<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C.
-------------------
FORM T-3
FOR APPLICATIONS FOR QUALIFICATION OF INDENTURES UNDER THE
TRUST INDENTURE ACT OF 1939
-------------------
UGLY DUCKLING CORPORATION
(NAME OF APPLICANT)
2525 E. CAMELBACK, SUITE 1150, PHOENIX, ARIZONA 85016
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
-------------------
SECURITIES TO BE ISSUED UNDER THE INDENTURE TO BE QUALIFIED
<TABLE>
<CAPTION>
TITLE OF CLASS AMOUNT
-------------- ------
<S> <C>
12% Subordinated Debentures due 2003 $32,500,000
</TABLE>
Approximate date of proposed public offering:
September 17, 1998
Name and address of agent for service:
Steven P. Johnson, Esq.
General Counsel
Ugly Duckling Corporation
2525 East Camelback Road, Suite 1150
Phoenix, Arizona 85016
copy to:
Steve Pidgeon
Snell & Wilmer L.L.P.
One Arizona Center
Phoenix, Arizona 85004-0001
The Company hereby amends this application for qualification on such date or
dates as may be necessary to delay its effectiveness until (i) the 20th day
after the filing of a further amendment which specifically states that it shall
supersede this application, or (ii) such date as the Securities and Exchange
Commission, acting pursuant to Section 307(c) of the Act, may determine upon
written request of the Company.
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GENERAL
1. General Information.
(a) Form of organization: A corporation
(b) State or other sovereign power under the laws of which organized: Delaware
2. Securities Act exemption applicable.
Ugly Duckling Corporation, a Delaware corporation (the "Company"), is relying on
the exemption from the registration requirements of the Securities Act of 1933,
as amended (the "Securities Act") provided by Section 3(a)(9) thereunder in
connection with the Company's exchange offer as described herein (the "Exchange
Offer"). The Exchange Offer is being made by the Company pursuant to its
Offering Circular dated September 17, 1998 ("Offering Circular"), and the
related Letter of Transmittal and Notice of Guaranteed Delivery of even date
therewith, and consists of an offer to exchange up to $32,500,000 aggregate
principal amount of the Company's 12% Subordinated Debentures due 2003
("Debentures") for up to 5,000,000 shares of the Company's Common Stock, par
value $.001 per share ("Common Stock") on the basis of $6.50 principal amount of
Debentures per share.
There have not been any sales of securities of the same class as the Debentures,
nor are there any such other sales planned, by the Company or by or through an
underwriter at or about the time of the Exchange Offer.
The Company has retained Corporate Investor Communications, Inc. as the
"Information Agent" and Harris Trust Company of California as the "Exchange
Agent" in connection with the Exchange Offer. The Information Agent and Exchange
Agent will provide to holders of Common Stock only information otherwise
contained in the Offering Circular and general information regarding the
mechanics of the exchange process. The Exchange Agent will provide the actual
acceptance and exchange services with respect to the exchange of the Common
Stock and the Debentures. Neither the Information Agent nor the Exchange Agent
will solicit exchanges in connection with the Exchange Offer or make
recommendations as to the acceptance or rejection of the Exchange Offer. Both
the Information Agent and the Exchange Agent will be paid reasonable fees
directly by the Company for their services.
There are no cash payments made or to be made by any holder of the Common Stock.
AFFILIATIONS
3. Affiliates.
The following is a list of all direct and indirect subsidiaries and affiliates
of the Company. Indirect subsidiaries are indented and listed under their direct
parent. Unless otherwise indicated the basis of control is ownership of equity
securities and all subsidiaries are wholly-owned subsidiaries.
Ugly Duckling Corporation (Delaware)
A. Duck Ventures, Inc. (Arizona)
1. Champion Acceptance Corporation (Arizona)
a. Champion Financial Services, Inc. (Arizona)
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2. Ugly Duckling Car Sales, Inc. (Arizona)
a. Ugly Duckling Car Sales Florida, Inc. (Florida)
b. Ugly Duckling Car Sales New Mexico, Inc. (New Mexico)
c. Ugly Duckling Car Sales Texas, L.L.P. (Arizona)
d. Ugly Duckling Car Sales Georgia, Inc. (Georgia)
e. Ugly Duckling Car Sales California, Inc. (California)
3. Champion Portfolio Corporation (Arizona)
4. Ugly Duckling Receivables Corp. (Delaware)
5. Ugly Duckling Receivables Corp. II (Delaware)
6. Drake Insurance Services, Inc. (Arizona)
a. Drake Insurance Agency, Inc. (Arizona)
b. Drake Property & Casualty Life Insurance Co.
(Turks & Caicos Islands)
c. Drake Life Insurance Co. (Turks & Caicos Islands)
7. Ugly Duckling Dealer Finance, Inc. (Arizona)
a. Ugly Duckling Dealer Finance Alabama, Inc. (Arizona)
8. UDRAC, Inc. (Arizona)
9. UDRAC Rentals, Inc. (Arizona)
10. Cygnet Financial Corporation (Delaware)
a. Cygnet Financial Services, Inc. (Arizona)
b. Cygnet Dealer Finance, Inc. (Arizona)
1. Cygnet Finance Alabama, Inc. (Arizona)
c. Cygnet Financial Portfolio, Inc. (Arizona)
d. Cygnet Support Services, Inc. (Arizona)
As described in the Company's Notice and Proxy Statement dated August
4, 1998 (the "Proxy Statement"), a copy of which is filed as Exhibit T3E.3, the
Company has proposed and its stockholders have approved the separation of the
Company's non-dealership operations into a separate company (the "Split-up"). If
all conditions to the Split-up are satisfied, the Company will transfer to
Cygnet Financial Corporation, a newly-formed Delaware corporation currently
wholly-owned by the Company ("Cygnet"), its bulk purchase and servicing
operations, its third party dealer finance operations, and substantially all
assets and certain liabilities acquired pursuant to transactions with First
Merchants Acceptance Corporation ("FMAC") and Reliance Acceptance Group, Inc.
("Reliance"). In connection with the Split-Up, Cygnet currently is conducting a
Rights Offering pursuant to which holders of the Company's Common Stock as of
August 17, 1998 were distributed Rights to purchase shares of Cygnet's Common
Stock at a price of $7.00 per share, as described in Cygnet's Prospectus dated
August 26, 1998, a copy of which is filed as Exhibit T3E.4 hereto. The Rights
Offering will terminate on September 21, 1998, unless extended. If the Rights
Offering is completed and the Split-up is consummated, the Company will continue
to operate its chain of Buy Here-Pay Here used car dealerships and underwrite,
finance and service retail installment contracts generated from the sale of used
cars by its Company dealerships, Cygnet will acquire and operate the bulk
purchase and servicing operations, the third party dealer finance operations,
and substantially all of the assets and certain liabilities acquired pursuant to
the transactions with FMAC and Reliance, and Cygnet will no longer be controlled
by the Company. If the Rights Offering is not completed and the Split-up is not
consummated, the Company would retain both its dealership and non-dealership
operations.
Ernest C. Garcia II owns approximately 25.2% of the outstanding Common
Stock of the Company, but hereby disclaims control of the Company. Mr. Garcia
also owns 100% of the outstanding voting securities of Verde Investments, Inc.
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MANAGEMENT AND CONTROL
4. Directors and executive officers.
The names and mailing addresses of the directors and executive officers of the
Company are set forth below. The title of each of the executive officers set
forth below refers to such executive officer's position with the Company.
Prior to the Split-up:
<TABLE>
<CAPTION>
NAME ADDRESS OFFICE
- ---- ------- ------
<S> <C> <C>
Ernest C. Garcia II 2525 E. Camelback Rd., Suite 1150 Chief Executive Officer
Phoenix, Arizona 85016 and Director
Gregory B. Sullivan 2525 E. Camelback Rd., Suite 1150 Chief Operating Officer,
Phoenix, Arizona 85016 President, Director
Steven P. Johnson 2525 E. Camelback Rd., Suite 1150 Senior Vice President,
Phoenix, Arizona 85016 General Counsel and Secretary
Russell J. Grisanti 2525 E. Camelback Rd., Suite 1150 Executive Vice President
Phoenix, Arizona 85016 Operations
Steven T. Darak 2525 E. Camelback Rd., Suite 1150 Chief Financial Officer
Phoenix, Arizona 85016 Senior Vice President and Treasurer
Steven A. Tesdahl 2525 E. Camelback Rd., Suite 1150 Chief Information Officer
Phoenix, Arizona 85016 and Senior Vice President
Donald L. Addink 2525 E. Camelback Rd., Suite 1150 Vice President and
Phoenix, Arizona 85016 Senior Analyst
Peter R. Fratt 2525 E. Camelback Rd., Suite 1150 Vice President Real
Phoenix, Arizona 85016 Estate
Eric J. Splaver 2525 E. Camelback Rd., Suite 1150 Corporate Controller
Phoenix, Arizona 85016
Robert J. Abrahams 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
Christopher D. Jennings 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
John N. MacDonough 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
</TABLE>
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<TABLE>
<S> <C> <C>
Frank P. Willey 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
</TABLE>
Following the Split-up:
<TABLE>
<CAPTION>
NAME ADDRESS OFFICE
- ---- ------- ------
<S> <C> <C>
Ernest C. Garcia II 2525 E. Camelback Rd., Suite 1150 Director
Phoenix, Arizona 85016
Gregory B. Sullivan 2525 E. Camelback Rd., Suite 1150 Chief Executive Officer,
Phoenix, Arizona 85016 President, and Director
Russell J. Grisanti 2525 E. Camelback Rd., Suite 1150 Executive Vice President
Phoenix, Arizona 85016 Servicing Operations
Peter G. Levas 2525 E. Camelback Rd., Suite 1150 Executive Vice President
Phoenix, Arizona 85016 Sales Operations
Steven T. Darak 2525 E. Camelback Rd., Suite 1150 Chief Financial Officer
Phoenix, Arizona 85016 Executive Vice President and Treasurer
Steven A. Tesdahl 2525 E. Camelback Rd., Suite 1150 Chief Information Officer
Phoenix, Arizona 85016 and Executive Vice President
Jon D. Ehlinger 2525 E. Camelback Rd., Suite 1150 General Counsel and
Phoenix, Arizona 85016 Secretary
Peter R. Fratt 2525 E. Camelback Rd., Suite 1150 Vice President Real
Phoenix, Arizona 85016 Estate
Robert J. Abrahams 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
Christopher D. Jennings 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
John N. MacDonough 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
Frank P. Willey 2525 E. Camelback Rd., Suite 1150 Independent Director
Phoenix, Arizona 85016
</TABLE>
5. Principal owners of voting securities.
Based upon the most recent information available to the Company, the following
individuals own ten percent (10%) or more of the voting securities of the
Company.
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As of August 31, 1998
<TABLE>
<CAPTION>
NAME AND COMPLETE TITLE OF AMOUNT % OF VOTING
MAILING ADDRESS CLASS OWNED OWNED SECURITIES OWNED
--------------- ----------- ----- ----------------
<S> <C> <C> <C>
Ernest C. Garcia II Common Stock 4,699,500 25.2
2525 E. Camelback Rd.
Suite 1150
Phoenix, Arizona 85016
</TABLE>
UNDERWRITERS
6. Underwriters. The following are the names and complete mailing address of (a)
each person who within three years prior to the date of filing the application,
acted as an underwriter of any securities of the obligor which were outstanding
on the date of filing the application and (b) each proposed principal
underwriter of the securities proposed to be offered. The title of each class of
securities underwritten by each person specified in (a) also follows.
(a) The following were the underwriters in the Company's issuances in 1996 and
1997 of shares of its common stock:
Cruttenden Roth Incorporated
18301 Von Karman, Suite 100
Irvine, California 92715
Friedman, Billings, Ramsey & Co., Inc.
Potomac Tower
1001 19th Street North
Arlington, VA 22209
In addition, Greenwich Capital Markets has acted as underwriter in connection
with the issuance of certificates in a number of securitizations of finance
receivables generated by Company dealerships or purchased from third parties,
certain limited obligations as to which have been guaranteed by the Company.
(b) There are no underwriters of the securities proposed to be offered in the
Exchange Offer.
CAPITAL SECURITIES
7. Capitalization.
(a) The following information is provided as to each authorized class of
securities of the Company.
(i) Equity Securities (as of August 31, 1998)
<TABLE>
<CAPTION>
TITLE OF CLASS AMOUNT AUTHORIZED AMOUNT OUTSTANDING
- -------------- ----------------- -------------------
<S> <C> <C>
Common Stock 100,000,000 18,605,337 (1)
$.001 par value
Preferred Stock 10,000,000 0
$.001 par value
</TABLE>
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(1) The Company also has outstanding warrants to purchase Common Stock as
follows:
<TABLE>
<CAPTION>
EXERCISE PRICE
NO. OF WARRANTS EXERCISABLE THROUGH PER SHARE
- --------------- ------------------- ---------
<S> <C> <C>
121,023 June 21, 2006 $ 6.75
170,000 June 21, 2001 $ 9.45
389,800 February 20, 2000 $20.00
325,000 April 1, 2001 $20.00
50,000 February 9, 2001 $12.50
500,000 February, 2001 $10.00
</TABLE>
In addition, the Company is obligated to issue 115,000 warrants exercisable for
a period of three years from the issue date at a price of 120% of the then
market price of the Company's Common Stock per share to a lender to Cygnet in
the event the Split-up does not occur by December 31, 1998, and additional
warrants in an indeterminate amount as described in the Notice and Proxy
Statement under "Management's Discussion and Analysis of Results of Operations
and Financial Condition of the Continuing Company Businesses -- Liquidity and
Capital Resources -- Reliance Transaction." As of August 31, 1998, the Company
also had outstanding options to purchase Common Stock issued under
employee benefit plans of the Company.
(ii) Debt Securities (as of August 31, 1998)
The Company has registered $200,000,000 in aggregate principal amount of its
debt securities under the Securities Act of 1933, as amended pursuant to a
Registration Statement on Form S-3 (No. 333-31531) filed with the Commission on
July 18, 1997. To date, no debt securities have been issued thereunder.
The Company also has outstanding a $10 million subordinated debenture payable to
Verde Investments, Inc., $15 million of subordinated notes payable, and
approximately $6 million of notes payable secured by real estate.
See also description of certain guarantees of the Company in Item 6(a).
(b) The following is a brief outline of the voting rights of each class of
voting securities referred to in paragraph (a) above.
See description of the Company's Common Stock and Preferred Stock under
"Description of Capital Stock" in the Offering Circular attached as Exhibit
T3E.1.
INDENTURE SECURITIES
8. Analysis of indenture provisions.
The following is an analysis of the indenture provisions required under Section
305(a)(2) of the Trust Indenture Act of 1939, as amended.
For purposes of this Section 8, the "Indenture" refers to the Indenture to be
entered into by and between Ugly Duckling Corporation and Harris Trust and
Savings Bank, as Trustee (the "Trustee") and the First Supplemental Indenture to
such Indenture pursuant to which the Debentures will be issued. Other
capitalized terms are defined in the Indenture or in the Offering Circular. Up
to $100,000,000 of securities ("Securities") may be issued under the Indenture
in one or more series of which the Debentures will be one series.
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A. EVENTS OF DEFAULT
Each of the following will constitute an Event of Default under the Indenture
with respect to Securities of any series: (a) failure to pay principal of or any
premium on any Securities of that series when due; (b) failure to pay any
interest on any Securities of that series when due, continued for 30 days; (c)
failure to deposit any sinking fund payment, when due, in respect of any
Securities of that series; (d) failure to perform any other covenant of the
Company in the Indenture (other than a covenant included in the Indenture solely
for the benefit of a series other than that series), continued for 90 days after
written notice has been given by the Trustee, or the Holders of at least 25% in
principal amount of the Outstanding Securities of that series, as provided in
the Indenture; (e) certain events in bankruptcy, insolvency, or reorganization,
and (f) any other Event of Default specified for such series in the supplemental
indenture or Board Resolution creating or governing such series. There are no
additional Events of Default provided for the Debentures.
If a default with respect to Securities of any series occurs, the Trustee shall
give the Holders of such Securities notice of such default as and to the extent
provided in the Trust Indenture Act; provided that in the case of any default
specified in subclause (d) of the immediately preceding paragraph, no such
notice shall be given until at least 30 days after the occurrence thereof.
B. AUTHENTICATION AND DELIVERY
The Securities shall be executed on behalf of the Company by its Chairman of the
Board, its Vice Chairman of the Board, its President or one of its Vice
Presidents, and attested by its Secretary or one of its Assistant Secretaries.
The signature of any of these officers on the Securities may be manual or
facsimile. The Indenture does not contain any provisions limiting the use of
proceeds from sale of the Securities. The Company will not receive any proceeds
(other than shares of Common Stock) upon issuance of the Debentures.
C. RELEASE OF PROPERTY SUBJECT TO LIEN
The Company's obligations under the Securities will not be secured by any liens
or security interests on any assets of the Company. Therefore, the Indenture
does not contain any provisions with respect to the release or the release and
substitution of any property subject to such a lien.
D. SATISFACTION AND DISCHARGE
Under the terms of the Indenture, the Company will be discharged from all its
obligations with respect to the Securities of a series (except for certain
obligations to exchange or register the transfer of such Securities, to replace
stolen, lost, or mutilated Securities, to maintain paying agencies, and to hold
moneys for payment in trust) upon satisfaction of certain conditions, including
the deposit in trust for the benefit of the Holders of such Securities of money
or U.S. Government Obligations, or both, which, through the payment of principal
and interest in respect thereof in accordance with their terms, will provide
money in an amount sufficient to pay the principal of and any premium and
interest on such Securities on the respective Stated Maturities or on any
Redemption Date established for such Securities in accordance with their terms.
Such defeasance or discharge may occur only if, among other things, the Company
has delivered to the Trustee an Opinion of Counsel to the effect that the
Company has received from, or there has been published by, the United States
Internal Revenue Service a ruling, or there has been a change in tax law, in
either case to the effect that Holders of such Securities will not recognize
gain or loss for federal income tax purposes as a result of such deposit,
defeasance, and discharge and will be subject to federal income tax on the same
amount, in the same manner, and at the same times as would have been the case if
such deposit, defeasance, and discharge were not to occur.
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The Indenture will also be deemed to be satisfied and discharged, except as to
certain limited provisions, as to Securities of a series that have become due
and payable or will become due and payable at their Stated Maturity within one
year from the date of determination or are to be called for redemption within
one year under arrangements satisfactory to the Trustee, but only if the Company
deposits money in an amount sufficient to pay the entire principal, premium, and
interest to the date of deposit (as to Securities that have become due and
payable) or to the Stated Maturity or Redemption Date, as the case may be, and
certain other conditions are satisfied.
E. EVIDENCE OF COMPLIANCE WITH CONDITIONS AND COVENANTS
The Company will deliver to the Trustee, within 120 days after the end of each
fiscal year of the Company ending after the date hereof, an Officers'
Certificate, stating whether or not to the best knowledge of the signers thereof
the Company is in default in the performance and observance of any of the terms,
provisions and conditions of this Indenture (without regard to any period of
grace or requirement of notice provided hereunder) and, if the Company shall be
in default, specifying all such defaults and the nature and status thereof of
which they may have knowledge.
9. Other Obligors. The following is the name and complete mailing address of any
person, other than the applicant, who is an obligor upon the indenture
securities.
No person other than the Company is an obligor with respect to the Debentures.
Contents of the application for qualification. This application for
qualification comprises --
(a) Pages numbered 1 to 10, consecutively.
(b) The statement of eligibility and qualification of each trustee under the
indenture to be qualified.
(c) The following exhibits in addition to those filed as a part of the statement
of eligibility and qualification of each trustee.
(i) Exhibit T3A -- The Company's Certificate of Incorporation
(incorporated by reference to the Company's Quarterly report on Form 10-Q, filed
August 10, 1998).
(ii) Exhibit T3B -- The Company's Bylaws (incorporated by reference to
the Company's Quarterly Report on Form 10-Q, filed August 14, 1997)
(iii) Exhibit T3C.1 -- A copy of the form of Indenture to be qualified
(iv) Exhibit T3C.2 -- A copy of the form of First Supplemental
Indenture to the Indenture to be qualified.
(v) Exhibit T3D -- Not applicable
(vi) Exhibit T3E.1 -- Form of Offering Circular, dated as of
September 17, 1998
(vii) Exhibit T3E.2 -- Form of Letter of Transmittal, dated as of
September 17, 1998 and accompanying documents
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(viii) Exhibit T3E.3 -- Notice and Proxy Statement dated August 4, 1998
(ix) Exhibit T3E.4 -- Prospectus of Cygnet Financial Corporation dated
August 26, 1998
(x) Exhibit T3F -- Cross Reference Sheet (see page ii of Exhibit T3C)
(xi) Exhibit 99.7 -- Form T-1 Statement of Eligibility of Harris Trust
and Savings Bank under the Trust Indenture Act of 1939.
SIGNATURE
Pursuant to the requirements of the Trust Indenture Act of 1939, the
applicant, Ugly Duckling Corporation, a corporation organized and existing under
the laws of the State of Delaware, has duly caused this application to be signed
on its behalf by the undersigned, thereunto duly authorized, all in the city of
Phoenix, and State of Arizona, on the 17th day of September, 1998.
__________________________________________
By: /s/ Ernest C. Garcia, II
__________________________________________
(Ernest C. Garcia, II, Chairman of the
Board, Chief Executive Officer, and
President)
Attest: /s/ Jon D. By: /s/ Steven P. Johnson
___________________________ __________________________________________
(Steven P. Johnson, Senior Vice President,
General Counsel and Secretary)
10
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EXHIBIT T3C.1
UGLY DUCKLING CORPORATION
TO
HARRIS TRUST AND SAVINGS BANK
Trustee
INDENTURE
Dated as of ________ __, 1998
(For Subordinated Securities or, if Article Fourteen is made non-applicable
(as permitted by Section 301), for Senior Securities)
<PAGE> 2
Certain Sections of this Indenture relating to Sections 310 through 318,
inclusive, of the Trust Indenture Act of 1939:
Trust Indenture Act Section Indenture Section
Section 310 (a)(1) .................................... 609
(a)(2) .................................... 609
(a)(3) .................................... Not Applicable
(a)(4) .................................... Not Applicable
(a)(5) .................................... 609
(b) ....................................... 608
609
Section 311 (a) ....................................... 613
(b) ....................................... 613
Section 312 (a) ....................................... 701
702
(b) ....................................... 702
(c) ....................................... 702
Section 313 (a) ....................................... 703
(b) ....................................... 703
(c) ....................................... 703
(d) ....................................... 703
Section 314 (a) ....................................... 704
(a)(4) .................................... 101
1004
(b) ....................................... Not Applicable
(c)(1) .................................... 102
(c)(2) .................................... 102
(c)(3) .................................... 1304
(d) ....................................... Not Applicable
(e) ....................................... 102
Section 315 (a) ....................................... 601
(b) ....................................... 602
(c) ....................................... 601
(d) ....................................... 601
607
(e) ....................................... 514
Section 316 (a) ....................................... 101
(a)(1)(A) ................................. 502
512
(a)(1)(B) ................................. 513
(a)(2) .................................... Not Applicable
(b) ....................................... 508
(c) ....................................... 104
Section 317 (a)(1) .................................... 503
505
(a)(2) .................................... 504
(b) ....................................... 1003
Section 318 (a) ....................................... 107
Note: This reconciliation and tie shall not, for any purpose, be deemed to be a
part of the Indenture.
ii
<PAGE> 3
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
ARTICLE ONE
Definitions and Other Provisions
of General Application .................................................................... 1
Section 101. Definitions .................................................................. 1
Section 102. Compliance Certificates and Opinions ......................................... 8
Section 103. Form of Documents Delivered to Trustee ....................................... 9
Section 104. Acts of Holders; Record Dates ................................................ 9
Section 105. Notices, Etc., to Trustee and Company ........................................ 11
Section 106. Notice to Holders; Waiver .................................................... 12
Section 107. Conflict with Trust Indenture Act ............................................ 12
Section 108. Effect of Headings and Table of Contents ..................................... 12
Section 109. Successors and Assigns ....................................................... 12
Section 110. Separability Clause .......................................................... 12
Section 111. Benefits of Indenture ........................................................ 13
Section 112. Governing Law ................................................................ 13
Section 113. Legal Holidays ............................................................... 13
ARTICLE TWO
Security Forms ............................................................................ 13
Section 201. Forms Generally .............................................................. 13
Section 202. Form of Face of Security ..................................................... 14
Section 203. Form of Reverse of Security .................................................. 15
Section 204. Form of Legend for Global Securities ......................................... 19
Section 205. Form of Trustee's Certificate of Authentication .............................. 20
ARTICLE THREE
The Securities ............................................................................ 20
Section 301. Amount of Securities; Issuable in Series ..................................... 20
Section 302. Denominations ................................................................ 23
Section 303. Execution, Authentication, Delivery and Dating ............................... 23
Section 304. Temporary Securities ......................................................... 25
Section 305. Registration, Registration of Transfer and Exchange .......................... 25
Section 306. Mutilated, Destroyed, Lost and Stolen Securities ............................. 27
Section 307. Payment of Interest; Interest Rights Preserved ............................... 28
Section 308. Persons Deemed Owners ........................................................ 29
</TABLE>
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<TABLE>
<S> <C>
Section 309. Cancellation ................................................................. 29
Section 310. Computation of Interest ...................................................... 29
Section 311. CUSIP Numbers ................................................................ 30
ARTICLE FOUR
Satisfaction and Discharge ................................................................ 30
Section 401. Satisfaction and Discharge of Indenture ...................................... 30
Section 402. Application of Trust Money ................................................... 31
ARTICLE FIVE
Remedies .................................................................................. 31
Section 501. Events of Default ............................................................ 31
Section 502. Acceleration of Maturity; Rescission and Annulment ........................... 33
Section 503. Collection of Indebtedness and Suits for Enforcement by Trustee .............. 34
Section 504. Trustee May File Proofs of Claim ............................................. 34
Section 505. Trustee May Enforce Claims Without Possession of Securities .................. 35
Section 506. Application of Money Collected ............................................... 35
Section 507. Limitation on Suits .......................................................... 35
Section 508. Unconditional Right of Holders to Receive Principal, Premium
and Interest ................................................................. 36
Section 509. Restoration of Rights and Remedies ........................................... 36
Section 510. Rights and Remedies Cumulative ............................................... 36
Section 511. Delay or Omission Not Waiver ................................................. 37
Section 512. Control by Holders ........................................................... 37
Section 513. Waiver of Past Defaults ...................................................... 37
Section 514. Undertaking for Costs ........................................................ 38
Section 515. Waiver of Usury, Stay or Extension Laws ...................................... 38
ARTICLE SIX
The Trustee ............................................................................... 38
Section 601. Certain Duties and Responsibilities .......................................... 38
Section 602. Notice of Defaults ........................................................... 38
Section 603. Certain Rights of the Trustee ................................................ 39
Section 604. Not Responsible for Recitals or Issuance of Securities ....................... 40
Section 605. May Hold Securities .......................................................... 40
Section 606. Money Held in Trust .......................................................... 40
Section 607. Compensation and Reimbursement ............................................... 40
Section 608. Conflicting Interests ........................................................ 41
Section 609. Corporate Trustee Required; Eligibility ...................................... 41
Section 610. Resignation and Removal; Appointment of Successor ............................ 42
</TABLE>
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<TABLE>
<S> <C>
Section 611. Acceptance of Appointment by Successor ....................................... 43
Section 612. Merger, Conversion, Consolidation or Succession to Business .................. 44
Section 613. Preferential Collection of Claims Against Company ............................ 44
Section 614. Appointment of Authenticating Agent .......................................... 44
ARTICLE SEVEN
Holders' Lists and Reports by Trustee and Company ......................................... 46
Section 701. Company to Furnish Trustee Names and Addresses of Holders .................... 46
Section 702. Preservation of Information; Communications to Holders ....................... 46
Section 703. Reports by Trustee ........................................................... 47
Section 704. Reports by Company ........................................................... 47
ARTICLE EIGHT
Consolidation, Merger, Conveyance, Transfer or Lease ...................................... 47
Section 801. Company May Consolidate, Etc., Only on Certain Terms ......................... 48
Section 802. Successor Substituted ........................................................ 49
ARTICLE NINE
Supplemental Indentures ................................................................... 49
Section 901. Supplemental Indentures Without Consent of Holders ........................... 49
Section 902. Supplemental Indentures With Consent of Holders .............................. 50
Section 903. Execution of Supplemental Indentures ......................................... 51
Section 904. Effect of Supplemental Indentures ............................................ 51
Section 905. Conformity with Trust Indenture Act .......................................... 52
Section 906. Reference in Securities to Supplemental Indentures ........................... 52
ARTICLE TEN
Covenants ................................................................................. 52
Section 1001. Payment of Principal, Premium and Interest .................................. 52
Section 1002. Maintenance of Office or Agency ............................................. 52
Section 1003. Money for Securities Payments to Be Held in Trust ........................... 53
Section 1004. Statement by Officers as to Default ......................................... 54
Section 1005. Existence ................................................................... 54
Section 1006. Maintenance of Properties ................................................... 54
Section 1007. Payment of Taxes and Other Claims ........................................... 54
Section 1008. Waiver of Certain Covenants ................................................. 55
Section 1009. Calculation of Original Issue Discount ...................................... 55
</TABLE>
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<TABLE>
<S> <C>
ARTICLE ELEVEN
Redemption of Securities .................................................................. 55
Section 1101. Applicability of Article .................................................... 55
Section 1102. Election to Redeem; Notice to Trustee ....................................... 55
Section 1103. Selection by Trustee of Securities to Be Redeemed ........................... 56
Section 1104. Notice of Redemption ........................................................ 56
Section 1105. Deposit of Redemption Price ................................................. 58
Section 1106. Securities Payable on Redemption Date ....................................... 58
Section 1107. Securities Redeemed in Part ................................................. 58
ARTICLE TWELVE
Sinking Funds ............................................................................. 59
Section 1201. Applicability of Article .................................................... 59
Section 1202. Satisfaction of Sinking Fund Payments with Securities ....................... 59
Section 1203. Redemption of Securities for Sinking Fund ................................... 59
ARTICLE THIRTEEN
Defeasance and Covenant Defeasance ........................................................ 60
Section 1301. Company's Option to Effect Defeasance or Covenant Defeasance ................ 60
Section 1302. Defeasance and Discharge .................................................... 60
Section 1303. Covenant Defeasance ......................................................... 60
Section 1304. Conditions to Defeasance or Covenant Defeasance ............................. 61
Section 1305. Deposited Money and U.S. Government Obligations to Be Held in
Trust; Miscellaneous Provisions ............................................. 63
Section 1306. Reinstatement ............................................................... 64
ARTICLE FOURTEEN
Subordination of Securities ............................................................... 64
Section 1401. Securities Subordinate to Senior Indebtedness ............................... 64
Section 1402. Suspension of Payment When Senior Indebtedness in Default ................... 65
Section 1403. Payment Over of Proceeds Upon Dissolution, Etc .............................. 65
Section 1404. Monies Held in Trust ........................................................ 67
Section 1405. Subrogation to Rights of Holders of Senior Indebtedness ..................... 67
Section 1406. Unconditional Obligation .................................................... 67
Section 1407. Trustee to Effectuate Subordination ......................................... 68
Section 1408. Notice to Trustee ........................................................... 68
Section 1409. Rights of Trustee as Holder of Senior Indebtedness; Preservation of
Trustee's Rights ............................................................ 69
Section 1410. Trustee Not Fiduciary for Holders of Senior Indebtedness .................... 69
</TABLE>
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<TABLE>
<S> <C>
Section 1411. No Waiver of Subordination Provisions ....................................... 69
Section 1412. Defeasance of this Article Fourteen ......................................... 70
</TABLE>
Note: This table of contents shall not, for any purpose, be deemed to be a part
of the Indenture.
vii
<PAGE> 8
INDENTURE, dated as of _________ __, 1998, between Ugly Duckling
Corporation, a corporation duly organized and existing under the laws of the
State of Delaware (herein called the "Company"), having its principal office at
2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016, and Harris Trust
and Savings Bank, a ______________ banking corporation, as Trustee (herein
called the "Trustee").
