period is discussed with the Third Party
Dealers and appropriate action taken.
Collateralized Dealer Financing. The Company believes that many Third
Party Dealers have difficulty obtaining traditional debt financing and, as a
result, are forced to sell the contracts that they originate through used car
sales at deep discounts in order to obtain the working capital necessary to
operate their businesses. To capitalize on this opportunity, the Company
initiated the Cygnet Dealer Program, pursuant to which it will provide
qualified Third Party Dealers (generally, dealers that meet certain minimum
net worth and operating history criteria) with operating credit lines secured
by the dealers' retail installment contract portfolios. These lines will be
for a specified amount but will in all cases be subject to various collateral
coverage ratios, maximum advance rates, and performance measurements depending
on the financial condition of the dealer and the quality of the contracts
originated. As a condition to providing such financing, the Company will
require each dealer to upload its portfolio information to the Company's
computer network on a daily basis, utilize the Company's management
information systems, and provide the Company with periodic financial
statements in a standardized format. These controls will allow Company account
officers, who will oversee the operations of each dealer participating in the
program, to maintain supervision over the dealers, thereby enabling the
account officers to ensure dealer compliance with financial covenants and
determine the appropriateness of continued credit extensions.
The Company believes that the Cygnet Dealer Program will fulfill the need
of Third Party Dealers for debt financing to expand their businesses while
enabling the Company to earn finance income at favorable rates and diversify
its earning asset base. The Company also believes that the relationships
established with these dealers will provide it with a preferred position to
acquire retail installment contracts from them. Such contract purchases would
provide these dealers with an additional source of financing and enable the
Company to further expand its contract portfolio. The Company has hired a
person with extensive sub-prime finance industry experience to oversee the
Cygnet Dealer Program and began implementing the program with one Third Party
Dealer during the fourth quarter of 1996. The Company began full-scale
marketing of the program during the first quarter of 1997, although the
program is not expected to begin generating any substantial revenue before the
second quarter of 1997.
Insurance Services. The retail installment contracts that the Company
purchases from Third Party Dealers generally require the customers to obtain
casualty insurance within 30 days of their vehicle purchase. While all
customers are free to obtain such coverage from an insurer of their choice, if
a customer fails to obtain the required coverage, the Company may purchase a
policy on the customer's behalf and charge back to the customer the cost of
the premiums and fees associated with such policy. The Company's ability to
force place such insurance has significantly increased the number of customers
who have obtained their own casualty insurance.
To facilitate its ability to force place mandated insurance coverage, the
Company has contracted with American Bankers Insurance Group ("ABIG"), a
licensed property, casualty, and life insurance company. Through its
subsidiary, Drake Insurance Agency, Inc., which acts as agent for ABIG, the
Company places casualty insurance policies issued by ABIG with Third Party
Dealer customers. These policies provide for a maximum payment on a claim
equal to the current contract principal balance. ABIG, in turn, reinsures the
policies it issues with Drake Property & Casualty Insurance Company, one of
the Company's Turks and Caicos Islands-chartered and licensed reinsurance
subsidiaries. Under the terms of its relationship with ABIG, the Company earns
commissions on each policy issued by ABIG (which mitigate any credit loss the
Company might suffer in the event of an otherwise uninsured casualty), while
ABIG administers all accounts and claims and is responsible for regulatory
compliance. As of December 31, 1996, the Company had placed casualty insurance
policies with approximately 1,200 customers. The Company anticipates expanding
its insurance services to include the provision of credit life, disability,
and unemployment insurance.
COMPARISON OF CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS AND THIRD PARTY
DEALERS
The chart below compares the characteristics of the average contract
originated by Company Dealerships and purchased from Third Party Dealers for
the twelve months ended November 30, 1996:
<TABLE>
<CAPTION>
COMPANY THIRD PARTY
--------- -------------
<S> <C> <C>
Principal Amount of Contract $ 7,071 $ 5,778
Annual Percentage Rate 29.9% 24.5%
Loan Term (Months) 37.5 33.4
Total Down Payment $ 858 $ 1,368
Company Cost or Third Party Dealer Advance $ 3,304 $ 5,119
Blue Book Value (Wholesale) $ 3,685 $ 4,983
Model Year 88 89
Age of Borrower 34 34
Annual Income $ 25,589 $ 30,559
Years at Current Residence 4.6 3.8
Years at Current Job 3.2 3.4
</TABLE>
The Company expects that approximately 35.0% to 40.0% of Company
Dealership contracts will ultimately default at some time prior to maturity
for a net loss, after charge offs and recoveries of approximately 20.0% to
25.0% of the original principal amount financed. See Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Allowance for Credit Losses - Contracts Originated at Company Dealerships."
The Company expects that approximately 20.0% to 25.0% of Third Party
Dealer contracts will ultimately default at some time prior to maturity for a
net loss, after charge offs and recoveries of approximately 8.0% to 12.0% of
the original principal amount financed. See Item 7. "Management's Discussion
and Analysis of Financial Condition and Results of Operations - Allowance for
Credit Losses - Contracts Purchased From Third Party Dealers."
MONITORING AND COLLECTIONS
The Company believes that its ability to minimize credit losses is due in
great part to the sophisticated manner in which it monitors the Company
Dealership and Third Party Dealer contracts in its portfolio.
Upon the origination or purchase of a contract, Company personnel enter
all terms of the contract into the Company's centralized computer system. The
Company's monitoring and collections staff then utilizes the Company's
collections software to monitor the performance of the contracts.
The collections software provides the Company with, among other things,
up-to-date activity reports, allowing immediate identification of customers
whose accounts have become past due. In accordance with Company policy,
collections personnel contact a customer with a past due account within three
days of delinquency (or in the case of first payment delinquencies, within one
day) to inquire as to the reasons for such delinquency and to suggest ways in
which the customer can resolve the underlying problem, thereby enabling the
customer to continue making payments and keep the car. The Company's early
detection of a customer's delinquent status, as well as its commitment to
working with its customers, allows it to identify and address payment problems
quickly, thereby reducing the amount of credit loss. See Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Allowance for Credit Losses."
If the Company's efforts to work with a customer are unsuccessful and the
customer becomes seriously delinquent, the Company will take the necessary
steps to protect its collateral. Frequently, delinquent customers will
recognize their inability to honor their contractual obligations and will work
with the Company to coordinate "voluntary repossessions" of their cars. For
cases involving uncooperative customers, the Company retains independent firms
to repossess the cars pursuant to prescribed legal procedures. Upon
repossession and after a statutorily-mandated waiting period, the Company will
recondition the car, if necessary, and sell it in the wholesale market or at
retail through its Company Dealerships. The Company estimates that it recovers
over 90.0% of the cars that it attempts to repossess, approximately 90.0% of
which are sold on a wholesale basis and the remainder of which are sold
through Company Dealerships. The Company's access to a retail outlet for its
repossessed collateral provides the Company with additional flexibility with
respect to the disposal of the collateral and helps lessen its credit losses.
See Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Allowance for Credit Losses."
Unlike most other used car dealerships with multiple locations or
automobile finance companies, the Company permits its customers to make cash
payments on their contracts in person at Company Dealerships or at the
Company's collection facilities. Cash payments account for a significant
portion of monthly contract receipts on the Company Dealership portfolio. The
Company's computer technology enables it to process these payments on-line in
real time and its internal procedures enable it to verify that such cash
receipts are deposited and credited to the appropriate accounts.
COMPETITION
Although the used car industry has historically been highly fragmented,
it has attracted significant attention recently from a number of large
companies, including AutoNation, U.S.A. and Driver's Mart, which have entered
the used car sales business or announced plans to develop large used car sales
operations. Many franchised automobile dealers have increased their focus on
the used car market as well. The Company believes that these companies are
attracted by the relatively high gross margins that can be achieved in this
market as well as the industry's lack of consolidation. Many of these
companies and franchised dealers have significantly greater financial,
marketing, and other resources than the Company.
The Company's targeted competition for its Company Dealerships are the
numerous independent Buy Here-Pay Here dealers that sell and finance sales of
used cars to Sub-Prime Borrowers. The Company distinguishes its direct sales
and financing operations from those of typical Buy Here-Pay Here dealers by
providing multiple locations, upgraded facilities, large inventories of used
automobiles, centralized purchasing, value-added marketing programs, and
dedication to customer service. In addition, the Company has developed
flexible underwriting guidelines and techniques to facilitate rapid credit
decisions, as well as an integrated, technology-based corporate infrastructure
that enables the Company to monitor and service large volumes of contracts.
The Company believes that it is the largest Buy Here-Pay Here dealer in
Arizona and one of the largest in the United States. Of the numerous large
companies that have entered the used car business, none have announced an
intention to focus on the Buy Here-Pay Here segment.
The sub-prime segment of the used car financing business is also highly
fragmented and very competitive. In recent periods, several consumer finance
companies have completed public offerings in order to raise the capital
necessary to fund expansion and support increased purchases of used car retail
installment contracts. These companies have increased the competition for the
purchase of contracts, in many cases purchasing contracts at prices which the
Company believes are not commensurate with the associated risk. In addition,
there are numerous financial services companies serving, or capable of
serving, this market. While traditional financial institutions, such as
commercial banks, savings and loans, credit unions, and captive finance
companies of major automobile manufacturers, have not consistently serviced
Sub-Prime Borrowers, the high rates of return earned by companies involved in
sub-prime financing have encouraged certain of these traditional institutions
to enter, or contemplate entering, this market. Increased competition may
cause downward pressure on the interest rate the Company charges on contracts
originated by its Company Dealerships or cause the Company to reduce or
eliminate the nonrefundable acquisition discount on the contracts it purchases
from Third Party Dealers. Such events would have a material adverse affect on
the Company's profitability.
REGULATION, SUPERVISION, AND LICENSING
The Company's operations are subject to ongoing regulation, supervision,
and licensing under various federal, state, and local statutes, ordinances,
and regulations. Among other things, these laws require that the Company
obtain and maintain certain licenses and qualifications, limit or prescribe
terms of the contracts that the Company originates and/or purchases, require
specified disclosures to customers, limit the Company's right to repossess and
sell collateral, and prohibit the Company from discriminating against certain
customers. The Company is also subject to federal and state franchising and
insurance laws.
The Company typically charges fixed interest rates ranging from 21.0% to
29.9% on the contracts originated at Company Dealerships, while rates range
from 17.6% to 29.9% on the Third Party Dealer contracts it purchases. As of
December 31, 1996, a majority of the Company's used car sales activities were
conducted in, and a majority of the contracts the Company services were
originated in, Arizona, which does not impose limits on the interest rate that
a lender may charge. However, the Company has expanded, and will continue to
expand, its operations into states that impose usury limits, such as Florida
and Texas. The Company attempts to mitigate these rate restrictions by
purchasing contracts originated in these states at a higher discount.
The Company believes that it is currently in substantial compliance with
all applicable federal, state, and local laws and regulations. There can be no
assurance, however, that the Company will be able to remain in compliance with
such laws, and such failure could have a material adverse effect on the
operations of the Company. In addition, the adoption of additional statutes
and regulations, changes in the interpretation of existing statutes and
regulations, or the Company's entrance into jurisdictions with more stringent
regulatory requirements could have a material adverse effect on the Company's
business.
TRADEMARKS AND PROPRIETARY RIGHTS
The Company has obtained federal trademark registrations on its duck
mascot and logo, as well as for the trade names "Ugly Duckling Car Sales,"
"Ugly Duckling Rent-A-Car," and "America's Second Car." These registrations
are effective through 2002 and are renewable for additional terms of ten
years. The Company grants its Ugly Duckling Rent-a-Car franchisees the limited
right to use its duck mascot and logo in their used car rental operations. The
Company has also obtained a federal trademark registration for the slogan
"Putting You On the Road to Good Credit."
The Company licenses software from various third parties. It has also
developed and copyrighted customized software to facilitate its sales and
financing activities. Although the Company believes it takes appropriate
measures to protect its proprietary rights and technology, there can be no
assurance that such efforts will be successful. The Company believes it is in
material compliance with all third party licensing requirements.
EMPLOYEES
At December 31, 1996, the Company employed 652 persons, of which 69 were
employed in the Company's executive and administrative offices, 242 were
employed in its Company Dealership operations, 155 were employed in the
Company's credit and collection activities, and 186 were employed in Third
Party Dealer operations. None of the Company's employees are covered by a
collective bargaining agreement. The Company considers its relations with its
employees to be good.
ITEM 2 - PROPERTIES
As of December 31, 1996, the Company owned the property in which six of
its dealerships, two of its collection facilities and one reconditioning
facility are located. In addition, the Company leased 47 other facilities. The
Company's corporate headquarters are located in approximately 13,300 square
feet of leased space in Phoenix, Arizona. This lease commenced in April 1996
and expires in August 2001. Five of the Company's dealerships are leased from
unrelated third parties. The Company's other leased facilities at that date
included a monitoring and collection facility, two storage lots, and 38 Branch
Offices (of which 35 were open). The leases contain renewal options from one
to ten years and require aggregate monthly base rents of $136,000.
ITEM 3 - LEGAL PROCEEDINGS
The Company sells its cars on an "as is" basis, and requires all
customers to sign an agreement on the date of sale pursuant to which the
Company disclaims any obligation for vehicle-related problems that
subsequently occur. Although the Company believes that such disclaimers are
enforceable under Arizona and other applicable law, there can be no assurance
that they will be upheld in every instance. Despite obtaining these
disclaimers, the Company, in the ordinary course of business, receives
complaints from customers relating to such vehicle-related problems as well as
alleged violations of federal and state consumer lending or other similar laws
and regulations. While most of these complaints are made directly to the
Company or to various consumer protection organizations and are subsequently
resolved, the Company is named occasionally as a defendant in civil suits
filed by customers in state, local, or small claims courts. There can be no
assurance that the Company will not be a target of similar claims in the
future. In the opinion of the Company, 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 acquisition of the Florida dealerships and finance
operations (disclosed in Item 1. "Business - Recent Acquisitions"), 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. In
the opinion of the Company, the ultimate disposition of this matter will not
have a material effect on the Company.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company did not submit any matter to a vote of its security holders
during the fourth quarter of 1996.
PART II
ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY SECURITIES
AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock trades on the Nasdaq National Market tier
under the symbol "UGLY." The Company's initial public offering was June 17,
1996. The high and low sales prices of the Common Stock, as reported by
Nasdaq since that date are reported below.
<TABLE>
<CAPTION>
MARKET PRICE
-------------
FISCAL YEAR 1996 HIGH LOW
- -------------------------------------- ------------- ------
<S> <C> <C>
Second Quarter (from June 18, 1996) $ 10.00 $ 8.50
Third Quarter $ 15.50 $ 8.13
Fourth Quarter $ 21.63 $13.00
FISCAL YEAR 1997
- --------------------------------------
First Quarter (through March 15, 1997) $ 25.75 $17.50
</TABLE>
On March 10, 1997 there were 127 record owners of the Company's Common
Stock. The Company estimates that as of such date there were 1,600 beneficial
owners of the Company's Common Stock.
Dividend Policy. The Company has never paid cash dividends on its Common
Stock and does not anticipate doing so in the foreseeable future. It is the
current policy of the Company's Board of Directors to retain any earnings to
finance the operation and expansion of the Company's business. In addition,
the terms of the Company's Revolving Facility prevent the Company from
declaring or paying dividends in excess of 15.0% of each year's net earnings
available for distribution. See Item 7. "Management's Discussion and Analysis
of Financial Condition and Results of Operations - Liquidity and Capital
Resources - Revolving Facility.
Reincorporation. On April 24, 1996, the Company reincorporated from
Arizona to Delaware by way of a merger in which the Company, an Arizona
corporation, merged with and into a newly created Delaware subsidiary of the
Company. In the merger, each share of the Arizona corporation's issued and
outstanding common stock was exchanged for 1.16 shares of the Delaware
corporation's common stock and each option to purchase shares of the Arizona
corporation's common stock was exchanged for 1.16 options to purchase shares
of the Delaware corporation's common stock. All share figures set forth above
give effect to this exchange ratio.
Warrant Issuance. In connection with the Company's initial public
offering, the Company issued warrants to Cruttenden Roth to purchase 170,000
shares of Common Stock at an exercise price per share of $9.45. The warrants
were issued in exchange for $1,700 pursuant to an Underwriting Agreement
between the Company and Cruttenden Roth, as the representative of the several
underwriters in the initial public offering, and pursuant to a
Representative's Warrant Agreement between the Company and Cruttenden Roth.
Subordinated Debt Conversion. In connection with the Company's initial
public offering, on June 21, 1996, Sun America converted $3,000,000 of
subordinated debt into Common Stock (444,444 shares at the initial public
offering price of $6.75 per share) in accordance with the terms of a
Convertible Note, dated as of August 31, 1995. In addition, in partial
consideration for Sun America's agreement to convert the Convertible Note, the
Company issued warrants to Sun America, on June 21, 1996, to purchase 121,023
shares of Common Stock at an exercise price per share of $6.75.
Private Placement. On February 13, 1997, the Company sold 5,075,500
shares of Common Stock to approximately 115 institutional purchasers for an
aggregate purchase price of $94,531,188. Friedman, Billings, Ramsey & Co.,
Inc. acted as placement agent in the transaction. The total proceeds to the
Company, net of discounts and commissions, was $89,804,629 before deducting
offering expenses.
Exemption from registration for the reincorporation, the warrant
issuances, the subordinated debt conversions, and the private placement was
claimed pursuant to Section 4(2) of the Securities Act regarding transactions
by an issuer not involving any public offering and/or pursuant to Rule 145
under the Securities Act regarding transactions the sole purpose of which is
to change an issuer's domicile solely within the United States.
FACTORS THAT MAY AFFECT FUTURE STOCK PERFORMANCE
The performance of the Company's Common Stock is dependent upon several
factors including those set forth below and in Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations -
Factors That May Affect Future Results and Financial Condition."
Control by Principal Stockholder. Mr. Ernest C. Garcia, II, the
Company's Chairman, Chief Executive Officer, and principal stockholder, holds
25.1% of the outstanding Common Stock. As a result, Mr. Garcia will have a
significant influence upon the activities of the Company, as well as on all
matters requiring approval of the stockholders, including electing or removing
members of the Company's Board of Directors, causing the Company to engage in
transactions with affiliated entities, causing or restricting the sale or
merger of the Company, and changing the Company's dividend policy.
Potential Anti-Takeover Effect of Preferred Stock. 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.
Shares Eligible for Future Sale. Approximately 10,535,600 shares of
Common Stock outstanding as of March 15, 1997 were "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 at March 15, 1997, substantially all of these shares
have either been held for the one-year holding period required under Rule 144
or were subsequently registered for resale under the Securities Act of 1933,
as amended (the "Securities Act"), including 5,075,500 shares sold in the
private placement discussed above. No predictions can be made with respect to
the effect, if any, that sales of Common Stock in the market or the
availability of shares of Common Stock for sale under Rule 144 will have on
the market price of Common Stock prevailing from time to time. Nevertheless,
the possibility that substantial amounts of Common Stock may be sold in the
public market may adversely affect prevailing market prices for the Common
Stock.