Recitals of the Company
The Company has duly authorized the execution and delivery of this
Indenture to provide for the issuance from time to time of its unsecured
debentures, notes or other evidences of indebtedness (herein called the
"Securities"), to be issued in one or more series as in this Indenture provided.
All things necessary to make this Indenture a valid agreement of the
Company, in accordance with its terms, have been done.
Now, Therefore, This Indenture Witnesseth:
For and in consideration of the premises and the purchase of the
Securities by the Holders thereof, it is mutually agreed, for the equal and
proportionate benefit of all Holders of the Securities or of series thereof, as
follows:
ARTICLE ONE
Definitions and Other Provisions
of General Application
Section 101. Definitions.
For all purposes of this Indenture, except as otherwise expressly
provided or unless the context otherwise requires:
(1) the terms defined in this Article have the meanings
assigned to them in this Article and include the plural as well as the
singular;
(2) all other terms used herein which are defined in the Trust
Indenture Act, either directly or by reference therein, have the
meanings assigned to them therein;
(3) all accounting terms not otherwise defined herein have the
meanings assigned to them in accordance with generally accepted
accounting principles, and, except as otherwise herein expressly
provided, the term "generally accepted accounting principles" with
respect to any computation required or permitted hereunder shall mean
such accounting principles as are generally accepted in the United
States of America;
<PAGE> 9
(4) unless the context otherwise requires, any reference to an
"Article" or a "Section" refers to an Article or a Section, as the case
may be, of this Indenture; and
(5) the words "herein", "hereof" and "hereunder" and other
words of similar import refer to this Indenture as a whole and not to
any particular Article, Section or other subdivision.
"Act", when used with respect to any Holder, has the meaning specified
in Section 104.
"Affiliate" of any specified Person means any other Person directly or
indirectly controlling or controlled by or under direct or indirect common
control with such specified Person. For the purposes of this definition,
"control" when used with respect to any specified Person means the power to
direct the management and policies of such Person, directly or indirectly,
whether through the ownership of voting securities, by contract or otherwise;
and the terms "controlling" and "controlled" have meanings correlative to the
foregoing.
"Authenticating Agent" means any Person authorized by the Trustee
pursuant to Section 614 to act on behalf of the Trustee to authenticate
Securities of one or more series.
"Board of Directors" means either the board of directors of the Company
or any duly authorized committee of that board.
"Board Resolution" means a copy of a resolution certified by the
Secretary or an Assistant Secretary of the Company to have been duly adopted by
the Board of Directors and to be in full force and effect on the date of such
certification, and delivered to the Trustee.
"Business Day", when used with respect to any Place of Payment, means
each Monday, Tuesday, Wednesday, Thursday and Friday which is not a day on which
banking institutions in Phoenix, Arizona or that Place of Payment are authorized
or obligated by law or executive order to close.
"Capitalized Lease Obligation" means, as to any Person, the obligations
of such Person under a lease that are required to be classified and accounted
for as capital lease obligations under GAAP and, for purposes of this
definition, the amount of such obligations at any date shall be the capitalized
amount of such obligations at such date, determined in accordance with GAAP.
"Commission" means the Securities and Exchange Commission, as from time
to time constituted, or, if at any time after the execution of this instrument
such Commission is not existing and performing the duties now assigned to it
under the Trust Indenture Act, then the body performing such duties at such
time.
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<PAGE> 10
"Company" means the Person named as the "Company" in the first
paragraph of this instrument until a successor Person shall have become such
pursuant to the applicable provisions of this Indenture, and thereafter
"Company" shall mean such successor Person.
"Company Request" or "Company Order" means a written request or order
signed in the name of the Company by its Chairman of the Board, its Vice
Chairman of the Board, its President or a Vice President, and by its Treasurer,
an Assistant Treasurer, its Secretary or an Assistant Secretary, and delivered
to the Trustee.
"Conditional Notice" has the meaning specified in Section 1104.
"Corporate Trust Office" means the principal corporate trust office of
the Trustee at which at any particular time its corporate trust business shall
be administered, which office at the date hereof is located at Chicago,
Illinois.
"Corporation" means a corporation, association, company, joint-stock
company or business trust.
"Covenant Defeasance" has the meaning specified in Section 1303.
"Credit Agreement" means the Amended and Restated Motor Vehicle
Installment Contract Loan and Security Agreement dated as of August 15, 1997
among the Company, General Electric Capital Corporation, and certain other
parties, as such agreement may be amended, restated, modified, renewed,
refunded, replaced or refinanced from time to time, including any notes,
guarantees, security or pledge agreements, letters of credit and other documents
or instruments executed pursuant thereto and any exhibits or schedules to any of
the foregoing.
"Defaulted Interest" has the meaning specified in Section 307.
"Defeasance" has the meaning specified in Section 1302.
"Depositary" means, with respect to Securities of any series issuable
in whole or in part in the form of one or more Global Securities, a clearing
agency registered under the Exchange Act that is designated to act as Depositary
for such Securities as contemplated by Section 301.
"Designated Senior Indebtedness" means (i) all Indebtedness outstanding
under the Credit Agreement and (ii) any other Senior Indebtedness designated by
the Company as "Designated Senior Indebtedness" from time to time.
"Event of Default" has the meaning specified in Section 501.
"Exchange Act" means the Securities Exchange Act of 1934 and any
statute successor thereto, in each case as amended from time to time.
"Expiration Date" has the meaning specified in Section 104.
"GAAP" means generally accepted accounting principles in the United
States of America as in effect from time to time.
"Global Security" means a Security that evidences all or part of the
Securities of any series and bears the legend set forth in Section 204 (or such
legend as may be specified as contemplated by Section 301 for such Securities).
"Holder" means a Person in whose name a Security is registered in the
Security Register.
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<PAGE> 11
"Indebtedness" means with respect to any Person, without duplication,
(i) all Obligations of such Person for borrowed money, (ii) all Obligations of
such Person evidenced by bonds, debentures, notes or other similar instruments,
(iii) all Capitalized Lease Obligations of such Person, (iv) all obligations of
such Person issued or assumed as the deferred purchase price of property, all
conditional sale obligations and all Obligations under any title retention
agreement (but excluding trade accounts payable and other similar accrued
liabilities arising in the ordinary course of business and payable in accordance
with customary terms), (v) all obligations for the reimbursement of any obligor
on any letter of credit, banker's acceptance or similar credit transaction, (vi)
guarantees and other contingent obligations in respect of Indebtedness referred
to in clauses (i) through (v) above and clause (viii) below, (vii) all
obligations of any other Person of the type referred to in clauses (i) through
(vi) which are secured by any lien on any property or asset of such Person, the
amount of such obligation being deemed to be the lesser of the fair market value
of such property or asset or the amount of the obligation so secured, and (viii)
all obligations under currency agreements and interest swap agreements of such
Person.
"Indenture" means this instrument as originally executed and as it may
from time to time be supplemented or amended by one or more indentures
supplemental hereto entered into pursuant to the applicable provisions hereof,
including, for all purposes of this instrument and any such supplemental
indenture, the provisions of the Trust Indenture Act that are deemed to be a
part of and govern this instrument and any such supplemental indenture,
respectively. The term "Indenture" shall also include the terms of particular
series of Securities established as contemplated by Section 301.
"Interest", when used with respect to an Original Issue Discount
Security which by its terms bears interest only after Maturity, means interest
payable after Maturity.
"Interest Payment Date", when used with respect to any Security, means
the Stated Maturity of an instalment of interest on such Security.
"Investment Company Act" means the Investment Company Act of 1940 and
any statute successor thereto, in each case as amended from time to time.
"Maturity", when used with respect to any Security, means the date on
which the principal of such Security or an instalment of principal becomes due
and payable as therein or herein provided, whether at the Stated Maturity or by
declaration of acceleration, call for redemption or otherwise.
"Notice of Default" means a written notice of the kind specified in
Section 501(4).
"Obligations" means all obligations for principal, premium, interest,
penalties, fees, indemnifications, reimbursements, damages and other liabilities
payable under the documentation governing any Indebtedness.
4
<PAGE> 12
"Officers' Certificate" means a certificate signed by the Chairman of
the Board, a Vice Chairman of the Board, the President or a Vice President, and
by the Treasurer, an Assistant Treasurer, the Secretary or an Assistant
Secretary, of the Company, and delivered to the Trustee. One of the officers
signing an Officers' Certificate given pursuant to Section 1004 shall be the
principal executive, financial or accounting officer of the Company.
"Opinion of Counsel" means a written opinion of counsel, who may be
counsel for the Company, or other counsel who shall be acceptable to the
Trustee.
"Original Issue Discount Security" means any Security which provides
for an amount less than the principal amount thereof to be due and payable upon
a declaration of acceleration of the Maturity thereof pursuant to Section 502.
"Outstanding", when used with respect to Securities, means, as of the
date of determination, all Securities theretofore authenticated and delivered
under this Indenture, except:
(1) Securities theretofore canceled by the Trustee or
delivered to the Trustee for cancellation;
(2) Securities for whose payment or redemption money in the
necessary amount has been theretofore deposited with the Trustee or any
Paying Agent (other than the Company) in trust or set aside and
segregated in trust by the Company (if the Company shall act as its own
Paying Agent) for the Holders of such Securities; provided that, if
such Securities are to be redeemed, notice of such redemption has been
duly given pursuant to this Indenture or provision therefor
satisfactory to the Trustee has been made;
(3) Securities as to which Defeasance has been effected
pursuant to Section 1302; and
(4) Securities which have been paid pursuant to Section 306 or
in exchange for or in lieu of which other Securities have been
authenticated and delivered pursuant to this Indenture, other than any
such Securities in respect of which there shall have been presented to
the Trustee proof satisfactory to it that such Securities are held by a
bona fide purchaser in whose hands such Securities are valid
obligations of the Company;
provided, however, that in determining whether the Holders of the requisite
principal amount of the Outstanding Securities have given, made or taken any
request, demand, authorization, direction, notice, consent, waiver or other
action hereunder as of any date, (A) the principal amount of an Original Issue
Discount Security which shall be deemed to be Outstanding shall be the amount of
the principal thereof which would be due and payable as of such date upon
acceleration of the Maturity thereof to such date pursuant to Section 502, (B)
if, as of such date, the principal amount payable at the Stated Maturity of a
Security is not determinable, the principal amount of such Security which shall
be deemed to be Outstanding shall be the amount as specified or determined
5
<PAGE> 13
as contemplated by Section 301, (C) the principal amount of a Security
denominated in one or more foreign currencies or currency units which shall be
deemed to be Outstanding shall be the U.S. dollar equivalent, determined as of
such date in the manner provided as contemplated by Section 301, of the
principal amount of such Security (or, in the case of a Security described in
Clause (A) or (B) above, of the amount determined as provided in such Clause),
and (D) Securities owned by the Company or any other obligor upon the Securities
or any Affiliate of the Company or of such other obligor shall be disregarded
and deemed not to be Outstanding, except that, in determining whether the
Trustee shall be protected in relying upon any such request, demand,
authorization, direction, notice, consent, waiver or other action, only
Securities which the Trustee actually knows to be so owned shall be so
disregarded. Securities so owned which have been pledged in good faith may be
regarded as Outstanding if the pledgee establishes to the satisfaction of the
Trustee the pledgee's right so to act with respect to such Securities and that
the pledgee is not the Company or any other obligor upon the Securities or any
Affiliate of the Company or of such other obligor.
"Paying Agent" means any Person authorized by the Company to pay the
principal of or any premium or interest on any Securities on behalf of the
Company.
"Person" means any individual, corporation, partnership, joint venture,
trust, unincorporated organization or government or any agency or political
subdivision thereof.
"Place of Payment", when used with respect to the Securities of any
series, means the place or places where the principal of and any premium and
interest on the Securities of that series are payable as specified as
contemplated by Section 301.
"Predecessor Security" of any particular Security means every previous
Security evidencing all or a portion of the same debt as that evidenced by such
particular Security; and, for the purposes of this definition, any Security
authenticated and delivered under Section 306 in exchange for or in lieu of a
mutilated, destroyed, lost or stolen Security shall be deemed to evidence the
same debt as the mutilated, destroyed, lost or stolen Security.
"Redemption Date", when used with respect to any Security to be
redeemed, means the date fixed for such redemption by or pursuant to this
Indenture.
"Redemption Price", when used with respect to any Security to be
redeemed, means the price at which it is to be redeemed pursuant to this
Indenture.
"Regular Record Date" for the interest payable on any Interest Payment
Date on the Securities of any series means the date specified for that purpose
as contemplated by Section 301.
"Responsible Officer", when used with respect to the Trustee, means the
chairman or any vice-chairman of the board of directors, the chairman or any
vice-chairman of the executive committee of the board of directors, the chairman
of the trust committee, the president, any vice president, the secretary, any
assistant secretary, the treasurer, any assistant treasurer, any senior trust
6
<PAGE> 14
officer, any trust officer or assistant trust officer, the controller or any
assistant controller or any other officer of the Trustee customarily performing
functions similar to those performed by any of the above designated officers and
also means, with respect to a particular corporate trust matter, any other
officer to whom such matter is referred because of his knowledge of and
familiarity with the particular subject.
"Securities" has the meaning stated in the first recital of this
Indenture and more particularly means any Securities authenticated and delivered
under this Indenture.
"Securities Act" means the Securities Act of 1933 and any statute
successor thereto, in each case as amended from time to time.
"Security Register" and "Security Registrar" have the respective
meanings specified in Section 305.
"Senior Indebtedness" means all obligations on any Indebtedness of the
Company, whether outstanding on the date of original issuance of the Securities
of any series or thereafter created, incurred or assumed, unless, in the case of
any particular Indebtedness, the instrument creating or evidencing the same or
pursuant to which the same is outstanding expressly provides that such
Indebtedness shall not be senior in right of payment to the Securities of any
series. Notwithstanding the foregoing, except as otherwise provided with respect
to a series of Securities, "Senior Indebtedness" shall not include (i) any
Indebtedness of the Company to a Subsidiary of the Company, (ii) Indebtedness
to, or guaranteed on behalf of, any shareholder, director, officer or employee
of the Company (including, without limitation, amounts owed for compensation),
(iii) any liability for federal, state, local or other taxes owed or owing by
the Company, and (iv) Indebtedness which, when incurred and without respect to
any election under Section 1111(b) of Title 11, United States Code, is without
recourse to the Company.
"Special Record Date" for the payment of any Defaulted Interest means a
date fixed by the Trustee pursuant to Section 307.
"Stated Maturity", when used with respect to any Security or any
instalment of principal thereof or interest thereon, means the date specified in
such Security as the fixed date on which the principal of such Security or such
instalment of principal or interest is due and payable.
"Subsidiary" means, in respect of any Person, any corporation,
association, partnership or other business entity of which more than 50% of the
total voting power of shares of capital stock or other interests (including
partnership interests) entitled (without regard to the occurrence of any
contingency) to vote in the election of directors, managers or trustees thereof
is at the time owned
7
<PAGE> 15
or controlled, directly or indirectly, by (i) such Person, (ii) such Person and
one or more other Subsidiaries of such Person or (iii) one or more other
Subsidiaries of such Person. Unless otherwise specified, "Subsidiary" means a
Subsidiary of the Company.
"Trust Indenture Act" means the Trust Indenture Act of 1939 as in force
at the date as of which this instrument was executed; provided, however, that in
the event the Trust Indenture Act of 1939 is amended after such date, "Trust
Indenture Act" means, to the extent required by any such amendment, the Trust
Indenture Act of 1939 as so amended.
"Trustee" means the Person named as the "Trustee" in the first
paragraph of this instrument until a successor Trustee shall have become such
pursuant to the applicable provisions of this Indenture, and thereafter
"Trustee" shall mean or include each Person who is then a Trustee hereunder, and
if at any time there is more than one such Person, "Trustee" as used with
respect to the Securities of any series shall mean the Trustee with respect to
Securities of that series.
"U.S. Government Obligation" has the meaning specified in Section 1304.
"Vice President", when used with respect to the Company or the Trustee,
means any vice president, whether or not designated by a number or a word or
words added before or after the title "vice president".
Section 102. Compliance Certificates and Opinions.
Upon any application or request by the Company to the Trustee to take
any action under any provision of this Indenture, the Company shall furnish to
the Trustee such certificates and opinions as may be required under the Trust
Indenture Act. Each such certificate or opinion shall be given in the form of an
Officers' Certificate, if to be given by an officer of the Company, or an
Opinion of Counsel, if to be given by counsel, and shall comply with the
requirements of the Trust Indenture Act and any other requirements set forth in
this Indenture.
Every certificate or opinion with respect to compliance with a
condition or covenant provided for in this Indenture shall include,
(1) a statement that each individual signing such certificate
or opinion has read such covenant or condition and the definitions
herein relating thereto;
(2) a brief statement as to the nature and scope of the
examination or investigation upon which the statements or opinions
contained in such certificate or opinion are based;
(3) a statement that, in the opinion of each such individual,
he has made such examination or investigation as is necessary to enable
him to express an informed opinion as to whether or not such covenant
or condition has been complied with; and
8
<PAGE> 16
(4) a statement as to whether, in the opinion of each such
individual, such condition or covenant has been complied with.
Section 103. Form of Documents Delivered to Trustee.
In any case where several matters are required to be certified by, or
covered by an opinion of, any specified Person, it is not necessary that all
such matters be certified by, or covered by the opinion of, only one such
Person, or that they be so certified or covered by only one document, but one
such Person may certify or give an opinion with respect to some matters and one
or more other such Persons as to other matters, and any such Person may certify
or give an opinion as to such matters in one or several documents.
Any certificate or opinion of an officer of the Company may be based,
insofar as it relates to legal matters, upon a certificate or opinion of, or
representations by, counsel, unless such officer knows, or in the exercise of
reasonable care should know, that the certificate or opinion or representations
with respect to the matters upon which his certificate or opinion is based are
erroneous. Any such certificate or opinion of counsel may be based, insofar as
it relates to factual matters, upon a certificate or opinion of, or
representations by, an officer or officers of the Company stating that the
information with respect to such factual matters is in the possession of the
Company, unless such counsel knows, or in the exercise of reasonable care should
know, that the certificate or opinion or representations with respect to such
matters are erroneous.
Where any Person is required to make, give or execute two or more
applications, requests, consents, certificates, statements, opinions or other
instruments under this Indenture, they may, but need not, be consolidated and
form one instrument.
Section 104. Acts of Holders; Record Dates.
Any request, demand, authorization, direction, notice, consent, waiver
or other action provided or permitted by this Indenture to be given, made or
taken by Holders may be embodied in and evidenced by one or more instruments of
substantially similar tenor signed by such Holders in person or by agent duly
appointed in writing; and, except as herein otherwise expressly provided, such
action shall become effective when such instrument or instruments are delivered
to the Trustee and, where it is hereby expressly required, to the Company. Such
instrument or instruments (and the action embodied therein and evidenced
thereby) are herein sometimes referred to as the "Act" of the Holders signing
such instrument or instruments. Proof of execution of any such instrument or of
a writing appointing any such agent shall be sufficient for any purpose of this
Indenture and (subject to Section 601) conclusive in favor of the Trustee and
the Company, if made in the manner provided in this Section.
The fact and date of the execution by any Person of any such instrument
or writing may be proved by the affidavit of a witness of such execution or by a
certificate of a notary public or other officer authorized by law to take
acknowledgments of deeds, certifying that the individual signing
9
<PAGE> 17
such instrument or writing acknowledged to him the execution thereof. Where such
execution is by a signer acting in a capacity other than his individual
capacity, such certificate or affidavit shall also constitute sufficient proof
of his authority. The fact and date of the execution of any such instrument or
writing, or the authority of the Person executing the same, may also be proved
in any other manner which the Trustee deems sufficient.
The ownership of Securities shall be proved by the Security Register.
Any request, demand, authorization, direction, notice, consent, waiver
or other Act of the Holder of any Security shall bind every future Holder of the
same Security and the Holder of every Security issued upon the registration of
transfer thereof or in exchange therefor or in lieu thereof in respect of
anything done, omitted or suffered to be done by the Trustee or the Company in
reliance thereon, whether or not notation of such action is made upon such
Security.
The Company may set any day as a record date for the purpose of
determining the Holders of Outstanding Securities of any series entitled to
give, make or take any request, demand, authorization, direction, notice,
consent, waiver or other action provided or permitted by this Indenture to be
given, made or taken by Holders of Securities of such series, provided that the
Company may not set a record date for, and the provisions of this paragraph
shall not apply with respect to, the giving or making of any notice,
declaration, request or direction referred to in the next paragraph. If any
record date is set pursuant to this paragraph, the Holders of Outstanding
Securities of the relevant series on such record date, and no other Holders,
shall be entitled to take the relevant action, whether or not such Holders
remain Holders after such record date; provided that no such action shall be
effective hereunder unless taken on or prior to the applicable Expiration Date
by Holders of the requisite principal amount of Outstanding Securities of such
series on such record date. Nothing in this paragraph shall be construed to
prevent the Company from setting a new record date for any action for which a
record date has previously been set pursuant to this paragraph (whereupon the
record date previously set shall automatically and with no action by any Person
be cancelled and of no effect), and nothing in this paragraph shall be construed
to render ineffective any action taken by Holders of the requisite principal
amount of Outstanding Securities of the relevant series on the date such action
is taken. Promptly after any record date is set pursuant to this paragraph, the
Company, at its own expense, shall cause notice of such record date, the
proposed action by Holders and the applicable Expiration Date to be given to the
Trustee in writing and to each Holder of Securities of the relevant series in
the manner set forth in Section 106.
The Trustee may set any day as a record date for the purpose of
determining the Holders of Outstanding Securities of any series entitled to join
in the giving or making of (i) any Notice of Default, (ii) any declaration of
acceleration referred to in Section 502, (iii) any request to institute
proceedings referred to in Section 507(2) or (iv) any direction referred to in
Section 512, in each case with respect to Securities of such series. If any
record date is set pursuant to this paragraph, the Holders of Outstanding
Securities of such series on such record date, and no other Holders, shall be
entitled to join in such notice, declaration, request or direction, whether or
not such Holders remain Holders after such record date; provided that no such
action shall be effective hereunder unless taken
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<PAGE> 18
on or prior to the applicable Expiration Date by Holders of the requisite
principal amount of Outstanding Securities of such series on such record date.
Nothing in this paragraph shall be construed to prevent the Trustee from setting
a new record date for any action for which a record date has previously been set
pursuant to this paragraph (whereupon the record date previously set shall
automatically and with no action by any Person be canceled and of no effect),
and nothing in this paragraph shall be construed to render ineffective any
action taken by Holders of the requisite principal amount of Outstanding
Securities of the relevant series on the date such action is taken. Promptly
after any record date is set pursuant to this paragraph, the Trustee, at the
Company's expense, shall cause notice of such record date, the proposed action
by Holders and the applicable Expiration Date to be given to the Company in
writing and to each Holder of Securities of the relevant series in the manner
set forth in Section 106.
With respect to any record date set pursuant to this Section, the party
hereto which sets such record date may designate any day as the "Expiration
Date" and from time to time may change the Expiration Date to any earlier or
later day; provided that no such change shall be effective unless notice of the
proposed new Expiration Date is given to the other party hereto in writing, and
to each Holder of Securities of the relevant series in the manner set forth in
Section 106, on or prior to the existing Expiration Date. If an Expiration Date
is not designated with respect to any record date set pursuant to this Section,
the party hereto which set such record date shall be deemed to have initially
designated the 180th day after such record date as the Expiration Date with
respect thereto, subject to its right to change the Expiration Date as provided
in this paragraph. Notwithstanding the foregoing, no Expiration Date shall be
later than the 180th day after the applicable record date.
Without limiting the foregoing, a Holder entitled hereunder to take any
action hereunder with regard to any particular Security may do so with regard to
all or any part of the principal amount of such Security or by one or more duly
appointed agents each of which may do so pursuant to such appointment with
regard to all or any part of such principal amount.
Section 105. Notices, Etc., to Trustee and Company.
Any request, demand, authorization, direction, notice, consent, waiver
or Act of Holders or other document provided or permitted by this Indenture to
be made upon, given or furnished to, or filed with,
(1) the Trustee by any Holder or by the Company shall be
sufficient for every purpose hereunder if made, given, furnished or
filed in writing to or with the Trustee at its Corporate Trust Office,
Attention: Corporate Trust Trustee Administration, or
(2) the Company by the Trustee or by any Holder shall be
sufficient for every purpose hereunder (unless otherwise herein
expressly provided) if in writing and mailed, first-class postage
prepaid, to the Company addressed to it at the address of its principal
office specified in the first paragraph of this instrument or at any
other address previously furnished in writing to the Trustee by the
Company.
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<PAGE> 19
Section 106. Notice to Holders; Waiver.
Where this Indenture provides for notice to Holders of any event, such
notice shall be sufficiently given (unless otherwise herein expressly provided)
if in writing and mailed, first-class postage prepaid, to each Holder affected
by such event, at his address as it appears in the Security Register, not later
than the latest date (if any), and not earlier than the earliest date (if any),
prescribed for the giving of such notice. In any case where notice to Holders is
given by mail, neither the failure to mail such notice, nor any defect in any
notice so mailed, to any particular Holder shall affect the sufficiency of such
notice with respect to other Holders. Where this Indenture provides for notice
in any manner, such notice may be waived in writing by the Person entitled to
receive such notice, either before or after the event, and such waiver shall be
the equivalent of such notice. Waivers of notice by Holders shall be filed with
the Trustee, but such filing shall not be a condition precedent to the validity
of any action taken in reliance upon such waiver.
In case by reason of the suspension of regular mail service or by
reason of any other cause it shall be impracticable to give such notice by mail,
then such notification as shall be made with the approval of the Trustee shall
constitute a sufficient notification for every purpose hereunder.
Section 107. Conflict with Trust Indenture Act.
If any provision hereof limits, qualifies or conflicts with a provision
of the Trust Indenture Act which is required under such Act to be a part of and
govern this Indenture, the latter provision shall control. If any provision of
this Indenture modifies or excludes any provision of the Trust Indenture Act
which may be so modified or excluded, the latter provision shall be deemed to
apply to this Indenture as so modified or to be excluded, as the case may be.
Section 108. Effect of Headings and Table of Contents.
The Article and Section headings herein and the Table of Contents are
for convenience only and shall not affect the construction hereof.
Section 109. Successors and Assigns.
All covenants and agreements in this Indenture by the Company shall
bind its successors and assigns, whether so expressed or not.
Section 110. Separability Clause.
In case any provision in this Indenture or in the Securities shall be
invalid, illegal or unenforceable, the validity, legality and enforceability of
the remaining provisions shall not in any way be affected or impaired thereby.
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<PAGE> 20
Section 111. Benefits of Indenture.
Nothing in this Indenture or in the Securities, express or implied,
shall give to any Person, other than the parties hereto and their successors
hereunder and the Holders, any benefit or any legal or equitable right, remedy
or claim under this Indenture.
Section 112. Governing Law.
This Indenture and the Securities shall be governed by and construed in
accordance with the law of the State of Arizona, without regard to conflicts of
laws principles thereof.
Section 113. Legal Holidays.
In any case where any Interest Payment Date, Redemption Date or Stated
Maturity of any Security shall not be a Business Day at any Place of Payment,
then (notwithstanding any other provision of this Indenture or of the Securities
(other than a provision of any Security which specifically states that such
provision shall apply in lieu of this Section)) payment of interest or principal
(and premium, if any) need not be made at such Place of Payment on such date,
but may be made on the next succeeding Business Day at such Place of Payment
with the same force and effect as if made on the Interest Payment Date or
Redemption Date, or at the Stated Maturity.
ARTICLE TWO
Security Forms
Section 201. Forms Generally.
The Securities of each series shall be in substantially the form set
forth in this Article, or in such other form as shall be established by or
pursuant to a Board Resolution or in one or more indentures supplemental hereto,
in each case with such appropriate insertions, omissions, substitutions and
other variations as are required or permitted by this Indenture, and may have
such letters, numbers or other marks of identification and such legends or
endorsements placed thereon as may be required to comply with the rules of any
securities exchange or Depositary therefor or as may, consistently herewith, be
determined by the officers executing such Securities, as evidenced by their
execution thereof. If the form of Securities of any series is established by
action taken pursuant to a Board Resolution, a copy of an appropriate record of
such action shall be certified by the Secretary or an Assistant Secretary of the
Company and delivered to the Trustee at or prior to the delivery of the Company
Order contemplated by Section 303 for the authentication and delivery of such
Securities.
The definitive Securities shall be printed, lithographed or engraved on
steel engraved borders or may be produced in any other manner, all as determined
by the officers executing such Securities, as evidenced by their execution of
such Securities.
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<PAGE> 21
Section 202. Form of Face of Security.
[Insert any legend required by the Internal Revenue Code and the
regulations thereunder.]
UGLY DUCKLING CORPORATION
No. _____________ $_________
CUSIP NO. _________
Ugly Duckling Corporation, a corporation duly organized and existing
under the laws of Delaware (herein called the "Company," which term includes any
successor Person under the Indenture hereinafter referred to), for value
received, hereby promises to pay to __________________ or registered assigns,
the principal sum of __________________ Dollars on __________________ [if the
Security is to bear interest prior to Maturity, insert --, and to pay interest
thereon from __________________ or from the most recent Interest Payment Date to
which interest has been paid or duly provided for, semi-annually on
__________________ and __________________ in each year, commencing
__________________ , at the rate of __________________ % per annum, until the
principal hereof is paid or made available for payment [if applicable, insert
- --, provided that any principal and premium, and any such instalment of
interest, which is overdue shall bear interest at the rate of __________________
% per annum (to the extent that the payment of such interest shall be legally
enforceable), from the dates such amounts are due until they are paid or made
available for payment, and such interest shall be payable on demand]. The
interest so payable, and punctually paid or duly provided for, on any Interest
Payment Date will, as provided in such Indenture, be paid to the Person in whose
name this Security (or one or more Predecessor Securities) is registered at the
close of business on the Regular Record Date for such interest, which shall be
the __________________ or __________________ (whether or not a Business Day), as
the case may be, next preceding such Interest Payment Date. Any such interest
not so punctually paid or duly provided for will forthwith cease to be payable
to the Holder on such Regular Record Date and may either be paid to the Person
in whose name this Security (or one or more Predecessor Securities) is
registered at the close of business on a Special Record Date for the payment of
such Defaulted Interest to be fixed by the Trustee, notice whereof shall be
given to Holders of Securities of this series not less than 10 days prior to
such Special Record Date, or be paid at any time in any other lawful manner not
inconsistent with the requirements of any securities exchange on which the
Securities of this series may be listed, and upon such notice as may be required
by such exchange, all as more fully provided in said Indenture].
[If the Security is not to bear interest prior to Maturity, insert --
The principal of this Security shall not bear interest except in the case of a
default in payment of principal upon acceleration, upon redemption or at Stated
Maturity and in such case the overdue principal and any overdue premium shall
bear interest at the rate of __________________ % per annum (to the extent that
the payment of such interest shall be legally enforceable), from the dates such
amounts are due until they are paid or made
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<PAGE> 22
available for payment. Interest on any overdue principal or premium
shall be payable on demand. Any such interest on overdue principal or premium
which is not paid on demand shall bear interest at the rate of
__________________ % per annum (to the extent that the payment of such interest
on interest shall be legally enforceable), from the date of such demand until
the amount so demanded is paid or made available for payment. Interest on any
overdue interest shall be payable on demand.]
Payment of the principal of (and premium, if any) and [if applicable,
insert -- any such] interest on this Security will be made at the office or
agency of the Company maintained for that purpose in __________________ , in
such coin or currency of the United States of America as at the time of payment
is legal tender for payment of public and private debts [if applicable,
insert--; provided, however, that at the option of the Company payment of
interest may be made by check mailed to the address of the Person entitled
thereto as such address shall appear in the Security Register].
Reference is hereby made to the further provisions of this Security set
forth on the reverse hereof, which further provisions shall for all purposes
have the same effect as if set forth at this place.
Unless the certificate of authentication hereon has been executed by
the Trustee referred to on the reverse hereof by manual signature, this Security
shall not be entitled to any benefit under the Indenture or be valid or
obligatory for any purpose.
In Witness Whereof, the Company has caused this instrument to be duly
executed.
UGLY DUCKLING CORPORATION
By_______________________________________
Attest:
_________________________
Section 203. Form of Reverse of Security.
This Security is one of a duly authorized issue of securities of the
Company (herein called the "Securities"), issued and to be issued in one or more
series under an Indenture, dated as of __________________ , 199___________
(herein called the "Indenture", which term shall have the meaning assigned to it
in such instrument), between the Company and ___________________________ , as
Trustee (herein called the "Trustee", which term includes any successor trustee
under the Indenture), and reference is hereby made to the Indenture for a
statement of the respective rights, limitations of rights, duties
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<PAGE> 23
and immunities thereunder of the Company, the Trustee and the Holders of the
Securities and of the terms upon which the Securities are, and are to be,
authenticated and delivered. This Security is one of the series designated on
the face hereof [if applicable, insert --, limited in aggregate principal amount
to $__________________ ].
[If applicable, insert -- The Securities of this series are subject to
redemption upon not less than 30 days' notice by mail, [if applicable, insert --
(1) on __________________ in any year commencing with the year
__________________ and ending with the year __________________ through operation
of the sinking fund for this series at a Redemption Price equal to 100% of the
principal amount, and (2)] at any time [if applicable, insert -- on or after
__________________ , 19__________________ ], as a whole or in part, at the
election of the Company, at the following Redemption Prices (expressed as
percentages of the principal amount): If redeemed [if applicable, insert -- on
or before __________________ , and if redeemed] during the 12-month period
beginning __________________ of the years indicated,
<TABLE>
<CAPTION>
Redemption Redemption
Year Price Year Price
<S> <C> <C> <C>
</TABLE>
and thereafter at a Redemption Price equal to __________________ % of the
principal amount, together in the case of any such redemption [if applicable,
insert -- (whether through operation of the sinking fund or otherwise)] with
accrued interest to the Redemption Date, but interest installments whose Stated
Maturity is on or prior to such Redemption Date will be payable to the Holders
of such Securities, or one or more Predecessor Securities, of record at the
close of business on the relevant Record Dates referred to on the face hereof
for such interest installments, all as provided in the Indenture.]
[If applicable, insert -- The Securities of this series are subject to
redemption upon not less than 30 days' notice by mail, (1) on __________________
in any year commencing with the year __________________ and ending with the year
__________________ through operation of the sinking fund for this series at the
Redemption Prices for redemption through operation of the sinking fund
(expressed as percentages of the principal amount) set forth in the table below,
and (2) at any time [if applicable, insert -- on or after __________________ ],
as a whole or in part, at the election of the Company, at the Redemption Prices
for redemption otherwise than through operation of the sinking fund (expressed
as percentages of the principal amount) set forth in the table below: If
redeemed during the 12-month period beginning __________________ of the years
indicated,
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<PAGE> 24
<TABLE>
<CAPTION>
Redemption Price
For Redemption Redemption Otherwise
Through Operation Than Through
of the Operation
Year Sinking Fund Of the Sinking Fund
<S> <C> <C>
</TABLE>
and thereafter at a Redemption Price equal to __________________ % of the
principal amount, together in the case of any such redemption (whether through
operation of the sinking fund or otherwise) with accrued interest to the
Redemption Date, but interest installments whose Stated Maturity is on or prior
to such Redemption Date will be payable to the Holders of such Securities, or
one or more Predecessor Securities, of record at the close of business on the
relevant Record Dates referred to on the face hereof for such interest
installments, all as provided in the Indenture.]
[If applicable, insert -- The sinking fund for this series provides for
the redemption on __________________ in each year beginning with the year
__________________ and ending with the year __________________ of [if
applicable, insert -- not less than $__________________ ("mandatory sinking
fund") and not more than] $__________________ aggregate principal amount of
Securities of this series. Securities of this series acquired or redeemed by the
Company otherwise than through [if applicable, insert -- mandatory] sinking fund
payments may be credited against subsequent [if applicable, insert -- mandatory]
sinking fund payments otherwise required to be made [if applicable, insert -- in
the inverse order in which they become due].]
[If the Security is subject to redemption of any kind, insert -- In the
event of redemption of this Security in part only, a new Security or Securities
of this series and of like tenor for the unredeemed portion hereof will be
issued in the name of the Holder hereof upon the cancellation hereof.]
[If applicable, insert paragraph regarding subordination of the
Security.]
[If applicable, insert -- The Indenture contains provisions for
defeasance at any time of [the entire indebtedness of this Security] [or]
[certain restrictive covenants and Events of Default with respect to this
Security] [, in each case] upon compliance with certain conditions set forth in
the Indenture.]
[If the Security is not an Original Issue Discount Security, insert --
If an Event of Default with respect to Securities of this series shall occur and
be continuing, the principal of the Securities of this series may be declared
due and payable in the manner and with the effect provided in the Indenture.]
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<PAGE> 25
[If the Security is an Original Issue Discount Security, insert -- If
an Event of Default with respect to Securities of this series shall occur and be
continuing, an amount of principal of the Securities of this series may be
declared due and payable in the manner and with the effect provided in the
Indenture. Such amount shall be equal to [insert -- formula for determining the
amount]. Upon payment (i) of the amount of principal so declared due and payable
and (ii) of interest on any overdue principal, premium and interest (in each
case to the extent that the payment of such interest shall be legally
enforceable), all of the Company's obligations in respect of the payment of the
principal of and premium and interest, if any, on the Securities of this series
shall terminate.]
The Indenture permits, with certain exceptions as therein provided, the
amendment thereof and the modification of the rights and obligations of the
Company and the rights of the Holders of the Securities of each series to be
affected under the Indenture at any time by the Company and the Trustee without
the consent of any Holders in certain limited cases, and with the consent of the
Holders of a majority in principal amount of the Securities at the time
Outstanding of each series to be affected subject to certain exceptions. The
Indenture also contains provisions permitting the Holders of specified
percentages in principal amount of the Securities of each series at the time
Outstanding, on behalf of the Holders of all Securities of such series, to waive
compliance by the Company with certain provisions of the Indenture and certain
past defaults under the Indenture and their consequences. Any such consent or
waiver shall be conclusive and binding upon the Holder of this Security and upon
all future Holders of this Security and of any Security issued upon the
registration of transfer hereof or in exchange herefor or in lieu hereof,
whether or not notation of such consent or waiver is made upon this Security.
As provided in and subject to the provisions of the Indenture, the
Holder of this Security shall not have the right to institute any proceeding
with respect to the Indenture or for the appointment of a receiver or trustee or
for any other remedy thereunder, unless such Holder shall have previously given
the Trustee written notice of a continuing Event of Default with respect to the
Securities of this series, the Holders of not less than 25% in principal amount
of the Securities of this series at the time Outstanding shall have made written
request to the Trustee to institute proceedings in respect of such Event of
Default as Trustee and offered the Trustee reasonable indemnity, and the Trustee
shall not have received from the Holders of a majority in principal amount of
Securities of this series at the time Outstanding a direction inconsistent with
such request, and shall have failed to institute any such proceeding, for 60
days after receipt of such notice, request and offer of indemnity. The foregoing
shall not apply to any suit instituted by the Holder of this Security for the
enforcement of any payment of principal hereof or any premium or interest hereon
on or after the respective due dates expressed herein.
No reference herein to the Indenture and no provision of this Security
or of the Indenture shall alter or impair the obligation of the Company, which
is absolute and unconditional, to pay the principal of and any premium and
interest on this Security at the times, place and rate, and in the coin or
currency, herein prescribed.
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<PAGE> 26
As provided in the Indenture and subject to certain limitations therein
set forth, the transfer of this Security is registrable in the Security
Register, upon surrender of this Security for registration of transfer at the
office or agency of the Company in any place where the principal of and any
premium and interest on this Security are payable, duly endorsed by, or
accompanied by a written instrument of transfer in form satisfactory to the
Company and the Security Registrar duly executed by, the Holder hereof or his
attorney duly authorized in writing, and thereupon one or more new Securities of
this series and of like tenor, of authorized denominations and for the same
aggregate principal amount, will be issued to the designated transferee or
transferees.
The Securities of this series are issuable only in registered form without
coupons in denominations of $__________________ and any integral multiple
thereof. As provided in the Indenture and subject to certain limitations therein
set forth, Securities of this series are exchangeable for a like aggregate
principal amount of Securities of this series and of like tenor of a different
authorized denomination, as requested by the Holder surrendering the same.
No service charge shall be made for any such registration of transfer
or exchange, but the Company may require payment of a sum sufficient to cover
any tax or other governmental charge payable in connection therewith.
Prior to due presentment of this Security for registration of transfer,
the Company, the Trustee and any agent of the Company or the Trustee may treat
the Person in whose name this Security is registered as the owner hereof for all
purposes, whether or not this Security be overdue, and neither the Company, the
Trustee nor any such agent shall be affected by notice to the contrary.
All terms used in this Security which are defined in the Indenture
shall have the meanings assigned to them in the Indenture.
Section 204. Form of Legend for Global Securities.
Unless otherwise specified as contemplated by Section 301 for the
Securities evidenced thereby, every Global Security authenticated and delivered
hereunder shall bear a legend in substantially the following form:
THIS SECURITY IS A GLOBAL SECURITY WITHIN THE MEANING OF THE INDENTURE
HEREINAFTER REFERRED TO AND IS REGISTERED IN THE NAME OF A DEPOSITARY OR A
NOMINEE THEREOF. THIS SECURITY MAY NOT BE EXCHANGED IN WHOLE OR IN PART FOR A
SECURITY REGISTERED, AND NO TRANSFER OF THIS SECURITY IN WHOLE OR IN PART MAY BE
REGISTERED, IN THE NAME OF ANY PERSON OTHER THAN SUCH DEPOSITARY OR A NOMINEE
THEREOF, EXCEPT IN THE LIMITED CIRCUMSTANCES DESCRIBED IN THE INDENTURE.
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<PAGE> 27
Section 205. Form of Trustee's Certificate of Authentication.
The Trustee's certificates of authentication shall be in substantially
the following form:
This is one of the Securities of the series designated therein referred
to in the within-mentioned Indenture.
____________________________________,
As Trustee
By ____________________________________
Authorized Officer
ARTICLE THREE
The Securities
Section 301. Amount of Securities; Issuable in Series.
The aggregate principal amount of Securities which may be authenticated
and delivered under this Indenture is limited to $100,000,000, except for
Securities authenticated and delivered upon transfer of or in exchange for, or
in lieu of other Securities pursuant to Section 304, 305, 306, 906, and 1107,
and except for Securities which, pursuant to Section 303, are deemed never to
have been authenticated and delivered hereunder.
The Securities may be issued in one or more series. There shall be
established in or pursuant to a Board Resolution and, subject to Section 303,
set forth, or determined in the manner provided, in an Officers' Certificate, or
established in one or more indentures supplemental hereto, prior to the issuance
of Securities of any series,
(1) the title of the Securities of the series (which shall
distinguish the Securities of the series from Securities of any other
series);
(2) any limit upon the aggregate principal amount of the
Securities of the series which may be authenticated and delivered under
this Indenture (except for Securities authenticated and delivered upon
registration of transfer of, or in exchange for, or in lieu of, other
Securities of the series pursuant to Section 304, 305, 306, 906 or 1107
and except for any Securities which, pursuant to Section 303, are
deemed never to have been authenticated and delivered hereunder);
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<PAGE> 28
(3) the Person to whom any interest on a Security of the
series shall be payable, if other than the Person in whose name that
Security (or one or more Predecessor Securities) is registered at the
close of business on the Regular Record Date for such interest;
(4) the date or dates on which the principal of any Securities
of the series is payable;
(5) the rate or rates at which any Securities of the series
shall bear interest, if any, the basis of computation of such interest
(if other than as provided in Section 310), the date or dates from
which any such interest shall accrue, the Interest Payment Dates on
which any such interest shall be payable the manner of determination of
such Interest Payment Dates and the Regular Record Date for any such
interest payable on any Interest Payment Date;
(6) the right, if any, to extend the interest payment periods
and the duration of such extension;
(7) the place or places where the principal of and any premium
and interest on any Securities of the series shall be payable;
(8) the period or periods within which, the price or prices at
which and the terms and conditions upon which any Securities of the
series may be redeemed, in whole or in part, at the option of the
Company and, if other than by a Board Resolution, the manner in which
any election by the Company to redeem the Securities shall be
evidenced;
(9) the obligation, if any, of the Company to redeem or
purchase any Securities of the series pursuant to any sinking fund or
analogous provisions or at the option of the Holder thereof and the
period or periods within which, the price or prices at which and the
terms and conditions upon which any Securities of the series shall be
redeemed or purchased, in whole or in part, pursuant to such
obligation;
(10) if other than denominations of $1,000 and any integral
multiple thereof, the denominations in which any Securities of the
series shall be issuable;
(11) if the amount of principal of or any premium or interest
on any Securities of the series may be determined with reference to an
index or pursuant to a formula, the manner in which such amounts shall
be determined;
(12) if other than the currency of the United States of
America, the currency, currencies or currency units in which the
principal of or any premium or interest on any Securities of the series
shall be payable and the manner of determining the equivalent thereof
in the currency of the United States of America for any purpose,
including for purposes of the definition of "Outstanding" in Section
101;
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<PAGE> 29
(13) if the principal of or any premium or interest on any
Securities of the series is to be payable, at the election of the
Company or the Holder thereof, in one or more currencies or currency
units other than that or those in which such Securities are stated to
be payable, the currency, currencies or currency units in which the
principal of or any premium or interest on such Securities as to which
such election is made shall be payable, the periods within which and
the terms and conditions upon which such election is to be made and the
amount so payable (or the manner in which such amount shall be
determined);
(14) if other than the entire principal amount thereof, the
portion of the principal amount of any Securities of the series which
shall be payable upon declaration of acceleration of the Maturity
thereof pursuant to Section 502;
(15) if the principal amount payable at the Stated Maturity of
any Securities of the series will not be determinable as of any one or
more dates prior to the Stated Maturity, the amount which shall be
deemed to be the principal amount of such Securities as of any such
date for any purpose thereunder or hereunder, including the principal
amount thereof which shall be due and payable upon any Maturity other
than the Stated Maturity or which shall be deemed to be Outstanding as
of any date prior to the Stated Maturity (or, in any such case, the
manner in which such amount deemed to be the principal amount shall be
determined);
(16) if applicable, that the Securities of the series, in
whole or any specified part, shall be defeasible pursuant to Section
1302 or Section 1303 or both such Sections and, if other than by a
Board Resolution, the manner in which any election by the Company to
defease such Securities shall be evidenced;
(17) if applicable, that any Securities of the series shall be
issuable in whole or in part in the form of one or more Global
Securities and, in such case, the respective Depositaries for such
Global Securities, the form of any legend or legends which shall be
borne by any such Global Securities in addition to or in lieu of that
set forth in Section 204 and any circumstances in addition to or in
lieu of those set forth in Clause (2) of the last paragraph of Section
305 in which any such Global Security may be exchanged in whole or in
part for Securities registered, and any transfer of such Global
Security in whole or in part may be registered, in the name or names of
Persons other than the Depositary for such Global Security or a nominee
thereof;
(18) any addition to or change in the Events of Default which
applies to any Securities of the series and any change in the right of
the Trustee or the requisite Holders of such Securities to declare the
principal amount thereof due and payable pursuant to Section 502;
(19) any addition to or change in the covenants set forth in
Article Ten which applies to Securities of the series; and
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<PAGE> 30
(20) the non-application of, or any addition to or change in,
Article Fourteen with respect to Securities of the series;
(21) any other terms of the series (which terms shall not be
inconsistent with the provisions of this Indenture, except as permitted
by Section 901(5)).
All Securities of any one series shall be substantially identical
except as to denomination and except as may otherwise be provided in or pursuant
to the Board Resolution referred to above and (subject to Section 303) set
forth, or determined in the manner provided, in the Officers' Certificate
referred to above or in any such indenture supplemental hereto.
If any of the terms of the series are established by action taken
pursuant to a Board Resolution, a copy of an appropriate record of such action
shall be certified by the Secretary or an Assistant Secretary of the Company and
delivered to the Trustee at or prior to the delivery of the Officers'
Certificate setting forth the terms of the series.
Section 302. Denominations.
The Securities of each series shall be issuable only in registered form
without coupons and only in such denominations as shall be specified as
contemplated by Section 301. In the absence of any such specified denomination
with respect to the Securities of any series, the Securities of such series
shall be issuable in denominations of $1,000 and any integral multiple thereof.
Section 303. Execution, Authentication, Delivery and Dating.
The Securities shall be executed on behalf of the Company by its
Chairman of the Board, its Vice Chairman of the Board, its President or one of
its Vice Presidents, and attested by its Secretary or one of its Assistant
Secretaries. The signature of any of these officers on the Securities may be
manual or facsimile.
Securities bearing the manual or facsimile signatures of individuals
who were at any time the proper officers of the Company shall bind the Company,
notwithstanding that such individuals or any of them have ceased to hold such
offices prior to the authentication and delivery of such Securities or did not
hold such offices at the date of such Securities.
At any time and from time to time after the execution and delivery of
this Indenture, the Company may deliver Securities of any series executed by the
Company to the Trustee for authentication, together with a Company Order for the
authentication and delivery of such Securities, and the Trustee in accordance
with the Company Order shall authenticate and deliver such Securities. If the
form or terms of the Securities of the series have been established by or
pursuant to one or more Board Resolutions as permitted by Sections 201 and 301,
in authenticating such Securities, and accepting the additional responsibilities
under this Indenture in relation to such
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Securities, the Trustee shall be entitled to receive, and (subject to Section
601) shall be fully protected in relying upon, an Opinion of Counsel stating,
(1) if the form of such Securities has been established by or
pursuant to Board Resolution as permitted by Section 201, that such
form has been established in conformity with the provisions of this
Indenture;
(2) if the terms of such Securities have been established by
or pursuant to Board Resolution as permitted by Section 301, that such
terms have been established in conformity with the provisions of this
Indenture; and
(3) that such Securities, when authenticated and delivered by
the Trustee and issued by the Company in the manner and subject to any
conditions specified in such Opinion of Counsel, will constitute valid
and legally binding obligations of the Company enforceable in
accordance with their terms, subject to bankruptcy, insolvency,
fraudulent transfer, reorganization, moratorium and similar laws of
general applicability relating to or affecting creditors' rights and to
general equity principles.
If such form or terms have been so established, the Trustee shall not be
required to authenticate such Securities if the issue of such Securities
pursuant to this Indenture will affect the Trustee's own rights, duties or
immunities under the Securities and this Indenture or otherwise in a manner
which is not reasonably acceptable to the Trustee.
Notwithstanding the provisions of Section 301 and of the preceding
paragraph, if all Securities of a series are not to be originally issued at one
time, it shall not be necessary to deliver the Officers' Certificate otherwise
required pursuant to Section 301 or the Company Order and Opinion of Counsel
otherwise required pursuant to such preceding paragraph at or prior to the
authentication of each Security of such series if such documents are delivered
at or prior to the authentication upon original issuance of the first Security
of such series to be issued.
Each Security shall be dated the date of its authentication.
No Security shall be entitled to any benefit under this Indenture or be
valid or obligatory for any purpose unless there appears on such Security a
certificate of authentication substantially in the form provided for herein
executed by the Trustee by manual signature, and such certificate upon any
Security shall be conclusive evidence, and the only evidence, that such Security
has been duly authenticated and delivered hereunder. Notwithstanding the
foregoing, if any Security shall have been authenticated and delivered hereunder
but never issued and sold by the Company, and the Company shall deliver such
Security to the Trustee for cancellation as provided in Section 309, for all
purposes of this Indenture such Security shall be deemed never to have been
authenticated and delivered hereunder and shall never be entitled to the
benefits of this Indenture.
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Section 304. Temporary Securities.
Pending the preparation of definitive Securities of any series, the
Company may execute, and upon Company Order the Trustee shall authenticate and
deliver, temporary Securities which are printed, lithographed, typewritten,
mimeographed or otherwise produced, in any authorized denomination,
substantially of the tenor of the definitive Securities in lieu of which they
are issued and with such appropriate insertions, omissions, substitutions and
other variations as the officers executing such Securities may determine, as
evidenced by their execution of such Securities.
If temporary Securities of any series are issued, the Company will
cause definitive Securities of that series to be prepared without unreasonable
delay. After the preparation of definitive Securities of such series, the
temporary Securities of such series shall be exchangeable for definitive
Securities of such series upon surrender of the temporary Securities of such
series at the office or agency of the Company in a Place of Payment for that
series, without charge to the Holder. Upon surrender for cancellation of any one
or more temporary Securities of any series, the Company shall execute and the
Trustee shall authenticate and deliver in exchange therefor one or more
definitive Securities of the same series, of any authorized denominations and of
like tenor and aggregate principal amount. Until so exchanged, the temporary
Securities of any series shall in all respects be entitled to the same benefits
under this Indenture as definitive Securities of such series and tenor.
Section 305. Registration, Registration of Transfer and Exchange.
The Company shall cause to be kept at the Corporate Trust Office of the
Trustee a register (the register maintained in such office or in any other
office or agency of the Company in a Place of Payment being herein sometimes
referred to as the "Security Register") in which, subject to such reasonable
regulations as it may prescribe, the Company shall provide for the registration
of Securities and of transfers of Securities. The Trustee is hereby appointed
"Security Registrar" for the purpose of registering Securities and transfers of
Securities as herein provided.
Upon surrender for registration of transfer of any Security of a series
at the office or agency of the Company in a Place of Payment for that series,
the Company shall execute, and the Trustee shall authenticate and deliver, in
the name of the designated transferee or transferees, one or more new Securities
of the same series, of any authorized denominations and of like tenor and
aggregate principal amount.
At the option of the Holder, Securities of any series may be exchanged
for other Securities of the same series, of any authorized denominations and of
like tenor and aggregate principal amount, upon surrender of the Securities to
be exchanged at such office or agency. Whenever any Securities are so
surrendered for exchange, the Company shall execute, and the Trustee shall
authenticate and deliver, the Securities which the Holder making the exchange is
entitled to receive.
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All Securities issued upon any registration of transfer or exchange of
Securities shall be the valid obligations of the Company, evidencing the same
debt, and entitled to the same benefits under this Indenture, as the Securities
surrendered upon such registration of transfer or exchange.
Every Security presented or surrendered for registration of transfer or
for exchange shall (if so required by the Company or the Trustee) be duly
endorsed, or be accompanied by a written instrument of transfer in form
satisfactory to the Company and the Security Registrar duly executed, by the
Holder thereof or his attorney duly authorized in writing.
No service charge shall be made for any registration of transfer or
exchange of Securities, but the Company may require payment of a sum sufficient
to cover any tax or other governmental charge that may be imposed in connection
with any registration of transfer or exchange of Securities, other than
exchanges pursuant to Section 304, 906 or 1107 not involving any transfer.
If the Securities of any series (or of any series and specified tenor)
are to be redeemed, the Company shall not be required (A) to issue, register the
transfer of or exchange any Securities of that series (or of that series and
specified tenor, as the case may be) during a period beginning at the opening of
business 15 days before the day of the mailing of a notice of redemption of any
such Securities selected for redemption and ending at the close of business on
the day of such mailing, or (B) to register the transfer of or exchange any
Security so selected for redemption in whole or in part, except the unredeemed
portion of any Security being redeemed in part.
The provisions of Clauses (1), (2), (3) and (4) below shall apply only
to Global Securities:
(1) Each Global Security authenticated under this Indenture
shall be registered in the name of the Depositary designated for such
Global Security or a nominee thereof and delivered to such Depositary
or a nominee thereof or custodian therefor, and each such Global
Security shall constitute a single Security for all purposes of this
Indenture.
(2) Notwithstanding any other provision in this Indenture, no
Global Security may be exchanged in whole or in part for Securities
registered and no transfer of a Global Security in whole or in part may
be registered, in the name of any Person other than the Depositary for
such Global Security or a nominee thereof unless (A) such Depositary
(i) has notified the Company that it is unwilling or unable to continue
as Depositary for such Global Security or (ii) has ceased to be a
clearing agency registered under the Exchange Act, (B) there shall have
occurred and be continuing an Event of Default with respect to such
Global Security, (C) the Company executes and delivers to the Trustee a
Company Order that such Global Security shall be so transferable or
exchangeable, or (D) there shall exist such circumstances, if any, in
addition to or in lieu of the foregoing as have been specified for this
purpose as contemplated by Section 301.
(3) Subject to Clause (2) above, any exchange of a Global
Security for other Securities may be made in whole or in part, and all
Securities issued in exchange for a Global
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Security or any portion thereof shall be registered in such names as
the Depositary for such Global Security shall direct.
(4) Every Security authenticated and delivered upon
registration of transfer of, or in exchange for or in lieu of, a Global
Security or any portion thereof, whether pursuant to this Section,
Section 304, 306, 906 or 1107 or otherwise, shall be authenticated and
delivered in the form of, and shall be, a Global Security, unless such
Security is registered in the name of a Person other than the
Depositary for such Global Security or a nominee thereof.