Possible Volatility of Stock Price. The market price of the Common Stock
could be subject to significant fluctuations in response to such factors as,
among others, variations in the anticipated or actual results of operations of
the Company or other companies in the used car sales and finance industry,
changes in conditions affecting the economy generally, analyst reports, or
general trends in the industry.
ITEM 6 - SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
The following table sets forth selected historical consolidated financial
data of the Company for each of the years in the five-year period ended
December 31, 1996. The selected annual historical consolidated financial data
for 1993, 1994, 1995, and 1996 are derived from the Company's Consolidated
Financial Statements audited by KPMG Peat Marwick LLP, independent certified
public accountants. The selected annual historical consolidated financial data
for 1992 are derived from the Company's Consolidated Financial Statements
audited by Toback & Co., independent certified public accountants. For
additional information, see the Consolidated Financial Statements of the
Company included elsewhere in this report. The following table should be read
in conjunction with Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE><CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------------------
1996 1995 1994 1993 1992
------------ ------- -------- ------- --------
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Sales of Used Cars $ 53,768 $47,824 $27,768 $13,969 $ 2,136
Less:
Cost of Used Cars Sold 29,890 27,964 12,577 6,089 1,010
Provision for Credit Losses 9,811 8,359 8,140 3,292 826
------------ ------- -------- ------- --------
14,067 11,501 7,051 4,588 300
------------ ------- -------- ------- --------
Interest Income 15,856 10,071 5,449 1,629 148
Gain on Sale of Loans 4,434 - - - -
------------ ------- -------- ------- --------
20,290 10,071 5,449 1,629 148
------------ --------
Servicing Income 921 - - - -
Other Income 650 308 556 879 982
------------ ------- -------- ------- --------
1,571 308 556 879 982
------------ ------- -------- ------- --------
Income before Operating Expenses 35,928 21,880 13,056 7,096 1,430
Operating Expenses:
Selling and Marketing 3,585 3,856 2,402 1,293 656
General and Administrative 19,538 14,726 9,141 3,625 828
Depreciation and Amortization 1,577 1,314 777 557 429
------------ ------- -------- ------- --------
24,700 19,896 12,320 5,475 1,913
------------ ------- -------- ------- --------
Income before Interest Expense 11,228 1,984 736 1,621 (483)
Interest Expense 5,262 5,956 3,037 893 12
------------ ------- -------- ------- --------
Earnings (Loss) before Income Taxes 5,966 (3,972) (2,301) 728 (495)
Income Taxes (Benefit) 100 - (334) 30 -
------------ ------- -------- ------- --------
Net Earnings (Loss) $ 5,866 $(3,972) $(1,967) $ 698 $ (495)
============ ======= ======== ======= ========
Earnings (Loss) per Share $ 0.60 $ (0.67) $ (0.35) $ 0.14 $ (0.11)
============ ======= ======== ======= ========
Shares used in Computation 8,283 5,892 5,584 5,011 4,640
============ ======= ======== ======= ========
BALANCE SHEET DATA:
Cash and Cash Equivalents $ 18,455 $ 1,419 $ 168 $ 79 $ 415
Finance Receivables, Net 51,063 40,726 15,858 7,089 1,758
Total Assets 118,083 60,790 29,711 11,936 4,392
Subordinated Notes Payable 14,000 14,553 18,291 8,941 93
Total Debt 26,904 49,754 28,233 9,380 4,189
Preferred Stock - 10,000 - - -
Common Stock 82,612 127 77 1 1
Total Stockholders' Equity (Deficit) 82,319 4,884 (1,194) 697 (1)
Principal Balances Outstanding:
Dealership Sales Portfolio 7,068 34,226 19,881 9,588 2,492
Third Party Dealer Portfolio 51,213 13,805 1,620 - -
Portfolio Securitized with Servicing Retained 51,663 - - - -
------------ ------- -------- ------- --------
Total $ 109,944 $48,031 $21,501 $ 9,588 $2,492
============ ======= ======== ======= ========
</TABLE>
SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
(IN THOUSANDS, EXCEPT PER SHARE AND OPERATING DATA)
<TABLE><CAPTION>
YEARS ENDED DECEMBER 31,
---------------------------------------------------
1996 1995 1994 1993 1992(1)
------------ -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
DEALERSHIP OPERATING DATA (UNAUDITED):
Average Sales Price per Car $ 7,107 $ 6,478 $ 5,269 $ 4,159 n/a
Number of Used Cars Sold 7,565 7,383 5,270 3,359 n/a
Company Dealerships 8 8 8 5 1
Units Sold per Dealership 946 923 659 672 n/a
Number of Contracts Originated 6,929 6,129 4,731 3,093 n/a
Principal Balances Originated (000 Omitted) $ 48,996 $36,568 $23,589 $12,984 n/a
Retained Portfolio:
Number of Contracts Outstanding 1,045 8,049 5,515 2,929 803
Allowance as % of Outstanding Principal 23.0% 21.9% 30.4% 30.0% 29.4%
Average Principal Balance Outstanding 6,764 $ 4,252 $ 3,605 $ 3,273 $ 3,105
Average Yield on Contracts 29.2% 28.0% 28.2% 26.4% n/a
Delinquencies:
Principal Balances 31 to 60 Days 2.3% 4.2% 5.1% 10.5% n/a
Principal Balances over 60 Days 0.6% 1.1% 1.3% 15.0% n/a
THIRD PARTY OPERATING DATA (UNAUDITED):
Number of Contracts Purchased 9,825 3,012 1,423 - -
Principal Balances Purchased (000 Omitted) $ 56,770 $16,455 $ 3,607 $ - $ -
Number of Branch Offices 35 8 1 - -
Number of Third Party Dealers 1,400 118 20 - -
Number of Contracts Outstanding 8,430 2,733 726 - -
Retained Portfolio:
Allowance as % of Outstanding Principal 12.7% 7.2% 9.8% - -
Average Principal Balance Outstanding 5,252 $ 5,051 $ 2,232 $ - $ -
Average Yield on Contracts 25.8% 26.7% 30.9% - -
Delinquencies:
Principal Balances 31 to 60 days 3.1% 1.2% 6.0% - -
Principal Balances over 60 days 1.1% 0.4% 2.6% - -
Per Contract Purchased:
Average Discount $ 660 $ 551 $ 504 $ - $ -
Average Percent Discount 11.4% 10.1% 12.5% - -
__________
(1) n/a - not available
</TABLE>
<PAGE>
ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
This report 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, and Section 21E of the Securities Exchange Act of 1934,
as amended (the "Exchange Act"). Such statements may include, but not be
limited to, projections of revenues, income, or loss, estimates of capital
expenditures, plans for future operations, products or services, and financing
needs or plans, as well as assumptions relating to the foregoing. The words
"believe," "expect," "anticipate," "estimate," "project," and similar
expressions identify forward looking statements, which speak only as of the
date the statement was made. Forward looking statements are inherently subject
to risks and uncertainties, some of which cannot be predicted or quantified.
Future events and actual results could differ materially from those set forth
in, contemplated by, or underlying the forward looking statements. The
following disclosures, as well as other statements in the Company's report,
including those contained below in Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations," in Item 5.
"Market for the Registrant's Common Equity Securities and Related Stockholders
Matters," and in the Notes to the Company's Consolidated Financial Statements,
describe factors, among others, that could contribute to or cause such
differences, or that could affect the Company's stock price.
INTRODUCTION
General. The Company commenced its used car sales and finance operations
with the acquisition of two Company Dealerships in 1992. During 1993, the
Company acquired three additional Company Dealerships. In 1994, the Company
constructed and opened four new Company Dealerships that were built
specifically to meet the Company's new standards of appearance, reconditioning
capabilities, size, and location. During 1994, the Company closed one Company
Dealership because the facility failed to satisfy these new standards and, at
the end of 1995, closed its Gilbert, Arizona dealership (the "Gilbert
Dealership"). In July, 1996, the Company opened a small dealership in
Prescott, Arizona.
For substantially all of 1995 the Gilbert Dealership was used by the
Company to evaluate the sale of later model used cars. These cars had an
average age of approximately three years, which is two to seven years newer
than the cars typically sold at Company Dealerships, and cost more than twice
that of typical Company Dealership cars. The Company determined that its
standard financing program could not be implemented on these higher cost cars.
Furthermore, operation of this dealership required additional corporate
infrastructure to support its market niche, such as distinct advertising and
marketing programs, which the Company was unable to leverage across its other
operations. Accordingly, the Company terminated this program, and sold the
land, dealership building, and other improvements to a third party for $1.7
million. Pursuant to this sale and the disposition of other assets, the
Company recognized a loss of approximately $221,000. During fiscal year 1995,
the Gilbert Dealership produced sales of $9.5 million (average of $8,946 per
car sold) and gross profits (Sales of Used Cars less Cost of Used Cars Sold)
of $2.2 million (average of $2,060 per car sold), and the Company incurred
selling and marketing expenses of $627,000 (average of $593 per car sold). The
results of operations discussed below have been adjusted as if the Gilbert
Dealership had been terminated as of December 31, 1994, as management believes
these pro forma results are more indicative of ongoing operations.
Accordingly, 1995 amounts followed by "(pro forma)" have been adjusted to
eliminate Gilbert Dealership operations. For the Company's actual 1995
results, including the Gilbert Dealership, see Item 6. - "Selected
Consolidated Financial Data" and Item 8. - "Consolidated Financial Statements
and Supplementary Data."
In 1994, the Company acquired Champion Financial Services, Inc., an
independent automobile finance company, primarily for its management expertise
and contract servicing software and systems. Champion had one office and a
portfolio of approximately $1.9 million in sub-prime contracts averaging
approximately $2,000 in principal amount. For the balance of 1994, the Company
purchased an additional $1.7 million in contracts.
In April 1995, the Company initiated an aggressive plan to expand the
number of contracts purchased from its Third Party Dealer network. By the end
of 1996 the Company had 35 branch offices in 12 states. This expansion
enabled the Company to leverage its existing infrastructure and increase its
contract portfolio much more quickly than it could through the expansion of
its Company Dealerships. The Company is in the process of further expanding
its Third Party Dealer operations and diversifying its earning asset base by
implementing the Cygnet Dealer Program pursuant to which the Company will
provide Third Party Dealers with operating credit lines secured by the
dealers' retail installment contract portfolios.
In 1996 the Company completed an initial public offering and a secondary
offering in which it sold common stock for a total of $82.3 million.
On January 15, 1997, the Company acquired substantially all of the
assets of Seminole Finance Corporation and related companies ("Seminole") in
exchange for approximately $2.5 million in cash and assumption of $29.9
million in debt. The combination of the Company's audited consolidated
statement of operations for the year ended December 31, 1996 with Seminole's
audited combined statement of operations for the same period as if the
Seminole acquisition had taken place on January 1, 1996 results in a combined
net loss for the year ended December 31, 1996 of $(3.6) million. These pro
forma results are not necessarily indicative of the future results of
operations of the Company or the results that would have been obtained had the
Seminole acquisition occurred on January 1, 1996. In addition, such pro forma
results are not intended to be a projection of future results. The Company
expects the results of operations in 1997 for the assets acquired from
Seminole to differ materially from 1996 results because the Company's
management intends to significantly alter the type of vehicles sold at the
newly acquired car dealerships, the methodology by which the acquired
operations acquire, recondition, and market used cars, and the methodology by
which the related finance receivables are underwritten and collected, which
management believes will result in the acquired operations being profitable in
1997. Furthermore, Seminole's audited combined statement of operations for
1996 was impacted by several factors that are not expected to have an impact
on future operations. Such factors were related to the deterioration of its
loan portfolio, which the Company believes resulted from poor underwriting and
ineffective collection efforts. First, due to the deterioration of its loan
portfolio in 1996, Seminole recorded a total of $7.1 million in provision for
credit losses. Second, the deterioration of its loan portfolio also reduced
its borrowing capacity, thereby reducing Seminole's liquidity. As a result,
in order to raise cash, Seminole sold vehicles at substantially lower margins
and sold a portfolio of notes in December, 1996 for a loss of approximately
$1.5 million.
The following discussion and analysis provides information regarding the
Company's consolidated financial position as of December 31, 1996, and 1995,
and its results of operations for the years ended December 31, 1996, 1995 and
1994.
Growth in Finance Receivables. As a result of the Company's rapid
expansion, contract receivables serviced increased by 129.0% to $109.9 million
at December 31, 1996 (including $51.7 million in contracts serviced under the
Company's Securitization Program) from $48.0 million at December 31, 1995,
which was an increase of 123.3% from $21.5 million at December 31, 1994.
The following tables reflect the growth in contract originations by
Company Dealerships and contract purchases from Third Party Dealers as well as
the period end balances measured in terms of the principal amount and the
number of contracts.
<TABLE><CAPTION>
TOTAL CONTRACTS ORIGINATED/PURCHASED
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1996 1995 1994
---------------------- --------------------- ---------------------
PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL NO. OF
AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Company Dealerships $ 48,996 6,929 $ 36,568 6,129 $ 23,589 4,731
Third Party Dealers 56,770 9,825 16,455 3,012 3,607 1,423
---------- ---------- --------- ---------- --------- ----------
Total $ 105,766 16,754 $ 53,023 9,141 $ 27,196 6,154
========== ========== ========= ========== ========= ==========
</TABLE>
<PAGE>
<TABLE><CAPTION>
TOTAL CONTRACTS OUTSTANDING
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
YEARS ENDED DECEMBER 31,
--------------------------------------------------------------------
1996 1995 1994
---------------------- --------------------- ---------------------
PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL NO. OF
AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C>
Company Dealerships $ 49,066 9,615 $ 34,226 8,049 $ 19,881 5,515
Third Party Dealers 60,878 12,942 13,805 2,733 1,620 726
---------- ---------- --------- ---------- --------- ----------
Total Portfolio Serviced $ 109,944 22,557 $ 48,031 10,782 $ 21,501 6,241
Less Portfolio Securitized
and Sold (51,663) (10,612) - - - -
---------- ---------- --------- ---------- --------- ----------
Company Total $ 58,281 11,945 $ 48,031 10,782 $ 21,501 6,241
========== ========== ========= ========== ========= ==========
</TABLE>
The first table, reflecting Third Party Dealer purchases excludes $5.6
million in principal balances (2,095 contracts) acquired in a single bulk
purchase in late December 1996 and also excludes $1.6 million in lease
contracts acquired in October 1996 as part of a purchase of certain assets of
a used car dealership in Las Vegas, Nevada. The second table, reflecting Third
Party Dealer principal balances, includes $5.5 million in principal balances
related to this bulk purchase and includes $1.4 million (375 contracts) in
balances related to these leases. There were no material bulk purchases in
1995 or 1994.
RESULTS OF OPERATIONS
The prices at which the Company sells its cars and the interest rates
that it charges to finance these sales take into consideration that the
Company's primary customers are high-risk borrowers, many of whom ultimately
default. The Provision for Credit Losses reflects these factors and is treated
by the Company as a cost of both the future interest income derived on the
contract receivables originated at Company Dealerships as well as a cost of
the sale of the cars themselves. Accordingly, unlike traditional car
dealerships, the Company does not present gross profits in its Statements of
Operations calculated as Sales of Used Cars less Cost of Used Cars Sold.
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
Sales of Used Cars. Sales of Used Cars increased by 40.1% to $53.8
million for the year ended December 31, 1996 from $38.4 million (pro forma)
for the year ended December 31, 1995 and by 38.1% for the year ended December
31, 1995 from $27.8 million for the year ended December 31, 1994. This growth
reflects increases in the average unit sales price and the average number of
units sold by each Company Dealership.
The average sales price per car increased by 17.2% to $7,107 for the year
ended December 31, 1996 from $6,065 (pro forma) for the year ended December
31, 1995 compared to 15.1% from $5,269 in 1994. This increase reflects
management's decision to sell higher quality vehicles at its Company
Dealerships. Units sold per Company Dealership averaged 946, 904 (pro forma),
and 659 for the years ended December 31, 1996, 1995, and 1994, respectively.
The Company attributes the increase in units sold per Company Dealership to
the success of the Company's business strategy, most notably its advertising
and marketing programs.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 44.4% to $29.9 million for the year ended December 31, 1996 from
$20.7 million (pro forma) for the year ended December 31, 1995, which was an
increase of 64.3% from $12.6 million for the year ended December 31, 1994. On
a per unit basis, the Cost of Used Cars Sold increased by 20.8% to $3,951 for
the year ended December 31, 1996 from $3,270 (pro forma) for the year ended
December 31, 1995, which was an increase of 37.0% from $2,387 for the year
ended December 31, 1994, largely due to management's determination to sell
higher quality cars throughout its operations. The gross margin on used car
sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision for
Credit Losses) increased by 35.0% to $23.9 million for the year ended December
31, 1996 from $17.7 million (pro forma) for the year ended December 31, 1995,
which was an increase of 16.4% from $15.2 million for the year ended December
31, 1994. As a percentage of sales, the gross margin was 44.4%, 46.1% (pro
forma), and 54.7% for the years ended December 31, 1996, 1995, and 1994,
respectively. The Company attributes the decline in the gross margin
percentage to management's strategy of increasing the quality and, therefore,
the cost, of cars sold at Company Dealerships while maintaining a consistent
dollar gross margin per unit sold. The decline in the gross margin percentage
was offset by corresponding increases in the quality of finance contracts
generated (resulting in a lower Provision for Credit Losses) and greater unit
sales per Company Dealership. On a per unit basis, the gross margin per car
sold was $3,156, $2,795(pro forma), and $2,882 for the years ended December
31, 1996, 1995, and 1994, respectively.
Provision for Credit Losses. A high percentage of Company Dealership
customers ultimately do not make all of their contractually scheduled
payments, requiring the Company to charge off the remaining principal balance
due. As a result, the Company recognizes a Provision for Credit Losses in
order to establish an Allowance for Credit Losses sufficient to absorb
anticipated future losses. The Provision for Credit Losses increased by 25.6%
to $9.8 million in 1996 over $7.8 million (pro forma) in 1995, which was a
decrease of $300,000 or 3.7% from $8.1 million in 1994. This includes an
increase of $153,000 in the Provision for Credit Losses in 1996 for third
party receivables over 1995 when the Company recorded no Provision for Credit
Losses for third party receivables. In 1994, the Company recorded Provision
for Credit Losses totaling $116,000 for its third party loan portfolio. On a
percentage basis, the Provision for Credit Losses per unit originated at
Company Dealerships increased by 3.1% to $1,277 per unit in 1996 over $1,239
(pro forma) per unit in 1995, which was a decrease of 18.7% from 1994 when the
average was $1,523 per unit. As a percentage of contract balances originated,
the Provision for Credit Losses averaged 19.7%, 22.8% (pro forma), and 34.5%
in 1996, 1995, and 1994, respectively. This decrease reflects the Company's
strengthened underwriting requirements, the higher quality of the cars sold,
and the Company's improved collection efforts.
The Company charges its Provision for Credit Losses to current operations
and does not recognize any portion of the unearned interest income as a
component of its Allowance for Credit Losses. Accordingly, the Company's
unearned finance income is comprised of the full annual percentage rate
("APR") on its contracts less amortization of loan origination costs.
Interest Income. Interest Income consists primarily of interest on both
finance receivables from Company Dealership sales and interest on Third Party
Dealer finance receivables.
Company Dealership Sales - Interest Income increased by 2.4% to $8.4
million for the year ended December 31, 1996 from $8.2 million for the year
ended December 31, 1995, which increased by 74.5% compared to $4.7 million in
the year ended December 31, 1994. Interest Income during the year ended
December 31, 1996 was affected by the sale of $58.2 million in contract
principal balances pursuant to 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 91.1% of sales revenue and
91.6% of the used cars sold at Company Dealerships for the year ended December
31, 1996 compared to 89.7% (pro forma) of sales revenue and 91.2% (pro forma)
of the used cars sold for the year ended December 31, 1995, and 85.0% of sales
revenue and 89.8% of used cars sold in the year ended December 31, 1994. The
average amount financed increased to $7,071 for the year ended December 31,
1996 from $5,966 for the year ended December 31, 1995 which had increased from
$4,986 for the year ended December 31, 1994. The effective yield on Finance
Receivables from Company Dealerships was 29.2%, 28.0%, and 28.2% for the years
ended December 31, 1996, 1995, and 1994, respectively. The Company operated 8,
7 (pro forma), and 8 dealerships at December 31, 1996, 1995, and 1994,
respectively.
Third Party Dealers - Interest Income increased by 305.6% to $7.3 million
for the year ended December 31, 1996 from $1.8 million in 1995, which was an
increase of 153.5% from $710,000 in 1994. Interest Income during the year
ended December 31, 1996 was effected by the sale of $10.0 million in contract
principal balances pursuant to the Securitization Program, and will continue
to be effected in future periods by additional securitizations. Interest
income has increased in conjunction with the increases in Third Party Dealer
contracts purchased and outstanding. As noted above, the Company began to
significantly expand its Third Party Dealer branch office operations in April
1995. Further, subsequent to June 30, 1995, as a result of its migration to
higher quality contracts and expansion into markets with interest rate limits,
the Company's yield on its Third Party Dealer contract portfolio has trended
downward. Portfolio yield was approximately 25.8%, 26.7%, and 30.9% for the
years ended December 31, 1996, 1995, and 1994, respectively. The Company
operated 35, 8 and 1 branch office(s) at December 31, 1996, 1995, and 1994,
respectively.
Gain on Sale of Loans. Champion Receivables Corporation ("CRC") a
"bankruptcy remote entity" is the Company's wholly-owned special purpose
securitization subsidiary. During the first quarter of 1996, the Company
initiated a Securitization Program under which CRC sells securities backed by
contracts to SunAmerica. Under the Securitization Program, CRC assigns and
transfers the contracts to separate trusts (the "Trusts") pursuant to Pooling
and Servicing Agreements (the "Pooling Agreements"). Pursuant to the Pooling
Agreements, Class A certificates and subordinated Class B Certificates are
issued to CRC. CRC then sells the Class A Certificates to SunAmerica or its
nominees. The transferred contracts are serviced by Champion Acceptance
Corporation ("CAC"), another subsidiary of the Company. As a requirement to
obtain a "BBB" rating from Standard & Poors, CRC is required to provide a
credit enhancement by establishing and maintaining a cash spread account for
the benefit of the certificate holders. The Company makes an initial cash
deposit into the spread account, ranging from 3% to 4% of the initial
underlying finance receivables principal balance and pledges this cash to the
Trusts. The Company is also required to then make additional deposits from
the residual cash flow (through the trustees) to the spread account as
necessary to attain and maintain the spread account at a specified percentage,
ranging from 6.0% to 8.0%, of the underlying finance receivables principal
balance. Distributions are not made to CRC on the Class B Certificates unless
the spread account has the required balance, the required periodic payments to
the Class A Certificate holders are current, and the trustee, servicer and
other administrative costs are current. During 1996, the Company made initial
spread account deposits totaling $2,630,000. Additional net deposits through
the trustees during 1996 totaled $213,000 resulting in a total balance in the
spread accounts of $2,843,000 as of December 31, 1996. In connection
therewith, the specified spread account balance based upon the aforementioned
specified percentages of the balances of the underlying portfolios as of
December 31, 1996 was $3,941,000, resulting in additional funding requirements
from future cash flows as of December 31, 1996 of $1,098,000. The additional
funding requirement will decline as the trustees deposit additional cash flows
into the spread accounts and as the principal balance of the underlying
finance receivables declines.
The contracts transferred to the Trusts were purchased by CRC from either
CAC or Champion Financial Services ("CFS"), another subsidiary of the Company
in "true sale" transactions pursuant to separate Purchase Agreements. The
obligations of CAC, as servicer, pursuant to the Pooling Agreements, are
guaranteed by the Company and certain other subsidiaries of the Company, other
than CRC, CAC and CFS.
The Company recognized a Gain on Sale of Loans equal to the difference
between the yield earned on the contract portfolio securitized and the return
on the securities sold. The amount of any Gain on Sale of Loans is based upon
certain estimates, which may not subsequently be realized. To the extent that
actual cash flows on a securitization are materially below estimates, the
Company would be required to revalue the residual portion of the
securitization which it retains, and record a charge to earnings based upon
the reduction.
The Company utilizes a number of estimates in arriving at the Gain on
Sale of Loans. The estimated cash flows into the trusts were discounted with
rates ranging from 16% to 25%. For contracts originated at Company
Dealerships, net losses were estimated using total expected cumulative net
losses at loan origination of approximately 25.0%, adjusted for actual
cumulative net losses prior to securitization. For contracts purchased from
Third Party Dealers, net losses were estimated using total expected cumulative
net losses at loan origination of approximately 13.5%, adjusted for actual
cumulative net losses prior to securitization. Losses are discounted at an
assumed risk free rate. Prepayment rates were estimated to be 1.5% per month
of the beginning of month balance. The assumptions utilized in prior
securitizations may not necessarily be the same as those utilized in future
securitizations, if any.
Through December 31, 1996, the Company had securitized an aggregate of
$68.2 million in contracts, issuing $53.5 million in securities to SunAmerica.
Pursuant to these transactions, the Company reduced its Allowance for Credit
Losses by $10.0 million during 1996 and retained a residual in the contract
sold of $9.9 million at December 31, 1996. The Company also recorded Gain on
Sale of Loans during 1996 of $4.4 million, net of expenses.
During 1996, the Trusts issued certificates to SunAmerica at a weighted
average yield of 8.38%, with the yields ranging from 8.15% to 8.62%, resulting
in net spreads, after servicing and trustee fees, ranging from 12.56% to
17.40% and averaging 16.36%.
<PAGE>
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.
Servicing Income. The Company services the $51.7 million in contracts
sold in the securitization for monthly fees ranging from .33% to .42% of
beginning of period principal balances (4% to 5% annualized). Servicing Income
for the year ended December 31, 1996 totaled $921,000.
Other Income. Other Income consists primarily of franchise fees from the
Company's rent-a-car franchisees and insurance premiums earned on force placed
insurance policies. This income increased by 111.0% to $650,000 for the year
ended December 31, 1996 from $308,000 for the year ended December 31, 1995,
which was a decrease of 44.6% from the $556,000 in 1994. 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 77.7% to $35.9 million for
the year ended December 31, 1996 from $20.2 million (pro forma) for the year
ended December 31, 1995, which was an increase of 54.2% from $13.1 million in
1994. Interest Income on the loan portfolios and Gain on Sale of Loans were
the primary contributors to the increase. The increase also reflects the
growth of Sales of Used Cars.
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization. The allocation of these expenses to each of the Company's
business segments (Company Dealerships, Company Dealership Receivables, Third
Party Dealers, and Corporate and Other) is shown at Note 20 to the
Consolidated Financial Statements.
Selling and Marketing Expenses. For the years ended December 31, 1996,
1995, and 1994, Selling and Marketing Expenses were comprised almost entirely
of advertising costs and commissions relating to Company Dealership
operations. Selling and Marketing Expenses increased by 12.5% to $3.6 million
for the year ended December 31, 1996 from $3.2 million (pro forma) for the
year ended December 31, 1995, which was an increase of 33.3% from $2.4 million
in 1994. As a percentage of Sales of Used Cars, these expenses averaged 6.7%,
8.3% (pro forma), and 8.6% for the years ended December 31, 1996, 1995, and
1994, respectively. On a per unit sold basis, Selling and Marketing Expenses
of Company Dealerships decreased by 7.1% to $474 per unit for the year ended
December 31, 1996 from $510 (pro forma) per unit for the year ended December
31, 1995, which was an increase of 18.9% from $429 per unit in 1994.
General and Administrative Expenses. General and Administrative Expenses
increased by 45.5% to $19.5 million for the year ended December 31, 1996 from
$13.4 million (pro forma) for the year ended December 31, 1995, which was an
increase of 47.3% from $9.1 million in 1994. These expenses represented 25.8%,
27.5%, and 27.0% of total revenues for the years ended December 31, 1996,
1995, and 1994, respectively. For the year ended December 31, 1996, 42.5% of
General and Administrative Expenses were attributable to Company Dealership
sales, 15.6% to the Company Dealership Receivables' financing activities,
20.2% to Third Party Dealer activities and 21.7% to Corporate overhead. For
the year ended December 31, 1995, 55.8% of General and Administrative Expenses
were attributable to Company Dealership sales, 18.2% to the Company Dealership
Receivables' financing activities, 7.9% to Third Party Dealer activities and
18.1% to Corporate overhead. The increase in General and Administrative
Expenses is a direct result of the Company's 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 trademarks. Depreciation and amortization
increased by 23.1% to $1.6 million for the year ended December 31, 1996 from
$1.3 million for the year ended December 31, 1995, which was an increase of
62.5% from $777,000 in 1994 . The increase was due primarily to the
construction of Company servicing facilities, which opened in June 1995, and
the purchase of associated equipment. For the year ended December 31, 1996,
20.2% of these expenses were attributable to Company Dealership sales, 48.7%
to the Company Dealership receivables' financing activities, 12.4% to Third
Party Dealer activities and 18.7% to Corporate overhead. For the year ended
December 31, 1995, 21.2% of these expenses were attributable to Company
Dealership sales, 36.5% to the Company Dealership receivables' financing
activities, 6.8% to Third Party Dealer activities and 35.5% to Corporate
overhead. Amortization of Covenants was $296,000 and $296,000 for the years
ended December 31, 1995, and 1994 respectively. As of December 31, 1995, all
existing covenants had been fully amortized.
Interest Expense. Interest expense decreased by 11.7% to $5.3 million in
1996 from $6.0 million in 1995, which was an increase of 100.0% from $3.0
million in 1994. The decrease in 1996, despite significant growth in Company
assets, is the direct result of the two public offerings that were completed
in 1996 which generated $79.4 million in cash, and the Company's
Securitization Program which generated $39.0 million in 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 tax expense totaled $100,000 in 1996, up from zero
in 1995. In 1994, the Company realized a tax benefit of $334,000. In 1996, the
Company utilized all of the Valuation Allowance that existed against its
deferred income tax assets as of December 31, 1995. Therefore, the Company
anticipates incurring income tax expense in the future at the statutory income
tax rates.
ALLOWANCE FOR CREDIT LOSSES
The Company has established an Allowance for Credit Losses ("Allowance")
to cover anticipated credit losses on the contracts currently in its
portfolio. The Allowance has been established through the Provision for Credit
Losses on contracts originated at Company Dealerships, and through
nonrefundable acquisition discounts and Provision for Credit Losses on
contracts purchased from Third Party Dealers. The Allowance on contracts
originated at Company Dealerships increased to 23.0% of outstanding principal
balances as of December 31, 1996 compared to 21.9% as of December 31, 1995.
The Allowance as a percentage of Third Party Dealer contracts increased to
12.7% from 7.2% over the same period. However, the Allowance as a percentage
of the Company's combined contract portfolio decreased to 13.9% at December
31, 1996 from 17.7% at December 31, 1995 reflecting the fact that a greater
portion of the Company's overall contract portfolio, is represented by
contracts purchased from Third Party Dealers, for which a lower level of
Allowance is required.
The following table reflects activity in the Allowance, as well as
information regarding charge off activity, for the years ended December 31,
1996 and 1995, in thousands.
<TABLE><CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------
COMPANY DEALERSHIPS THIRD PARTY DEALERS
-------------------- ---------------------
1996 1995 1996 1995
---------- -------- --------- ----------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 7,500 $ 6,050 $ 1,000 $ 159
Provision for Credit Losses 9,658 8,359 153 -
Discount Acquired - - 8,963 1,660
Reduction Attributable to Loans Sold (9,331) - (650) -
Net Charge Offs (6,202) (6,909) (2,966) (819)
---------- -------- --------- ----------
Balance, End of Period $ 1,625 $ 7,500 $ 6,500 $ 1,000
========== ======== ========= ==========
Allowance as Percent of Period
Ended Principal Balance 23.0% 21.9% 12.7% 7.2%
========== ======== ========= ==========
Charge off Activity:
Principal Balances:
Collateral Recovered $ 6,256 $ 6,686 $ 3,618 $ 806
Collateral Not Recovered 1,859 2,478 717 220
---------- -------- --------- ----------
Total Principal Balances 8,115 9,164 4,335 $ 1,026
Accrued Interest 487 653 123 59
Recoveries, Net (2,400) (2,908) (1,492) (266)
---------- -------- --------- ----------
Net Charge Offs $ 6,202 $ 6,909 $ 2,966 $ 819
========== ======== ========= ==========
Net Charge Offs as % of Average
Principal Outstanding 23.0% 24.0% 10.7% 11.9%
========== ======== ========= ==========
</TABLE>
The Company's policy is to charge off contracts when they are deemed
uncollectible, but in any event at such time as a contract is delinquent for
90 days.
Net Charge Offs - Company Dealerships. Net Charge Offs for contracts
originated at Company dealerships in 1996 were 23.0% of the average principal
balance outstanding compared to 24.0% in 1995. As discussed above, beginning
in 1995 and continuing in 1996 the Company has migrated to selling higher
quality cars at its dealerships. Accordingly, repossessions have less
frequently met Company standards for resale and, therefore, have been sold
primarily at wholesale auction.
Recoveries averaged 29.6% of principal balances charged off in 1996
compared to 31.7% in 1995, primarily reflecting reductions in the percentage
of repossessed cars sold at Company Dealerships of 11.0% in 1996 compared to
33.6% in 1995.
The Company's net charge offs on contracts generated through Company
Dealerships are favorably affected by a reduction in sales tax liability as a
result of loan defaults.
Net Charge Offs - Third Party Dealers. Net Charge Offs for contracts
purchased from Third Party Dealers in 1996 were 10.7% of the average principal
balance outstanding compared to 11.9% in 1995. Prior to April 1995, the
Company purchased from Third Party Dealers, at discounts of approximately
15.0% to 25.0%, contracts with average principal balances of approximately
$4,000 bearing a typical APR of 29.9%. In April 1995 the Company significantly
revised and expanded its Third Party Dealer program. Under the current
program, which is aimed at more creditworthy borrowers, it purchases from
Third Party Dealers, at discounts averaging approximately 11.0%, contracts
with average principal balances of approximately $5,800 bearing an average APR
of 24.5%.
Recoveries averaged 34.4% of principal balances charged off on contracts
purchased from Third Party Dealers in 1996 compared to 25.9% for the year
ended December 31, 1995. The increase is due to both an increase in the
percent of charged off collateral actually recovered to 83.5% in 1996 from
78.6% in 1995 and an increase in the percent realized from the resale of
recovered collateral to 41.2% in 1996 from 33.0% in 1995.
The Company's Net Charge Offs on its Third Party Dealer contract
portfolio are significantly lower than those incurred on its Company
Dealership contract portfolio. This is attributable to the relationship of the
average amount financed to the underlying collateral's wholesale value and to
a lesser degree the generally more creditworthy customers served by Third
Party Dealers. In its Third Party Dealer portfolio, the Company generally
limits the amount financed to not more than 120.0% of the wholesale value of
the underlying car, although the Company will make exceptions on a
case-by-case basis. For 1996, the amount financed to wholesale book on the
Third Party Dealer portfolio averaged 116.0%, as compared to 191.9% for the
Company Dealership portfolio (112.3% of Kelly Blue Book retail value). For
1995, the amount financed to wholesale book on the Third Party Dealer
portfolio averaged 117.0%, as compared to 184.0% for the Company Dealership
portfolio (105.0% of Kelly Blue Book retail value). See Item 1. "Business -
Comparison of Contracts Originated at Company Dealerships and Third Party
Dealers."
Net Charge Off percentage trends for the respective portfolios are
considered by management in determining the adequacy of the Allowance as a
percentage of contract principal balances outstanding.
Static Pool Analysis. To monitor contract performance, beginning in June
1995, the Company implemented "static pool" analysis for all contracts
originated since January 1, 1993. Static pool analysis is a monitoring
methodology by which each month's originations and subsequent charge offs are
assigned a unique pool and the pool performance is monitored separately.
Improving or deteriorating performance is measured based on cumulative gross
and net charge offs as a percentage of original principal balances, based on
the number of complete payments made by the customer before charge off. The
tables herein set 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.
CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS
The following table sets forth the cumulative net charge offs as a
percentage of original contract cumulative balances, based on the quarter of
origination and segmented by the number of monthly payments made prior to
charge off.