Section 306. Mutilated, Destroyed, Lost and Stolen Securities.
If any mutilated Security is surrendered to the Trustee, the Company
shall execute and the Trustee shall authenticate and deliver in exchange
therefor a new Security of the same series and of like tenor and principal
amount and bearing a number not contemporaneously outstanding.
If there shall be delivered to the Company and the Trustee (i) evidence
to their satisfaction of the destruction, loss or theft of any Security and (ii)
such security or indemnity as may be required by them to save each of them and
any agent of either of them harmless, then, in the absence of notice to the
Company or the Trustee that such Security has been acquired by a bona fide
purchaser, the Company shall execute and the Trustee shall authenticate and
deliver, in lieu of any such destroyed, lost or stolen Security, a new Security
of the same series and of like tenor and principal amount and bearing a number
not contemporaneously outstanding.
In case any such mutilated, destroyed, lost or stolen Security has
become or is about to become due and payable, the Company in its discretion may,
instead of issuing a new Security, pay such Security.
Upon the issuance of any new Security under this Section, the Company
may require the payment of a sum sufficient to cover any tax or other
governmental charge that may be imposed in relation thereto and any other
expenses (including the fees and expenses of the Trustee) connected therewith.
Every new Security of any series issued pursuant to this Section in
lieu of any destroyed, lost or stolen Security shall constitute an original
additional contractual obligation of the Company, whether or not the destroyed,
lost or stolen Security shall be at any time enforceable by anyone, and shall be
entitled to all the benefits of this Indenture equally and proportionately with
any and all other Securities of that series duly issued hereunder.
The provisions of this Section are exclusive and shall preclude (to the
extent lawful) all other rights and remedies with respect to the replacement or
payment of mutilated, destroyed, lost or stolen Securities.
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Section 307. Payment of Interest; Interest Rights Preserved.
Except as otherwise provided as contemplated by Section 301 with
respect to any series of Securities, interest on any Security which is payable,
and is punctually paid or duly provided for, on any Interest Payment Date shall
be paid to the Person in whose name that Security (or one or more Predecessor
Securities) is registered at the close of business on the Regular Record Date
for such interest, at the office or agency of the Company maintained for that
purpose in a Place of Payment for such series of Securities, in such coin or
currency of the United States of America as at the time of payment is legal
tender for payment of public and private debts; provided, however, that at the
option of the Company payment of interest may be made by check mailed to the
address of the Person entitled thereto as such address shall appear in the
Security Register.
Any interest on any Security of any series which is payable, but is not
punctually paid or duly provided for, on any Interest Payment Date (herein
called "Defaulted Interest") shall forthwith cease to be payable to the Holder
on the relevant Regular Record Date by virtue of having been such Holder, and
such Defaulted Interest may be paid by the Company, at its election in each
case, as provided in Clause (1) or (2) below:
(1) The Company may elect to make payment of any Defaulted
Interest to the Persons in whose names the Securities of such series
(or their respective Predecessor Securities) are registered at the
close of business on a Special Record Date for the payment of such
Defaulted Interest, which shall be fixed in the following manner. The
Company shall notify the Trustee in writing of the amount of Defaulted
Interest proposed to be paid on each Security of such series and the
date of the proposed payment, and at the same time the Company shall
deposit with the Trustee an amount of money equal to the aggregate
amount proposed to be paid in respect of such Defaulted Interest or
shall make arrangements satisfactory to the Trustee for such deposit
prior to the date of the proposed payment, such money when deposited to
be held in trust for the benefit of the Persons entitled to such
Defaulted Interest as in this Clause provided. Thereupon the Trustee
shall fix a Special Record Date for the payment of such Defaulted
Interest which shall be not more than 15 days and not less than 10 days
prior to the date of the proposed payment and not less than 10 days
after the receipt by the Trustee of the notice of the proposed payment.
The Trustee shall promptly notify the Company of such Special Record
Date and, in the name and at the expense of the Company, shall cause
notice of the proposed payment of such Defaulted Interest and the
Special Record Date therefor to be given to each Holder of Securities
of such series in the manner set forth in Section 106, not less than 10
days prior to such Special Record Date. Notice of the proposed payment
of such Defaulted Interest and the Special Record Date therefor having
been so mailed, such Defaulted Interest shall be paid to the Persons in
whose names the Securities of such series (or their respective
Predecessor Securities) are registered at the close of business on such
Special Record Date and shall no longer be payable pursuant to the
following Clause (2).
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(2) The Company may make payment of any Defaulted Interest on
the Securities of any series in any other lawful manner not
inconsistent with the requirements of any securities exchange on which
such Securities may be listed, and upon such notice as may be required
by such exchange, if, after notice given by the Company to the Trustee
of the proposed payment pursuant to this Clause, such manner of payment
shall be deemed practicable by the Trustee.
Subject to the foregoing provisions of this Section, each Security
delivered under this Indenture upon registration of transfer of or in exchange
for or in lieu of any other Security shall carry the rights to interest accrued
and unpaid, and to accrue, which were carried by such other Security.
Section 308. Persons Deemed Owners.
Prior to due presentment of a Security for registration of transfer,
the Company, the Trustee and any agent of the Company or the Trustee may treat
the Person in whose name such Security is registered as the owner of such
Security for the purpose of receiving payment of principal of and any premium
and (subject to Section 307) any interest on such Security and for all other
purposes whatsoever, whether or not such Security be overdue, and neither the
Company, the Trustee nor any agent of the Company or the Trustee shall be
affected by notice to the contrary.
Section 309. Cancellation.
All Securities surrendered for payment, redemption, registration of
transfer or exchange or for credit against any sinking fund payment shall, if
surrendered to any Person other than the Trustee, be delivered to the Trustee
and shall be promptly cancelled by it. The Company may at any time deliver to
the Trustee for cancellation any Securities previously authenticated and
delivered hereunder which the Company may have acquired in any manner
whatsoever, and may deliver to the Trustee (or to any other Person for delivery
to the Trustee) for cancellation any Securities previously authenticated
hereunder which the Company has not issued and sold, and all Securities so
delivered shall be promptly cancelled by the Trustee. No Securities shall be
authenticated in lieu of or in exchange for any Securities cancelled as provided
in this Section, except as expressly permitted by this Indenture. All cancelled
Securities held by the Trustee shall be disposed of as directed by a Company
Order.
Section 310. Computation of Interest.
Except as otherwise specified as contemplated by Section 301 for
Securities of any series, interest on the Securities of each series shall be
computed on the basis of a 360-day year of twelve 30-day months.
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Section 311. CUSIP Numbers.
The Company in issuing the Securities may use "CUSIP" numbers (if then
generally in use), and, if so, the Trustee shall use "CUSIP" numbers in notices
of redemption as a convenience to Holders; provided that any such notice may
state that no representation is made as to the correctness of such numbers
either as printed on the Securities or as contained in any notice of a
redemption and that reliance may be placed only on the other identification
numbers printed on the Securities, and any such redemption shall not be affected
by any defect in or omission of such numbers.
ARTICLE FOUR
Satisfaction and Discharge
Section 401. Satisfaction and Discharge of Indenture.
This Indenture shall upon Company Request cease to be of further effect
(except as to any surviving rights of registration of transfer or exchange of
Securities herein expressly provided for), and the Trustee, at the expense of
the Company, shall execute proper instruments acknowledging satisfaction and
discharge of this Indenture, when
(1) either
(A) all Securities theretofore authenticated and delivered
(other than (i) Securities which have been destroyed, lost or stolen
and which have been replaced or paid as provided in Section 306 and
(ii) Securities for whose payment money has theretofore been deposited
in trust or segregated and held in trust by the Company and thereafter
repaid to the Company or discharged from such trust, as provided in
Section 1003) have been delivered to the Trustee for cancellation; or
(B) all such Securities not theretofore delivered to the
Trustee for cancellation
(i) have become due and payable, or
(ii) will become due and payable at their Stated Maturity
within one year, or
(iii) are to be called for redemption within one year under
arrangements satisfactory to the Trustee for the giving of
notice of redemption by the Trustee in the name, and at the
expense, of the Company,
and the Company, in the case of (i), (ii) or (iii) above, has deposited or
caused to be deposited with the Trustee as trust funds in trust for the purpose
money in an amount sufficient to pay and discharge the entire indebtedness on
such Securities not theretofore delivered to the Trustee for cancellation, for
principal and any premium and interest to the date of such deposit (in the case
of Securities
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which have become due and payable) or to the Stated Maturity or Redemption Date,
as the case may be;
(2) the Company has paid or caused to be paid all other sums
payable hereunder by the Company; and
(3) the Company has delivered to the Trustee an Officers'
Certificate and an Opinion of Counsel, each stating that all conditions
precedent herein provided for relating to the satisfaction and
discharge of this Indenture have been complied with.
Notwithstanding the satisfaction and discharge of this Indenture, the
obligations of the Company to the Trustee under Section 607, the obligations of
the Company to any Authenticating Agent under Section 614 and, if money shall
have been deposited with the Trustee pursuant to subclause (B) of Clause (1) of
this Section, the obligations of the Trustee under Section 402 and the last
paragraph of Section 1003 shall survive.
Section 402. Application of Trust Money.
Subject to the provisions of the last paragraph of Section 1003, all
money deposited with the Trustee pursuant to Section 401 shall be held in trust
and applied by it, in accordance with the provisions of the Securities and this
Indenture, to the payment, either directly or through any Paying Agent
(including the Company acting as its own Paying Agent) as the Trustee may
determine, to the Persons entitled thereto, of the principal and any premium and
interest for whose payment such money has been deposited with the Trustee.
ARTICLE FIVE
Remedies
Section 501. Events of Default.
"Event of Default", wherever used herein with respect to Securities of
any series, means any one of the following events (whatever the reason for such
Event of Default and whether it shall be voluntary or involuntary or be effected
by operation of law or pursuant to any judgment, decree or order of any court or
any order, rule or regulation of any administrative or governmental body):
(1) default in the payment of any interest upon any Security
of that series when it becomes due and payable, and continuance of such
default for a period of 30 days; or
(2) default in the payment of the principal of or any premium
on any Security of that series at its Maturity; or
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(3) default in the deposit of any sinking fund payment, when
and as due by the terms of a Security of that series; or
(4) default in the performance, or breach, of any covenant or
warranty of the Company in this Indenture (other than a covenant or
warranty a default in whose performance or whose breach is elsewhere in
this Section specifically dealt with or which has expressly been
included in this Indenture solely for the benefit of a series of
Securities other than that series), and continuance of such default or
breach for a period of 90 days after there has been given, by
registered or certified mail, to the Company by the Trustee or to the
Company and the Trustee by the Holders of at least 25% in principal
amount of the Outstanding Securities of that series a written notice
specifying such default or breach and requiring it to be remedied and
stating that such notice is a "Notice of Default" hereunder; or
(5) the entry by a court having jurisdiction in the premises
of (A) a decree or order for relief in respect of the Company in an
involuntary case or proceeding under any applicable Federal or State
bankruptcy, insolvency, reorganization or other similar law or (B) a
decree or order adjudging the Company a bankrupt or insolvent, or
approving as properly filed a petition seeking reorganization,
arrangement, adjustment or composition of or in respect of the Company
under any applicable Federal or State law, or appointing a custodian,
receiver, liquidator, assignee, trustee, sequestrator or other similar
official of the Company or of any substantial part of its property, or
ordering the winding up or liquidation of its affairs, and the
continuance of any such decree or order for relief or any such other
decree or order unstayed and in effect for a period of 90 consecutive
days; or
(6) the commencement by the Company of a voluntary case or
proceeding under any applicable Federal or State bankruptcy,
insolvency, reorganization or other similar law or of any other case or
proceeding to be adjudicated a bankrupt or insolvent, or the consent by
it to the entry of a decree or order for relief in respect of the
Company in an involuntary case or proceeding under any applicable
Federal or State bankruptcy, insolvency, reorganization or other
similar law or to the commencement of any bankruptcy or insolvency case
or proceeding against it, or the filing by it of a petition or answer
or consent seeking reorganization or relief under any applicable
Federal or State law, or the consent by it to the filing of such
petition or to the appointment of or taking possession by a custodian,
receiver, liquidator, assignee, trustee, sequestrator or other similar
official of the Company or of any substantial part of its property, or
the making by it of an assignment for the benefit of creditors, or the
admission by it in writing of its inability to pay its debts generally
as they become due, or the taking of corporate action by the Company in
furtherance of any such action; or
(7) any other Event of Default provided with respect to
Securities of that series.
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Section 502. Acceleration of Maturity; Rescission and Annulment.
If an Event of Default (other than an Event of Default specified in
Section 501(5) or 501(6)) with respect to Securities of any series at the time
Outstanding occurs and is continuing, then in every such case the Trustee or the
Holders of not less than 25% in principal amount of the Outstanding Securities
of that series may declare the principal amount of all the Securities of that
series (or, if any Securities of that series are Original Issue Discount
Securities, such portion of the principal amount of such Securities as may be
specified by the terms thereof) to be due and payable immediately, by a notice
in writing to the Company (and to the Trustee if given by Holders), and upon any
such declaration such principal amount (or specified amount) shall become
immediately due and payable. If an Event of Default specified in Section 501(5)
or 501(6) with respect to Securities of any series at the time Outstanding
occurs, the principal amount of all the Securities of that series (or, if any
Securities of that series are Original Issue Discount Securities, such portion
of the principal amount of such Securities as may be specified by the terms
thereof) shall automatically, and without any declaration or other action on the
part of the Trustee or any Holder, become immediately due and payable.
At any time after such a declaration of acceleration with respect to
Securities of any series has been made and before a judgment or decree for
payment of the money due has been obtained by the Trustee as hereinafter in this
Article provided, the Holders of a majority in principal amount of the
Outstanding Securities of that series, by written notice to the Company and the
Trustee, may rescind and annul such declaration and its consequences if
(1) the Company has paid or deposited with the Trustee a sum
sufficient to pay
(A) all overdue interest on all Securities of that series,
(B) the principal of (and premium, if any, on) any Securities
of that series which have become due otherwise than by such declaration
of acceleration and any interest thereon at the rate or rates
prescribed therefor in such Securities,
(C) to the extent that payment of such interest is lawful,
interest upon overdue interest at the rate or rates prescribed therefor
in such Securities, and
(D) all sums paid or advanced by the Trustee hereunder and the
reasonable compensation, expenses, disbursements and advances of the
Trustee, its agents and counsel;
and
(2) all Events of Default with respect to Securities of that
series other than the non-payment of the principal of Securities of
that series which has become due solely by such declaration of
acceleration, have been cured or waived as provided in Section 513.
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No such rescission shall affect any subsequent default or impair any right
consequent thereon.
Section 503. Collection of Indebtedness and Suits for Enforcement by Trustee.
The Company covenants that if
(1) default is made in the payment of any interest on any
Security when such interest becomes due and payable and such default
continues for a period of 30 days, or
(2) default is made in the payment of the principal of (or
premium, if any, on) any Security at the Maturity thereof,
the Company will, upon demand of the Trustee, pay to it, for the benefit of the
Holders of such Securities, the whole amount then due and payable on such
Securities for principal and any premium and interest and, to the extent that
payment of such interest shall be legally enforceable, interest on any overdue
principal and premium and on any overdue interest, at the rate or rates
prescribed therefor in such Securities, and, in addition thereto, such further
amount as shall be sufficient to cover the costs and expenses of collection,
including the reasonable compensation, expenses, disbursements and advances of
the Trustee, its agents and counsel.
If an Event of Default with respect to Securities of any series occurs
and is continuing, the Trustee may in its discretion proceed to protect and
enforce its rights and the rights of the Holders of Securities of such series by
such appropriate judicial proceedings as the Trustee shall deem most effectual
to protect and enforce any such rights, whether for the specific enforcement of
any covenant or agreement in this Indenture or in aid of the exercise of any
power granted herein, or to enforce any other proper remedy.
Section 504. Trustee May File Proofs of Claim.
In case of any judicial proceeding relative to the Company (or any
other obligor upon the Securities), its property or its creditors, the Trustee
shall be entitled and empowered, by intervention in such proceeding or
otherwise, to take any and all actions authorized under the Trust Indenture Act
in order to have claims of the Holders and the Trustee allowed in any such
proceeding. In particular, the Trustee shall be authorized to collect and
receive any moneys or other property payable or deliverable on any such claims
and to distribute the same; and any custodian, receiver, assignee, trustee,
liquidator, sequestrator or other similar official in any such judicial
proceeding is hereby authorized by each Holder to make such payments to the
Trustee and, in the event that the Trustee shall consent to the making of such
payments directly to the Holders, to pay to the Trustee any amount due it for
the reasonable compensation, expenses, disbursements and advances of the
Trustee, its agents and counsel, and any other amounts due the Trustee under
Section 607.
No provision of this Indenture shall be deemed to authorize the Trustee
to authorize or consent to or accept or adopt on behalf of any Holder any plan
of reorganization, arrangement,
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adjustment or composition affecting the Securities or the rights of any Holder
thereof or to authorize the Trustee to vote in respect of the claim of any
Holder in any such proceeding; provided, however, that the Trustee may, on
behalf of the Holders, vote for the election of a trustee in bankruptcy or
similar official and be a member of a creditors' or other similar committee.
Section 505. Trustee May Enforce Claims Without Possession of Securities.
All rights of action and claims under this Indenture or the Securities
may be prosecuted and enforced by the Trustee without the possession of any of
the Securities or the production thereof in any proceeding relating thereto, and
any such proceeding instituted by the Trustee shall be brought in its own name
as trustee of an express trust, and any recovery of judgment shall, after
provision for the payment of the reasonable compensation, expenses,
disbursements and advances of the Trustee, its agents and counsel, be for the
ratable benefit of the Holders of the Securities in respect of which such
judgment has been recovered.
Section 506. Application of Money Collected.
Any money collected by the Trustee pursuant to this Article shall be
applied in the following order, at the date or dates fixed by the Trustee and,
in case of the distribution of such money on account of principal or any premium
or interest, upon presentation of the Securities and the notation thereon of the
payment if only partially paid and upon surrender thereof if fully paid:
First: To the payment of all amounts due the Trustee under Section 607;
Second: To the payment of the amounts then due and unpaid for principal
of and any premium and interest on the Securities in respect of which or for the
benefit of which such money has been collected, ratably, without preference or
priority of any kind, according to the amounts due and payable on such
Securities for principal and any premium and interest, respectively, and
Third: To the payment of the balance, if any, to the Company or any
other Person or Persons legally entitled thereto.
Section 507. Limitation on Suits.
No Holder of any Security of any series shall have any right to
institute any proceeding, judicial or otherwise, with respect to this Indenture,
or for the appointment of a receiver or trustee, or for any other remedy
hereunder, unless
(1) such Holder has previously given written notice to the
Trustee of a continuing Event of Default with respect to the Securities
of that series;
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(2) the Holders of not less than 25% in principal amount of
the Outstanding Securities of that series shall have made written
request to the Trustee to institute proceedings in respect of such
Event of Default in its own name as Trustee hereunder;
(3) such Holder or Holders have offered to the Trustee
reasonable indemnity against the costs, expenses and liabilities to be
incurred in compliance with such request;
(4) the Trustee for 60 days after its receipt of such notice,
request and offer of indemnity has failed to institute any such
proceeding; and
(5) no direction inconsistent with such written request has
been given to the Trustee during such 60-day period by the Holders of a
majority in principal amount of the Outstanding Securities of that
series;
it being understood and intended that no one or more of such Holders shall have
any right in any manner whatever by virtue of, or by availing of, any provision
of this Indenture to affect, disturb or prejudice the rights of any other of
such Holders, or to obtain or to seek to obtain priority or preference over any
other of such Holders or to enforce any right under this Indenture, except in
the manner herein provided and for the equal and ratable benefit of all of such
Holders.
Section 508. Unconditional Right of Holders to Receive Principal, Premium and
Interest.
Notwithstanding any other provision in this Indenture, the Holder of
any Security shall have the right, which is absolute and unconditional, to
receive payment of the principal of and any premium and (subject to Section 307)
interest on such Security on the respective Stated Maturities expressed in such
Security (or, in the case of redemption, [except as provided in any Conditional
Notice given with respect thereto,] on the Redemption Date) and to institute
suit for the enforcement of any such payment, and such rights shall not be
impaired without the consent of such Holder.
Section 509. Restoration of Rights and Remedies.
If the Trustee or any Holder has instituted any proceeding to enforce
any right or remedy under this Indenture and such proceeding has been
discontinued or abandoned for any reason, or has been determined adversely to
the Trustee or to such Holder, then and in every such case, subject to any
determination in such proceeding, the Company, the Trustee and the Holders shall
be restored severally and respectively to their former positions hereunder and
thereafter all rights and remedies of the Trustee and the Holders shall continue
as though no such proceeding had been instituted.
Section 510. Rights and Remedies Cumulative.
Except as otherwise provided with respect to the replacement or payment
of mutilated, destroyed, lost or stolen Securities in the last paragraph of
Section 306, no right or remedy herein conferred upon or reserved to the Trustee
or to the Holders is intended to be exclusive of any other
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right or remedy, and every right and remedy shall, to the extent permitted by
law, be cumulative and in addition to every other right and remedy given
hereunder or now or hereafter existing at law or in equity or otherwise. The
assertion or employment of any right or remedy hereunder, or otherwise, shall
not prevent the concurrent assertion or employment of any other appropriate
right or remedy.
Section 511. Delay or Omission Not Waiver.
No delay or omission of the Trustee or of any Holder of any Securities
to exercise any right or remedy accruing upon any Event of Default shall impair
any such right or remedy or constitute a waiver of any such Event of Default or
an acquiescence therein. Every right and remedy given by this Article or by law
to the Trustee or to the Holders may be exercised from time to time, and as
often as may be deemed expedient, by the Trustee or by the Holders, as the case
may be.
Section 512. Control by Holders.
The Holders of a majority in principal amount of the Outstanding
Securities of any series shall have the right to direct the time, method and
place of conducting any proceeding for any remedy available to the Trustee, or
exercising any trust or power conferred on the Trustee, with respect to the
Securities of such series, provided that
(1) such direction shall not be in conflict with any rule of
law or with this Indenture,
(2) the Trustee may take any other action deemed proper by the
Trustee which is not inconsistent with such direction, and
(3) subject to the provisions of Section 601, the Trustee
shall have the right to decline to follow any such direction if the
Trustee in good faith shall, by a Responsible Officer or Officers of
the Trustee, determine that the proceeding so directed would involve
the Trustee in personal liability.
Section 513. Waiver of Past Defaults.
The Holders of not less than a majority in principal amount of the
Outstanding Securities of any series may on behalf of the Holders of all the
Securities of such series waive any past default hereunder with respect to such
series and its consequences, except a default
(1) in the payment of the principal of or any premium or
interest on any Security of such series, or
(2) in respect of a covenant or provision hereof which under
Article Nine cannot be modified or amended without the consent of the
Holder of each Outstanding Security of such series affected.
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Upon any such waiver, such default shall cease to exist, and any Event
of Default arising therefrom shall be deemed to have been cured, for every
purpose of this Indenture; but no such waiver shall extend to any subsequent or
other default or impair any right consequent thereon.
Section 514. Undertaking for Costs.
In any suit for the enforcement of any right or remedy under this
Indenture, or in any suit against the Trustee for any action taken, suffered or
omitted by it as Trustee, a court may require any party litigant in such suit to
file an undertaking to pay the costs of such suit, and may assess costs against
any such party litigant, in the manner and to the extent provided in the Trust
Indenture Act; provided that neither this Section nor the Trust Indenture Act
shall be deemed to authorize any court to require such an undertaking or to make
such an assessment in any suit instituted by the Company or the Trustee.
Section 515. Waiver of Usury, Stay or Extension Laws.
The Company covenants (to the extent that it may lawfully do so) that
it will not at any time insist upon, or plead, or in any manner whatsoever claim
or take the benefit or advantage of, any usury, stay or extension law wherever
enacted, now or at any time hereafter in force, which may affect the covenants
or the performance of this Indenture; and the Company (to the extent that it may
lawfully do so) hereby expressly waives all benefit or advantage of any such law
and covenants that it will not hinder, delay or impede the execution of any
power herein granted to the Trustee, but will suffer and permit the execution of
every such power as though no such law had been enacted.
ARTICLE SIX
The Trustee
Section 601. Certain Duties and Responsibilities.
The duties and responsibilities of the Trustee shall be as provided by
the Trust Indenture Act. Notwithstanding the foregoing, no provision of this
Indenture shall require the Trustee to expend or risk its own funds or otherwise
incur any financial liability in the performance of any of its duties hereunder,
or in the exercise of any of its rights or powers, if it shall have reasonable
grounds for believing that repayment of such funds or adequate indemnity against
such risk or liability is not reasonably assured to it. Whether or not therein
expressly so provided, every provision of this Indenture relating to the conduct
or affecting the liability of or affording protection to the Trustee shall be
subject to the provisions of this Section.
Section 602. Notice of Defaults.
If a default occurs hereunder with respect to Securities of any series,
the Trustee shall give the Holders of Securities of such series notice of such
default as and to the extent provided by the
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Trust Indenture Act; provided, however, that in the case of any default of the
character specified in Section 501(4) with respect to Securities of such series,
no such notice to Holders shall be given until at least 30 days after the
occurrence thereof. For the purpose of this Section, the term "default" means
any event which is, or after notice or lapse of time or both would become, an
Event of Default with respect to Securities of such series.
Section 603. Certain Rights of the Trustee.
Subject to the provisions of Section 601:
(1) the Trustee may rely and shall be protected in acting or
refraining from acting upon any resolution, certificate, statement,
instrument, opinion, report, notice, request, direction, consent,
order, bond, debenture, note, other evidence of indebtedness or other
paper or document believed by it to be genuine and to have been signed
or presented by the proper party or parties;
(2) any request or direction of the Company mentioned herein
shall be sufficiently evidenced by a Company Request or Company Order,
and any resolution of the Board of Directors shall be sufficiently
evidenced by a Board Resolution;
(3) whenever in the administration of this Indenture the
Trustee shall deem it desirable that a matter be proved or established
prior to taking, suffering or omitting any action hereunder, the
Trustee (unless other evidence be herein specifically prescribed) may,
in the absence of bad faith on its part, rely upon an Officers'
Certificate;
(4) the Trustee may consult with counsel of its selection and
the advice of such counsel or any Opinion of Counsel shall be full and
complete authorization and protection in respect of any action taken,
suffered or omitted by it hereunder in good faith and in reliance
thereon;
(5) the Trustee shall be under no obligation to exercise any
of the rights or powers vested in it by this Indenture at the request
or direction of any of the Holders pursuant to this Indenture, unless
such Holders shall have offered to the Trustee reasonable security or
indemnity against the costs, expenses and liabilities which might be
incurred by it in compliance with such request or direction;
(6) the Trustee shall not be bound to make any investigation
into the facts or matters stated in any resolution, certificate,
statement, instrument, opinion, report, notice, request, direction,
consent, order, bond, debenture, note, other evidence of indebtedness
or other paper or document, but the Trustee, in its discretion, may
make such further inquiry or investigation into such facts or matters
as it may see fit, and, if the Trustee shall determine to make such
further inquiry or investigation, it shall be entitled to examine the
books, records and premises of the Company, personally or by agent or
attorney; and
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(7) the Trustee may execute any of the trusts or powers
hereunder or perform any duties hereunder either directly or by or
through agents or attorneys and the Trustee shall not be responsible
for any misconduct or negligence on the part of any agent or attorney
appointed with due care by it hereunder.
Section 604. Not Responsible for Recitals or Issuance of Securities.
The recitals contained herein and in the Securities, except the
Trustee's certificates of authentication, shall be taken as the statements of
the Company, and neither the Trustee nor any Authenticating Agent assumes any
responsibility for their correctness. The Trustee makes no representations as to
the validity or sufficiency of this Indenture or of the Securities. Neither the
Trustee nor any Authenticating Agent shall be accountable for the use or
application by the Company of Securities or the proceeds thereof.
Section 605. May Hold Securities.
The Trustee, any Authenticating Agent, any Paying Agent, any Security
Registrar or any other agent of the Company, in its individual or any other
capacity, may become the owner or pledgee of Securities and, subject to Sections
608 and 613, may otherwise deal with the Company with the same rights it would
have if it were not Trustee, Authenticating Agent, Paying Agent, Security
Registrar or such other agent.
Section 606. Money Held in Trust.
Money held by the Trustee in trust hereunder need not be segregated
from other funds except to the extent required by law. The Trustee shall be
under no liability for interest on any money received by it hereunder except as
otherwise agreed in writing with the Company.
Section 607. Compensation and Reimbursement.
The Company agrees
(1) to pay to the Trustee from time to time such compensation
as shall be agreed to in writing between the Company and the Trustee
for all services rendered by it hereunder (which compensation shall not
be limited by any provision of law in regard to the compensation of a
trustee of an express trust);
(2) except as otherwise expressly provided herein, to
reimburse the Trustee upon its request for all reasonable expenses,
disbursements and advances incurred or made by the Trustee in
accordance with any provision of this Indenture (including the
reasonable compensation, expenses and disbursements of its agents and
counsel), except any such expense, disbursement or advance as may be
attributable to its negligence or bad faith; and
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(3) to indemnify the Trustee for, and to hold it harmless
against, any loss, liability or expense incurred without negligence or
bad faith on its part, arising out of or in connection with the
acceptance or administration of the trust or trusts hereunder,
including the costs and expenses of defending itself against any claim
or liability in connection with the exercise or performance of any of
its powers or duties hereunder.
The Trustee shall have a lien prior to the Securities upon all property
and funds held by it hereunder for any amount owing it or any predecessor
Trustee pursuant to this Section 607, except with respect to funds held in trust
for the benefit of the Holders of particular Securities.
Without limiting any rights available to the Trustee under applicable
law, when the Trustee incurs expenses or renders services in connection with an
Event of Default specified in Section 501(5) or Section 501(6), the expenses
(including the reasonable charges and expenses of its counsel) and compensation
for the services are intended to constitute expenses of administration under any
applicable Federal or State bankruptcy, insolvency or other similar law.
The provisions of this Section shall survive the termination of this
Indenture.
Section 608. Conflicting Interests.
If the Trustee has or shall acquire a conflicting interest within the
meaning of the Trust Indenture Act, the Trustee shall either eliminate such
interest or resign, to the extent and in the manner provided by, and subject to
the provisions of, the Trust Indenture Act and this Indenture. To the extent
permitted by such Act, the Trustee shall not be deemed to have a conflicting
interest by virtue of being a trustee under this Indenture with respect to
Securities of more than one series.
Section 609. Corporate Trustee Required; Eligibility.
There shall at all times be one (and only one) Trustee hereunder with
respect to the Securities of each series, which may be Trustee hereunder for
Securities of one or more other series. Each Trustee shall be a Person that is
eligible pursuant to the Trust Indenture Act to act as such and has a combined
capital and surplus of at least $50,000,000. If any such Person publishes
reports of condition at least annually, pursuant to law or to the requirements
of its supervising or examining authority, then for the purposes of this Section
and to the extent permitted by the Trust Indenture Act, the combined capital and
surplus of such Person shall be deemed to be its combined capital and surplus as
set forth in its most recent report of condition so published. If at any time
the Trustee with respect to the Securities of any series shall cease to be
eligible in accordance with the provisions of this Section, it shall resign
immediately in the manner and with the effect hereinafter specified in this
Article.
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Section 610. Resignation and Removal; Appointment of Successor.
No resignation or removal of the Trustee and no appointment of a
successor Trustee pursuant to this Article shall become effective until the
acceptance of appointment by the successor Trustee in accordance with the
applicable requirements of Section 611.
The Trustee may resign at any time with respect to the Securities of
one or more series by giving written notice thereof to the Company. If the
instrument of acceptance by a successor Trustee required by Section 611 shall
not have been delivered to the Trustee within 30 days after the giving of such
notice of resignation, the resigning Trustee may petition any court of competent
jurisdiction for the appointment of a successor Trustee with respect to the
Securities of such series.
The Trustee may be removed at any time with respect to the Securities
of any series by Act of the Holders of a majority in principal amount of the
Outstanding Securities of such series, delivered to the Trustee and to the
Company.
If at any time:
(1) the Trustee shall fail to comply with Section 608 after
written request therefor by the Company or by any Holder who has been a
bona fide Holder of a Security for at least six months, or
(2) the Trustee shall cease to be eligible under Section 609
and shall fail to resign after written request therefor by the Company
or by any such Holder, or
(3) the Trustee shall become incapable of acting or shall be
adjudged a bankrupt or insolvent or a receiver of the Trustee or of its
property shall be appointed or any public officer shall take charge or
control of the Trustee or of its property or affairs for the purpose of
rehabilitation, conservation or liquidation,
then, in any such case, (A) the Company by a Board Resolution may remove the
Trustee with respect to all Securities, or (B) subject to Section 514, any
Holder who has been a bona fide Holder of a Security for at least six months
may, on behalf of himself and all others similarly situated, petition any court
of competent jurisdiction for the removal of the Trustee with respect to all
Securities and the appointment of a successor Trustee or Trustees.
If the Trustee shall resign, be removed or become incapable of acting,
or if a vacancy shall occur in the office of Trustee for any cause, with respect
to the Securities of one or more series, the Company, by a Board Resolution,
shall promptly appoint a successor Trustee or Trustees with respect to the
Securities of that or those series (it being understood that any such successor
Trustee may be appointed with respect to the Securities of one or more or all of
such series and that at any time there shall be only one Trustee with respect to
the Securities of any particular series) and shall comply with the applicable
requirements of Section 611. If, within one year after such resignation,
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removal or incapability, or the occurrence of such vacancy, a successor Trustee
with respect to the Securities of any series shall be appointed by Act of the
Holders of a majority in principal amount of the Outstanding Securities of such
series delivered to the Company and the retiring Trustee, the successor Trustee
so appointed shall, forthwith upon its acceptance of such appointment in
accordance with the applicable requirements of Section 611, become the successor
Trustee with respect to the Securities of such series and to that extent
supersede the successor Trustee appointed by the Company. If no successor
Trustee with respect to the Securities of any series shall have been so
appointed by the Company or the Holders and accepted appointment in the manner
required by Section 611, any Holder who has been a bona fide Holder of a
Security of such series for at least six months may, on behalf of himself and
all others similarly situated, petition any court of competent jurisdiction for
the appointment of a successor Trustee with respect to the Securities of such
series.
The Company shall give notice of each resignation and each removal of
the Trustee with respect to the Securities of any series and each appointment of
a successor Trustee with respect to the Securities of any series to all Holders
of Securities of such series in the manner provided in Section 106. Each notice
shall include the name of the successor Trustee with respect to the Securities
of such series and the address of its Corporate Trust Office.
Section 611. Acceptance of Appointment by Successor.
In case of the appointment hereunder of a successor Trustee with
respect to all Securities, every such successor Trustee so appointed shall
execute, acknowledge and deliver to the Company and to the retiring Trustee an
instrument accepting such appointment, and thereupon the resignation or removal
of the retiring Trustee shall become effective and such successor Trustee,
without any further act, deed or conveyance, shall become vested with all the
rights, powers, trusts and duties of the retiring Trustee; but, on the request
of the Company or the successor Trustee, such retiring Trustee shall, upon
payment of its charges, execute and deliver an instrument transferring to such
successor Trustee all the rights, powers and trusts of the retiring Trustee and
shall duly assign, transfer and deliver to such successor Trustee all property
and money held by such retiring Trustee hereunder.
In case of the appointment hereunder of a successor Trustee with
respect to the Securities of one or more (but not all) series, the Company, the
retiring Trustee and each successor Trustee with respect to the Securities of
one or more series shall execute and deliver an indenture supplemental hereto
wherein each successor Trustee shall accept such appointment and which (1) shall
contain such provisions as shall be necessary or desirable to transfer and
confirm to, and to vest in, each successor Trustee all the rights, powers,
trusts and duties of the retiring Trustee with respect to the Securities of that
or those series to which the appointment of such successor Trustee relates, (2)
if the retiring Trustee is not retiring with respect to all Securities, shall
contain such provisions as shall be deemed necessary or desirable to confirm
that all the rights, powers, trusts and duties of the retiring Trustee with
respect to the Securities of that or those series as to which the retiring
Trustee is not retiring shall continue to be vested in the retiring Trustee, and
(3) shall add to or change any of the provisions of this Indenture as shall be
necessary to provide for or facilitate the administration
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of the trusts hereunder by more than one Trustee, it being understood that
nothing herein or in such supplemental indenture shall constitute such Trustees
co-trustees of the same trust and that each such Trustee shall be trustee of a
trust or trusts hereunder separate and apart from any trust or trusts hereunder
administered by any other such Trustee; and upon the execution and delivery of
such supplemental indenture the resignation or removal of the retiring Trustee
shall become effective to the extent provided therein and each such successor
Trustee, without any further act, deed or conveyance, shall become vested with
all the rights, powers, trusts and duties of the retiring Trustee with respect
to the Securities of that or those series to which the appointment of such
successor Trustee relates; but, on request of the Company or any successor
Trustee, such retiring Trustee shall duly assign, transfer and deliver to such
successor Trustee all property and money held by such retiring Trustee hereunder
with respect to the Securities of that or those series to which the appointment
of such successor Trustee relates.
Upon request of any such successor Trustee, the Company shall execute
any and all instruments for more fully and certainly vesting in and confirming
to such successor Trustee all such rights, powers and trusts referred to in the
first or second preceding paragraph, as the case may be.
No successor Trustee shall accept its appointment unless at the time of
such acceptance such successor Trustee shall be qualified and eligible under
this Article.
Section 612. Merger, Conversion, Consolidation or Succession to Business.
Any corporation into which the Trustee may be merged or converted or
with which it may be consolidated, or any corporation resulting from any merger,
conversion or consolidation to which the Trustee shall be a party, or any
corporation succeeding to all or substantially all the corporate trust business
of the Trustee, shall be the successor of the Trustee hereunder, provided such
corporation shall be otherwise qualified and eligible under this Article,
without the execution or filing of any paper or any further act on the part of
any of the parties hereto. In case any Securities shall have been authenticated,
but not delivered, by the Trustee then in office, any successor by merger,
conversion or consolidation to such authenticating Trustee may adopt such
authentication and deliver the Securities so authenticated with the same effect
as if such successor Trustee had itself authenticated such Securities.
Section 613. Preferential Collection of Claims Against Company.
If and when the Trustee shall be or become a creditor of the Company
(or any other obligor upon the Securities), the Trustee shall be subject to the
provisions of the Trust Indenture Act regarding the collection of claims against
the Company (or any such other obligor).
Section 614. Appointment of Authenticating Agent.
The Trustee may appoint an Authenticating Agent or Agents (by giving
notice of the appointment in the manner provided in Section 106 to the Company
and to all Holders of Securities
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of the series with respect to which the Authenticating Agent(s) will serve) with
respect to one or more series of Securities, which Authenticating Agent(s) shall
be authorized to act on behalf of the Trustee to authenticate Securities of such
series issued upon original issue and upon exchange, registration of transfer or
partial redemption thereof or pursuant to Section 306, and Securities so
authenticated shall be entitled to the benefits of this Indenture and shall be
valid and obligatory for all purposes as if authenticated by the Trustee
hereunder. Wherever reference is made in this Indenture to the authentication
and delivery of Securities by the Trustee or the Trustee's certificate of
authentication, such reference shall be deemed to include authentication and
delivery on behalf of the Trustee by an Authenticating Agent and a certificate
of authentication executed on behalf of the Trustee by an Authenticating Agent.
Each Authenticating Agent shall be acceptable to the Company and shall at all
times be a corporation organized and doing business under the laws of the United
States of America, any State thereof or the District of Columbia, authorized
under such laws to act as Authenticating Agent, having a combined capital and
surplus of not less than $50,000,000 and subject to supervision or examination
by Federal or State authority. If such Authenticating Agent publishes reports of
condition at least annually, pursuant to law or to the requirements of said
supervising or examining authority, then for the purposes of this Section, the
combined capital and surplus of such Authenticating Agent shall be deemed to be
its combined capital and surplus as set forth in its most recent report of
condition so published. If at any time an Authenticating Agent shall cease to be
eligible in accordance with the provisions of this Section, such Authenticating
Agent shall resign immediately in the manner and with the effect specified in
this Section.
Any corporation into which an Authenticating Agent may be merged or
converted or with which it may be consolidated, or any corporation resulting
from any merger, conversion or consolidation to which such Authenticating Agent
shall be a party, or any corporation succeeding to the corporate agency or
corporate trust business of an Authenticating Agent, shall continue to be an
Authenticating Agent, provided such corporation shall be otherwise eligible
under this Section, without the execution or filing of any paper or any further
act on the part of the Trustee or the Authenticating Agent.
An Authenticating Agent may resign at any time by giving written notice
thereof to the Trustee and to the Company. The Trustee may at any time terminate
the agency of an Authenticating Agent by giving written notice thereof to such
Authenticating Agent and to the Company. Upon receiving such a notice of
resignation or upon such a termination, or in case at any time such
Authenticating Agent shall cease to be eligible in accordance with the
provisions of this Section, the Trustee may appoint a successor Authenticating
Agent which shall be acceptable to the Company and shall give notice of such
appointment in the manner provided in Section 106 to all Holders of Securities
of the series with respect to which such Authenticating Agent will serve. Any
successor Authenticating Agent upon acceptance of its appointment hereunder
shall become vested with all the rights, powers and duties of its predecessor
hereunder, with like effect as if originally named as an Authenticating Agent.
No successor Authenticating Agent shall be appointed unless eligible under the
provisions of this Section.
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The Company agrees to pay to each Authenticating Agent from time to
time reasonable compensation for its services under this Section.
If an appointment with respect to one or more series is made pursuant
to this Section, the Securities of such series may have endorsed thereon, in
addition to the Trustee's certificate of authentication, an alternative
certificate of authentication in the following form:
This is one of the Securities of the series designated therein referred
to in the within-mentioned Indenture.
______________________________,
As Trustee
By ________________________________
As Authenticating Agent
By_________________________________
Authorized Officer
ARTICLE SEVEN
Holders' Lists and Reports by Trustee and Company
Section 701. Company to Furnish Trustee Names and Addresses of Holders.
The Company will furnish or cause to be furnished to the Trustee
(1) fifteen days after each Regular Record Date, a list, in
such form as the Trustee may reasonably require, of the names and
addresses of the Holders of Securities of each series as of such
Regular Record Date, and
(2) at such other times as the Trustee may request in writing,
within 30 days after the receipt by the Company of any such request, a
list in similar form and content as of a date not more than 15 days
prior to the time such list is furnished;
excluding from any such list names and addresses received by the Trustee in its
capacity as Security Registrar.
Section 702. Preservation of Information; Communications to Holders.
The Trustee shall preserve, in as current a form as is reasonably
practicable, the names and addresses of Holders contained in the most recent
list furnished to the Trustee as provided in Section
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701 and the names and addresses of Holders received by the Trustee in its
capacity as Security Registrar. The Trustee may destroy any list furnished to it
as provided in Section 701 upon receipt of a new list so furnished.
The rights of Holders to communicate with other Holders with respect to
their rights under this Indenture or under the Securities, and the corresponding
rights and privileges of the Trustee, shall be as provided by the Trust
Indenture Act.
Every Holder of Securities, by receiving and holding the same, agrees
with the Company and the Trustee that neither the Company nor the Trustee nor
any agent of either of them shall be held accountable by reason of any
disclosure of information as to names and addresses of Holders made pursuant to
the Trust Indenture Act.
Section 703. Reports by Trustee.
The Trustee shall transmit to Holders such reports concerning the
Trustee and its actions under this Indenture as may be required pursuant to the
Trust Indenture Act at the times and in the manner provided pursuant thereto. If
required by Section 313(a) of the Trust Indenture Act, the Trustee shall, within
sixty days after each May 15 following the date of this Indenture deliver to
Holders a brief report, dated as of such May 15, which complies with the
provisions of such Section 313(a).
A copy of each such report shall, at the time of such transmission to
Holders, be filed by the Trustee with each stock exchange upon which any
Securities are listed, with the Commission and with the Company. The Company
will promptly notify the Trustee when any Securities are listed on any stock
exchange.
Section 704. Reports by Company.
The Company shall file with the Trustee and the Commission, and
transmit to Holders, such information, documents and other reports, and such
summaries thereof, as may be required pursuant to the Trust Indenture Act at the
times and in the manner provided pursuant to such Act; provided that any such
information, documents or reports required to be filed with the Commission
pursuant to Section 13 or 15(d) of the Exchange Act shall be filed with the
Trustee within 15 days after the same is so required to be filed with the
Commission.
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ARTICLE EIGHT
Consolidation, Merger, Conveyance, Transfer or Lease
Section 801. Company May Consolidate, Etc., Only on Certain Terms.
The Company shall not consolidate with or merge into any other Person
or convey, transfer or lease its properties and assets substantially as an
entirety to any Person, and the Company shall not permit any Person to
consolidate with or merge into the Company or convey, transfer or lease its
properties and assets substantially as an entirety to the Company, unless:
(1) in case the Company shall consolidate with or merge into
another Person or convey, transfer or lease its properties and assets
substantially as an entirety to any Person, the Person formed by such
consolidation or into which the Company is merged or the Person which
acquires by conveyance or transfer, or which leases, the properties and
assets of the Company substantially as an entirety shall be a
corporation, partnership, unincorporated organization, trust, or other
entity shall be organized and validly existing under the laws of the
United States of America, any State thereof or the District of Columbia
and shall expressly assume, by an indenture supplemental hereto,
executed and delivered to the Trustee, in form satisfactory to the
Trustee, the due and punctual payment of the principal of and any
premium and interest on all the Securities and the performance or
observance of every covenant of this Indenture on the part of the
Company to be performed or observed;
(2) immediately after giving effect to such transaction and
treating any indebtedness which becomes an obligation of the Company or
any Subsidiary as a result of such transaction as having been incurred
by the Company or such Subsidiary at the time of such transaction, no
Event of Default, and no event which, after notice or lapse of time or
both, would become an Event of Default, shall have happened and be
continuing;
(3) if, as a result of any such consolidation or merger or
such conveyance, transfer or lease, properties or assets of the Company
would become subject to a mortgage, pledge, lien, security interest or
other encumbrance which would not be permitted by this Indenture, the
Company or such successor Person, as the case may be, shall take such
steps as shall be necessary effectively to secure the Securities
equally and ratably with (or prior to) all indebtedness secured
thereby; and
(4) the Company has delivered to the Trustee an Officers'
Certificate and an Opinion of Counsel, each stating that such
consolidation, merger, conveyance, transfer or lease and, if a
supplemental indenture is required in connection with such transaction,
such supplemental indenture comply with this Article and that all
conditions precedent herein provided for relating to such transaction
have been complied with.
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Section 802. Successor Substituted.
Upon any consolidation of the Company with, or merger of the Company
into, any other Person or any conveyance, transfer or lease of the properties
and assets of the Company substantially as an entirety in accordance with
Section 801, the successor Person formed by such consolidation or into which the
Company is merged or to which such conveyance, transfer or lease is made shall
succeed to, and be substituted for, and may exercise every right and power of,
the Company under this Indenture with the same effect as if such successor
Person had been named as the Company herein, and thereafter, except in the case
of a lease, the predecessor Person shall be relieved of all obligations and
covenants under this Indenture and the Securities.
ARTICLE NINE
Supplemental Indentures
Section 901. Supplemental Indentures Without Consent of Holders.
Without the consent of any Holders, the Company, when authorized by a
Board Resolution, and the Trustee, at any time and from time to time, may enter
into one or more indentures supplemental hereto, in form satisfactory to the
Trustee, for any of the following purposes:
(1) to evidence the succession of another Person to the
Company and the assumption by any such successor of the covenants of
the Company herein and in the Securities; or
(2) to add to the covenants of the Company for the benefit of
the Holders of all or any series of Securities (and if such covenants
are to be for the benefit of less than all series of Securities,
stating that such covenants are expressly being included solely for the
benefit of such series) or to surrender any right or power herein
conferred upon the Company; or
(3) to add any additional Events of Default for the benefit of
the Holders of all or any series of Securities (and if such additional
Events of Default are to be for the benefit of less than all series of
Securities, stating that such additional Events of Default are
expressly being included solely for the benefit of such series); or
(4) to add to or change any of the provisions of this
Indenture to such extent as shall be necessary to permit or facilitate
the issuance of Securities in bearer form, registrable or not
registrable as to principal, and with or without interest coupons, or
to permit or facilitate the issuance of Securities in uncertificated
form; or
(5) to add to, change or eliminate any of the provisions of
this Indenture in respect of one or more series of Securities, provided
that any such addition, change or
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elimination (A) shall neither (i) apply to any Security of any series
created prior to the execution of such supplemental indenture and
entitled to the benefit of such provision nor (ii) modify the rights of
the Holder of any such Security with respect to such provision or (B)
shall become effective only when there is no such Security Outstanding;
or
(6) to secure the Securities; or
(7) to establish the form or terms of Securities of any series
as permitted by Sections 201 and 301; or
(8) to evidence and provide for the acceptance of appointment
hereunder by a successor Trustee with respect to the Securities of one
or more series and to add to or change any of the provisions of this
Indenture as shall be necessary to provide for or facilitate the
administration of the trusts hereunder by more than one Trustee,
pursuant to the requirements of Section 611; or
(9) to cure any ambiguity, to correct or supplement any
provision herein which may be defective or inconsistent with any other
provision herein, or to make any other provisions with respect to
matters or questions arising under this Indenture, provided that such
action pursuant to this Clause (9) shall not adversely affect the
interests of the Holders of Securities of any series in any material
respect.
Section 902. Supplemental Indentures With Consent of Holders.
With the consent of the Holders of not less than a majority in
principal amount of the Outstanding Securities of each series affected by such
supplemental indenture, by Act of said Holders delivered to the Company and the
Trustee, the Company, when authorized by a Board Resolution, and the Trustee may
enter into an indenture or indentures supplemental hereto for the purpose of
adding any provisions to or changing in any manner or eliminating any of the
provisions of this Indenture or of modifying in any manner the rights of the
Holders of Securities of such series under this Indenture; provided, however,
that no such supplemental indenture shall, without the consent of the Holder of
each Outstanding Security affected thereby,
(1) change the Stated Maturity of the principal of, or any
instalment of principal of or interest on, any Security, or reduce the
principal amount thereof or the rate of interest thereon or any premium
payable upon the redemption thereof, or reduce the amount of the
principal of an Original Issue Discount Security or any other Security
which would be due and payable upon a declaration of acceleration of
the Maturity thereof pursuant to Section 502, or change any Place of
Payment where, or the coin or currency in which, any Security or any
premium or interest thereon is payable, or impair the right to
institute suit for the enforcement of any such payment on or after the
Stated Maturity thereof (or, in the case of redemption, [except as
provided in any Conditional Notice given with respect thereto,] on or
after the Redemption Date), or
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(2) reduce the percentage in principal amount of the
Outstanding Securities of any series, the consent of whose Holders is
required for any such supplemental indenture, or the consent of whose
Holders is required for any waiver (of compliance with certain
provisions of this Indenture or certain defaults hereunder and their
consequences) provided for in this Indenture, or
(3) modify any of the provisions of this Section, Section 513
or Section 1008, except to increase any such percentage or to provide
that certain other provisions of this Indenture cannot be modified or
waived without the consent of the Holder of each Outstanding Security
affected thereby; provided, however, that this clause shall not be
deemed to require the consent of any Holder with respect to changes in
the references to "the Trustee" and concomitant changes in this Section
and Section 1008, or the deletion of this proviso, in accordance with
the requirements of Sections 611 and 901(8).
A supplemental indenture which changes or eliminates any covenant or other
provision of this Indenture which has expressly been included solely for the
benefit of one or more particular series of Securities, or which modifies the
rights of the Holders of Securities of such series with respect to such covenant
or other provision, shall be deemed not to affect the rights under this
Indenture of the Holders of Securities of any other series.
It shall not be necessary for any Act of Holders under this Section to
approve the particular form of any proposed supplemental indenture, but it shall
be sufficient if such Act shall approve the substance thereof.
Section 903. Execution of Supplemental Indentures.
In executing, or accepting the additional trusts created by, any
supplemental indenture permitted by this Article or the modifications thereby of
the trusts created by this Indenture, the Trustee shall be entitled to receive,
and (subject to Section 601) shall be fully protected in relying upon, an
Opinion of Counsel stating that the execution of such supplemental indenture is
authorized or permitted by this Indenture. The Trustee may, but shall not be
obligated to, enter into any such supplemental indenture which affects the
Trustee's own rights, duties or immunities under this Indenture or otherwise.
Section 904. Effect of Supplemental Indentures.
Upon the execution of any supplemental indenture under this Article,
this Indenture shall be modified in accordance therewith, and such supplemental
indenture shall form a part of this Indenture for all purposes; and every Holder
of Securities theretofore or thereafter authenticated and delivered hereunder
shall be bound thereby.
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Section 905. Conformity with Trust Indenture Act.
Every supplemental indenture executed pursuant to this Article shall
conform to the requirements of the Trust Indenture Act.
Section 906. Reference in Securities to Supplemental Indentures.
Securities of any series authenticated and delivered after the
execution of any supplemental indenture pursuant to this Article may, and shall
if required by the Trustee, bear a notation in form approved by the Trustee as
to any matter provided for in such supplemental-indenture. If the Company shall
so determine, new Securities of any series so modified as to conform, in the
opinion of the Trustee and the Company, to any such supplemental indenture may
be prepared and executed by the Company and authenticated and delivered by the
Trustee in exchange for Outstanding Securities of such series.
ARTICLE TEN
Covenants
Section 1001. Payment of Principal, Premium and Interest.
The Company covenants and agrees for the benefit of each series of
Securities that it will duly and punctually pay the principal of and any premium
and interest on the Securities of that series in accordance with the terms of
the Securities and this Indenture.
Section 1002. Maintenance of Office or Agency.
The Company will maintain in each Place of Payment for any series of
Securities an office or agency where Securities of that series may be presented
or surrendered for payment, where Securities of that series may be surrendered
for registration of transfer or exchange and where notices and demands to or
upon the Company in respect of the Securities of that series and this Indenture
may be served. The Company will give prompt written notice to the Trustee of the
location, and any change in the location, of such office or agency. If at any
time the Company shall fail to maintain any such required office or agency or
shall fail to furnish the Trustee with the address thereof, such presentations,
surrenders, notices and demands may be made or served at the Corporate Trust
Office of the Trustee, and the Company hereby appoints the Trustee as its agent
to receive all such presentations, surrenders, notices and demands.
The Company may also from time to time designate one or more other
offices or agencies where the Securities of one or more series may be presented
or surrendered for any or all such purposes and may from time to time rescind
such designations; provided, however, that no such designation or rescission
shall in any manner relieve the Company of its obligation to maintain an office
or agency in each Place of Payment for Securities of any series for such
purposes. The
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Company will give prompt written notice to the Trustee of any such designation
or rescission and of any change in the location of any such other office or
agency.
Section 1003. Money for Securities Payments to Be Held in Trust.
If the Company shall at any time act as its own Paying Agent with
respect to any series of Securities, it will, on or before each due date of the
principal of or any premium or interest on any of the Securities of that series,
segregate and hold in trust for the benefit of the Persons entitled thereto a
sum sufficient to pay the principal and any premium and interest so becoming due
until such sums shall be paid to such Persons or otherwise disposed of as herein
provided and will promptly notify the Trustee of its action or failure so to
act.
Whenever the Company shall have one or more Paying Agents for any
series of Securities, it will, prior to each due date of the principal of or any
premium or interest on any Securities of that series, deposit with a Paying
Agent a sum sufficient to pay such amount, such sum to be held as provided by
the Trust Indenture Act, and (unless such Paying Agent is the Trustee) the
Company will promptly notify the Trustee of its action or failure so to act.
The Company will cause each Paying Agent for any series of Securities
other than the Trustee to execute and deliver to the Trustee an instrument in
which such Paying Agent shall agree with the Trustee, subject to the provisions
of this Section, that such Paying Agent will (1) comply with the provisions of
the Trust Indenture Act applicable to it as a Paying Agent and (2) during the
continuance of any default by the Company (or any other obligor upon the
Securities of that series) in the making of any payment in respect of the
Securities of that series, upon the written request of the Trustee, forthwith
pay to the Trustee all sums held in trust by such Paying Agent for payment in
respect of the Securities of that series.
The Company may at any time, for the purpose of obtaining the
satisfaction and discharge of this Indenture or for any other purpose, pay, or
by Company Order direct any Paying Agent to pay, to the Trustee all sums held in
trust by the Company or such Paying Agent, such sums to be held by the Trustee
upon the same trusts as those upon which such sums were held by the Company or
such Paying Agent; and, upon such payment by any Paying Agent to the Trustee,
such Paying Agent shall be released from all further liability with respect to
such money.
Any money deposited with the Trustee or any Paying Agent, or then held
by the Company, in trust for the payment of the principal of or any premium or
interest on any Security of any series and remaining unclaimed for two years
after such principal, premium or interest has become due and payable shall be
paid to the Company on Company Request, or (if then held by the Company) shall
be discharged from such trust; and the Holder of such Security shall thereafter,
as an unsecured general creditor, look only to the Company for payment thereof,
and all liability of the Trustee or such Paying Agent with respect to such trust
money, and all liability of the Company as trustee thereof, shall thereupon
cease; provided, however, that the Trustee or such Paying Agent, before being
required to make any such repayment, may at the expense of the Company cause to
be
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published once, in a newspaper published in the English language, customarily
published on each business day and of general circulation in the Borough of
Manhattan, The City of New York, New York, notice that such money remains
unclaimed and that, after a date specified therein, which shall not be less than
30 days from the date of such publication, any unclaimed balance of such money
then remaining will be repaid to the Company.
Section 1004. Statement by Officers as to Default.
The Company will deliver to the Trustee, within 120 days after the end
of each fiscal year of the Company ending after the date hereof, an Officers'
Certificate, stating whether or not to the best knowledge of the signers thereof
the Company is in default in the performance and observance of any of the terms,
provisions and conditions of this Indenture (without regard to any period of
grace or requirement of notice provided hereunder) and, if the Company shall be
in default, specifying all such defaults and the nature and status thereof of
which they may have knowledge.
Section 1005. Existence.
Subject to Article Eight, the Company will do or cause to be done all
things necessary to preserve and keep in full force and effect its existence,
rights (charter and statutory) and franchises; provided, however, that the
Company shall not be required to preserve any such right or franchise if the
Board of Directors shall determine that the preservation thereof is no longer
desirable in the conduct of the business of the Company and that the loss
thereof is not disadvantageous in any material respect to the Holders.
Section 1006. Maintenance of Properties.
The Company will cause all properties used or useful in the conduct of
its business to be maintained and kept in good condition, repair and working
order and supplied with all necessary equipment and will cause to be made all
necessary repairs, renewals replacements, betterments and improvements thereof,
all as in the judgment of the Company may be necessary so that the business
carried on in connection therewith may be properly and advantageously conducted
at all times; provided, however, that nothing in this Section shall prevent the
Company from discontinuing the operation or maintenance of any of such
properties if such discontinuance is, in the judgment of the Company, desirable
in the conduct of its business and not disadvantageous in any material respect
to the Holders.