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
<TABLE><CAPTION>
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF
----------------------------------------------------------
0 3 6 12 18 24
----- ----- ----- ----- ----- ----
<S> <C> <C> <C> <C> <C> <C>
1993:
1st Quarter 6.6% 18.3% 26.6% 33.2% 35.1% 35.3%
2nd Quarter 7.7% 18.4% 26.2% 30.6% 32.1% 32.3%
3rd Quarter 8.5% 19.9% 25.2% 30.4% 31.5% 31.7%
4th Quarter 7.1% 16.9% 23.4% 27.7% 28.9% 29.5%
1994:
1st Quarter 3.5% 10.8% 14.3% 17.7% 19.3% 21.4%
2nd Quarter 3.7% 11.3% 15.3% 19.7% 21.7% 22.8%
3rd Quarter 3.5% 8.5% 12.9% 17.0% 19.4% 20.0%
4th Quarter 2.9% 9.1% 13.3% 18.0% 20.1% x
1995:
1st Quarter 1.6% 8.3% 13.8% 18.2% 20.6% -
2nd Quarter 2.5% 7.9% 12.7% 17.2% x -
3rd Quarter 1.9% 6.5% 11.3% 18.3% - -
4th Quarter 1.1% 5.8% 11.0% x - -
1996:
1st Quarter 1.4% 7.6% 13.3% - - -
2nd Quarter 2.2% 9.3% x - - -
3rd Quarter 1.5% - - - - -
</TABLE>
Analysis of portfolio delinquencies is also considered in evaluating the
adequacy of the Allowance. Principal balances 31 to 60 days delinquent as a
percentage of total outstanding contract principal balances totaled 2.3% and
4.2% as of December 31, 1996 and 1995, respectively. Principal balances 61 to
90 days delinquent as a percentage of total outstanding contract principal
balances totaled 0.6% and 1.1% as of December 31, 1996 and 1995, respectively.
In accordance with the Company's charge off policy, there are no accounts more
than 90 days delinquent as of December 31, 1996 and 1995.
CONTRACTS PURCHASED FROM THIRD PARTY DEALERS
Non-refundable acquisition discount ("Discount") acquired totaled $9.0
million and $1.7 million for the years ended December 31, 1996 and 1995,
respectively. The Discount, attributable to Third Party Dealer branch
purchases, averaged 11.4% as a percentage of principal balances purchased in
1996, compared to 10.1% in 1995. Beginning in 1996, the Company expanded into
markets with interest rate limits. While contractual interest rates on these
contracts are limited by law, the Company has been able to purchase these
contracts at a reasonably consistent effective yield and therefore Discounts
have trended upward. To date, the Company has credited the Allowance for
Credit Losses all Discount acquired with the purchase of contracts from Third
Party Dealers.
The following table sets forth the cumulative net charge offs as a
percentage of original contract cumulative balances, based on the quarter of
origination and segmented by the number of monthly payments made prior to
charge off.
<PAGE>
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
<TABLE><CAPTION>
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF
----------------------------------------------------------
0 3 6 12 18 24
---- ---- ---- ---- --- ---
<S> <C> <C> <C> <C> <C> <C>
1995:
2nd Quarter 0.9% 4.1% 5.7% 7.8% x -
3rd Quarter 1.4% 4.0% 5.2% 7.0% - -
4th Quarter 1.0% 4.4% 6.8% x - -
1996:
1st Quarter 0.8% 3.7% 6.9% - - -
2nd Quarter 1.6% 6.3% x - - -
3rd Quarter 1.4% - - - - -
</TABLE>
Beginning April 1, 1995, the Company initiated a new purchasing program
for Third Party Dealer contracts which included a rapid migration to higher
quality contracts. As of March 31, 1995, the Third Party Dealer portfolio
originated under the prior program had a principal balance of $2.0 million and
has a remaining balance of $133,000 as of December 31, 1996. Static pool
results under the prior program are not a material consideration for
management evaluation of the current Third Party Dealer portfolio and contract
performance under this prior program has been excluded from the table above.
While the static pool information is developing, management augments its
evaluation of the adequacy of the Allowance for Third Party Dealers through
comparisons in the characteristics of collateral ratios and borrowers on Third
Party Dealer contracts versus those of the Company Dealership contracts, as
well as through comparisons of portfolio delinquency, actual contract
performance and, to the extent information is available, industry statistics.
Analysis of portfolio delinquencies is also considered in evaluating the
adequacy of the Allowance. Principal balances 31 to 60 days delinquent as a
percentage of total outstanding contract principal balances totaled 3.1% and
1.2% as of December 31, 1996 and 1995, respectively. Principal balances 61 to
90 days delinquent as a percentage of total outstanding contract principal
balances totaled 1.1% and 0.4% as of December 31, 1996 and 1995, respectively.
In accordance with the Company's charge off policy, there are no Third Party
Dealer contracts more than 90 days delinquent as of December 31, 1996 and
1995.
At December 31, 1995 the average number of days a customer was delinquent
when repossession took place was under 30 days for both contracts originated
at Company Dealerships and those purchased from Third Party Dealers. In 1996,
the Company elected to extend the time period before repossession is ordered
with respect to those customers who exhibit a willingness and capacity to
bring their contracts current. As a result of this revised repossession
policy, delinquencies increased slightly, as expected.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support increases in its contract
portfolio, expansion of Company Dealerships and Branch Offices, the purchase
of inventories, the purchase of property and equipment, and for working
capital and general corporate purposes. The Company funds its capital
requirements through equity offerings, operating cash flow, the sale of
finance receivables, and supplemental borrowings.
The Company's Net Cash Provided by Operating Activities increased by
10.1% from $6.3 million for 1995 to $7.0 in 1996, compared to an increase of
87.8% from $3.4 million in 1994. The increase was primarily due to increases
in Net Earnings, and the Provision for Credit Losses, offset by an increase in
Other Assets, and the Gain on Sale of Finance Receivables. The increase in
1995 over 1994 was primarily a result of a smaller increase in Inventory of
$1.5 million, and an increase in Accounts Payable, Accrued Expenses and Other
Liabilities of $2.0 million.
Net Cash Used in Investing Activities decreased by 17.6% from $36.4
million in the year ended December 31, 1995 to $30.0 million in the year ended
December 31, 1996. The decrease was due primarily to a net increase in Finance
Receivables of $14.6 million and the $2.8 million used for the net increase in
the securitization spread account (Investments Held in Trust), the deposit of
$636,000 into a trust account and the $2.9 million increase used for the
purchases of Property and Equipment. Gross deposits into the spread account
by the trustees were $955,000 while gross disbursements from the spread
account totaled $742,000 during 1996. Cash used in investing activities
increased from 1994 to 1995 by $15.8 million or 76.8% primarily as a result of
a net increase in Finance Receivables of $18.2 million offset by Property and
Equipment additions of $2.1 million.
The Company's Net Cash Provided by Financing Activities increased by
28.1% from $31.3 million in the year ended December 31, 1995 to $40.1 million
in the year ended December 31, 1996. This increase was the result of the $79.4
million in proceeds from the Company's public offerings of common stock, net
of the $28.6 million of repayment of Notes Payable and the redemption of $10.0
million of Preferred Stock. The Company's Net Cash Provided by Financing
Activities increased by 80.9% or $14.0 million from 1994 to 1995 due primarily
to a net increase in Notes Payable of $12.3 million.
Revolving Facility. The Company maintains a Revolving Facility with GE
Capital that has a maximum commitment of up to $50.0 million. Under the
Revolving Facility, the Company may borrow up to 65.0% of the principal
balance of eligible Company Dealership contracts and up to 90.0% of the
principal balance of eligible Third Party Dealer contracts. The Revolving
Facility expires in September 1997, at which time the Company has the option
to renew the Revolving Facility for one additional year. The facility is
secured by substantially all of the Company's assets. As of December 31, 1996,
the Company's borrowing capacity under the Revolving Facility was $50.0
million, the aggregate principal amount outstanding under the Revolving
Facility was $4.6 million, and the amount available to be borrowed under the
facility was $45.4 million. The Revolving Facility bears interest at the
30-day LIBOR plus 3.60%, payable daily (total rate of 9.0% as of December 31,
1996).
The Revolving Facility contains covenants that, among other things, limit
the Company's ability to, without GE Capital's consent: (i) incur additional
indebtedness; (ii) make unsecured loans or other advances of money to
officers, directors, employees, stockholders, or affiliates in excess of
$25,000 in total; (iii) engage in securitization transactions (other than the
Securitization Program with SunAmerica, for which GE Capital has consented);
(iv) merge with, consolidate with, acquire, or otherwise combine with any
other person or entity, transfer any division or segment of its operations to
another person or entity, or form new subsidiaries; (v) make any change in its
capital structure; (vi) declare or pay dividends except in accordance with all
applicable laws and not in excess of fifteen percent (15%) of each year's net
earnings available for distribution; (vii) make certain investments and
capital expenditures; and (viii) engage in certain transactions with
affiliates. These covenants also require the Company to maintain specified
financial ratios, including a debt ratio of 2.0 to 1 and a net worth of at
least $75,000,000 and to comply with all laws relating to the Company's
business. The Revolving Facility also provides that a transfer of ownership of
the Company that results in less than 15.0% of the Company's voting stock
being owned by Mr. Ernest C. Garcia II, will result in an event of default
under the Revolving Facility.
Subordinated Indebtedness and Preferred Stock. The Company has
historically borrowed substantial amounts from Verde Investments Inc.
("Verde"), an affiliate of the Company. The Subordinated Notes Payable
balances outstanding to Verde totaled $14.6 million as of December 31, 1995
($24.6 million prior to the conversion of $10.0 million to Preferred Stock as
discussed below), and $14.0 million as of December 31, 1996. Prior to June 21,
1996, these borrowings accrued interest at an annual rate of 18.0%. Effective
June 21, 1996 the annual interest rate on these borrowings was reduced to
10.0%. The Company is required to make monthly payments of interest and annual
payments of principal in the amount of $2.0 million. This debt is junior to
all of the Company's other indebtedness and the Company may suspend interest
and principal payments in the event it is in default on obligations to any
other creditors.
On December 31, 1995, Verde converted $10.0 million of subordinated debt
to Preferred Stock of the Company. Prior to June 21, 1996, the Preferred Stock
accrued a dividend of 12.0% annually, increasing one percent per year up to a
maximum of 18.0%. Effective June 21, 1996, the dividend on the Preferred Stock
was decreased from 12.0% to 10.0%. During 1996, the Company paid a total of
$916,000 in dividends to Verde on the Preferred Stock, which was redeemed in
November 1996.
Convertible Note. In August 1995, the Company entered into a note
purchase agreement with SunAmerica pursuant to which SunAmerica purchased a
$3.0 million convertible subordinated note. The convertible note, which was
due June 30, 1998, bore interest at a rate of 12.5%, payable quarterly, and
was secured by a pledge of the Common Stock of the Company held by the
Company's Chairman, Chief Executive Officer and principal stockholder.
Effective June 21, 1996, SunAmerica converted the note into Common Stock
(444,444 shares at the initial public offering price of $6.75 per share). In
return for the conversion, the Company granted SunAmerica a ten-year warrant
to purchase 121,023 (as adjusted) shares of Common Stock at the initial public
offering price per share and paid fees to SunAmerica totaling $150,000.
Securitizations. SunAmerica and the Company have entered into the
Securitization Program under which SunAmerica may purchase up to $175.0
million of certificates secured by contracts. The Securitization Program
provides the Company with a source of funding in addition to the Revolving
Facility. At the closing of each securitization, the Company receives payment
from SunAmerica for the certificates sold (net of Investments Held in Trust).
The Company also generates cash flow under this program from ongoing servicing
fees and excess cash flow distributions resulting from the difference between
the payments received from customers on the contracts and the payments paid to
SunAmerica. In addition, securitization allows the Company to fix its
borrowing cost for a given contract portfolio, broadens the Company's capital
source alternatives, and provides a higher advance rate than that available
under the Revolving Facility.
In connection with its securitization transactions, the Company is
required to make an initial cash deposit into an account held by the trustee
(spread account) and to pledge this cash to the trust to which the finance
receivables were sold. The trust in turn invests the cash in high quality
liquid investment securities. In addition, the Company (through the trustee)
deposits additional cash flows from the residual to the spread account as
necessary to attain and maintain the spread account at a specified percentage
of the underlying finance receivables principal balance. In the event that
the cash flows generated by the finance receivables sold to the trust are
insufficient to pay obligations of the trust, including principal or interest
due to certificate holders or expenses of the trust, the trustee will draw
funds from the spread account as necessary to pay the obligations of the
trust. The spread account must be maintained at a specified percentage of the
principal balances of the finance receivable held by the trust, which can be
increased in the event delinquencies or losses exceed specified levels. If
the spread account exceeds the specified percentage, the trustee will release
the excess cash to the Company from the pledged spread account.
Capital Expenditures and Commitments. The Company is pursuing an
aggressive growth strategy. In the fourth quarter of 1996, the Company
acquired the leasehold rights to an existing dealership in Las Vegas, Nevada,
and has three other dealerships (one in Phoenix, Arizona and two in
Albuquerque, New Mexico) currently under development. In addition, the Company
opened thirteen new Branch Offices during the fourth quarter of 1996, and has
recently completed expansion of its contract servicing and collection
facility.
In January 1997, the Company acquired selected operating assets of a
group of companies engaged in the business of selling and financing used
vehicles, including four dealerships located in the Tampa Bay/St. Petersburg
market. See Item 1. "Business - Recent Acquisitions."
On April 1, 1997, the Company purchased substantially all of the assets
of a company engaged in the business of selling and financing used motor
vehicles, including seven dealerships in San Antonio and a contract portfolio
of approximately $24.3 million. The purchase price for the acquisition was
$26.3 million, subject to adjustment. The seven dealerships had sales in 1996
of approximately $22.5 million. The assets purchased have an unaudited book
value of $28.1 million, exclusive of allowances on approximately $26.2 million
of contract receivable principal balances. See Item 1. "Business - Recent
Acquisitions." In addition to the facilities currently under development, the
Company intends to open 15 or more new Branch Offices and three or more
Company Dealerships through the end of 1997. The Company believes that it will
expend approximately $50,000 to establish each new Branch Office. New Company
Dealerships cost approximately $1.5 to $1.7 million to construct (excluding
inventory). The Company intends to finance these expenditures through
operating cash flows and supplemental borrowings, including amounts available
under the Revolving Facility and Securitization Program.
SEASONALITY
Historically, the Company has experienced higher revenues in the first
two quarters of the year than in the latter half of the year. The Company
believes that these results are due to seasonal buying patterns resulting in
part from the fact that many of its customers receive income tax refunds
during the first half of the year, which are a primary source of down payments
on used car purchases.
INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's borrowings would decrease the profitability of
the Company's existing portfolio. The Company will seek to limit this risk
through its Securitization Program and, to the extent market conditions
permit, for contracts originated at Company Dealerships, either by increasing
the interest rate charged, or the profit margin on, the cars sold, or for
contracts acquired from Third Party Dealers, either by acquiring contracts at
a higher discount or with a higher APR. To date, inflation has not had a
significant impact on the Company's operations.
ACCOUNTING MATTERS
Statement of Financial Accounting Standards No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities" (SFAS No. 125), which the Company will adopt for its fiscal year
beginning January 1, 1997, establishes accounting and reporting standards for
transfers and servicing of financial assets and extinguishments of
liabilities. Management has not determined the impact that adoption of SFAS
No. 125 will have on the Company.
FACTORS THAT MAY AFFECT FUTURE RESULTS AND FINANCIAL CONDITION
The Company's future operating results and financial condition are
dependent upon, among other things, the Company's ability to implement its
business strategy. The Company began operations in 1992 and incurred
significant losses in 1994 and 1995. In 1996, however, the Company achieved
profitability with net earnings of approximately $5.9 million (including $4.4
million of gains recognized from the sale of contract receivables pursuant to
the Securitization Program) on total revenues of $75.6 million. There can be
no assurance that the Company will remain profitable. Potential risks and
uncertainties that could affect the Company's profitability are set forth
below.
Dependence on Securitizations. In recent periods, a significant portion
of the Company's net earnings have been attributable to gains on sales of
contract receivables under its Securitization Program, which the Company
expects to continue for the foreseeable future. Consequently, the Company's
net earnings may fluctuate from quarter to quarter as a result of the timing
and size of its securitizations. The Company's ability to successfully
complete securitizations in the future may be affected by several factors,
including the condition of securities markets generally, conditions in the
asset-backed securities markets specifically, and the credit quality of the
Company's portfolio. The amount of any gain on sale is based upon certain
estimates, which may not subsequently be realized. To the extent that actual
cash flows on a securitization are materially below estimates, the Company
would be required to revalue the residual portion of the securitization which
it retains, and record a charge to earnings based upon the reduction. In
addition, the Company records ongoing income based upon the cash flows on its
residual portion. The income recorded on the residual portion will vary from
quarter to quarter based upon cash flows received in a given period.
Poor Creditworthiness of Borrowers; High Risk of Credit Losses.
Substantially all of the contracts that the Company services are with
Sub-Prime Borrowers. Due to their poor credit histories, Sub-Prime Borrowers
are generally unable to obtain credit from traditional financial institutions,
such as banks, savings and loans, credit unions, or captive finance companies
owned by automobile manufacturers. The Company typically charges fixed
interest rates ranging from 21.0% to 29.9% on contracts originated at Company
Dealerships, while rates range from 17.6% to 29.9% on the Third Party Dealer
contracts it purchases. In addition, the Company has established an Allowance
for Credit Losses, which approximated 13.9% and 17.7% of contract principal
balances for 1996 and 1995, respectively, to cover anticipated credit losses
on the contracts 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
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 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's profitability. See - Allowance for Credit
Losses" and Item 1. "Business - Monitoring and Collections."
Risks Associated with Growth Strategy and New Product Offerings. The
Company's business strategy calls for aggressive growth in its sales and
financing activities through the development and acquisition of new Company
Dealerships and Branch Offices and the expansion of its existing operations to
include additional financing and insurance services. The Company's ability to
remain profitable as it pursues this business strategy will depend upon its
ability to: (i) expand its revenue generating operations while not
proportionately increasing its administrative overhead; (ii) originate and
purchase contracts with an acceptable level of credit risk; (iii) effectively
collect payments due on the contracts in its portfolio; (iv) locate sufficient
financing, with acceptable terms, to fund the expansion of used car sales and
the origination and purchase of additional contracts; and (v) adapt to the
increasingly competitive market in which it operates. Outside factors, such as
the economic, regulatory, and judicial environments in which it operates, will
also have an effect on the Company's business. The Company's inability to
achieve or maintain any or all of these goals could have a material adverse
effect on the Company's operations, profitability, and growth. See Item 1.
"Business - Business Strategy."
The Company has initiated its Cygnet Dealer Program, pursuant to which
the Company provides qualified Third Party Dealers with operating lines of
credit secured by such dealers' retail installment contract portfolios. While
the Company will require Third Party Dealers to meet certain minimum net worth
and operating history criteria to be considered for inclusion in the Cygnet
Dealer Program, the Company will, nevertheless, be extending credit to dealers
who are not otherwise able to obtain debt financing from traditional lending
institutions such as banks, credit unions, and major finance companies.
Consequently, as with its other financing activities, the Company will be
subject to a high risk of credit losses that could have a material adverse
effect on the Company's financial condition and results of operations and on
the Company's ability to meet its own financing obligations. Further, there
can be no assurance that the Company will be able to obtain the financing
necessary to fully implement the Cygnet Dealer Program. In addition, there can
be no assurance that the Company will be successful in its efforts to expand
its insurance services. See Item 1. "Business - Third Party Dealer Operations
- - Collateralized Dealer Financing" and Item 1. "Business - Third Party Dealer
Operations - Insurance Services."