Section 1007. Payment of Taxes and Other Claims.
The Company will pay or discharge or cause to be paid or discharged,
before the same shall become delinquent, (1) all taxes, assessments and
governmental charges levied or imposed upon the Company or upon the income,
profits or property of the Company, and (2) all lawful claims for labor,
materials and supplies which, if unpaid, might by law become a lien upon the
property of the Company; provided, however, that the Company shall not be
required to pay or discharge or cause
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to be paid or discharged any such tax, assessment, charge or claim (i) whose
amount, applicability or validity is being contested in good faith by
appropriate proceedings or (ii) if the failure to pay such tax, assessment,
charge or claim is not likely to have a material adverse effect on the financial
condition of the Company and its consolidated Subsidiaries, taken as a whole.
Section 1008. Waiver of Certain Covenants.
Except as otherwise specified as contemplated by Section 301 for
Securities of such series, the Company may, with respect to the Securities of
any series, omit in any particular instance to comply with any term, provision
or condition set forth in any covenant provided pursuant to Section 301(19),
901(2) or 901(7) for the benefit of the Holders of such series or in any of
Sections 1006 through 1007 if before the time for such compliance the Holders of
at least a majority in principal amount of the Outstanding Securities of such
series shall, by Act of such Holders, either waive such compliance in such
instance or generally waive compliance with such term, provision or condition,
but no such waiver shall extend to or affect such term, provision or condition
except to the extent so expressly waived, and, until such waiver shall become
effective, the obligations of the Company and the duties of the Trustee in
respect of any such term, provision or condition shall remain in full force and
effect.
Section 1009. Calculation of Original Issue Discount.
The Company shall file with the Trustee promptly at the end of each
calendar year a written notice specifying the amount of original issue discount
(including daily rates and accrual periods) accrued on Outstanding Securities as
of the end of such year.
ARTICLE ELEVEN
Redemption of Securities
Section 1101. Applicability of Article.
Securities of any series which are redeemable before their Stated
Maturity shall be redeemable in accordance with their terms and (except as
otherwise specified as contemplated by Section 301 for such Securities) in
accordance with this Article.
Section 1102. Election to Redeem; Notice to Trustee.
The election of the Company to redeem any Securities shall be evidenced
by a Board Resolution or in another manner specified as contemplated by Section
301 for such Securities. In case of any redemption at the election of the
Company the Company shall, at least 45 days prior to the Redemption Date fixed
by the Company (unless a shorter notice shall be satisfactory to the Trustee),
notify the Trustee of such Redemption Date, of the principal amount of
Securities of such series to be redeemed and, if applicable, of the tenor of the
Securities to be redeemed. In the case
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of any redemption of Securities (a) prior to the expiration of any restriction
on such redemption provided in the terms of such Securities or elsewhere in this
Indenture, or (b) pursuant to an election of the Company which is subject to a
condition specified in the terms of such Securities or elsewhere in this
Indenture, the Company shall furnish the Trustee with an Officers' Certificate
evidencing compliance with such restriction.
Section 1103. Selection by Trustee of Securities to Be Redeemed.
If less than all the Securities of any series are to be redeemed
(unless all the Securities of such series and of a specified tenor are to be
redeemed or unless such redemption affects only a single Security), the
particular Securities to be redeemed shall be selected not more than 60 days
prior to the Redemption Date by the Trustee, from the Outstanding Securities of
such series not previously called for redemption, by such method as the Trustee
shall deem fair and appropriate and which may provide for the selection for
redemption of a portion of the principal amount of any Security of such series,
provided that the unredeemed portion of the principal amount of any Security
shall be in an authorized denomination (which shall not be less than the minimum
authorized denomination) for such Security. If less than all the Securities of
such series and of a specified tenor are to be redeemed (unless such redemption
affects only a single Security), the particular Securities to be redeemed shall
be selected not more than 60 days prior to the Redemption Date by the Trustee,
from the Outstanding Securities of such series and specified tenor not
previously called for redemption in accordance with the preceding sentence.
The Trustee shall promptly notify the Company in writing of the
Securities selected for redemption as aforesaid and, in case of any Securities
selected for partial redemption as aforesaid, the principal amount thereof to be
redeemed.
The provisions of the two preceding paragraphs shall not apply with
respect to any redemption affecting only a single Security, whether such
Security is to be redeemed in whole or in part. In the case of any such
redemption in part, the unredeemed portion of the principal amount of the
Security shall be in an authorized denomination (which shall not be less than
the minimum authorized denomination) for such Security.
For all purposes of this Indenture, unless the context otherwise
requires, all provisions relating to the redemption of Securities shall relate,
in the case of any Securities redeemed or to be redeemed only in part, to the
portion of the principal amount of such Securities which has been or is to be
redeemed.
Section 1104. Notice of Redemption.
Notice of redemption shall be given by first-class mail, postage
prepaid, mailed not less than 30 nor more than 60 days prior to the Redemption
Date, to each Holder of Securities to be redeemed, at his address appearing in
the Security Register.
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All notices of redemption shall identify the Securities to be redeemed
(including CUSIP number) and shall state:
(1) the Redemption Date,
(2) the Redemption Price,
(3) if less than all the Outstanding Securities of any series
and of a specified tenor consisting of more than a single Security are
to be redeemed, the identification (and, in the case of partial
redemption of any such Securities, the principal amounts) of the
particular Securities to be redeemed and, if less than all the
Outstanding Securities of any series and of a specified tenor
consisting of a single Security are to be redeemed, the principal
amount of the particular Security to be redeemed,
(4) that on the Redemption Date [, except as otherwise
provided in any Conditional Notice (as defined below),] the Redemption
Price will become due and payable upon each such Security to be
redeemed and, if applicable, that interest thereon will cease to accrue
on and after said date,
(5) the place or places where each such Security is to be
surrendered for payment of the Redemption Price, and
(6) that the redemption is for a sinking fund, if such is the
case.
Notice of redemption of Securities to be redeemed at the election of
the Company shall be given by the Company or, at the Company's request, by the
Trustee in the name and at the expense of the Company and shall be irrevocable.
Each notice of redemption (except with respect to any mandatory sinking
fund payment, as defined in Section 1201) may include a statement that such
redemption shall be conditional upon the receipt by the Trustee on or prior to
the Redemption Date of amounts sufficient to pay principal of, and premium, if
any, and interest on, the Securities to be redeemed, and that if such amounts
shall not have been so received, said notice shall be of no force and effect,
the Securities to be redeemed will not become due and payable, and the Company
shall not be required to redeem such Securities (a "Conditional Notice"). In the
event that a Conditional Notice is given and sufficient amounts as referred to
in the Conditional Notice are not so received, the redemption shall not be made
and the Trustee shall, within a reasonable time thereafter, give notice, to the
persons and in the manner in which the notice of redemption was given, that such
amounts were not received and the redemption was not effected.
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Section 1105. Deposit of Redemption Price.
Prior to any Redemption Date, the Company shall deposit with the
Trustee or with a Paying Agent (or, if the Company is acting as its own Paying
Agent, segregate and hold in trust as provided in Section 1003) an amount of
money sufficient to pay the Redemption Price of, and (except if the Redemption
Date shall be an Interest Payment Date) accrued interest on, all the Securities
which are to be redeemed on that date.
Section 1106. Securities Payable on Redemption Date.
Notice of redemption having been given as aforesaid, [and, in the event
that a Conditional Notice was given, money for the payment of the Redemption
Price having been deposited as provided in Section 1105,] the Securities so to
be redeemed shall, on the Redemption Date, become due and payable at the
Redemption Price therein specified, and from and after such date (unless the
Company shall default in the payment of the Redemption Price and accrued
interest) such Securities shall cease to bear interest and the holders thereof
will have no rights in respect to the Securities so to be redeemed except to
receive payment of the Redemption Price thereof, without interest accrued on any
funds held after the Redemption Date to pay such Redemption Price. Upon
surrender of any such Security for redemption in accordance with said notice,
such Security shall be paid by the Company at the Redemption Price, together
with accrued interest to the Redemption Date; provided, however, that, unless
otherwise specified as contemplated by Section 301, installments of interest
whose Stated Maturity is on or prior to the Redemption Date will be payable to
the Holders of such Securities, or one or more Predecessor Securities,
registered as such at the close of business on the relevant Record Dates
according to their terms and the provisions of Section 307.
If any Security called for redemption shall not be so paid upon
surrender thereof for redemption, the principal and any premium shall, until
paid, bear interest from the Redemption Date at the rate prescribed therefor in
the Security.
Section 1107. Securities Redeemed in Part.
Any Security which is to be redeemed only in part shall be surrendered
at a Place of Payment therefor (with, if the Company or the Trustee so requires,
due endorsement by, or a written instrument of transfer in form satisfactory to
the Company and the Trustee duly executed by, the Holder thereof or his attorney
duly authorized in writing), and the Company shall execute, and the Trustee
shall authenticate and deliver to the Holder of such Security without service
charge, a new Security or Securities of the same series and of like tenor, of
any authorized denomination as requested by such Holder, in aggregate principal
amount equal to and in exchange for the unredeemed portion of the principal of
the Security so surrendered.
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ARTICLE TWELVE
Sinking Funds
Section 1201. Applicability of Article.
The provisions of this Article shall be applicable to any sinking fund
for the retirement of Securities of any series except as otherwise specified as
contemplated by Section 301 for such Securities.
The minimum amount of any sinking fund payment provided for by the
terms of any Securities is herein referred to as a "mandatory sinking fund
payment", and any payment in excess of such minimum amount provided for by the
terms of such Securities is herein referred to as an "optional sinking fund
payment". If provided for by the terms of any Securities, the cash amount of any
sinking fund payment may be subject to reduction as provided in Section 1202.
Each sinking fund payment shall be applied to the redemption of Securities as
provided for by the terms of such Securities.
Section 1202. Satisfaction of Sinking Fund Payments with Securities.
The Company (1) may deliver Outstanding Securities of a series (other
than any previously called for redemption) and (2) may apply as a credit
Securities of a series which have been redeemed either at the election of the
Company pursuant to the terms of such Securities or through the application of
permitted optional sinking fund payments pursuant to the terms of such
Securities, in each case in satisfaction of all or any part of any sinking fund
payment with respect to any Securities of such series required to be made
pursuant to the terms of such Securities as and to the extent provided for by
the terms of such Securities; provided that the Securities to be so credited
have not been previously so credited. The Securities to be so credited shall be
received and credited for such purpose by the Trustee at the Redemption Price,
as specified in the Securities so to be redeemed, for redemption through
operation of the sinking fund and the amount of such sinking fund payment shall
be reduced accordingly.
Section 1203. Redemption of Securities for Sinking Fund.
Not less than 60 days prior to each sinking fund payment date for any
Securities, the Company will deliver to the Trustee an Officers' Certificate
specifying the amount of the next ensuing sinking fund payment for such
Securities pursuant to the terms of such Securities, the portion thereof, if
any, which is to be satisfied by payment of cash and the portion thereof, if
any, which is to be satisfied by delivering and crediting Securities pursuant to
Section 1202 and stating the basis for such credit and that such Securities have
not been previously so credited and will also deliver to the Trustee any
Securities to be so delivered. Not less than 30 days prior to each such sinking
fund payment date, the Trustee shall select the Securities to be redeemed upon
such sinking fund payment date in the manner specified in Section 1103 and cause
notice of the redemption
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thereof to be given in the name of and at the expense of the Company in the
manner provided in Section 1104. Such notice having been duly given, the
redemption of such Securities shall be made upon the terms and in the manner
stated in Sections 1106 and 1107.
ARTICLE THIRTEEN
Defeasance and Covenant Defeasance
Section 1301. Company's Option to Effect Defeasance or Covenant Defeasance.
The Company may elect, at its option at any time, to have Section 1302
or Section 1303 applied to any Securities or any series of Securities, as the
case may be, designated pursuant to Section 301 as being defeasible pursuant to
such Section 1302 or 1303, in accordance with any applicable requirements
provided pursuant to Section 301 and upon compliance with the conditions set
forth below in this Article. Any such election shall be evidenced by a Board
Resolution or in another manner specified as contemplated by Section 301 for
such Securities.
Section 1302. Defeasance and Discharge.
Upon the Company's exercise of its option (if any) to have this Section
applied to any Securities or any series of Securities, as the case may be, the
Company shall be deemed to have been discharged from its obligations, and the
provisions of Article Fourteen shall cease to be effective, with respect to such
Securities as provided in this Section on and after the date the conditions set
forth in Section 1304 are satisfied (hereinafter called "Defeasance"). For this
purpose, such Defeasance means that the Company shall be deemed to have paid and
discharged the entire indebtedness represented by such Securities and to have
satisfied all its other obligations under such Securities and this Indenture
insofar as such Securities are concerned (and the Trustee, at the expense of the
Company, shall execute proper instruments acknowledging the same), subject to
the following which shall survive until otherwise terminated or discharged
hereunder: (1) the rights of Holders of such Securities to receive, solely from
the trust fund described in Section 1304 and as more fully set forth in such
Section, payments in respect of the principal of and any premium and interest on
such Securities when payments are due, (2) the Company's obligations with
respect to such Securities under Sections 304, 305, 306, 1002 and 1003 and with
respect to the Trustee under Section 607, (3) the rights, powers, trusts, duties
and immunities of the Trustee hereunder and (4) this Article. Subject to
compliance with this Article, the Company may exercise its option (if any) to
have this Section applied to any Securities notwithstanding the prior exercise
of its option (if any) to have Section 1303 applied to such Securities.
Section 1303. Covenant Defeasance.
Upon the Company's exercise of its option (if any) to have this Section
applied to any Securities or any series of Securities, as the case may be, (1)
the Company shall be released from its obligations under Section 801(3),
Sections 1006 through 1007, inclusive, and any covenants
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provided pursuant to Section 301(19), 901(2), 901(6) or 901(7) for the benefit
of the Holders of such Securities and (2) the occurrence of any event specified
in Sections 501(4) (with respect to any of Section 801(3), Sections 1006 through
1007, inclusive, and any such covenants provided pursuant to Section 301(19),
901(2), 901(6) or 901(7)), and 501(7) shall be deemed not to be or result in an
Event of Default and the provisions of Article Fourteen shall cease to be
effective, in each case with respect to such Securities as provided in this
Section on and after the date the conditions set forth in Section 1304 are
satisfied (hereinafter called "Covenant Defeasance"). For this purpose, such
Covenant Defeasance means that, with respect to such Securities, the Company may
omit to comply with and shall have no liability in respect of any term,
condition or limitation set forth in any such specified Section (to the extent
so specified in the case of Section 501(4)) or Article Fourteen, whether
directly or indirectly by reason of any reference elsewhere herein to any such
Section or Article or by reason of any reference in any such Section or Article
to any other provision herein or in any other document, but the remainder of
this Indenture and such Securities shall be unaffected thereby.
Section 1304. Conditions to Defeasance or Covenant Defeasance.
The following shall be the conditions to the application of Section
1302 or Section 1303 to any Securities or any series of Securities, as the case
may be:
(1) The Company shall irrevocably have deposited or caused to
be deposited with the Trustee as trust funds in trust for the purpose
of making the following payments, specifically pledged as security for,
and dedicated solely to, the benefit of the Holders of such Securities,
(A) money in an amount, or (B) U.S. Government Obligations which
through the scheduled payment of principal and interest in respect
thereof in accordance with their terms will provide, not later than one
day before the due date of any payment, money in an amount, or (C) a
combination thereof, in each case sufficient, in the opinion of a
nationally recognized firm of independent public accountants expressed
in a written certification thereof delivered to the Trustee, to pay and
discharge, and which shall be applied by the Trustee to pay and
discharge, the principal of and any premium and interest on such
Securities on the respective Stated Maturities or on any Redemption
Date established pursuant to clause (9) below, in accordance with the
terms of this Indenture and such Securities. As used herein, "U.S.
Government Obligation" means (x) any security which is (i) a direct
obligation of the United States of America for the payment of which the
full faith and credit of the United States of America is pledged or
(ii) an obligation of a Person controlled or supervised by and acting
as an agency or instrumentality of the United States of America the
payment of which is unconditionally guaranteed as a full faith and
credit obligation by the United States of America, which, in either
case (i) or (ii), is not callable or redeemable at the option of the
issuer thereof, and (y) any depositary receipt issued by a bank (as
defined in Section 3(a)(2) of the Securities Act) as custodian with
respect to any U.S. Government Obligation which is specified in Clause
(x) above and held by such bank for the account of the holder of such
depositary receipt, or with respect to any specific payment of
principal of or interest on any U.S. Government Obligation which is so
specified and held,
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provided that (except as required by law) such custodian is not
authorized to make any deduction from the amount payable to the holder
of such depositary receipt from any amount received by the custodian in
respect of the U.S. Government Obligation or the specific payment of
principal or interest evidenced by such depositary receipt.
(2) In the event of an election to have Section 1302 apply to
any Securities or any series of Securities, as the case may be, the
Company shall have delivered to the Trustee an Opinion of Counsel
stating that (A) the Company has received from, or there has been
published by, the Internal Revenue Service a ruling or (B) since the
date of this instrument, there has been a change in the applicable
Federal income tax law, in either case (A) or (B) to the effect that,
and based thereon such opinion shall confirm that, the Holders of such
Securities will not recognize gain or loss for Federal income tax
purposes as a result of the deposit, Defeasance and discharge to be
effected with respect to such Securities and will be subject to Federal
income tax on the same amount, in the same manner and at the same times
as would be the case if such deposit, Defeasance and discharge were not
to occur.
(3) In the event of an election to have Section 1303 apply to
any Securities or any series of Securities, as the case may be, the
Company shall have delivered to the Trustee an Opinion of Counsel to
the effect that the Holders of such Securities will not recognize gain
or loss for Federal income tax purposes as a result of the deposit and
Covenant Defeasance to be effected with respect to such Securities and
will be subject to Federal income tax on the same amount, in the same
manner and at the same times as would be the case if such deposit and
Covenant Defeasance were not to occur.
(4) The Company shall have delivered to the Trustee an
Officers' Certificate to the effect that neither such Securities nor
any other Securities of the same series, if then listed on any
securities exchange, will be delisted as a result of such deposit.
(5) No event which is, or after notice or lapse of time or
both would become, an Event of Default with respect to such Securities
or any other Securities shall have occurred and be continuing at the
time of such deposit or, with regard to any such event specified in
Sections 501(5) and (6), at any time on or prior to the 90th day after
the date of such deposit (it being understood that this condition shall
not be deemed satisfied until after such 90th day).
(6) Such Defeasance or Covenant Defeasance shall not cause the
Trustee to have a conflicting interest within the meaning of the Trust
Indenture Act (assuming all Securities are in default within the
meaning of such Act).
(7) Such Defeasance or Covenant Defeasance shall not result in
a breach or violation of, or constitute a default under, any other
agreement or instrument to which the Company is a party or by which it
is bound.
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(8) Such Defeasance or Covenant Defeasance shall not result in
the trust arising from such deposit constituting an investment company
within the meaning of the Investment Company Act unless such trust
shall be registered under such Act or exempt from registration
thereunder.
(9) If the Securities are to be redeemed prior to Stated
Maturity (other than from mandatory sinking fund payments or analogous
payments), notice of such redemption shall have been duly given
pursuant to this Indenture or provision therefor satisfactory to the
Trustee shall have been made.
(10) At the time of such deposit, (A) no default in the
payment of any principal of or premium or interest on any Senior Debt
shall have occurred and be continuing, (B) no event of default with
respect to any Senior Debt shall have resulted in such Senior Debt
becoming, and continuing to be, due and payable prior to the date on
which it would otherwise have become due and payable (unless payment of
such Senior Debt has been made or duly provided for), and (C) no other
event of default with respect to any Senior Debt shall have occurred
and be continuing permitting (after notice or lapse of time or both)
the holders of such Senior Debt (or a trustee on behalf of such
holders) to declare such Senior Debt due and payable prior to the date
on which it would otherwise have become due and payable.
(11) The Company shall have delivered to the Trustee an
Officers' Certificate and an Opinion of Counsel, each stating that all
conditions precedent with respect to such Defeasance or Covenant
Defeasance have been complied with.
Section 1305. Deposited Money and U.S. Government Obligations to Be Held in
Trust; Miscellaneous Provisions.
Subject to the provisions of the last paragraph of Section 1003, all
money and U.S. Government Obligations (including the proceeds thereof) deposited
with the Trustee pursuant to Section 1304 in respect of any Securities shall be
held in trust and applied by the Trustee, in accordance with the provisions of
such Securities and this Indenture, to the payment, either directly or through
any such Paying Agent (including the Company acting as its own Paying Agent) as
the Trustee may determine, to the Holders of such Securities, of all sums due
and to become due thereon in respect of principal and any premium and interest,
but money so held in trust need not be segregated from other funds except to the
extent required by law.
Money and U.S. Government Obligations so held in trust shall not be
subject to the provisions of Article Fourteen.
The Company shall pay and indemnify the Trustee against any tax, fee or
other charge imposed on or assessed against the U.S. Government Obligations
deposited pursuant to Section 1304 or the principal and interest received in
respect thereof other than any such tax, fee or other charge which by law is for
the account of the Holders of Outstanding Securities.
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Anything in this Article to the contrary notwithstanding, the Trustee
shall deliver or pay to the Company from time to time upon Company Request any
money or U.S. Government Obligations held by it as provided in Section 1304 with
respect to any Securities which, in the opinion of a nationally recognized firm
of independent public accountants expressed in a written certification thereof
delivered to the Trustee, are in excess of the amount thereof which would then
be required to be deposited to effect the Defeasance or Covenant Defeasance, as
the case may be, with respect to such Securities.
Section 1306. Reinstatement.
If the Trustee or the Paying Agent is unable to apply any money in
accordance with this Article with respect to any Securities by reason of any
order or judgment of any court or governmental authority enjoining, restraining
or otherwise prohibiting such application, then the obligations under this
Indenture and such Securities from which the Company has been discharged or
released pursuant to Section 1302 or 1303 shall be revived and reinstated as
though no deposit had occurred pursuant to this Article with respect to such
Securities, until such time as the Trustee or Paying Agent is permitted to apply
all money held in trust pursuant to Section 1305 with respect to such Securities
in accordance with this Article; provided, however, that at any such time or
during the continuance of any such event, the Company may request the return of
all money or securities deposited hereunder with respect to such Securities and
the Trustee will return to the Company all such money and securities.
ARTICLE FOURTEEN
Subordination of Securities
Section 1401. Securities Subordinate to Senior Indebtedness.
Unless otherwise provided in a supplemental indenture or pursuant to
Section 301, the Company covenants and agrees, and each Holder of Securities
issued hereunder by his acceptance thereof likewise covenants and agrees, that
all Securities shall be issued subject to the provisions of this Article
Fourteen; and each Holder of a Security, whether upon original issue or upon
transfer or assignment thereof, accepts and agrees to be bound by such
provisions.
The payment of all Obligations on all Securities issued hereunder
shall, to the extent and in the manner hereinafter set forth, be subordinate and
junior in right of payment to the prior payment in full of all Obligations on
Senior Indebtedness, whether outstanding at the date of this Indenture or
thereafter incurred.
No provision of this Article Fourteen shall prevent the occurrence of
any default or Event of Default hereunder.
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Section 1402. Suspension of Payment When Senior Indebtedness in Default.
(a) If any default occurs and is continuing in the payment when due,
whether at maturity, upon any redemption, by acceleration or otherwise, of any
principal, premium or interest on any Senior Indebtedness, no payment of any
kind or character shall be made by or on behalf of the Company or any other
Person on its behalf with respect to any Obligations on the Securities or to
acquire any of the Securities for cash or property or otherwise.
(b) In addition, if any other event of default occurs and is continuing
with respect to any Senior Indebtedness, other than Designated Senior
Indebtedness, as such event of default is defined in the instrument creating or
evidencing such Senior Indebtedness, permitting the holders of such Senior
Indebtedness then outstanding to immediately accelerate the maturity thereof and
if a representative for such issue of Senior Indebtedness gives written notice
of the event of default to the Trustee (a "Default Notice"), then unless and
until all events of default with respect to such Senior Indebtedness have been
cured, or waived in writing or have ceased to exist or the Trustee receives
notice from such representative for the respective issue of Senior Indebtedness
terminating the Blockage Period (as defined below), during the 179 days after
the delivery of such Default Notice (the "Blockage Period"), neither the Company
nor any other Person on its behalf shall (x) make any payment of any kind or
character with respect to any Obligations on the Securities or (y) acquire any
of the Securities for cash or property or otherwise. Notwithstanding anything
herein to the contrary, in no event will a Blockage Period extend beyond 179
days from the date the payment on the Securities was due and only one such
Blockage Period may be commenced within any 365 consecutive days, irrespective
of the number of defaults with respect to Senior Indebtedness during such
period. In no event may the total number of days during which any Blockage
Period is or Blockage Periods are in effect exceed 179 days in the aggregate
during any consecutive 365 day period. No event of default which existed or was
continuing on the date of the commencement of any Blockage Period with respect
to the Senior Indebtedness shall be, or be made, the basis for commencement of a
second Blockage Period by a representative of such Senior Indebtedness unless
such event of default shall have been cured or waived for a period of not less
than 90 consecutive days (it being acknowledged that any subsequent action, or
any breach of any financial covenants for a period commencing after the date of
commencement of such Blockage Period that, in either case, would give rise to an
event of default pursuant to any provisions under which an event of default
previously existed or was continuing shall constitute a new event of default for
this purpose.)
(c) In addition, if any event of default (as defined in the instrument
creating or evidencing any Designated Senior Indebtedness) occurs and is
continuing with respect to any Designated Senior Indebtedness or an executive
officer of the Company has actual knowledge of a default under any Designated
Senior Indebtedness, which with notice or lapse of time or both would result in
an event of default under such Designated Senior Indebtedness, then the Company
shall give notice thereof to the Trustee and, regardless of the giving of such
notice, no payment of any kind or character shall be made by or on behalf of the
Company or any other Person on its behalf with respect to any Obligations on the
Securities or to acquire any of the Securities for cash or property or otherwise
for a period of 179 days from the date of each such event of default on the date
that an executive officer obtains actual knowledge that there is such a default
(a "Designated Senior Indebtedness Blockage Period"), unless and until all such
events of defaults or defaults with respect to such Designated Senior
Indebtedness have been cured or waived in writing pursuant to the Designated
Senior Indebtedness or have ceased to exist or the Trustee receives notice from
a representative for the applicable issue of Designated Senior Indebtedness
terminating the Designated Senior Indebtedness Blockage Period. Immediately upon
receipt of a notice of default from a representative of any Designated Senior
Indebtedness by the Company, the Company shall give notice thereof to the
Trustee, but the failure of the Company to give such notice shall not affect the
rights of the Designated Senior Indebtedness hereunder.
(d) The Company further agrees, for the benefit of the holders of
Designated Senior Indebtedness, that in the event any Security is declared due
and payable under Section 502 hereof before its expressed maturity, (i) the
Company will give prompt notice in writing of such happening to the holders of
Designated Senior Indebtedness and (ii) no payment of any kind or character
shall be made by or on behalf of the Company or any other Person on its behalf
with respect to any Obligations on the Securities or to acquire any of the
Securities for cash or property or otherwise without the consent of the
Designated Senior Indebtedness.
Section 1403. Payment Over of Proceeds Upon Dissolution, Etc.
(a) Upon any payment by the Company, or distribution of assets of the
Company of any kind or character, whether in cash, property or securities, to
creditors upon any liquidation, dissolution, winding-up, assignment for the
benefit of creditors or marshaling of assets of the Company or in bankruptcy,
reorganization, insolvency, receivership or other similar proceeding relating to
the Company or its property, whether voluntary or involuntary, all Obligations
due or to become due upon all Senior Indebtedness shall first be paid in full,
or payment thereof duly provided for to the satisfaction of holders of Senior
Indebtedness, before any payment or distribution of any kind or character is
made on account of any Obligations on the Securities, or for the
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acquisition of any of the Securities for cash, or property, or otherwise. Upon
any such dissolution, winding-up, liquidation, reorganization, receivership or
similar proceeding, any payment by the Company, or distribution of assets of the
Company of any kind or character, whether in cash, property or securities, to
which the Holders of the Securities or the Trustee for the benefit of such
Holders would be entitled, except for the provisions of this Article Fourteen,
shall be paid by the Company or by any receiver, trustee in bankruptcy,
liquidating trustee, agent or other person making such payment or distribution,
or by the Holders of the Securities or by the Trustee under this Indenture if
received by them or it, directly to the holders of Senior Indebtedness (pro rata
to such holders on the basis of the respective amounts of Senior Indebtedness
held by such holders) or their representative or representatives, or to the
trustee or trustees under any indenture pursuant to which any instruments
evidencing any Senior Indebtedness may have been issued, as their respective
interests may appear to the extent necessary to pay all Senior Indebtedness in
full, in money or money's worth, after giving effect to any concurrent payment
or distribution or provision therefor to or for the holders of Senior
Indebtedness, before any payment or distribution is made to the Holders of
Securities or to the Trustee for the benefit of such Holders.
(b) To the extent any payment of Senior Indebtedness (whether by or on
behalf of the Company, as proceeds of security or enforcement of any right of
setoff or otherwise) is declared to be fraudulent or preferential, set aside or
required to be paid to any receiver, trustee in bankruptcy, liquidating trustee,
agent or other similar Person under any bankruptcy, insolvency, receivership,
fraudulent conveyance or similar law, then, if such payment is recovered by, or
paid over to, such receiver, trustee in bankruptcy, liquidating trustee, agent
or other similar Person, the Senior Indebtedness or part thereof originally
intended to be satisfied shall be deemed to be reinstated and outstanding as if
such payment had not occurred.
For purposes of this Article Fourteen, the words, "cash, property or
securities" shall not be deemed to include shares of stock of the Company as
reorganized or readjusted, or securities of the Company or any other corporation
provided for by a plan of reorganization or readjustment, the payment of which
is subordinated at least to the extent provided in this Article Fourteen with
respect to the Securities to the payment of all Senior Indebtedness which may at
the time be outstanding; provided that (i) the Senior Indebtedness is assumed by
the new corporation, if any, resulting from any such reorganization or
readjustment, and (ii) the rights of the holders of the Senior Indebtedness are
not, without the consent pursuant to such Senior Indebtedness, altered by such
reorganization or readjustment. The consolidation of the Company with, or the
merger of the Company into, another corporation or the liquidation or
dissolution of the Company following the conveyance, transfer or lease of its
property as an entirety, or substantially as an entirety, to another corporation
upon the terms and conditions provided for in Article Eight hereof shall not be
deemed a dissolution, winding-up, or liquidation for the proposes of this
Section 1403 if such other corporation shall, as a part of such consolidation,
merger, conveyance or transfer, comply with the conditions stated in Article
Eight hereof.
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Section 1404. Monies Held in Trust.
In the event that, notwithstanding the foregoing, any payment or
distribution of assets of the Company of any kind or character, whether in cash,
property or securities, prohibited by the foregoing, shall be received by the
Holders of the Securities or by the Trustee on behalf of such Holders in
violation of this Article Fourteen, such payment or distribution shall be held
in trust for the benefit of and shall be paid over or delivered to the holders
of Senior Indebtedness (pro rata to such holders on the basis of the respective
amounts of Senior Indebtedness held by such holders) or their representative or
representatives, or to the trustee or trustees under any indenture pursuant to
which any instruments evidencing any Senior Indebtedness may have been issued,
as their respective interests may appear, for application to the payment of all
Senior Indebtedness remaining unpaid in full in money or monies worth in
accordance with its terms, after giving effect to any concurrent payment or
distribution or provision therefor to or for the holders of such Senior
Indebtedness.
Section 1405. Subrogation to Rights of Holders of Senior Indebtedness.
Subject to the payment in full of all Senior Indebtedness, the Holders
of the Securities shall be subrogated to the rights of the holders of Senior
Indebtedness to receive payments or distributions of cash, property or
securities of the Company applicable to the Senior Indebtedness until the
Obligations on the Securities shall be paid in full; and, for the purposes of
such subrogation, no payment or distributions to the holders of the Senior
Indebtedness of any cash, property or securities to which the Holders of the
Securities or the Trustee would be entitled except for the provisions of this
Article Fourteen, and no payment over pursuant to the provisions of this Article
Fourteen, to or for the benefit of the holders of Senior Indebtedness by Holders
of the Securities or the Trustee, shall, as between the Company, its creditors
other than holders of Senior Indebtedness, and the Holders of the Securities, be
deemed to be a payment by the Company to or on account of the Senior
Indebtedness. It is understood that the provisions of this Article Fourteen are
and are intended solely for the purposes of defining the relative rights of the
Holders of the Securities, on the one hand, and the holders of the Senior
Indebtedness on the other hand.
Section 1406. Unconditional Obligation.
Nothing contained in this Article Fourteen or elsewhere in this
Indenture or in the Securities is intended to or shall impair, as between the
Company and the Holders of the Securities, the obligation of the Company, which
is absolute and unconditional, to pay to the Holders of the Securities the
principal of (and premium, if any) and interest on the Securities as and when
the same shall become due and payable in accordance with their terms, or is
intended to or shall affect the relative rights of the Holders of the Securities
and creditors of the Company other than the holders of the Senior Indebtedness,
nor shall anything herein or therein prevent the Trustee or the Holder of any
Security from taking any action to accelerate the maturity of Securities
pursuant to Section 502 or from exercising all remedies otherwise permitted by
applicable law upon default under this Indenture, subject to the rights, if any,
under this Article Fourteen of the holders of Senior
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Indebtedness in respect of cash, property or securities of the Company received
upon the exercise of any such remedy.
Section 1407. Trustee to Effectuate Subordination.
Each Holder of a Security by his acceptance thereof authorizes and
directs the Trustee in his behalf to take such action as may be necessary or
appropriate to effectuate the subordination provided in this Article Fourteen
and appoints the Trustee his attorney-in-fact for any and all such purposes.
Section 1408. Notice to Trustee.
The Company shall give prompt written notice to a Responsible Officer
of the Trustee of any fact known to the Company which would prohibit the making
of any payment of monies to or by the Trustee in respect of the Securities
pursuant to the provisions of this Article Fourteen; provided, however, that
except as provided in Section 1402(c) hereof, nothing herein shall require the
Company to give any notice of a default on any of the Senior Indebtedness other
than a payment default, and the Company shall not be deemed a representative of
the Senior Indebtedness for purposes of instituting a Blockage Period.
Notwithstanding the provisions of this Article Fourteen or any other provision
of this Indenture, the Trustee shall not be charged with knowledge of the
existence of any facts which would prohibit the making of any payment of monies
to or by the Trustee in respect of the Securities pursuant to the provisions of
this Article Fourteen, unless and until a Responsible Officer of the Trustee
shall have received written notice thereof at the Corporate Trust Office of the
Trustee from the Company or a holder or holders of Senior Indebtedness or their
representative or representatives or from any trustee or trustees therefor; and
before the receipt of any such written notice, the Trustee, subject to the
provisions of Article Six, shall be entitled in all respects to assume that no
such facts exist; provided, however, that if the Trustee shall not have received
the notice provided for in this Section 1408 prior to the date upon which by the
terms hereof any money may become payable for any purpose (including, without
limitation, the payment of the principal of (or premium, if any) or interest on
any Security), then, anything herein contained to the contrary notwithstanding,
the Trustee shall have full power and authority to receive such money and to
apply the same to the purposes for which they were received.
The Trustee shall be entitled to rely on information regarding amounts
then due and owing on the Senior Indebtedness, if any, received from the holders
of Senior Indebtedness (or their representatives) or, if such information is not
received from such holders or their representatives, from the Company and only
amounts included in the information provided to the Trustee shall be paid to the
holders of Senior Indebtedness.
The Trustee, subject to the provisions of Article Six, shall be
entitled to rely on the delivery to it of a written notice by a Person
representing himself to be a holder of Senior Indebtedness (or a representative
or trustee on behalf of such holder) to establish that such notice has been
given by
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a holder of Senior Indebtedness or a representative or trustee on behalf of any
such holder or holders. In the event that the Trustee determines in good faith
that further evidence is required with respect to the right of any Person as a
holder of Senior Indebtedness to participate in any payment or distribution
pursuant to this Article Fourteen, the Trustee may request such Person to
furnish evidence to the reasonable satisfaction of the Trustee as to the amount
of Senior Indebtedness held by such Person, the extent to which such Person is
entitled to participate in such payment or distribution and any other facts
pertinent to the rights of such Person under this Article Fourteen, and if such
evidence is not furnished the Trustee may defer any payment to such Person
pending judicial determination as to the right of such Person to receive such
payment.
Upon any payment or distribution of assets of the Company referred to
in this Article Fourteen, the Trustee, subject to the provision of Article Six,
and the Holders of the Securities shall be entitled to rely upon any order or
decree made by any court of competent jurisdiction in which such dissolution,
winding-up, liquidation or reorganization proceedings are pending, or a
certificate of the receiver, trustee in bankruptcy, liquidation trustee, agent
or other person making such payment or distribution, delivered to the Trustee or
to the Holders of the Securities, for the purposes of ascertaining the persons
entitled to participate in such distribution, the holders of the Senior
Indebtedness and other indebtedness of the Company, the amount thereof or
payable thereon, the amount or amounts paid or distributed thereon and all other
facts pertinent thereto or to this Article Fourteen.
Section 1409. Rights of Trustee as Holder of Senior Indebtedness; Preservation
of Trustee's Rights.
The Trustee in its individual capacity shall be entitled to all the
rights set forth in this Article Fourteen in respect of any Senior Indebtedness
at any time held by it, to the same extent as any other holder of Senior
Indebtedness, and nothing in this Indenture shall deprive the Trustee of any of
its rights as such holder.
Nothing in this Article Fourteen shall apply to claims of, or payments
to, the Trustee under or pursuant to Section 607.
Section 1410. Trustee Not Fiduciary for Holders of Senior Indebtedness.
The Trustee shall not be deemed to owe any fiduciary duty to the
holders of Senior Indebtedness and, subject to the provisions of Article Six,
the Trustee shall not be liable to any holder of Senior Indebtedness if it shall
in good faith mistakenly pay over or deliver to Holders of Securities, the
Company or any other person money or assets to which any holder of Senior
Indebtedness shall be entitled by virtue of this Article Fourteen or otherwise.
Section 1411. No Waiver of Subordination Provisions.
No right of any present or future holder of any Senior Indebtedness to
enforce subordination as herein provided shall at any time in any way be
prejudiced or impaired by any act or failure to act
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on the part of the Company or by any act or failure to act, in good faith, by
any such holder, or by any noncompliance by the Company with the terms,
provisions and covenants of this Indenture, regardless of any knowledge thereof
which any such holder may have or otherwise be charged with.
Without in any way limiting the generality of the foregoing paragraph,
the holders of Senior Indebtedness may, at any time and from time to time,
without the consent of or notice to the Trustee or the Holders of the
Securities, without incurring responsibility to the Holders of the Securities
and without impairing or releasing the subordination provided in this Article or
the obligations hereunder of the Holders of the Securities to the holders of
Senior Indebtedness, do any one or more of the following: (i) change the manner,
place or terms of payment or extend the time of payment of, or renew or alter,
Senior Indebtedness, or otherwise amend or supplement in any manner Senior
Indebtedness or any instrument evidencing the same or any agreement under which
Senior Indebtedness is outstanding; (ii) sell, exchange, release or otherwise
deal with any property pledged, mortgaged or otherwise securing Senior
Indebtedness; (iii) release any person liable in any manner for the collection
of Senior Indebtedness; and (iv) exercise or refrain from exercising any rights
against the Company and any other Person.
Each Holder by purchasing or accepting a Security waives any and all
notice of the creation, modification, renewal, extension or accrual of any
Senior Indebtedness and notice of or proof of reliance by any holder or owner of
Senior Indebtedness upon this Article Fourteen and Senior Indebtedness shall
conclusively be deemed to have been created, contracted or incurred in reliance
upon this Article Fourteen, and all dealings between the Company and the holders
and owners of Senior Indebtedness shall be deemed to have been consummated in
reliance upon this Article Fourteen.
Section 1412. Defeasance of this Article Fourteen.
The subordination of the Securities provided by this Article Fourteen
shall apply only to Securities that are Outstanding under this Indenture and is
expressly made subject to the provisions for Defeasance or Covenant Defeasance
in Article Thirteen hereof and the provisions for satisfaction and discharge of
this Indenture in Article Four hereof and, anything herein to the contrary
notwithstanding, upon the effectiveness of any such Defeasance or Covenant
Defeasance or any such satisfaction and discharge, the Securities then
Outstanding shall thereupon cease to be subordinated pursuant to this Article
Fourteen.
This instrument may be executed in any number of counterparts, each of
which so executed shall be deemed to be an original, but all such counterparts
shall together constitute but one and the same instrument.
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In Witness Whereof, the parties hereto have caused this Indenture to be
duly executed all as of the day and year first above written.
UGLY DUCKLING CORPORATION
By:
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Attest:
- ----------------------------
HARRIS TRUST AND SAVINGS BANK, as Trustee
By:
------------------------------------
------------------------------------
Attest:
- ----------------------------
71
<PAGE> 79
State of Arizona )
)ss.:
County of Maricopa )
On the ______ day of ____________, 199___ before me personally came
______________________, to me known, who, being by me duly sworn, did depose
and say that he is _________________________ of Ugly Duckling Corporation, one
of the corporations described in and which executed the foregoing instrument.
_____________________________________________
State of ________________ )
)ss.:
County of _______________ )
On the ______ day of ____________, before me personally came
______________________, to me known, who, being by me duly sworn, did depose and
say that he is _________________________ of Harris Trust and Savings Bank, one
of the corporations described in and which executed the foregoing instrument;
that he knows the seal of said corporation; that the seal affixed to said
instrument is such corporate seal; that it was so affixed by authority of the
Board of Directors of said corporation; and that he signed his name thereto by
like authority.
_____________________________________________
72
<PAGE> 1
EXHIBIT T3C.2
UGLY DUCKLING CORPORATION
TO
HARRIS TRUST AND SAVINGS BANK
Trustee
First Supplemental Indenture
Dated as of _______ __, 1998
To
Indenture
Dated as of _______ __, 1998
12% Subordinated Debentures due 2003
FIRST SUPPLEMENTAL INDENTURE, dated as of _______ __, 1998,
between Ugly Duckling Corporation, a corporation duly organized and existing
under the laws of the State of Arizona (herein called the "Company"), having its
principal office at 2525 East Camelback Road, Suite 1150, Phoenix, Arizona
85016, and Harris Trust and Savings Bank, an Illinois banking corporation, as
Trustee (herein called the "Trustee") under the Indenture dated as of _______
__, 1998 between the Company and the Trustee (the "Indenture").
<PAGE> 2
Recitals of the Company
The Company has executed and delivered the Indenture to the
Trustee to provide for the issuance from time to time of its unsecured
debentures, notes or other evidences of indebtedness (the "Securities"), said
Securities to be issued in one or more series as in the Indenture provided.
Pursuant to the terms of the Indenture, the Company desires to
provide for the establishment of a new series of its Securities to be known as
its 12% Subordinated Debentures due 2003 (herein called the "Debentures"), the
form and substance of such Debentures and the terms, provisions and conditions
thereof to be set forth as provided in the Indenture and this First Supplemental
Indenture.
All things necessary to make this First Supplemental Indenture
a valid agreement of the Company, and to make the Debentures, when executed by
the Company and authenticated and delivered by the Trustee, the valid
obligations of the Company, have been done.
Now, Therefore, This First Supplemental Indenture Witnesseth:
For and in consideration of the premises and the purchase of
the Debentures by the Holders thereof, and for the purpose of setting forth, as
provided in the Indenture, the form and substance of the Debentures and the
terms, provisions and conditions thereof, it is mutually agreed, for the equal
and proportionate benefit of all Holders of the Debentures, as follows:
ARTICLE ONE
General Terms and Conditions of
the Debentures
Section 101. There shall be and is hereby authorized a series
of Securities designated the "12% Subordinated Debentures due 2003", limited in
aggregate principal amount to $32,500,000, which amount shall be as set forth in
any written order of the Company for the authentication and delivery of
Debentures. The Debentures shall mature and the principal shall be due and
payable together with all accrued and unpaid interest thereon on _______ __,
2003, and shall be issued in the form of registered Debentures without coupons
in denominations of $1.00 and any integral multiple thereof.
Section 102. Except as provided in Section 103 herein, the
Debentures shall be issued in certificated form. Principal and interest on the
Debentures issued in certificated form will be payable, the transfer of such
Debentures will be registrable and such Debentures will be exchangeable for the
Debentures bearing identical terms and provisions at the Corporate Trust Office
of the Trustee from time to time, which is initially in Chicago, Illinois;
provided, however, that payment of interest may be made at the option of the
Company by check mailed to the registered holder at such address as shall appear
in the Security Register.
2
<PAGE> 3
Section 103. Each Note will bear interest at the rate of 12%
per annum from the original date of issuance until the principal thereof becomes
due and payable, and on any overdue principal, payable semiannually on _____ __
and _______ __ of each calendar year (each, an "Interest Payment Date"),
commencing on _____ __, 1999, to the person in whose name such Note or any
predecessor Note is registered, at the close of business on each _____ __ and
_______ __ next preceding such Interest Payment Date. Any such interest
installment not punctually paid or duly provided for shall forthwith cease to be
payable to the registered holders on such Regular Record Date, and may be paid
to the person in whose name the Note (or one or more Predecessor Securities) is
registered at the close of business on a Special Record Date to be fixed by the
Trustee for the payment of such defaulted interest, notice whereof shall be
given to the registered holders of the Debentures not less than 10 days prior to
such Special Record Date, or may be paid at any time in any other lawful manner
not inconsistent with the requirements of any securities exchange on which the
Debentures may be listed, and upon such notice as may be required by such
exchange, all as more fully provided in the Indenture.
The amount of interest payable for any period will be computed
on the basis of a 360-day year of twelve 30-day months. Interest will accrue
from the date of original issuance to, but not including, the relevant payment
date. In the event that any date on which interest is payable on the Debentures
is not a Business Day, then payment of interest payable on such date will be
made on the next succeeding day which is a Business Day (and without any
interest or other payment in respect of any such delay), in each case with the
same force and effect as if made on such date.
Section 104. The Debentures shall be defeasible pursuant to
Section 1302 and Section 1303 of the Indenture.
ARTICLE TWO
Redemption of the Debentures
Section 201. The Debentures will be redeemable at any time and
from time to time prior to maturity at the option of the Company, as a whole or
in part, upon not less than 30 nor more than 60 days' notice, at the principal
amount to be redeemed, together with accrued interest to the date fixed for
redemption.
ARTICLE THREE
Additional Covenants
Section 301. Definitions. For purposes of this Article Three,
except as otherwise expressly provided or unless the context otherwise requires:
"CONSOLIDATED LEVERAGE RATIO" as of any date of determination
means the ratio of (i) the total liabilities of the Company and its
consolidated Subsidiaries, as determined in
3
<PAGE> 4
accordance with GAAP, excluding Junior Subordinated Obligations, to
(ii) the Consolidated Net Worth of the Company.
"CONSOLIDATED NET WORTH" as of any date of determination means
the consolidated stockholders' equity of the Company and its
consolidated Subsidiaries, as determined in accordance with GAAP, plus
all Junior Subordinated Obligations of the Company and its consolidated
Subsidiaries.
"GAAP" means generally accepted accounting principles in the
United States of America as in effect from time to time.
"JUNIOR SUBORDINATED OBLIGATION" means any indebtedness of the
Company or its Subsidiaries that by its terms is expressly subordinated
in right of payment to the Debentures.
Section 302. Minimum Equity. The Company shall, at all times
while any of the Debentures remain Outstanding, maintain Consolidated Net Worth
of at least $100,000,000.
Section 303. Consolidated Leverage Ratio. The Company will not
allow its Consolidated Leverage Ratio to exceed 6.0 to 1.0.
ARTICLE FOUR
Form of Debentures
Section 401. The Debentures and the Trustee's certificate of
authentication to be endorsed thereon are to be substantially in the following
form:
[INSERT OID LEGEND]
UGLY DUCKLING CORPORATION
No. _____________ $_________
CUSIP NO. _________
Ugly Duckling Corporation, a corporation duly organized and existing
under the laws of Delaware (herein called the "Company," which term includes any
successor Person under the Indenture hereinafter referred to), for value
received, hereby promises to pay to ______________ or registered assigns, the
principal sum of ___________ Dollars on _______ __, 2003, and to pay interest
thereon from the original date of issuance or from the most recent Interest
Payment Date to
4
<PAGE> 5
which interest has been paid or duly provided for, semi-annually on _______ __
and _____ __ in each year, commencing _____ __, 1999, at the rate of 12% per
annum, until the principal hereof is paid or made available for payment. The
interest so payable, and punctually paid or duly provided for, on any Interest
Payment Date will, as provided in such Indenture, be paid to the Person in whose
name this Security (or one or more Predecessor Securities) is registered at the
close of business on the Regular Record Date for such interest, which shall be
the _______ _ or _____ _ (whether or not a Business Day), as the case may be,
next preceding such Interest Payment Date. Any such interest not so punctually
paid or duly provided for will forthwith cease to be payable to the Holder on
such Regular Record Date and may either be paid to the Person in whose name this
Security (or one or more Predecessor Securities) is registered at the close of
business on a Special Record Date for the payment of such Defaulted Interest to
be fixed by the Trustee, notice whereof shall be given to Holders of Securities
of this series not less than 10 days prior to such Special Record Date, or be
paid at any time in any other lawful manner not inconsistent with the
requirements of any securities exchange on which the Securities of this series
may be listed, and upon such notice as may be required by such exchange, all as
more fully provided in said Indenture.
Payment of the principal of (and premium, if any) and any such interest
on this Security will be made at the office or agency of the Company maintained
for that purpose in Chicago, Illinois, in such coin or currency of the United
States of America as at the time of payment is legal tender for payment of
public and private debts; provided, however, that at the option of the Company
payment of interest may be made by check mailed to the address of the Person
entitled thereto as such address shall appear in the Security Register.
Reference is hereby made to the further provisions of this Security set
forth on the reverse hereof, which further provisions shall for all purposes
have the same effect as if set forth at this place.
Unless the certificate of authentication hereon has been executed by
the Trustee referred to on the reverse hereof by manual signature, this Security
shall not be entitled to any benefit under the Indenture or be valid or
obligatory for any purpose.
In Witness Whereof, the Company has caused this instrument to be duly
executed.
UGLY DUCKLING CORPORATION
By_______________________________________
Attest:
- ----------------------
5
<PAGE> 6
Form of Reverse of Security.
This Security is one of a duly authorized issue of securities of the
Company (herein called the "Securities"), issued and to be issued in one or more
series under an Indenture, dated as of _______ __, 1998 (herein called the
"Indenture", which term shall have the meaning assigned to it in such
instrument), between the Company and Harris Bank and Trust Company, as Trustee
(herein called the "Trustee", which term includes any successor trustee under
the Indenture), and reference is hereby made to the Indenture for a statement of
the respective rights, limitations of rights, duties and immunities thereunder
of the Company, the Trustee and the Holders of the Securities and of the terms
upon which the Securities are, and are to be, authenticated and delivered. This
Security is one of the series designated on the face hereof, limited in
aggregate principal amount to $32,500,000.
The Securities of this series are subject to redemption upon not less
than 30 days' notice by mail, at any time, as a whole or in part, at the
election of the Company, at a Redemption Price equal to 100% of the principal
amount, together with accrued interest to the Redemption Date, but interest
installments whose Stated Maturity is on or prior to such Redemption Date will
be payable to the Holders of such Securities, or one or more Predecessor
Securities, of record at the close of business on the relevant Record Dates
referred to on the face hereof for such interest installments, all as provided
in the Indenture. The Indenture provides that a notice of redemption may be
given that is conditional upon the receipt by the Trustee on or prior to the
Redemption Date of amounts sufficient to pay principal of, and premium, if any,
and interest on, the Securities to be redeemed, and that if such amounts shall
not have been so received, said notice shall be of no force and effect, the
Securities to be redeemed will not become due and payable on the Redemption
Date, and the Company will not be required to redeem such Securities on such
date.
In the event of redemption of this Security in part only, a new
Security or Securities of this series and of like tenor for the unredeemed
portion hereof will be issued in the name of the Holder hereof upon the
cancellation hereof.
The Securities of this series are subordinate in right of payment, in
the manner and to the extent set forth in the Indenture, to the prior payment in
full of all Senior Indebtedness of the Company. To the extent and in the manner
provided in the Indenture, Senior Indebtedness must be paid before any payment
may be made to any Holder of this Security. Any Holder by accepting this
Security agrees to the subordination and authorizes the Trustee to give it
effect.
The Indenture contains provisions for defeasance at any time of the
entire indebtedness of this Security or certain restrictive covenants and Events
of Default with respect to this Security, in each case upon compliance with
certain conditions set forth in the Indenture.
If an Event of Default with respect to Securities of this series shall
occur and be continuing, the principal of the Securities of this series may be
declared due and payable in the manner and with the effect provided in the
Indenture.
6
<PAGE> 7
The Indenture permits, with certain exceptions as therein provided, the
amendment thereof and the modification of the rights and obligations of the
Company and the rights of the Holders of the Securities of each series to be
affected under the Indenture at any time by the Company and the Trustee without
the consent of any Holders in certain limited cases, and with the consent of the
Holders of a majority in principal amount of the Securities at the time
Outstanding of each series to be affected subject to certain exceptions. The
Indenture also contains provisions permitting the Holders of specified
percentages in principal amount of the Securities of each series at the time
Outstanding, on behalf of the Holders of all Securities of such series, to waive
compliance by the Company with certain provisions of the Indenture and certain
past defaults under the Indenture and their consequences. Any such consent or
waiver shall be conclusive and binding upon the Holder of this Security and upon
all future Holders of this Security and of any Security issued upon the
registration of transfer hereof or in exchange herefor or in lieu hereof,
whether or not notation of such consent or waiver is made upon this Security.
As provided in and subject to the provisions of the Indenture, the
Holder of this Security shall not have the right to institute any proceeding
with respect to the Indenture or for the appointment of a receiver or trustee or
for any other remedy thereunder, unless such Holder shall have previously given
the Trustee written notice of a continuing Event of Default with respect to the
Securities of this series, the Holders of not less than 25% in principal amount
of the Securities of this series at the time Outstanding shall have made written
request to the Trustee to institute proceedings in respect of such Event of
Default as Trustee and offered the Trustee reasonable indemnity, and the Trustee
shall not have received from the Holders of a majority in principal amount of
Securities of this series at the time Outstanding a direction inconsistent with
such request, and shall have failed to institute any such proceeding, for 60
days after receipt of such notice, request and offer of indemnity. The foregoing
shall not apply to any suit instituted by the Holder of this Security for the
enforcement of any payment of principal hereof or any premium or interest hereon
on or after the respective due dates expressed herein.
No reference herein to the Indenture and no provision of this Security
or of the Indenture shall alter or impair the obligation of the Company, which
is absolute and unconditional, to pay the principal of and any premium and
interest on this Security at the times, place and rate, and in the coin or
currency, herein prescribed.
As provided in the Indenture and subject to certain limitations therein
set forth, the transfer of this Security is registrable in the Security
Register, upon surrender of this Security for registration of transfer at the
office or agency of the Company in any place where the principal of and any
premium and interest on this Security are payable, duly endorsed by, or
accompanied by a written instrument of transfer in form satisfactory to the
Company and the Security Registrar duly executed by the Holder hereof or his
attorney duly authorized in writing, and thereupon one or more new Securities of
this series and of like tenor, of authorized denominations and for the same
aggregate principal amount, will be issued to the designated transferee or
transferees.
7
<PAGE> 8
The Securities of this series are issuable only in registered form
without coupons in denominations of $1.00 and any integral multiple thereof. As
provided in the Indenture and subject to certain limitations therein set forth,
Securities of this series are exchangeable for a like aggregate principal amount
of Securities of this series and of like tenor of a different authorized
denomination, as requested by the Holder surrendering the same.
No service charge shall be made for any such registration of transfer
or exchange, but the Company may require payment of a sum sufficient to cover
any tax or other governmental charge payable in connection therewith.
Prior to due presentment of this Security for registration of transfer,
the Company, the Trustee and any agent of the Company or the Trustee may treat
the Person in whose name this Security is registered as the owner hereof for all
purposes, whether or not this Security be overdue, and neither the Company, the
Trustee nor any such agent shall be affected by notice to the contrary.
All terms used in this Security which are defined in the Indenture
shall have the meanings assigned to them in the Indenture.
ARTICLE FIVE
Original Issue of Debentures
Section 501. Debentures in the aggregate principal amount of
$32,500,000, may, upon execution of this First Supplemental Indenture, or from
time to time thereafter, be executed by the Company and delivered to the Trustee
for authentication, and the Trustee shall thereupon authenticate and deliver
said Debentures to or upon the written order of the Company, signed by its
Chairman, its President, or any Vice President and its Treasurer, an Assistant
Treasurer, its Secretary or an Assistant Secretary, without any further action
by the Company.
ARTICLE SIX
Application of Article Fourteen
Section 6.01. The Debentures will be subject to the
subordination provisions of Article Fourteen of the Indenture. Notwithstanding
the definition of Senior Indebtedness in the Indenture, for purposes of the
Debentures, Senior Indebtedness will include the Company's 10% Subordinated
Debenture dated June 21, 1996 payable to Verde Investments, Inc.
8
<PAGE> 9
ARTICLE SEVEN
Paying Agent and Registrar
Section 701. The Trustee will be the Paying Agent, transfer
agent, and Registrar for the Debentures.
ARTICLE EIGHT
Sundry Provisions
Section 801. Except as otherwise expressly provided in this
First Supplemental Indenture or in the form of Debentures or otherwise clearly
required by the context hereof or thereof, all terms used herein or in said form
of Debentures that are defined in the Indenture shall have the several meanings
respectively assigned to them thereby.
Section 802. The Indenture, as supplemented by this First
Supplemental Indenture, is in all respects ratified and confirmed, and this
First Supplemental Indenture shall be deemed part of the Indenture in the manner
and to the extent herein and therein provided.
This instrument may be executed in any number of counterparts,
each of which so executed shall be deemed to be an original, but all such
counterparts shall together constitute but one and the same instrument.
In Witness Whereof, the parties hereto have caused this First
Supplemental Indenture to be duly executed all as of the day and year first
above written.
UGLY DUCKLING CORPORATION
By ____________________________
Attest:
- ----------------------------
9
<PAGE> 10
HARRIS TRUST AND SAVINGS BANK,
As Trustee
By ______________________________
(seal)
Attest:
- ------------------------------
10
<PAGE> 11
State of Arizona )
) ss.:
County of Maricopa )
On the ____ day of _______, 1998, before me personally came
_____________________________, to me known, who being by me duly sworn, did
depose and say that she/he is the ________________ of Ugly Duckling Corporation,
one of the corporations described in and which executed the foregoing
instrument; and that she/he signed her/his name thereto by the authority of the
Board of Directors of said Corporation.