No Assurance of Successful Acquisitions. The Company has recently
completed two acquisitions and intends to consider acquisitions of and
alliances with other companies that could complement the Company's existing
business. There can be no assurance that suitable acquisition or joint
venture candidates can be identified, or that, if identified, any such
transactions will be consummated. Furthermore, there can be no assurance that
the Company will be able to integrate successfully such acquired businesses,
including those recently acquired into its existing operations, which could
increase the Company's operating expenses in the short-term and materially and
adversely affect the Company's results of operations. Moreover, any
acquisition by the Company may result in potentially dilutive issuances of
equity securities, the incurrance of additional debt, and amortization of
expenses related to goodwill and intangible assets, all of which could
adversely affect the Company's profitability. Acquisitions involve numerous
risks, such as the diversion of the attention of the Company's management from
other business concerns, the entrance of the Company into markets in which it
has had no or only limited experience, and the potential loss of key employees
of the acquired company, all of which could have a material adverse effect on
the Company's business, financial condition, and results of operations. See
Item 1. "Business - Recent Acquisitions."
Highly Competitive Industry. Although the used car sales industry has
historically been highly fragmented, it has attracted significant attention
recently from a number of large companies, including AutoNation, U.S.A. and
Driver's Mart, which have entered the used car sales business or announced
plans to develop large used car sales operations. Many franchised new car
dealerships have also increased their focus on the used car market. The
Company believes that these companies are attracted by the relatively high
gross margins that can be achieved in this market and the industry's lack of
consolidation. Many of these companies and franchised dealers have
significantly greater financial, marketing, and other resources than the
Company. Among other things, increased competition could result in increased
wholesale costs for used cars, decreased retail sales prices, and lower
margins.
Like the sale of used cars, the business of purchasing and servicing
contracts originated from the sale of used cars to Sub-Prime Borrowers is
highly fragmented and very competitive. In recent years, several consumer
finance companies have completed public offerings in order to raise the
capital necessary to fund expansion and support increased purchases of
contracts. These companies have increased the competition for the purchase of
contracts, in many cases purchasing contracts at prices that the Company
believes are not commensurate with the associated risk. There are numerous
financial services companies serving, or capable of serving, this market,
including traditional financial institutions such as banks, savings and loans,
credit unions, and captive finance companies owned by automobile
manufacturers, and other non-traditional consumer finance companies, many of
which have significantly greater financial and other resources than the
Company. Increased competition may cause downward pressure on the interest
rates the Company charges on contracts originated by its Company Dealerships
or cause the Company to reduce or eliminate the nonrefundable acquisition
discount on the contracts it purchases from Third Party Dealers, which could
have a material adverse effect on the Company's profitability. See Item 1.
"Business - Competition."
The Company believes that recent demographic, economic, and industry
trends favor growth in the used car sales and Sub-Prime Borrower financing
markets. To the extent such trends do not continue, however, the Company's
profitability may be materially and adversely affected. See Item 1. "Business
- - Overview of Used Car Sales and Finance Industry."
General Economic Conditions. The Company's business is directly related
to sales of used cars, which are affected by employment rates, prevailing
interest rates, and other general economic conditions. While the Company
believes that current economic conditions favor continued growth in the
markets it serves and those in which it seeks to expand, a future economic
slowdown or recession could lead to 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. See
Item 1. "Business - Company Dealership Operations" and Item 1. "Business -
Third Party Dealer Operations."
Industry Considerations. In recent periods, several major used car
finance companies have announced major downward adjustments to their financial
statements, violations of loan covenants, related litigation and other events.
In addition, one of these companies has filed for bankruptcy protection. These
announcements have had and may continue to have a disruptive effect on the
market for securities of sub-prime automobile finance companies, are expected
to result in a tightening of credit to the sub-prime markets and could lead to
enhanced regulatory oversight. Furthermore, companies in the used car
financing market have been subject to 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 subject to any such lawsuits, no assurance can be given that such
claims will not be asserted against the Company in the future or that the
Company's operations will not be subject to enhanced regulatory oversight.
See "- Regulation, Supervision & Licensing."
Need to Establish and Maintain Relationships with Third Party Dealers.
The Company enters into nonexclusive agreements with Third Party Dealers,
which may be terminated by either party at any time, pursuant to which the
Company purchases contracts originated by such dealers that meet the Company's
established terms and conditions. Pursuant to the Cygnet Dealer Program, the
Company enters into financing agreements with qualified Third Party Dealers.
The Company's Third Party Dealer financing activities depend in large part
upon its ability to establish and maintain relationships with such dealers.
While the Company believes that it has been successful in developing and
maintaining relationships with Third Party Dealers in the markets that it
currently serves, there can be no assurance that the Company will be
successful in maintaining or increasing its existing Third Party Dealer base,
that such dealers will continue to generate a volume of contracts comparable
to the volume of contracts historically generated by such dealers, or that any
such dealers will become involved in the Cygnet Dealer Program. See Item 1.
"Business - Third Party Dealer Operations" and Item 1. "Business -
Collateralized Dealer Program."
Geographic Concentration. Company Dealership operations are currently
concentrated in Arizona, Florida, Nevada and Texas. In addition, a majority of
the Company's Branch Offices are located in Arizona, Texas, Florida, and
Indiana. Of the $109.9 million in total contracts serviced by the Company at
December 31, 1996, approximately $66.8 million were originated in Arizona.
Because of this concentration, the Company's business may be adversely
affected in the event of a downturn in the general economic conditions
existing in the Company's primary markets. See Item 1. "Business - Company
Dealership Operations" and Item 1. "Business - Third Party Dealer Operations."
Dependence on External Financing. The Company has borrowed, and will
continue to borrow, substantial amounts to fund its operations from financing
companies and other lenders, some of which are affiliated with the Company.
Currently, the Company receives financing pursuant to the Revolving Facility
with GE Capital, which has a maximum commitment of $50.0 million. Under the
Revolving Facility, the Company may borrow up to 65.0% of the principal
balance of eligible Company Dealership contracts and up to 90.0% of the
principal balance of eligible Third Party Dealer contracts. The Revolving
Facility expires in September 1997, at which time the Company has the option
to renew it for one additional year. The Revolving Facility is secured by
substantially all of the Company's assets. In addition, the Revolving Facility
contains various covenants that limit, among other things, the Company's
ability to engage in mergers and acquisitions, incur additional indebtedness,
and pay dividends or make other distributions, and also requires the Company
to meet certain financial tests. As of December 31, 1996, the aggregate
principal amount outstanding under the Revolving Facility was $4.6 million,
and the amount available to be borrowed was $45.4 million. Although the
Company believes it is currently in compliance with the terms and conditions
of the Revolving Facility, there can be no assurance that the 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 and SunAmerica have entered into the Securitization Program pursuant
to which SunAmerica may purchase up to $175.0 million of the Company's
asset-backed securities. The Securitization Program is subject to numerous
terms and conditions, including the Company's ability to achieve
investment-grade ratings on its asset-backed securities. As of December 31,
1996, the Company had securitized an aggregate of $58.2 million in contracts
originated through Company Dealerships and $10.0 million in loans originated
at Third Party Dealers and purchased by the Company, and had issued $53.5
million in asset-backed securities to SunAmerica in 1996. There can be no
assurance, however, that any further securitizations will be completed or that
the Company will be able to secure additional financing, including the
financing necessary to fully implement the Cygnet Dealer Program, when and as
needed in the future, or on terms acceptable to the Company. See "- Liquidity
and Capital Resources."
Sensitivity to Interest Rates. A substantial portion of the Company's
financing income results from the difference between the rate of interest it
pays on the funds it borrows and the rate of interest it earns on the
contracts in its portfolio. While the contracts the Company services bear
interest at a fixed rate, the indebtedness that the Company incurs under its
Revolving Facility bears interest at a floating rate. In the event the
Company's interest expense increases, it would seek to compensate for such
increases by raising the interest rates on its Company Dealership contracts,
increasing the acquisition discount at which it purchases Third Party Dealer
contracts, or raising the retail sales prices of its used cars. To the extent
the Company were unable to do so, the Company's net interest margins would
decrease, thereby adversely affecting the Company's profitability.
Impact of Usury Laws. The Company typically charges fixed interest rates
ranging from 21.0% to 29.9% on the contracts originated at Company
Dealerships, while rates range from 17.6% to 29.9% on the Third Party Dealer
contracts it purchases. Currently, a significant portion of the Company's used
car sales activities are conducted in, and a significant portion of the
contracts the Company services are originated in, Arizona, which does not
impose limits on the interest rate that a lender may charge. However, the
Company has expanded, and will continue to expand, its operations into states
that impose usury limits, such as Florida and Texas. The Company attempts to
mitigate these rate restrictions by purchasing contracts originated in these
states at a higher discount. The Company's inability to achieve adequate
discounts in states imposing usury limits would adversely affect the Company's
planned expansion and its results of operations. There can be no assurance
that 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. See Item 1. "Business -
Regulation, Supervision, and Licensing."
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.
Regulation, Supervision, and Licensing. The Company's operations are
subject to ongoing regulation, supervision, and licensing under various
federal, state, and local statutes, ordinances, and regulations. Among other
things, these laws require that the Company obtain and maintain certain
licenses and qualifications, limit or prescribe terms of the contracts that
the Company originates and/or purchases, require specified disclosures to
customers, limit the Company's right to repossess and sell collateral, and
prohibit the Company from discriminating against certain customers. The
Company is also subject to federal and state franchising and insurance laws.
See Item 1. "Business - Regulation, Supervision, and Licensing."
<PAGE>
The Company believes that it is currently in substantial compliance with all
applicable federal, state, and local laws and regulations. There can be no
assurance, however, that the Company will be able to remain in compliance with
such laws, and such failure could have a material adverse effect on the
operations of the Company. In addition, the adoption of additional statutes
and regulations, changes in the interpretation of existing statutes and
regulations, or the Company's entrance into jurisdictions with more stringent
regulatory requirements could have a material adverse effect on the Company's
business.
<PAGE>
ITEM 8 - CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Ugly Duckling Corporation:
We have audited the accompanying consolidated balance sheets of Ugly
Duckling Corporation and subsidiaries as of December 31, 1996 and 1995, and
the related consolidated statements of operations, stockholders' equity, and
cash flows for each of the years in the three-year period ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Ugly
Duckling Corporation and subsidiaries as of December 31, 1996 and 1995, and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 1996 in conformity with generally
accepted accounting principles.
KPMG PEAT MARWICK LLP
Phoenix, Arizona
January 31, 1997, except
for Note 19 to the Consolidated
Financial Statements which is
as of February 13, 1997
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE><CAPTION>
DECEMBER 31,
-------------------------
1996 1995
--------------- --------
(in thousands)
ASSETS
<S> <C> <C>
Cash and Cash Equivalents $ 18,455 $ 1,419
Finance Receivables:
Held for Investment 52,188 49,226
Held for Sale 7,000 -
--------------- --------
Principal Balances, Net 59,188 49,226
Less: Allowance for Credit Losses (8,125) (8,500)
--------------- --------
Finance Receivables, Net 51,063 40,726
--------------- --------
Residuals in Finance Receivables Sold 9,889 -
Investments Held in Trust 3,479 -
Inventory 5,752 6,329
Property and Equipment, Net 20,652 7,797
Goodwill and Trademarks, Net 2,150 269
Other Assets 6,643 4,250
--------------- --------
$ 118,083 $60,790
=============== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 2,132 $ 595
Accrued Expenses and Other Liabilities 6,728 5,557
Notes Payable 12,904 35,201
Subordinated Notes Payable 14,000 14,553
--------------- --------
Total Liabilities 35,764 55,906
--------------- --------
Stockholders' Equity:
Preferred Stock - 10,000
Common Stock 82,612 127
Accumulated Deficit (293) (5,243)
--------------- --------
Total Stockholders' Equity 82,319 4,884
--------------- --------
Commitments, Contingencies and Subsequent Events
$ 118,083 $60,790
=============== ========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE><CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1996 1995 1994
----------- ----------- -----------
(in thousands, except earnings per share amounts)
<S> <C> <C> <C>
Sales of Used Cars $ 53,768 $ 47,824 $ 27,768
Less:
Cost of Used Cars Sold 29,890 27,964 12,577
Provision for Credit Losses 9,811 8,359 8,140
----------- ----------- -----------
14,067 11,501 7,051
----------- ----------- -----------
Interest Income 15,856 10,071 5,449
Gain on Sale of Loans 4,434 - -
----------- ----------- -----------
20,290 10,071 5,449
----------- ----------- -----------
Servicing Income 921 - -
Other Income 650 308 556
----------- ----------- -----------
1,571 308 556
----------- ----------- -----------
Income before Operating Expenses 35,928 21,880 13,056
Operating Expenses:
Selling and Marketing 3,585 3,856 2,402
General and Administrative 19,538 14,726 9,141
Depreciation and Amortization 1,577 1,314 777
----------- ----------- -----------
24,700 19,896 12,320
----------- ----------- -----------
Income before Interest Expense 11,228 1,984 736
Interest Expense 5,262 5,956 3,037
----------- ----------- -----------
Earnings (Loss) before Income Taxes 5,966 (3,972) (2,301)
Income Taxes (Benefit) 100 - (334)
----------- ----------- -----------
Net Earnings (Loss) $ 5,866 $ (3,972) $ (1,967)
=========== =========== ===========
Earnings (Loss) per Share $ 0.60 $ (0.67) $ (0.35)
=========== =========== ===========
Shares Used in Computation 8,283 5,892 5,584
=========== =========== ===========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1996, 1995, AND 1994
(in thousands)
<TABLE><CAPTION>
RETAINED TOTAL
EARNINGS STOCKHOLDERS'
SHARES AMOUNT (ACCUMULATED EQUITY
---------- -----------
PREFERRED COMMON PREFERRED COMMON DEFICIT) (DEFICIT)
---------- ------ ----------- ------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Balances at December 31, 1993 - 4,640 $ - $ 1 $ 696 $ 697
Issuance of Common Stock for Purchase
of Subsidiary - 174 - 15 - 15
Issuance of Common Stock for Cash - 708 - 61 - 61
Net Loss for the Year - - - - (1,967) (1,967)
---------- ----------- ------- -------------- ---------------
Balances at December 31, 1994 - 5,522 - 77 (1,271) (1,194)
Issuance of Common Stock - 58 - 50 - 50
Conversion of Subordinated Notes
Payable to Preferred Stock 1,000 - 10,000 - - 10,000
Net Loss for the Year - - - - (3,972) (3,972)
---------- ----------- ------- -------------- ---------------
Balances at December 31, 1995 1,000 5,580 10,000 127 (5,243) 4,884
Issuance of Common Stock for Cash - 7,281 - 79,335 - 79,335
Conversion of Debt to Common Stock - 444 - 3,000 - 3,000
Issuance of Common Stock to Board of
Directors - 22 - 150 - 150
Redemption of Preferred Stock (1,000) - (10,000) - - (10,000)
Preferred Stock Dividends - - - - (916) (916)
Net Earnings for the Year - - - - 5,866 5,866
---------- ----------- ------- -------------- ---------------
Balances at December 31, 1996 - 13,327 $ - $82,612 $ (293) $ 82,319
========== =========== ======= ============== ===============
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE><CAPTION>
DECEMBER 31,
-------------------------------------
1996 1995 1994
--------------- --------- ---------
(in thousands)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss) $ 5,866 $ (3,972) $ (1,967)
Adjustments to Reconcile Net Earnings (Loss) to Net
Cash Provided by Operating Activities:
Provision for Credit Losses 9,811 8,359 8,140
Gain on Sale of Finance Receivables (4,434) - -
Decrease (Increase) in Deferred Income Taxes 249 449 (461)
Depreciation and Amortization 1,577 1,314 777
Decrease (Increase) in Inventory 577 (1,500) (3,098)
Finance Receivables Held for Sale (45,989) - -
Proceeds from Sale of Finance Receivables 38,989 - -
Increase in Other Assets (3,150) (529) (294)
Increase in Accounts Payable, Accrued Expenses, and
Other Liabilities 2,949 3,035 1,064
Increase (Decrease) in Income Taxes
Receivable/Payable 534 (984) (809)
Other, Net - 169 25
--------------- --------- ---------
Net Cash Provided by Operating Activities 6,979 6,341 3,377
--------------- --------- ---------
Cash Flows from Investing Activities:
Increase in Finance Receivables (67,803) (53,023) (27,196)
Collections of Finance Receivables 49,201 19,795 12,202
Increase in Investments Held in Trust (3,479) - -
Purchase of Property and Equipment (6,111) (3,195) (5,334)
Other, Net (1,809) - (270)
--------------- --------- ---------
Net Cash Used in Investing Activities (30,001) (36,423) (20,598)
--------------- --------- ---------
Cash Flows from Financing Activities:
Additions to Notes Payable 1,000 22,259 9,942
Repayments of Notes Payable (28,610) - (2,027)
Net Issuance (Repayment) of Subordinated Notes
Payable (553) 6,262 9,350
Redemption of Preferred Stock (10,000) - -
Proceeds from Issuance of Common Stock 79,435 5 61
Other, Net (1,214) 2,807 (16)
--------------- --------- ---------
Net Cash Provided by Financing Activities 40,058 31,333 17,310
--------------- --------- ---------
Net Increase in Cash and Cash Equivalents 17,036 1,251 89
Cash and Cash Equivalents at Beginning of Year 1,419 168 79
--------------- --------- ---------
Cash and Cash Equivalents at End of Year $ 18,455 $ 1,419 $ 168
=============== ========= =========
Supplemental Statement of Cash Flows Information:
Interest Paid $ 5,144 $ 5,890 $ 3,031
=============== ========= =========
Income Taxes Paid $ 450 $ 535 $ 960
=============== ========= =========
Conversion of Note Payable to Common Stock $ 3,000 $ - $ -
=============== ========= =========
Purchase of Property and Equipment with Notes Payable $ 8,313 $ - $ -
=============== ========= =========
Purchase of Property and Equipment with Capital Leases $ 57 $ 792 $ 399
=============== ========= =========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
(1) ORGANIZATION AND PURPOSE
Ugly Duckling Corporation, a Delaware corporation (the Company), was
incorporated in April 1996 as the successor to Ugly Duckling Holdings, Inc.
(UDH), an Arizona corporation, formed in 1992. Contemporaneous with the
formation of the Company, UDH was merged into the Company with each share of
UDH's common stock exchanged for 1.16 shares of common stock in the Company
and each share of UDH's preferred stock exchanged for one share of preferred
stock in the Company under identical terms and conditions. UDH was effectively
dissolved in the merger. The resulting effect of the merger was a
recapitalization increasing the number of authorized shares of common stock to
20,000,000 and a 1.16-to-1 common stock split effective April 24, 1996. The
stockholders' equity section of the Consolidated Balance Sheets as of December
31, 1996 and 1995, reflects the number of authorized shares after giving
effect to the merger and common stock split. The Company's principal
stockholder is also the sole stockholder of Verde Investments, Inc. (Verde).
The Company's subordinated debt is held by, and the land for certain of its
car dealerships and loan servicing facilities was leased from, Verde until
December 31, 1996, see Note 13.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations
The Company, through its subsidiaries, owns and operates sales finance
companies, used car sales dealerships, a property and casualty insurance
company, and is a franchiser of rental car operations. Additionally, Champion
Receivables Corporation, a "bankruptcy remote entity" is the Company's
wholly-owned special purpose securitization subsidiary. Its assets include
residuals in finance receivables sold, and investments held in trust, in the
amounts of $9,889,000 and $2,843,000, respectively, at December 31, 1996.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions have
been eliminated in consolidation.
Concentration of Credit Risk
Champion Acceptance Corporation and Champion Financial Services (CFS)
provide sales finance services in connection with the sales of used cars to
individuals residing primarily in the metropolitan areas of Phoenix and
Tucson, Arizona. The Company operated three, three and two dealerships in the
Tucson metropolitan area in 1996, 1995 and 1994, respectively; and five, five,
and three dealerships in the Phoenix metropolitan area in 1996, 1995 and 1994,
respectively (company dealerships). As of December 31, 1996, CFS maintains
relationships with approximately 1,400 third party car dealers (third party
dealers) in twelve states from whom it purchases sales finance contracts from
35 branch offices.
Periodically during the year, the Company maintains cash in financial
institutions in excess of the amounts insured by the federal government.
Cash Equivalents
The Company considers all highly liquid debt instruments purchased with
maturities of three months or less to be cash equivalents. Cash equivalents
generally consist of interest bearing money market accounts.
Revenue Recognition
Interest income is recognized using the interest method. Direct loan
origination costs related to contracts originated at company dealerships are
deferred and charged against finance income over the life of the related
installment sales contract as an adjustment of yield. Pre-opening and start-up
costs incurred on third party dealer branch offices are deferred and charged
to expense over a twelve month period. The accrual of interest is suspended if
collection becomes doubtful, generally 90 days past due, and is resumed when
the loan becomes current. Interest income also includes income on the
Company's residual interests from its Securitization Program.
Revenue from the sales of used cars is recognized upon delivery, when the
sales contract is signed and the agreed-upon down payment has been received.
Residuals in Finance Receivables Sold, Investments Held in Trust, and Gain
on Sale of Loans
In 1996, the Company initiated a Securitization Program under which it
sells (securitizes), on a non-recourse basis, finance receivables to a trust
which uses the finance receivables to create asset backed securities (A
certificates) which are remitted to the Company in consideration for the sale.
The Company then sells senior certificates to third party investors and
retains subordinated certificates (B certificates). In consideration of such
sale, the Company receives cash proceeds from the sale of certificates
collateralized by the finance receivables and the right to future cash flows
under the subordinated certificates (residual in finance receivables sold, or
residual) arising from those receivables to the extent not required to make
payments on the A certificates sold to a third party or to pay associated
costs.
Residuals in finance receivables result from the sale of finance
receivables on which the Company retains servicing rights and the excess cash
flows on the A certificates, including any excess cash flows on the B
certificates. The residual is determined by computing the difference between
the weighted average yield of the finance receivables sold and the yield to
the certificate purchaser, adjusted for the normal servicing fee based on the
agreements between the Company and the investor and further adjusted for
anticipated prepayments, repossessions, liquidations, and charge offs.
The Company is required to make an initial 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 trustee in turn invests the cash in
highly liquid investment securities. In addition, the Company (through the
trustee) deposits additional cash flows from the residual to the spread
account as necessary to attain and maintain the spread account at a specified
percentage of the underlying finance receivable principal balances. These
deposits are classified as Investments Held in Trust.
To the extent that the performance of the underlying finance receivable
portfolio differs from the Company's original estimates, the Company's
residual will be adjusted quarterly, with corresponding charges against income
in the period in which the adjustment is made. Such evaluations are performed
on a security by security basis, for each certificate or spread account
retained by the Company.
Gains or losses are determined based upon the difference between the
sales proceeds for the portion of finance receivables sold and the Company's
recorded investment in the finance receivables sold. The Company allocates the
recorded investment in the finance receivables between the portion of the
finance receivables sold and the portion retained based on the relative fair
values on the date of sale.
Servicing Income
Servicing Income is recognized when earned. Servicing costs are charged
to expense as incurred. In the event delinquencies and/or losses on the
portfolio serviced exceed specified levels, the trustee may require the
transfer of servicing of the portfolio to another servicer.
Finance Receivables, Allowance for Credit Losses and Nonrefundable
Acquisition Discount
The Company originates installment sales contracts from its company
dealerships and purchases contracts from third party dealers. Finance
receivables consist of contractually scheduled payments from installment sales
contracts net of unearned finance charges, accrued interest receivable, direct
loan origination costs, and an allowance for credit losses, including
nonrefundable acquisition discount.
Finance receivables held for investment represent finance receivables
that the Company expects to hold until they have matured. Finance receivables
held for sale represent finance receivables that the Company expects to
securitize within the next twelve months.
Unearned finance charges represent the balance of finance income
(interest) remaining from the capitalization of the total interest to be
earned over the original term of the related installment sales contract.
Direct loan origination costs represent the unamortized balance of costs
incurred in the origination of contracts at the Company's dealerships.
The Company follows the provisions of Statement of Financial Accounting
Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases" for
contracts originated at its company dealerships.
An allowance for credit losses (allowance) is established by charging the
provision for credit losses and the allocation of nonrefundable acquisition
discount. For contracts generated by the company dealerships, the allowance is
established by charging the provision for credit losses. Contracts purchased
from third party dealers are generally purchased with a nonrefundable
acquisition discount (discount). The discount is negotiated with third party
dealers pursuant to a financing program that bases the discount on, among
other things, the credit risk of the borrower and the amount to be financed in
relation to the car's wholesale value. The discount is allocated between
discount available for credit losses and discount available for accretion to
interest income. The portion of discount allocated to the allowance is based
upon historical performance and write-offs of contracts acquired from third
party dealers, as well as the general credit worthiness of the borrowers and
the wholesale value of the vehicle. The remaining discount, if any, is
deferred and accreted to income using the interest method. To the extent that
the allowance is considered insufficient to absorb anticipated losses on the
third party dealer portfolio, additions to the allowance are established
through a charge to the provision for credit losses. The evaluation of the
discount and allowance considers such factors as the performance of each third
party dealer's loan portfolio, the Company's historical credit losses, the
overall portfolio quality and delinquency status, the review of specific
problem loans, the value of underlying collateral, and current economic
conditions that may affect the borrower's ability to pay.
Inventory
Inventory consists of used vehicles held for sale and is valued at the
lower of cost or market. Vehicle reconditioning costs are capitalized as a
component of inventory cost. The cost of used vehicles sold is determined on a
specific identification basis. Repossessed vehicles are valued at market
value.
Property and Equipment
Property and Equipment are stated at cost. Depreciation is computed using
straight-line and accelerated methods over the estimated useful lives of the
assets which range from three to ten years for equipment and thirty years for
buildings. Leasehold and land improvements are amortized using straight-line
and accelerated methods over the shorter of the lease term or the estimated
useful lives of the related improvements.
The Company has capitalized costs related to the development of software
products for internal use. Capitalization of costs begins when technological
feasibility has been established and ends when the software is available for
general use. Amortization is computed using the straight-line method over the
estimated economic life of five years.
Trademarks, Trade Names, Logos, and Contract Rights
The registered trade names, "Ugly Duckling Car Sales," "Ugly Duckling
Rent-A-Car," "America's Second Car," "Putting You on the Road to Good Credit"
and related trademarks, logos, and contract rights are stated at cost. The
cost of trademarks, trade names, logos, and contract rights is amortized on a
straight-line basis over their estimated economic lives of ten years.
Goodwill
Goodwill, which represents the excess of purchase price over fair value
of net assets acquired, is amortized on a straight-line basis over the
expected periods to be benefited, generally fifteen years. The Company
assesses the recoverability of this intangible asset by determining whether
the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill will be impacted if estimated future operating cash
flows are not achieved.
Post Sale Customer Support Programs
A liability for the estimated cost of post sale customer support,
including car repairs and the Company's down payment back and credit card
programs, is established at the time the used car is sold by charging Cost of
Used Cars Sold. The liability is evaluated for adequacy through a separate
analysis of the various programs' historical performance.
Income Taxes
The Company utilizes the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
Advertising
All costs related to production and advertising are expensed in the
period incurred or ratably over the year in relation to revenues or certain
other performance measures. The Company had no advertising costs capitalized
as of December 31, 1996.
Stock Option Plan
Prior to January 1, 1996, the Company accounted for its stock option plan
in accordance with the provisions of Accounting Principles Board ("APB")
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. As such, compensation expense would be recorded on the date
of grant only if the current market price of the underlying stock exceeded the
exercise price. On January 1, 1996, the Company adopted SFAS No. 123,
Accounting for Stock-Based Compensation, which permits entities to recognize
as expense over the vesting period the fair value of all stock-based awards on
the date of grant. Alternatively, SFAS No. 123 also allows entities to
continue to apply the provisions of APB Opinion No. 25 and provide pro forma
net earnings and pro forma earnings per share disclosures for employee stock
option grants made in 1995 and future years as if the fair-value-based method
defined in SFAS No. 123 had been applied. The Company has elected to continue
to apply the provisions of APB Opinion No. 25 and provide the pro forma
disclosure provisions of SFAS No. 123.
The Company uses one of the most widely used option pricing models, the
Black-Scholes model (the Model), for purposes of valuing its stock option
grants. The Model was developed for use in estimating the fair value of
traded options which have no vesting restrictions and are fully transferable.
In addition, it requires the input of highly subjective assumptions, including
the expected stock price volatility, expected dividend yields, the risk free
interest rate, and the expected life. Because the Company's stock options
have characteristics significantly different from those of traded options, and
because changes in subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the value determined by the Model is
not necessarily indicative of the ultimate value of the granted options.
Earnings Per Share
Earnings per share is based upon the weighted average number of common
shares outstanding plus dilutive common stock equivalents after giving effect
to the payment of dividends on preferred stock.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company adopted the provisions of SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of, on
January 1, 1996. The Statement requires that long-lived assets and certain
identifiable intangibles be reviewed for impairment whenever events or changes
in circumstances indicate the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which
the carrying amount of the assets exceed the fair value of the assets. Assets
to be disposed of are reported at the lower of the carrying amount or fair
value less costs to sell. Adoption of this Statement did not have a materiel
impact on the Company's financial position, results of operations, or
liquidity.
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities
In June 1996, the Financial Accounting Standards Board issued SFAS No.
125, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. SFAS No. 125 is effective for transfers and
servicing of financial assets and extinguishments of liabilities occurring
after December 31, 1996 and is to be applied prospectively. This Statement
provides accounting and reporting standards for transfers and servicing of
financial assets and extinguishments of liabilities based on consistent
application of a financial-components approach that focuses on control. It
distinguishes transfers of financial assets that are sales from transfers that
are secured borrowings. Management of the Company does not expect that
adoption of SFAS No. 125 will have a material impact on the Company's
financial position, results of operations, or liquidity.
(3) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
A summary of Net Finance Receivables at December 31, 1996 and 1995
follows (in thousands):
<TABLE><CAPTION>
DECEMBER 31,
-------------------------
1996 1995
-------------- ---------
<S> <C> <C>
Contractually Scheduled Payments $ 77,982 $ 66,425
Less: Unearned Finance Income (19,701) (18,394)
-------------- ---------
Installment Sales Contract Principal Balances 58,281 48,031
Add: Accrued Interest Receivable 718 613
Loan Origination Costs, Net 189 582
-------------- ---------
Principal Balances, Net 59,188 49,226
Less: Allowance for Credit Losses (8,125) (8,500)
-------------- ---------
Finance Receivables, Net $ 51,063 $ 40,726
============== =========
Held for Investment $ 52,188 $ 49,226
Held for Sale 7,000 -
-------------- ---------
59,188 49,226
Less: Allowance for Credit Losses (8,125) (8,500)
-------------- ---------
$ 51,063 $ 40,726
============== =========
</TABLE>
Allowance for Credit Losses as a percent of principal balances totaled
13.9% and 17.7% at December 31, 1996 and 1995, respectively.
The changes in the Allowance for Credit Losses for the years ended
December 31, 1996, 1995 and 1994 follow (in thousands):
<TABLE><CAPTION>
DECEMBER 31,
--------------------------------
1996 1995 1994
----------- --------- --------
<S> <C> <C> <C>
Balances, Beginning of Year $ 8,500 $ 6,209 $ 2,876
Provision for Credit Losses 9,811 8,359 8,140
Allowance Acquired from Discount 8,963 1,660 579
Net Charge Offs (9,168) (7,728) (5,386)
Sale of Finance Receivables (9,981) - -
----------- --------- --------
Balances, End of Year $ 8,125 $ 8,500 $ 6,209
=========== ========= ========
</TABLE>
(4) RESIDUALS IN FINANCE RECEIVABLES SOLD
The valuation of the Residual in Finance Receivables Sold as of December
31, 1996 totaled $9,889,000 which represents the present value of the
Company's interest in the anticipated future cash flows of the underlying
portfolio, discounted at rates ranging from 16% to 25%, after taking into
consideration anticipated prepayments and net charge offs. For contracts
originated at Company Dealerships, net losses were estimated using total
expected cumulative net losses at loan origination of approximately 25.0%,
adjusted for actual cumulative net losses prior to securitization. For
contracts purchased from Third Party Dealers, net losses were estimated using
total expected cumulative net losses at loan origination of approximately
13.5%, adjusted for actual cumulative net losses prior to securitization.
Losses are discounted at an assumed risk free rate. Prepayment rates were
estimated to be 1.5% per month of the beginning of month balance.
At December 31, 1996, the Company serviced Finance Receivables totaling
$51,663,000 which serves as collateral on $40,770,000 in senior certificates
issued to one investor. Approximately 89% of these finance receivables were
originated in the state of Arizona.
The future net charge offs taken into consideration in arriving at the
residual of $9,889,000 totaled $7,593,000 at December 31, 1996. This
represents 14.70% of the underlying finance receivables of $51,663,000 at
December 31, 1996.
(5) INVESTMENTS HELD IN TRUST
In connection with its securitization transactions, the Company is
required to provide a credit enhancement to the investor. The Company makes
an initial cash deposit, ranging form 3% to 4% of the initial underlying
finance receivables principal balance, of cash into an account held by the
trustee (spread account) and pledges this cash to the trust to which the
finance receivables were sold and then makes additional deposits from the
residual cash flow (through the trustee) to the spread account as necessary to
attain and maintain the spread account at a specified percentage, ranging from
6.0% to 8.0%, of the underlying finance receivables principal balance.
In the event that the cash flows generated by the Finance Receivables
sold to the trust are insufficient to pay obligations of the trust, including
principal or interest due to certificate holders or expenses of the trust, the
trustee will draw funds from the spread account as necessary to pay the
obligations of the trust. The spread account must be maintained at a specified
percentage of the principal balances of the finance receivables held by the
trust, which can be increased in the event delinquencies or losses exceed
specified levels. If the spread account exceeds the specified percentage, the
trustee will release the excess cash to the Company from the pledged spread
account. Except for releases in this manner, the cash in the spread account is
restricted from use by the Company.
During 1996, the Company made initial spread account deposits
totaling $2,630,000. Additional net deposits through the trustee during 1996
totaled $213,000 resulting in a total balance in the spread accounts of
$2,843,000 as of December 31, 1996. In connection therewith, the specified
spread account balance based upon the aforementioned specified percentages of
the balances of the underlying portfolios as of December 31, 1996 was
$3,941,000, resulting in additional funding requirements from future cash
flows as of December 31, 1996 of $1,098,000. The additional funding
requirement will decline as the trustee deposits additional cash flows into
the spread account and as the principal balance of the underlying finance
receivables declines.
In connection with certain other agreements, the Company has deposited a
total of $636,000 in an interest bearing trust account.
(6) PROPERTY AND EQUIPMENT
A summary of Property and Equipment as of December 31, 1996 and 1995
follows (in thousands):
<TABLE><CAPTION>
DECEMBER 31,
------------------------
1996 1995
-------------- --------
<S> <C> <C>
Land $ 7,811 $ 15
Buildings and Leasehold Improvements 5,699 5,143
Furniture and Equipment 5,696 3,401
Software Development Costs 693 533
Vehicles 156 133
Construction in Process 3,536 11
-------------- --------
23,591 9,236
Less Accumulated Depreciation and Amortization (2,939) (1,439)
-------------- --------
Property and Equipment, Net $ 20,652 $ 7,797
============== ========
</TABLE>
No Interest Expense was capitalized in 1996. Interest Expense capitalized
in 1995 and 1994 totaled $54,000 and $142,000, respectively
(7) GOODWILL AND TRADEMARKS
In October, 1996, the Company acquired the operating lease and a loan
portfolio of a used car dealership. In connection with this acquisition, the
Company recorded goodwill totaling $1,944,000.
A summary of Trademarks as of December 31, 1996 and 1995 follows (in
thousands):
<TABLE><CAPTION>
DECEMBER 31,
---------------
1996 1995
------- ------
<S> <C> <C>
Original Cost $ 581 $ 581
Accumulated Amortization (375) (312)
------- ------
Trademarks, Net $ 206 $ 269
======== ======
</TABLE>
Amortization expense relating to Trademarks totaled $63,000 for each of
the years ended December 31, 1996, 1995 and 1994.
(8) OTHER ASSETS
A summary of Other Assets as of December 31, 1996 and 1995 follows (in
thousands):
<TABLE><CAPTION>
DECEMBER 31,
----------------
1996 1995
-------- ------
<S> <C> <C>
Note Receivable $ 1,063 $ -
Pre-opening and Startup Costs 1,242 -
Escrow Deposits 900 -
Prepaid Expenses 796 643
Deferred Income Taxes 676 925
Income Taxes Receivable 316 850
Property and Equipment Held for Sale - 1,086
Other Assets 1,650 746
-------- ------
$ 6,643 $4,250
======== ======
</TABLE>
(9) ACCRUED EXPENSES AND OTHER LIABILITIES
A summary of Accrued Expenses and Other Liabilities as of December 31,
1996 and 1995 follows (in thousands):
<TABLE><CAPTION>
DECEMBER 31,
-------------
1996 1995
-------- ------
<S> <C> <C>
Sales Taxes $ 2,904 $2,258
Others 3,824 3,299
-------- ------
$ 6,728 $5,557
======== ======
</TABLE>
In connection with the retail sale of vehicles, the Company is required
to pay sales taxes to certain government jurisdictions. The Company has
elected to pay these taxes using the "cash basis", which requires the Company
to pay the sales tax obligation for a sale transaction as principal is
collected over the life of the related finance receivable contract.
(10) NOTES PAYABLE
A summary of Notes Payable at December 31, 1996 and 1995 follows:
<TABLE><CAPTION>
DECEMBER 31,
------------------
1996 1995
---------- -------
(in thousands)
<S> <C> <C>
50,000,000 revolving loan with a finance company, interest payable daily
at 30 day LIBOR (5.40% at December 31, 1996) plus 3.60% through
September 1997, at which time the Company retains the right to extend
the loan for one additional year, secured by substantially all assets
of the Company $ 4,602 $32,201
Two notes payable to a finance company totaling $7,450,000, monthly
interest payable at the prime rate (8.25% at December 31, 1996) plus
1.50% through January 1998; thereafter, monthly payments of $89,000
plus interest through January 2002 when balloon payments totaling
3,282,000 are due, secured by first deeds of trust and assignments of
rents on certain real property 7,444 -
3,000,000 note payable to an insurance company, interest payable
quarterly at 12.5% per annum. Converted to common stock concurrent with
with the Company's initial public offering in 1996 - 3,000
Others bearing interest at rates ranging from 9% to 11% due through April
2007, secured by certain real property and certain property and
equipment 858 -
---------- -------
Total $ 12,904 $35,201
========== =======
</TABLE>
The aforementioned revolving loan agreement contains various reporting
and performance covenants including the maintenance of certain ratios,
limitations on additional borrowings from other sources, restrictions on
certain operating activities, and a restriction on the payment of dividends
under certain circumstances. The Company was in compliance with the covenants
at December 31, 1996 and 1995.
A summary of future minimum principal payments required (assuming the
Company exercises its right to extend the revolving loan through September
1998) under the aforementioned notes payable as of December 31, 1996 follows
(in thousands):
<TABLE><CAPTION>
DECEMBER 31, 1996
------------------
<S> <C>
1997 $ 86
1998 5,673
1999 1,169
2000 1,179
2001 1,191
Thereafter 3,606
------------------
$ 12,904
==================
</TABLE>
(11) SUBORDINATED NOTES PAYABLE
The Company has executed two subordinated notes payable with Verde. As
discussed in the following paragraphs, the balance outstanding under these
notes totaled $14,553,000 at December 31, 1995. There was no accrued interest
payable related to these notes at December 31, 1995.
In August 1993, the Company entered into a ten-year, subordinated note
payable agreement with Verde. This unsecured $15,000,000 note bears interest
at an annual rate of 18%, with interest payable monthly and is subordinated to
all other Company liabilities. The note also provides for suspension of
interest payments should the Company be in default with any other creditors.
The Company had $10,000,000 outstanding related to this note payable at
December 31, 1995.
In December 1995, the Company amended its five-year junior subordinated
revolving note payable agreement with Verde. The note was increased from
$3,000,000 to $5,000,000, bears interest at an annual rate of 18%, with
interest payable monthly, and is scheduled to mature in December 1999. The
Company had $4,553,000 outstanding related to this note payable at December
31, 1995.
Interest expense related to the subordinated notes payable with Verde
totaled $1,933,000, $3,492,000 and $2,569,000 during the years ended December
31, 1996, 1995 and 1994, respectively.
On December 31, 1995, Verde converted $10,000,000 of subordinated notes
payable to preferred stock of the Company. Verde agreed to waive any
prepayment penalties associated with the reduction of the subordinated notes
payable in connection with the conversion.
In conjunction with the closing of the Company's initial public offering
in June 1996, the two previously outstanding subordinated notes payable were
exchanged for a new subordinated note payable. The new $14,000,000 unsecured
note bears interest at an annual rate of 10%, with interest payable monthly
and is subordinate to all other Company indebtedness. The note also calls for
annual principal payments of $2,000,000 through June 2003 when the loan will
be paid in full. The Company had $14,000,000 outstanding under this note
payable at December 31, 1996.
(12) INCOME TAXES
Income tax expense (benefit) amounted to $100,000, zero and $(334,000)
for the years ended December 31, 1996, 1995 and 1994, respectively (an
effective tax rate of 1.7%, 0% and 14.5%, respectively). A reconciliation
between taxes computed at the federal statutory rate of 34% and at the
effective tax rate on earnings (loss) before income taxes follows (in
thousands):
<TABLE><CAPTION>
DECEMBER 31,
-------------------------
1996 1995 1994
------- -------- ------
<S> <C> <C> <C>
Computed "Expected" Tax Expense (Benefit) $ 2,028 $(1,350) $(782)
State Income Taxes, Net of Federal Effect 41 - (30)
Change in Valuation Allowance (2,315) 1,418 897
Other, Net 346 (68) (419)
-------- ------- ------
$ 100 $ - $(334)
======== ====== ======
</TABLE>
Components of income tax expense (benefit) for the years ended December
31, 1996, 1995 and 1994 follow (in thousands):
<TABLE><CAPTION>
CURRENT DEFERRED TOTAL
--------- ---------- -------
<S> <C> <C> <C>
1996:
Federal $ (149) $ 187 $ 38
State - 62 62
--------- ---------- -------
$ (149) $ 249 $ 100
========= ========== =======
1995:
Federal $ (449) $ 449 $ -
State - - -
--------- ---------- -------
$ (449) $ 449 $ -
========= ========== =======
1994:
Federal $ 79 $ (367) $ (288)
State 48 (94) (46)
--------- ---------- -------
$ 127 $ (461) $ (334)
========= ========== =======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of
December 31, 1996 and 1995 are presented below (in thousands):
<TABLE><CAPTION>
DECEMBER 31,
-------------------
1996 1995
--------- --------
<S> <C> <C>
Deferred Tax Assets:
Finance Receivables, Principally Due to the Allowance
for Credit Losses $ 131 $ 2,987
Federal and State Income Tax Net Operating Loss
Carryforwards 995 317
Residual in Finance Receivables 140 -
Other 279 443
--------- --------
Total Gross Deferred Tax Assets 1,545 3,747
Less: Valuation Allowance - (2,315)
--------- --------
Net Deferred Tax Assets 1,545 1,432
--------- --------
Deferred Tax Liabilities:
Acquisition Discount (112) -
Software Development Costs (192) (96)
Other Assets (490) -
Loan Origination Fees (75) (198)
Inventory - (213)
--------- --------
Total Gross Deferred Tax Liabilities (869) (507)
--------- --------
Net Deferred Tax Asset $ 676 $ 925
========= ========
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1996
and 1995 was zero and $2,315,000, respectively. The net change in the total
Valuation Allowance for the year ended December 31, 1996 was a decrease of
$2,315,000, and an increase of $1,418,000 for the year ended December 31,
1995. In assessing the realizability of Deferred Tax Assets, management
considers whether it is more likely than not that some portion or all of the
Deferred Tax Assets will not be realized. The ultimate realization of Deferred
Tax Assets is dependent upon generation of future taxable income during the
periods in which those temporary differences become deductible. Management
considers the scheduled reversal of Deferred Tax Liabilities, projected future
taxable income, and tax planning strategies in making this assessment. Based
upon the level of historical taxable income and projections for future taxable
income over the periods in which the Deferred Tax Assets are deductible,
management believes it is more likely than not that the Company will realize
the benefits of these deductible differences, net of the existing Valuation
Allowance.
At December 31, 1996, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $2,249,000, which, subject to
annual limitations, are available to offset future taxable income, if any,
through 2011 and net operating loss carryforwards for state income tax
purposes of $3,543,000, which are available to offset future taxable income
through 2001.
A summary of the net operating loss carryforwards follows (in thousands):
<TABLE><CAPTION>
YEAR OF EXPIRATION FEDERAL STATE
- ------------------ -------- -------
<S> <C> <C>
2000 - $ 1,927
2001 - 1,616
2006 633 -
2011 1,616 -
-------- --------
2,249 $ 3,543
======== ========
</TABLE>
(13) LEASE COMMITMENTS
The Company leases an operating facility, offices, a vehicle and office
equipment from unrelated entities under operating leases which expire through
August 2001. The leases require monthly rental payments aggregating
approximately $155,000 and contain various renewal options from one to ten
years. In certain instances, the Company is also responsible for occupancy and
maintenance costs, including real estate taxes, insurance, and utility costs.
The Company purchased six car lots, a vehicle reconditioning center, and
two office buildings from Verde. These properties had previously been rented
from Verde pursuant to various leases which called for base monthly rents
aggregating approximately $123,000 plus contingent rents as well as all
occupancy and maintenance costs, including real estate taxes, insurance, and
utilities. In connection with the purchase, Verde returned security deposits
which totaled $364,000. The security deposits are included in Other Assets in
the accompanying Consolidated Balance Sheet as of December 31, 1995.
Rent expense for the year ended December 31, 1996 totaled $2,394,000.
Rents paid to Verde totaled $1,498,000 including contingent rents of $440,000.
There was no accrued rent payable to Verde at December 31, 1996.
Rent expense for the year ended December 31, 1995 totaled $2,377,000.
Rents paid to Verde totaled $1,889,000, including contingent rents of
$465,000, and $113,000 of rent capitalized during the construction period of a
facility. Accrued rent payable to Verde totaled $101,000 at December 31, 1995
and is included in Accrued Expenses and Other Liabilities on the accompanying
Consolidated Balance Sheets.
Rent expense for the year ended December 31, 1994 totaled $1,400,000.
Rents paid to Verde totaled $1,221,000 including contingent rents of $310,000,
and $127,000 of rent capitalized during the construction period of two used
car dealership facilities.
A summary of future minimum lease payments required under noncancelable
operating leases with remaining lease terms in excess of one year as of
December 31, 1996 follows (in thousands):
<TABLE><CAPTION>
DECEMBER 31, 1996
------------------
<S> <C>
1997 $ 1,788
1998 1,547
1999 1,190
2000 533
2001 378
Thereafter 104
------------------
Total $ 5,540
==================
</TABLE>
(14) STOCKHOLDERS' EQUITY
On April 24, 1996, the Company effectuated a 1.16-to-1 stock split. The
effect of this stock split has been reflected for all periods presented in the
Consolidated Financial Statements.
The Company has authorized 20,000,000 shares of $.001 par value common
stock. There were 13,327,000 and 5,580,000 shares issued and outstanding at
December 31, 1996 and 1995, respectively. The common stock consists of $13,000
of common stock and $82,599,000 of additional paid-in capital at December 31,
1996. The common stock consists of $6,000 of common stock and $121,000 of
additional paid-in capital as of December 31, 1995.
During 1996, the Company completed two public offerings in which it
issued a total of 7,245,000 shares of common stock for approximately
$79,435,000 cash net of stock issuance costs.
Warrants to acquire 116,000 shares of the Company's common stock at $6.75
per share and 170,000 shares of the Company's common stock at $9.45 per share
were outstanding at December 31, 1996.
The Company has authorized 10,000,000 shares of $.001 par value preferred
stock. There were zero and 1,000,000 shares issued and outstanding at December
31, 1996, and 1995, respectively.
On December 31, 1995, the Company exchanged 1,000,000 shares of Series A
preferred stock for $10,000,000 of subordinated notes payable with Verde.
Cumulative dividends were payable at a rate of 12% per annum through June 21,
1996, at which time the Series A preferred stock was exchanged on a
share-for-share basis for 1,000,000 shares of Series B preferred stock. The
dividends were payable quarterly upon declaration by the Company's Board of
Directors. In November 1996, the Company redeemed the 1,000,000 shares of
Series B preferred stock.
The Company's Board of Directors declared quarterly dividends on
preferred stock totaling approximately $916,000 during the year ended December
31, 1996. There were no cumulative unpaid dividends at December 31, 1996.
(15) STOCK OPTION PLAN
In June, 1995, the Company adopted a long-term incentive plan (stock
option plan). The stock option plan, as amended, sets aside 1,300,000 shares
of common stock to be granted to employees at a price not less than fair
market value of the stock at the date of grant. Options are to vest over a
period to be determined by the Board of Directors upon grant and will
generally expire ten years after the date of grant. The options generally vest
over a period of five years.
At December 31, 1996, there were 388,000 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock
options granted during 1996 and 1995 was $8.39 and $1.10, respectively on the
date of grant using the Black-Scholes option-pricing model with the following
weighted-average assumptions: 1996 - expected dividend yield 0%, risk-free
interest rate of 6.3%, expected volatility of 56.5%, and an expected life of 7
years; 1995 - expected dividend yield 0%, risk-free interest rate of 6.1%,
expected volatility of 56.5% and an expected life of 7 years.
The Company applies APB Opinion 25 in accounting for its Plan, and
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under
SFAS No. 123, the Company's net earnings and earnings per share would have
been reduced to the pro forma amounts indicated below:
<TABLE><CAPTION>
DECEMBER 31,
---------------------------
1996 1995
------------- ------------
<S> <C> <C> <C>
Net Earnings (Loss) As reported $ 5,866,000 $(3,972,000)
Pro forma $ 5,748,000 $(3,985,000)
Earnings (Loss) per Share As reported $ 0.60 $ (0.67)
Pro forma $ 0.58 $ (0.68)
</TABLE>
The full impact of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma net earnings (loss) amounts
presented above because compensation cost is reflected over the options'
vesting period of five years.
A summary of the aforementioned stock plan follows:
<TABLE><CAPTION>
WEIGHTED
AVERAGE
PRICE PER
NUMBER SHARE
-------- ----------
<S> <C> <C>
Balance December 31, 1994 - -
Granted 459,000 $ 1.72
Forfeited (17,000) 2.16
-------- ----------
Balance, December 31, 1995 442,000 1.70
Granted 539,000 13.41
Forfeited (30,000) 3.26
Exercised (39,000) 1.00
-------- ----------
Balance, December 31, 1996 912,000 $ 8.60
======== ==========
</TABLE>
A summary of stock options granted at December 31, 1996 follows:
<TABLE><CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------- --------------------------
<S> <C> <C> <C> <C> <C>
NUMBER WEIGHTED-AVG. WEIGHTED-AVG. NUMBER WEIGHTED-AVG.
RANGE OF OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/96 CONTRACTUAL LIFE PRICE AT 12/31/96 PRICE
- ----------------- ------------ ---------------- -------------- ------------ ------------
$.50 to $1.00 130,000 8.0 years $ 0.86 - $ -
$1.50 to $2.60 247,000 8.5 years $ 2.16 51,000 2.15
$3.45 to $9.40 192,000 9.5 years $ 6.73 - -
$11.88 to $17.69 343,000 10.0 years $ 17.22 - -
------------ -------------- ------------ ------------
912,000 $ 8.60 51,000 $ 2.15
============ ============== ============ ============
</TABLE>
(16) COMMITMENTS AND CONTINGENCIES
The Company has executed an agreement to sell up to $50,000,000 in
finance receivable backed certificates through December 31, 1996 to an
insurance company. In addition, the purchaser has the right of first refusal
to purchase up to an additional $125,000,000 of finance receivables through
December 31, 1998. The Company completed the sale of approximately $58,000,000
in receivable-backed certificates during the year ended December 31, 1996.
The Company is involved in various claims and actions arising in the
ordinary course of business. In the opinion of management, based on
consultation with legal counsel, the ultimate disposition of these matters
will not have a materially adverse effect on the Company.
(17) RETIREMENT PLAN
During 1995, the Company established a qualified 401(k) retirement plan
(defined contribution plan) which became effective on October 1, 1995. The
plan covers substantially all employees having no less than one year of
service, have attained the age of 21, and work at least 1,000 hours per year.
Participants may voluntarily contribute to the plan up to the maximum limits
established by Internal Revenue Service regulations. The Company will match
10% of the participants' contributions. Participants are immediately vested in
the amount of their direct contributions and vest over a five-year period, as
defined by the plan, with respect to the Company's contribution. Pension
expense totaled $23,000 and $5,000 during the years ended December 31, 1996
and 1995, respectively.
(18) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires that the Company disclose
estimated fair values for its financial instruments. The following summary
presents a description of the methodologies and assumptions used to determine
such amounts.
Limitations
Fair value estimates are made at a specific point in time and are based
on relevant market information and information about the financial instrument;
they are subjective in nature and involve uncertainties, matters of judgment
and, therefore, cannot be determined with precision. These estimates do not
reflect any premium or discount that could result from offering for sale at
one time the Company's entire holdings of a particular instrument. Changes in
assumptions could significantly affect these estimates.
Since the fair value is estimated as of December 31, 1996 and 1995, the
amounts that will actually be realized or paid in settlement of the
instruments could be significantly different.
Cash and Cash Equivalents and Investments Held in Trust
The carrying amount is assumed to be the fair value because of the
liquidity of these instruments.
Finance Receivables and Residuals in Finance Receivables Sold
The carrying amount is assumed to be the fair value because of the
relative short maturity and repayment terms of the portfolio as compared to
similar instruments.
Accounts Payable, Accrued Expenses, and Notes Payable
The carrying amount approximates fair value because of the short maturity
of these instruments. The terms of the Company's notes payable approximate the
terms in the market place at which they could be replaced. Therefore, the fair
market value approximates the carrying value of these financial instruments.
Subordinated Notes Payable
The terms of the Company's subordinated notes payable approximate the
terms in the market place at which they could be replaced. Therefore, the fair
value approximates the carrying value of these financial instruments.
(19) SUBSEQUENT EVENTS
Subsequent to year end, the Company acquired the operating assets of five
used car dealerships and a finance company for a total of approximately
$32,130,000. The acquisition, which was financed with cash and borrowings
under the Company's revolving loan will be accounted for as a purchase.
On February 13, 1997, the Company completed a private placement of
5,075,500 shares of unregistered common stock for approximately $88,850,000
cash, net of stock issuance costs.
(20) BUSINESS SEGMENTS
Operating results and other financial data are presented for the
principal business segments of the Company for the years ended December 31,
1996, 1995, and 1994, respectively. The Company has four distinct business
segments. These consist of retail car sales operations (Company dealerships),
the income generated from the finance receivables generated at the Company
dealerships, finance income generated from third party finance receivables,
and corporate and other operations. In computing operating profit by business
segment, the following items were considered in the Corporate and Other
category: portions of administrative expenses, interest expense and other
items not considered direct operating expenses. Identifiable assets by
business segment are those assets used in each segment of Company operations.
<TABLE><CAPTION>
COMPANY THIRD
COMPANY DEALERSHIP PARTY CORPORATE
DEALERSHIPS RECEIVABLES RECEIVABLES AND OTHER TOTAL
--------------- ------------ ------------- ----------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
December 31, 1996:
Sales of Used Cars $ 53,768 $ - $ - $ - $ 53,768
Less: Cost of Cars Sold 29,890 - - - 29,890
Provision for Credit Losses 9,658 - 153 - 9,811
--------------- ------------ ------------- ----------- --------
14,220 - (153) - 14,067
Interest Income - 8,426 7,259 171 15,856
Gain on Sale of Loans - 3,925 509 - 4,434
Other Income 195 921 - 455 1,571
--------------- ------------ ------------- ----------- --------
Income before Operating
Expenses 14,415 13,272 7,615 626 35,928
--------------- ------------ ------------- ----------- --------
Operating Expenses:
Selling and Marketing 3,568 - - 17 3,585
General and Administrative 8,295 3,042 3,955 4,246 19,538
Depreciation and Amortization 318 769 195 295 1,577
--------------- ------------ ------------- ----------- --------
12,181 3,811 4,150 4,558 24,700
--------------- ------------ ------------- ----------- --------
Income before Interest Expense $ 2,234 $ 9,461 $ 3,465 $ (3,932) $ 11,228
=============== ============ ============= =========== ========
Capital Expenditures $ 4,530 $ 455 $ 621 $ 505 $ 6,111
=============== ============ ============= =========== ========
Identifiable Assets $ 20,698 $ 12,775 $ 45,558 $ 39,052 $118,083
=============== ============ ============= =========== ========
December 31, 1995:
Sales of Used Cars $ 47,824 $ - $ - $ - $ 47,824
Less: Cost of Cars Sold 27,964 - - - 27,964
Provision for Credit Losses 8,359 - - - 8,359
--------------- ------------ ------------- ----------- --------
11,501 - - - 11,501
Interest Income - 8,227 1,844 - 10,071
Other Income - - - 308 308
--------------- ------------ ------------- ----------- --------
Income before Operating
Expenses 11,501 8,227 1,844 308 21,880
--------------- ------------ ------------- ----------- --------
Operating Expenses:
Selling and Marketing 3,856 - - - 3,856
General and Administrative 8,210 2,681 1,163 2,672 14,726
Depreciation and Amortization 279 479 89 467 1,314
--------------- ------------ ------------- ----------- --------
12,345 3,160 1,252 3,139 19,896
--------------- ------------ ------------- ----------- --------
Income before Interest Expense $ (844) $ 5,067 $ 592 $ (2,831) $ 1,984
=============== ============ ============= =========== ========
Capital Expenditures $ 1,195 $ 1,561 $ 216 $ 223 $ 3,195
=============== ============ ============= =========== ========
Identifiable Assets $ 11,452 $ 32,187 $ 13,419 $ 3,732 $ 60,790
=============== ============ ============= =========== ========
</TABLE>
<TABLE><CAPTION>
COMPANY THIRD
COMPANY DEALERSHIP PARTY CORPORATE
DEALERSHIPS RECEIVABLES RECEIVABLES AND OTHER TOTAL
--------------- ------------ ------------- ----------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
December 31, 1994:
Sales of Used Cars $ 27,768 $ - $ - $ - $27,768
Less: Cost of Cars Sold 12,577 - - - 12,577
Provision for Credit Losses 7,190 834 116 - 8,140
--------------- ------------ ------------- ----------- --------
8,001 (834) (116) - 7,051
Interest Income - 4,683 766 - 5,449
Other Income - - - 556 556
--------------- ------------ ------------- ----------- --------
Income before Operating
Expenses 8,001 3,849 650 556 13,056
--------------- ------------ ------------- ----------- --------
Operating Expenses:
Selling and Marketing 2,263 - - 139 2,402
General and Administrative 5,069 1,631 240 2,201 9,141
Depreciation and Amortization 131 159 64 423 777
--------------- ------------ ------------- ----------- --------
7,463 1,790 304 2,763 12,320
--------------- ------------ ------------- ----------- --------
Income before Interest Expense $ 538 $ 2,059 $ 346 $ (2,207) $ 736
=============== ============ ============= =========== ========
Capital Expenditures $ 3,905 $ 757 $ 302 $ 370 $ 5,334
===============
Identifiable Assets $ 8,788 $ 16,764 $ 1,558 $ 2,601 $29,711
===============
</TABLE>
(21) QUARTERLY FINANCIAL DATA - UNAUDITED
A summary of the quarterly data for the years ended December 31, 1996 and
1995 follows:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
--------------- --------- --------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
1996:
Total Revenue $ 19,396 $ 20,081 $ 18,259 $ 17,893 $75,629
=============== ========= ========= ========= ========
Income before Operating Expenses 8,442 9,005 8,741 9,740 35,928
=============== ========= ========= ========= ========
Operating Expenses 5,694 6,296 5,522 7,188 24,700
=============== ========= ========= ========= ========
Income before Interest Expense 2,716 2,721 3,157 2,634 11,228
=============== ========= ========= ========= ========
Net Earnings $ 1,065 $ 1,083 $ 1,967 $ 1,751 $ 5,866
=============== ========= ========= ========= ========
Earnings Per Share $ 0.13 $ 0.13 $ 0.19 $ 0.14 $ 0.60
=============== ========= ========= ========= ========
1995:
Total Revenues $ 11,546 $ 14,975 $ 16,944 $ 14,738 $58,203
=============== ========= ========= ========= ========
Income before Operating Expenses 4,628 5,601 5,858 5,793 21,880
=============== ========= ========= ========= ========
Operating Expenses 3,970 4,646 5,366 5,914 19,896
=============== ========= ========= ========= ========
Income before Interest Expense 658 955 492 (121) 1,984
=============== ========= ========= ========= ========
Net Loss $ (465) $ (283) $ (1,169) $ (2,055) $(3,972)
=============== ========= ========= ========= ========
Loss Per Share $ (0.08) $ (0.05) $ (0.20) $ (0.35) $ (0.67)
=============== ========= ========= ========= ========
</TABLE>
ITEM 9 - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
The Company has had no disagreements with its independent accountants in
regard to accounting and financial disclosure and has not changed its
independent accountants during the two most recent fiscal years.
PART III
ITEM 10 - DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information regarding (i) directors and executive officers of the Company
is set forth under the caption "Information Concerning Directors and Executive
Officers" and (ii) compliance with Section 16(a) is set forth under the
caption "Section 16(a) Beneficial Ownership Reporting Compliance," in the
Company's Proxy Statement relating to its 1997 Annual Meeting of Stockholders
(the "1997 Proxy Statement") incorporated by reference into this Form 10-K
Report, which has been filed with the Commission in accordance with Rule 14a-6
promulgated under the Exchange Act. With the exception of the foregoing
information and other information specifically incorporated by reference into
this report, the Company's 1997 Proxy Statement is not being filed as a part
hereof.
ITEM 11 - EXECUTIVE COMPENSATION
Information regarding executive compensation is set forth under the
caption "Executive Compensation" in the 1997 Proxy Statement, which
information is incorporated herein by reference; provided, however, that the
"Compensation Committee Report on Executive Compensation" and the "Stock Price
Performance Graph" contained in the 1997 Proxy Statement are not incorporated
by reference herein.
ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information regarding security ownership of certain beneficial owners and
management is set forth under the caption "Security Ownership of Certain
Beneficial Owners and Management" in the 1997 Proxy Statement, which
information is incorporated herein by reference.
ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information regarding certain relationships and related transactions of
management is set forth under the caption "Certain Transactions and
Relationships" in the 1997 Proxy Statement, which information is incorporated
herein by reference.
PART IV
ITEM 14 - EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES, AND REPORTS
ON FORM 8-K
(a) CONSOLIDATED FINANCIAL STATEMENTS.
The following consolidated financial statements of Ugly Duckling
Corporation, are filed as part of this Form 10-K.
<TABLE><CAPTION>
Page
----
<S> <C>
Independent Auditors' Report 31
Consolidated Financial Statements and Notes thereto of Ugly Duckling Corporation:
Consolidated Balance Sheets - December 31, 1996 and 1995 32
Consolidated Statements of Operations - for the years ended December 31, 1996,
1995, and 1994 33
Consolidated Statements of Stockholders' Equity - for the years ended
December 31, 1996, 1995, and 1994 34
Consolidated Statements of Cash Flows - for the years ended December 31, 1996,
1995, and 1994 35
Notes to Consolidated Financial Statements 36
</TABLE>
All schedules have been omitted because they are not applicable, not
required, or the information has been disclosed in the consolidated financial
statements and related notes or otherwise in the form 10K.
(b) REPORTS ON FORM 8-K.
No report on Form 8-K was filed during the last quarter of the period
covered by this report.
(c) EXHIBITS.
The following exhibits are filed as part of this Form 10-K.
<TABLE><CAPTION>
<S> <C>
EXHIBIT
NUMBER DESCRIPTION
- -------- -----------------------------------------------------------------------------------------------------
3.1 Certificate of Incorporation of the Registrant(1)
3.1(a) Amendment to Certificate of Incorporation of the Registrant(1)
3.2 Bylaws of the Registrant(1)
3.2(a) Amendment to Bylaws of the Registrant(1)
4.1 Certificate of Incorporation of the Registrant filed as Exhibit 3.1(1)
4.2 Series A Preferred Stock Agreement(1)
4.3 18% Subordinated Debenture of the Registrant issued to Verde Investments, Inc.(1)
4.4 18% Junior Subordinated Revolving Debenture of the Registrant issued to Verde Investments, Inc., as
amended(1)
4.5 Convertible Note of the Registrant issued to SunAmerica Life Insurance Company(1)
4.6 Form of Certificate representing Common Stock(1)
4.7 Form of Warrant issued to Cruttenden Roth Incorporated as Representative of the several
underwriters(1)
4.8 Form of Warrant issued to SunAmerica Life Insurance Company(1)
10.1 Motor Vehicle Installment Contract Loan and Security Agreement between the Registrant and General
Electric Capital Corporation(1)
10.1(a) Amendment to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(1)
10.1(b) Amendment to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(1)
10.1(c) Amendment No. 3 to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(1)
10.1(d) Amendment No. 4 to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(1)
10.1(e) Amendment No. 5 to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(1)
10.1(f) Amendment No. 6 to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation(2)
10.1(g) Assumption and Amendment Agreement between the Registrant and General Electric Capital
Corporation(2)
10.1(h) Amendment No. 7 to Motor Vehicle Installment Contract Loan and Security Agreement between the
Registrant and General Electric Capital Corporation (5)
10.2 Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company(1)
10.2(a) First Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance
Company(1)
10.2(b) Second Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life
Insurance Company(1)
10.2(c) Third Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance
Company(1)
10.2(d) Fourth Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life
Insurance Company(1)
10.2(e) Commitment Letter entered into between the Registrant and SunAmerica Life Insurance Company(1)
10.2(f) Letter Agreement regarding Note Conversion between the Registrant and SunAmerica Life Insurance
Company(1)
10.3 Registration Rights Agreement between the Registrant and SunAmerica Life Insurance Company(1)
10.3(a) Amended and Restated Registration Rights Agreement between the Registrant and SunAmerica Life
Insurance Company(1)
10.4 Form of Pooling and Servicing Agreement relating to SunAmerica securitization program(1)
10.5 Form of Certificate Purchase Agreement relating to SunAmerica securitization program(1)
10.6 Form of Origination Agreement and Assignment relating to SunAmerica securitization program(1)
10.7 Form of Purchase Agreement and Assignment relating to SunAmerica securitization program(1)
10.8 Form of Servicing Guaranty relating to SunAmerica securitization program(1)
10.9 Ugly Duckling Corporation Long-Term Incentive Plan*
10.10 Employment Agreement between the Registrant and Ernest C. Garcia, II(1)*
10.11 Employment Agreement between the Registrant and Steven T. Darak(1)*
10.12 Employment Agreement between the Registrant and Wally Vonsh(1)*
10.13 Employment Agreement between the Registrant and Donald Addink(1)*
10.14 Lease Agreement between the Registrant and Camelback Esplanade Limited Partnership for corporate
offices in Phoenix, Arizona(1)
10.15 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 5104
West Glendale Avenue in Glendale, Arizona(1)
10.16 Building Lease Agreement between the Registrant and Verde Investments, Inc. for property and
buildings located at 9630 and 9650 North 19th Avenue in Phoenix, Arizona (1)
10.17 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 330
North 24th Street in Phoenix, Arizona (1)
10.18 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 333
South Alma School Road in Mesa, Arizona (1)
10.19 Lease Agreements between the Registrant and Blue Chip Motors, the Registrant and S & S Holding
Corporation and the Registrant and Edelman Brothers for certain properties located at 3901 East
Speedway Boulevard in Tucson, Arizona (1)
10.20 Real Property Lease between the Registrant and Peter and Alva Keesal for property located at 3737
South Park Avenue in Tucson, Arizona (1)
10.21 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 2301
North Oracle Road in Tucson, Arizona (1)
10.22 Related Party Transactions Modification Agreement between the Registrant and Verde Investments,
Inc. (1)
10.23 Sublease Agreement between the Registrant and Envirotest Systems Corp. for corporate offices in
Phoenix, Arizona (1)
10.24 Form of Indemnity Agreement between the Registrant and its directors and officers(1)
10.25 Ugly Duckling Corporation 1996 Director Incentive Plan (1)*
10.26 Purchase Agreement, dated February 10, 1997 between the Registrant and Friedman Billings, Ramsey &
Co., Inc. (4)
10.27 Agreement of Purchase and Sale of Assets dated as of December 31, 1996 (3)
10.28 Agreement of Purchase and Sale of Assets dated as of March 5, 1997 (5)
11 Earnings (Loss) per Share Computation (4)
22 List of Subsidiaries (4)
23 Independent Auditors' Consent
24.1 Power of Attorney of Robert J. Abrahams #
24.2 Power of Attorney of Christopher D. Jennings#
24.3 Power of Attorney of John N. MacDonough #
24.4 Power of Attorney of Arturo R. Moreno #
24.5 Power of Attorney of Frank P. Willey #
</TABLE>
__________
<TABLE>
<CAPTION>
<C> <S>
(1) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration
No. 333-3998), effective June 18, 1996.
(2) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration
No. 333-13755), effective October 30, 1996.
(3) Incorporated by reference to the Company's Current Report on Form 8-K, filed January 30, 1997.
(4) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration
No. 333-22237).
(5) Incorporated by reference to the Company's Annual Report on Form 10-K, filed on March 31, 1997.
</TABLE>
* Indicates a management contract or compensation plan.
# Previously filed.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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
a Delaware corporation
By: /s/ Gregory B. Sullivan
Gregory B. Sullivan
President and Chief Operating Officer
Date: May 14, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE><CAPTION>
<S> <C> <C>
Name and Signature Title Date
- ------------------------ ---------------------------- ------------
/s/ ERNEST C. GARCIA II Chief Executive Officer and May 14, 1997
- ------------------------
Ernest C. Garcia II Director (Principal
/s/ STEVEN T. DARAK Senior Vice President and May 14, 1997
- ------------------------
Steven T. Darak Chief Financial Officer
(Principal financial and
accounting officer)
* Director May 14, 1997
- ------------------------
Robert J. Abrahams
* Director May 14, 1997
- ------------------------
Christopher D. Jennings
* Director May 14, 1997
- ------------------------
John N. MacDonough
* Director May 14, 1997
- ------------------------
Arturo R. Moreno
* Director May 14, 1997
- ------------------------
Frank P. Willey
</TABLE>
* By: /s/ Gregory B. Sullivan
Gregory B. Sullivan
Attorney-in-Fact
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION
SCHEDULE OF COMPUTATION OF EARNINGS PER COMMON SHARE
Year Ended December 31,
----------------------------------------------------------------------------------
1996 1995 1994
------------------------ ------------------------- --------------------------
Fully Fully Fully
Primary Diluted Primary Diluted Primary Diluted
----------- ----------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Net earnings (loss) $5,866,000 $5,866,000 $(3,972,000) $(3,972,000) $(1,967,000) $(1,967,000)
Preferred dividends (916,000) (916,000) 0 0 0 0
---------- ----------- ------------ ------------ ------------ ------------
Net earnings (loss)available to
common shares $4,950,000 $4,950,000 $(3,972,000) $(3,972,000) $(1,967,000) $(1,967,000)
=========== =========== ============ ============ ============ ============
Earnings (loss) per common share $ 0.60 $ 0.60(a) $ (0.67) $ (0.67) $ (0.35) $ (0.35)
=========== =========== ============ ============ ============ ============
Weighted average common shares
outstanding $7,887,000 $7,887,000 $ 5,522,000 $ 5,522,000 $ 5,214,000 $ 5,214,000
Common equivalent shares outstanding
using the treasury stock method 396,000 430,000 370,000 370,000 370,000 370,000
----------- ----------- ------------ ------------ ------------ ------------
Weighted average common and common
equivalent shares outstanding $8,283,000 $8,317,000 $ 5,892,000 $ 5,892,000 $ 5,584,000 $ 5,584,000
=========== =========== ============ ============ ============ ============
</TABLE>
(a) This calculation is submitted in accordance with Regulation S-K item
601(b)(11) although not required by footnote 2 to paragraph 14 of APB
Opinion No. 15 because it results in dilution of less than 3%
Independent Auditors' Consent
The Board of Directors
Ugly Duckling Corporation:
We consent to incorporation by reference in the registration statements (No.
33-06615 and No. 33-08457) on Form S-8 of Ugly Duckling Corporation of our
report dated January 31, 1997, except for note 19 to the consolidated
financial statements which are as of February 13, 1997, relating to the
consolidated balance sheets of Ugly Duckling Corporation and subsidiaries as
of December 31, 1996 and 1995, and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the years in the
three-year period ended December 31, 1996, which report appears in the
December 31, 1996 annual report on Form 10-K/A of Ugly Duckling Corporation.
KPMG Peat Marwick LLP
Phoenix, Arizona
May 13, 1997
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
Company's unaudited financial statements as of and for the year ended
December 31, 1996, and is qualified in its entirety by reference to such
statements.
</LEGEND>
<CIK> 0001012704
<NAME> UGLY DUCKLING CORP
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-END> DEC-31-1996
<CASH> 18,455
<SECURITIES> 13,368
<RECEIVABLES> 59,188
<ALLOWANCES> 8,125
<INVENTORY> 5,752
<CURRENT-ASSETS> 0<F1>
<PP&E> 23,591
<DEPRECIATION> (2,939)
<TOTAL-ASSETS> 118,063
<CURRENT-LIABILITIES> 0<F1>
<BONDS> 0
0
0
<COMMON> 82,612
<OTHER-SE> (293)
<TOTAL-LIABILITY-AND-EQUITY> 118,063
<SALES> 53,768
<TOTAL-REVENUES> 75,629
<CGS> 29,890
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 24,700
<LOSS-PROVISION> 9,811
<INTEREST-EXPENSE> 5,262
<INCOME-PRETAX> 5,866
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,866
<EPS-PRIMARY> .60
<EPS-DILUTED> .60
<FN>
<F1>UNCLASSIFIEDBALANCESHEET
</FN>
</TABLE>