--------------------------------------
Official Seal
State of ___________)
) ss.:
County of ________ )
On the ____ day of _______, 1998, before me personally came
_____________________________, to me known, who being by me duly sworn, did
depose and say that she/he is the ________________ of Harris Trust and Savings
Bank, one of the corporations described in and which executed the foregoing
instrument; that she/he knows the seal of said corporation; that the seal
affixed to said instrument is such corporate seal; that it was so affixed by
authority of the Board of Directors of said corporation; and that she/he signed
her/his name thereto by like authority.
--------------------------------------
Official Seal
(seal)
11
<PAGE> 1
UGLY DUCKLING CORPORATION
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
To the holders of our Common Stock:
Enclosed are materials relating to our offer to exchange up to $32,500,000
aggregate principal amount of our 12% Subordinated Debentures due 2003 (the
"Debentures") for up to 5,000,000 shares of our Common Stock, par value $.001
per share ("Common Stock"), as described in the enclosed Offering Circular dated
September 17, 1998 (the "Exchange Offer).
This exchange would be made on the following basis:
- --------------------------------------------------------------------------------
$6.50 PRINCIPAL AMOUNT OF DEBENTURES
FOR EACH SHARE OF COMMON STOCK
- --------------------------------------------------------------------------------
Interest on the Debentures will accrue from their date of issuance, and
will be payable in cash semiannually on each April 15 and October 15, commencing
April 15, 1999, until the Debentures are paid in full.
The principal purpose of the Exchange Offer is to reduce the number of
shares of Common Stock outstanding, thereby offering the potential for increased
earnings per share in the future. To effect this reduction, the Company is
offering to purchase outstanding shares of its Common Stock at a purchase price
of $6.50 per share, representing a premium of approximately 39% above its market
price as reported on the Nasdaq National Market on September 15, 1998, which the
Company does not believe adequately reflects the underlying value of its Common
Stock, all as more fully described in the enclosed materials. Among other
conditions, the Exchange Offer is contingent upon the valid tender of at least
1,000,000 shares of Common Stock. Executive officers and directors of the
Company have advised the Company that they do not intend to tender any shares of
Common Stock in the Exchange Offer.
PLEASE READ THE ENCLOSED MATERIALS CAREFULLY.
For further assistance or additional copies of any of the enclosed
materials, please call Corporate Investor Communications, Inc. at 1-888-673-4478
(toll free).
Very truly yours,
ERNEST C. GARCIA, II
Chairman of the Board and
Chief Executive Officer
Ugly Duckling Corporation
September 17, 1998
Phoenix, Arizona
<PAGE> 2
UGLY DUCKLING CORPORATION
OFFER TO EXCHANGE
UP TO $32,500,000 AGGREGATE PRINCIPAL AMOUNT OF ITS
12% SUBORDINATED DEBENTURES DUE 2003
FOR UP TO 5,000,000 SHARES OF ITS
COMMON STOCK
Ugly Duckling Corporation, a Delaware corporation ("Ugly Duckling" or the
"Company"), hereby offers to exchange, upon the terms and subject to the
conditions set forth herein and in the accompanying Letter of Transmittal (which
together constitute the "Exchange Offer"), up to $32,500,000 aggregate principal
amount of its 12% Subordinated Debentures due 2003 (the "Debentures") for up to
5,000,000 shares ("Shares") of its Common Stock, $.001 par value per share
("Common Stock") on the basis of $6.50 principal amount of Debentures for each
Share of Common Stock.
On September 15, 1998, the closing price of the Common Stock as reported on
Nasdaq's National Market System ("Nasdaq") was $4.69. For a further description
of the Common Stock, see "Description of Capital Stock." The Company does not
intend to apply for listing or quotation of the Debentures on any exchange or
automated quotation system. Accordingly, there can be no assurance that any
public market will develop for the Debentures. See "Risk Factors -- Possible
Lack of Trading Market for the Debentures."
The Debentures will be unsecured obligations of the Company subordinated
and subject in right of payment to all existing and future senior indebtedness
of the Company. As of June 30, 1998, the Company's outstanding senior
indebtedness aggregated approximately $72.9 million. The Debentures will bear
interest at 12% per annum from their date of issuance, payable semiannually on
each April 15 and October 15, commencing April 15, 1999, until the Debentures
are paid in full. The Company will be required to repay the principal amount of
the Debentures on the fifth anniversary of their date of issuance. The
Debentures will be redeemable, at the Company's option, in whole at any time or
in part from time to time, at the principal amount to be redeemed plus accrued
and unpaid interest thereon to the redemption date. The Debentures will be
issued pursuant to an Indenture between the Company and Harris Trust and Savings
Bank, as Trustee. The Company will be subject to certain limited financial
covenants as more fully described in the Indenture. See "Description of the
Debentures."
THE EXCHANGE OFFER WILL EXPIRE AT 5:00 P.M. NEW YORK CITY TIME, ON FRIDAY,
OCTOBER 16, 1998, UNLESS EXTENDED.
The Company will accept up to 5,000,000 Shares if tendered (representing
approximately 27% of the Shares outstanding as of September 15, 1998). If more
than 5,000,000 shares of Common Stock are tendered, the Company will accept no
more than 5,000,000 of the tendered Shares, to be allocated among tendering
stockholders on a pro rata basis. The Exchange Offer is contingent upon the
tender of at least 1,000,000 Shares of Common Stock. If less than 1,000,000
Shares of Common Stock are tendered, the Company will accept none of the Shares
tendered. The Exchange Offer is subject to a number of additional conditions and
may be amended or withdrawn in certain circumstances. See "The Exchange
Offer -- Conditions to and Amendment of the Exchange Offer."
THESE SECURITIES ARE BEING OFFERED PURSUANT TO AN EXEMPTION FROM REGISTRATION
WITH THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION (THE "COMMISSION").
THE COMMISSION DOES NOT PASS UPON THE MERITS OF ANY SECURITIES NOR DOES IT PASS
UPON THE ACCURACY OR COMPLETENESS OF ANY OFFERING CIRCULAR OR OTHER SELLING
LITERATURE.
For a discussion of certain risks and other factors to be considered in
connection with the Exchange Offer, see "Risk Factors."
The Company, its Board of Directors and its executive officers make no
recommendations as to whether any stockholders should tender any or all of such
stockholders' Shares pursuant to the Exchange Offer. Each stockholder must make
his, her or its own decision whether to tender Shares of Common Stock and, if
so, how many Shares to tender. Executive officers and directors of the Company
have advised the Company that they do not intend to tender their Shares in the
Exchange Offer.
THE DATE OF THIS OFFERING CIRCULAR IS SEPTEMBER 17, 1998
<PAGE> 3
The Company has made no arrangements for and has no understanding with any
dealer, salesman or other person regarding the solicitation of tenders
hereunder, and no person has been authorized to give any information or to make
any representation not contained in this Offering Circular in connection with
the Exchange Offer, and, if given or made, such information or representation
must not be relied upon as having been authorized by the Company or any other
person. Neither the delivery of this Offering Circular nor any exchange or sale
made hereunder shall, under any circumstances, create any implication that there
has been no change in the affairs of the Company since the respective dates as
of which information is given herein.
This Offering Circular does not constitute an offer to exchange or sell, or
a solicitation of an offer to exchange or buy, any securities other than the
securities covered by this Offering Circular by the Company or any other person,
or any such offer or solicitation of such securities by the Company or any such
other person in any state or other jurisdiction to any person to whom it is
unlawful to make any such offer or solicitation. In any state or other
jurisdiction where it is required that the securities offered by this Offering
Circular be qualified for offering or that the offering be approved pursuant to
tender offer statutes in such state or jurisdiction, no offer is hereby being
made to, and tenders will not be accepted from residents of any such state or
jurisdiction unless and until such requirements have been satisfied.
<PAGE> 4
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
AVAILABLE INFORMATION....................................... 3
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE............. 3
SUMMARY OF EXCHANGE OFFER................................... 4
RISK FACTORS................................................ 8
THE EXCHANGE OFFER.......................................... 15
General................................................... 15
Expiration Time, Extensions, Termination and Amendments... 15
How to Tender............................................. 16
Withdrawal Rights......................................... 17
Acceptance of Shares for Exchange; Delivery of Debentures
to be Exchanged........................................ 18
Denominations; Fractional Interests....................... 18
Proration if Shares Tendered Exceed Maximum............... 18
Exchange Offer Subject to Minimum Number of Shares
Tendered............................................... 19
Conditions to and Amendment of the Exchange Offer......... 19
Exchange Agent............................................ 20
Information Agent......................................... 20
No Financial Advisor...................................... 20
Payment of Expenses....................................... 20
BACKGROUND, PURPOSE AND EFFECT OF THE EXCHANGE OFFER........ 21
CAPITALIZATION.............................................. 23
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA................ 24
CERTAIN PRO FORMA FINANCIAL INFORMATION..................... 27
PRICE RANGE OF COMMON STOCK................................. 29
DIVIDENDS................................................... 29
BUSINESS.................................................... 30
DESCRIPTION OF THE DEBENTURES............................... 31
DESCRIPTION OF CAPITAL STOCK................................ 40
CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES....... 41
EXHIBITS
Ugly Duckling's Notice and Proxy Statement dated August 4,
1998
Cygnet Financial Corporation's Prospectus dated August 26,
1998
</TABLE>
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<PAGE> 5
AVAILABLE INFORMATION
Corporate Investor Communications, Inc. (toll free telephone no.
1-888-673-4478) will act as Information Agent in connection with the Exchange
Offer. See "The Exchange Offer -- Information Agent."
Ugly Duckling is subject to the periodic reporting and other informational
requirements of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"), and, in accordance therewith, files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). Such
reports, proxy statements and other information may be inspected and copied at
the public reference facilities maintained by the Commission at Judiciary Plaza,
450 Fifth Street, NW, Washington, D.C. 20549, and at the following regional
offices of the Commission; Seven World Trade Center, Suite 1300, New York, New
York 10048 and Citicorp Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661-2511. Copies of such materials can be obtained by mail from the
Public Reference Section of the Commission at Judiciary Plaza, 450 Fifth Street,
NW, Washington, D.C. 20549, at prescribed rates. In addition, the Commission
maintains a site on the World Wide Web that contains reports, proxy and
information statements and other information filed electronically by Ugly
Duckling with the Commission which can be accessed over the Internet at
http:\\www.sec.gov.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents filed with the Commission are incorporated by
reference into this Offering Circular: (i) Ugly Duckling's Annual Report on Form
10-K for the fiscal year ended December 31, 1997, as amended ("Ugly Duckling's
Form 10-K"); (ii) Ugly Duckling's Quarterly Reports on Form 10-Q for the
quarters ended March 31 and June 30, 1998, respectively; (iii) Ugly Duckling's
Reports on Form 8-K filed with the Commission on January 2, February 9, February
10, February 20, June 16, June 25, and September 2, 1998, respectively; (iv)
Ugly Duckling's Notice and Proxy Statement dated August 4, 1998, a copy of which
accompanies this Offering Circular; and (v) Cygnet Financial Corporation's
Prospectus dated August 26, 1998, a copy of which accompanies this Offering
Circular. If any statement contained in any of the foregoing documents
incorporated by reference herein is modified or superseded by a statement in
this Offering Circular, the statement in any such foregoing document will be
deemed for the purposes of this Offering Circular to have been modified or
superseded by such statement in this Offering Circular, and the statement in any
such foregoing document is incorporated by reference herein only as modified or
to the extent it is not superseded. All documents subsequently filed by the
Company during the period of the Exchange Offer pursuant to Sections 13, 14 or
15(d) of the Exchange Act shall be deemed to be incorporated by reference in
this Offering Circular and to be a part hereof from the date of filing such
documents.
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<PAGE> 6
SUMMARY OF EXCHANGE OFFER
The following is a summary of certain features of the Exchange Offer and
other matters, and all statements contained herein are qualified in their
entirety by reference to the more detailed information and financial statements
hereinafter set forth.
THE COMPANY
The Company operates a chain of Buy Here-Pay Here used car dealerships in
the United States and underwrites, finances and services retail installment
contracts generated from the sale of used cars by its Company dealerships and by
third party dealers located in selected markets throughout the country. As part
of its financing activities, the Company has initiated its Cygnet Dealer
Program, pursuant to which the Company provides qualified independent used car
dealers with warehouse purchase facilities and operating credit lines primarily
secured by the dealer's retail installment contract portfolio. In addition, the
Company purchases loan portfolios in bulk and services loan portfolios on behalf
of third parties. 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.
As described in the Company's Notice and Proxy Statement dated August 4,
1998 (the "Proxy Statement"), a copy of which accompanies this Offering
Circular, the Company has proposed and its stockholders have approved the
separation of the Company's non-dealership operations into a separate
publicly-traded company (the "Split-up"). If all conditions to the Split-up are
satisfied, the Company will transfer to Cygnet Financial Corporation, a
newly-formed Delaware corporation ("Cygnet"), its bulk purchase and servicing
operations, its third party dealer finance operations (excluding the branch
office network operations that Ugly Duckling closed in the first quarter of
1998), and substantially all assets and certain liabilities acquired pursuant to
transactions with First Merchants Acceptance Corporation ("FMAC") and Reliance
Acceptance Group, Inc. ("Reliance"). The Company also has completed certain
other transactions and acquired other assets relating to its non-dealership
operations and intends to transfer to Cygnet these assets and related
liabilities as part of the Split-up. In connection with the Split-up, Cygnet
currently is conducting a Rights Offering pursuant to which holders of Ugly
Duckling's Common Stock as of August 17, 1998 were distributed Rights to
purchase shares of Cygnet's Common Stock at a price of $7.00 per share, as
described in Cygnet's Prospectus dated August 26, 1998, a copy of which
accompanies this Offering Circular. The Rights Offering is scheduled to
terminate on September 21, 1998, although it may be extended, withdrawn or
abandoned by the Company in its sole discretion. If the Rights Offering is
completed and the Split-up is consummated as described in the Proxy Statement,
the Company will continue to operate its chain of Buy Here-Pay Here used car
dealerships and underwrite, finance and service retail installment contracts
generated from the sale of used cars by its Company dealerships, and Cygnet will
acquire and operate the bulk purchase and servicing operations, the third party
dealer finance operations, and substantially all of the assets and certain
liabilities acquired pursuant to the transactions with FMAC and Reliance. If the
Rights Offering is not completed and the Split-up is not consummated, Ugly
Duckling would retain both its dealership and non-dealership operations.
BACKGROUND, PURPOSE AND EFFECT OF THE EXCHANGE OFFER
Ugly Duckling completed its initial public offering in June 1996 with the
sale of 2,300,000 Shares of its Common Stock at a price of $6.75 per share.
Following the initial public offering, the price of the Company's Common Stock
increased significantly, to a high of $25.75 per share in the first quarter of
1997, reflecting a stock market with generally increasing stock prices, a
healthy used car sales and finance industry, and growth in the Company's
revenues and earnings. In recent periods, however, the used car sales and
financing industry has encountered difficulties, with several used car companies
announcing major downward adjustments to their financial statements, violations
of loan covenants, related litigation, and other events. In addition, certain of
these companies have filed for bankruptcy protection. These difficulties have
corresponded with a general decline in the stock prices of companies involved in
this industry. At the same time, stock prices of small-cap companies have
recently experienced a broad-based decline. Consistent with this market decline,
particularly
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<PAGE> 7
with respect to companies in the used car sales and finance industry, the price
of the Company's Common Stock has decreased to $4.69 as of September 15, 1998, a
price that is at the low end of its 52-week trading range.
The Company does not believe that recent prices reflect the underlying
value of its Common Stock. In this regard, in establishing a tender price that
is significantly higher than the market price of the Shares as of September 15,
1998, the Company considered the following factors, among others.
- The closing price of $4.69 per Share as of September 15, 1998, two
business days prior to the announcement of the Exchange Offer, represents
an 82% decline from its all-time high in the first quarter of 1997 and a
63% decline from its high in 1998. See "Price Range of Common Stock."
- The recent Share price reflects a discount of approximately 53% to the
Company's book value per share as of June 30, 1998. See "Summary Selected
Consolidated Financial Data."
- The Company's recent and historical financial results, including the
Company's increase in revenues ($142.5 million compared to $46.0 million)
and basic earnings per share from continuing operations ($0.34 compared
to $0.17) for the six month period ended June 30, 1998 as compared to the
six month period ended June 30, 1997. See "Summary Selected Consolidated
Financial Data."
The principal purpose of the Exchange Offer is to reduce the number of
Shares of Common Stock outstanding by offering to purchase Shares in the
Exchange Offer, thereby offering the potential for increased earnings per share
in the future. The Company believes that if it is able to increase earnings per
share, this development could have a positive influence on the price of its
Common Stock. The increased indebtedness resulting from the Exchange Offer,
however, will significantly increase the Company's debt service requirements and
could negatively affect earnings per share. See "Risk Factors -- Increased
Leverage and Debt Service Obligations" and "-- No Assurance of Increased
Earnings Per Share."
Holders of Shares of Common Stock electing to participate in the Exchange
Offer will realize the following benefits.
- In exchange for Shares, tendering stockholders will receive a debt
security with a principal amount approximately 39% greater than the
market price of the Shares as of September 15, 1998.
- The Debentures will bear interest at 12% per annum, payable each April 15
and October 15 until the Debentures are paid in full.
- The Debentures, although subordinated in right of payment to all other
existing and future senior indebtedness of the Company, represent a claim
on the Company's assets senior to any claim of the holders of the
Company's Common Stock.
Notwithstanding the benefits to tendering stockholders summarized above,
holders of Shares contemplating the Exchange Offer should take into account the
following considerations.
- Tendering stockholders receiving Debentures will relinquish the right to
share in any capital appreciation of the Company's Common Stock.
- Unlike the Shares, the Debentures will not be listed on any exchange or
automated quotation system and there can be no assurance that a trading
market will develop.
- Unlike holders of Common Stock, holders of the Debentures will have no
rights to vote on matters submitted to the Company's stockholders.
- The Company has the right to prepay the Debentures at any time without
penalty or premium by paying the unpaid principal amount and accrued
interest on the Debentures.
- Tendering stockholders will be subject to certain tax consequences that
may differ from those that would be realized if the Shares were sold for
cash.
Finally, holders of Shares contemplating the Exchange Offer should consider
that the Company has not retained any financial advisor or investment banking
firm to assist the Company in determining the price and
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<PAGE> 8
terms of the Indentures or whether the consideration offered in the Exchange
Offer is adequate to tendering stockholders. The Company also has not requested
any report, opinion, or appraisal relating to the fairness of the consideration
being offered pursuant to the Exchange Offer. For a discussion of risk factors
which should be taken into account in considering the Exchange Offer, see "Risk
Factors."
THE EXCHANGE OFFER
EXPIRATION TIME............... 5:00 p.m., New York City time, on Monday,
October 19, 1998, unless extended (the
"Expiration Time").
EXCHANGE RATIO................ $6.50 principal amount of Debentures for each
share of Common Stock validly tendered.
ACCEPTANCE OF SHARES;
CONDITIONS OF THE EXCHANGE
OFFER....................... The Company will accept up to 5,000,000 Shares
(representing approximately 27% of the
outstanding Shares of the Company's Common
Stock as of September 15, 1998) in the Exchange
Offer. The Exchange Offer is contingent on the
tender of at least 1,000,000 Shares of Common
Stock. If less than 1,000,000 Shares are duly
tendered, the Company will accept none of the
Shares tendered. If more than 5,000,000 Shares
are tendered, the Company will accept no more
than 5,000,000 Shares of Common Stock, to be
allocated among the tendering stockholders on a
pro rata basis. The Exchange Offer is subject
to a number of additional conditions. See "The
Exchange Offer -- Conditions to and Amendment
of the Exchange Offer."
DESCRIPTION OF DEBENTURES..... The Debentures will be unsecured obligations of
the Company subordinated and subject in right
of payment to all existing and future senior
indebtedness of the Company. As of June 30,
1998, the Company's outstanding senior
indebtedness aggregated approximately $72.9
million, including the Company's revolving
credit facility with General Electric Capital
Corporation. The Debentures will bear interest
at 12% per annum from their date of issuance,
payable semiannually on each April 15 and
October 15, commencing April 15, 1999, until
the Debentures are paid in full. The Company
will be required to repay the principal amount
of the Debentures on the fifth anniversary of
their date of issuance. The Debentures will be
redeemable, at the Company's option, in whole
at any time or in part from time to time, at
the principal amount to be redeemed plus
accrued and unpaid interest thereon to the
redemption date. The Debentures will be issued
pursuant to an Indenture between the Company
and Harris Trust and Savings Bank, as Trustee.
The Company will be subject to certain limited
financial covenants and other restrictions as
more fully described in the Indenture. See
"Description of the Debentures."
HOW TO TENDER................. A holder of Shares wishing to accept the
Exchange Offer must either (a) complete the
accompanying Letter of Transmittal and forward
it with the certificates representing the
Shares to be tendered and any other required
documents to Harris Trust and Savings Bank (the
"Exchange Agent") or (b) request a broker or
bank to effect the transaction. Holders of
Shares registered in the name of a broker,
dealer, bank, trust company, or other nominee
must contact such institution to tender their
Shares. Certificates
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<PAGE> 9
representing the Shares may be physically
delivered after effecting a valid tender
pursuant to certain guaranteed delivery
procedures. Physical delivery is not required
if confirmation of book-entry transfers of such
Shares to the Exchange Agent's account at The
Depository Trust Company ("DTC") is delivered
in a timely fashion. See "The Exchange
Offer -- How to Tender."
DELIVERY OF SECURITIES........ The Company will deliver Debentures in exchange
for Shares pursuant to the Exchange Offer as
soon as practicable after the Expiration Time.
See "The Exchange Offer -- Acceptance of Shares
for Exchange; Delivery of Debentures to be
Exchanged."
WITHDRAWAL RIGHTS............. Tenders of Shares pursuant to the Exchange
Offer may be withdrawn prior to 5:00 p.m. on
October 19, 1998, and, if the Company has not
previously accepted such Shares for exchange,
after November 17, 1998. Except for such rights
of withdrawal, all tenders are irrevocable.
CERTAIN UNITED STATES FEDERAL
INCOME TAX CONSEQUENCES....... See "Certain United States Federal Income Tax
Consequences" for a discussion of certain
federal income tax consequences associated with
the Exchange Offer and the ownership of the
Debentures, and "Risk Factors -- Certain United
States Federal Income Tax Risks."
LISTING AND TRADING OF
SECURITIES.................... The Company's Common Stock (symbol: UGLY) is
listed on Nasdaq's National Market System. On
September 15, 1998, two business days before
the announcement of the Exchange Offer, the
closing per share price for the Common Stock as
reported by Nasdaq was $4.69. No market
currently exists with respect to the
Debentures, and the Company does not intend to
list the Debentures for trading on any exchange
or automated quotation system. Accordingly,
there can be no assurance that any trading
market will develop for the Debentures or, if
developed, as to any price at which they might
be traded. See "Risk Factors -- Possible Lack
of Trading Market for the Debentures."
EXCHANGE AGENT AND TRUSTEE.... Harris Trust and Savings Bank will serve as the
Exchange Agent for the Exchange Offer and as
Trustee under the Indenture. See "The Exchange
Offer -- Exchange Agent" and "Description of
the Debentures -- The Indenture."
INFORMATION AGENT............. Corporate Investor Communications, Inc. will
serve as the Information Agent in connection
with the Exchange Offer (the "Information
Agent") telephone no. 1-888-673-4478
(toll-free). See "The Exchange
Offer -- Information Agent."
COMMON STOCK OUTSTANDING...... Approximately 18,535,000 Shares were
outstanding as of September 15, 1998.
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<PAGE> 10
RISK FACTORS
Investment in the Debentures is subject to certain risks and other factors,
including but not limited to those set forth below. In considering the Exchange
Offer, an investor should carefully consider the following risk factors, as well
as the risk factors appearing in the Company's filings with the Commission and
incorporated herein by reference and all other information appearing in this
Offering Circular, as well as his or her particular financial circumstances,
investment objectives and tax situation.
EXCHANGE OFFER SUBJECT TO CERTAIN CONTINGENCIES
The Exchange Offer is subject to certain contingencies that are not within
the control of the Company. First, the Exchange Offer is subject to the
condition that holders of at least 1,000,000 Shares validly tender their Shares.
If less than 1,000,000 Shares are validly tendered, the Company will accept none
of the Shares and the Exchange Offer will be terminated. Second, the Company
will accept no more than 5,000,000 Shares in the Exchange Offer. If more than
5,000,000 Shares are validly tendered, the Company will allocate Debentures
among the tendering stockholders on a pro-rata basis based on the number of
Shares tendered. In addition, the Exchange Offer requires qualification of the
Indenture under the Trust Indenture Act and may require certain approvals or
consents from government regulatory agencies, self regulatory organizations, and
other third parties. Certain consents may be obtained only if the Company is
willing to provide certain concessions to third parties. There can be no
assurance that all required conditions, consents, or regulatory approvals will
be obtained or achieved in a timely manner. Moreover, the Exchange Offer may be
modified or withdrawn in certain circumstances subject to the discretion of the
Company's Board of Directors. See "The Exchange Offer -- Conditions to and
Amendment of the Exchange Offer."
LOSS OF RIGHTS ASSOCIATED WITH COMMON STOCK
To the extent stockholders exchange their Shares for Debentures, they will
be relinquishing certain rights available to holders of Common Stock in exchange
for acquiring rights as holders of debt. Stockholders whose Shares are validly
tendered and accepted for exchange will lose the right to share in any capital
appreciation of the Company's Common Stock, will not be entitled to vote upon
any matters submitted to the Company's stockholders, and will no longer be
entitled to dividends paid, if any, on the Company's Common Stock. In addition,
because there is an established trading market for the Shares and no established
trading market for the Debentures, the liquidity of a tendering stockholder's
investment in the Company will likely be reduced.
MARKET ISSUES
If successful, the Exchange Offer will reduce the Company's stockholder's
equity and increase its indebtedness, thereby increasing the Company's debt to
equity ratio and its debt service obligations. There can be no assurance that
the market will not regard these results unfavorably and that the price of the
Company's Common Stock will not be adversely affected. To the extent the market
does not regard the Exchange Offer as favorable, the market price of the
Debentures also could be adversely affected. In addition, although the Company
believes the Exchange Offer complies with all applicable listing and maintenance
requirements imposed by the Nasdaq National Market, there can be no assurance
that issues regarding the Common Stock's listing status will not arise.
POSSIBLE LACK OF TRADING MARKET FOR DEBENTURES
No market currently exists for the Debentures, and the Company does not
intend to list the Debentures on any exchange or automated quotation system.
Accordingly, no assurance can be given generally as to the liquidity of the
Debentures after their issuance or the prices at which they may trade, or that a
trading market will develop.
INCREASED PERCENTAGE OF SHARES HELD BY MANAGEMENT
As of September 15, 1998, the Company's officers and directors beneficially
owned approximately 30% of the outstanding Shares of the Company's Common Stock,
with Mr. Ernest Garcia II, the Company's
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<PAGE> 11
Chairman of the Board and Chief Executive Officer, beneficially owning
approximately 25%. The Company's executive officers and directors have advised
the Company that they do not intend to participate in the Exchange Offer.
Assuming the maximum number of Shares is exchanged in the Exchange Offer, the
Company's officers and directors will beneficially own approximately 42% of the
Company's outstanding Shares of Common Stock (with Mr. Garcia owning
approximately 35%), and assuming the minimum number of Shares of Common Stock is
exchanged in the Exchange Offer, the Company's officers and directors will own
approximately 32% of the Company's outstanding Shares of the Common Stock (with
Mr. Garcia owning approximately 27%).
RESTRICTIONS IMPOSED BY TERMS OF INDEBTEDNESS
The Indenture will contain certain covenants that, among other things, will
require the Company not to allow its Consolidated Leverage Ratio (as defined
herein) to exceed 6 to 1 and to maintain at all times a Consolidated Net Worth
(as defined herein) of at least $100,000,000. If the Company fails to meet these
covenants, such failure will constitute an Event of Default (as defined herein)
under the Indenture. See "Description of the Debentures." There can be no
assurance that the Company will be able to satisfy these financial covenants and
any other covenants contained in the Indenture. If the Company is unable to cure
an Event of Default on a timely basis, the principal amount of the Debentures
may become immediately due and payable. There can also be no assurance that
these financial covenants will not materially and adversely affect the Company's
ability to finance its future operations or capital needs or to engage in other
business activities, including implementation of its business and growth
strategies.
ARBITRARY DETERMINATION OF TERMS OF DEBENTURES
The Company has determined the terms of the Debentures without retaining
any independent financial advisor or investment banking firm. Accordingly, there
can be no assurance that the terms of the Debentures are fair from a financial
point of view to tendering stockholders. In this regard, there can be no
assurance that if the Company were to issue subordinated debt in the capital
markets, the interest rate on such debt would not be higher than 12% per annum,
or that the financial and other covenants would not be more restrictive.
Additionally, the subordination provisions would likely be more onerous than
those contained in the Indenture. For example, companies that issue unsecured,
non-investment grade subordinated debt similar to the Debentures typically are
subject to more restrictions than those imposed by the Indenture with respect to
the Debentures, including restrictions on incurring additional indebtedness
above a specified amount or in violation of a specified formula, paying
dividends or making certain other distributions, payments and investments,
creating liens, and engaging in transactions with affiliates or in unrelated
businesses, among others. In addition, the terms of such securities typically
include a change of control provision, which typically provides a right to debt
holders to force a company to redeem their debt in the event of a change of
control of that company's voting securities. As a result, stockholders who
tender their Shares in exchange for Debentures may not receive the same level of
protection that typically would be afforded to holders of unsecured, non-
investment grade subordinated debt issued by other similarly situated companies.
Because the Debentures contain terms that may be less attractive than other
similar types of securities issued in the market, there can be no assurance that
the Company will not record the Debentures at a discount from their principal
amount. In addition, the relative lack of standard restrictive covenants may
adversely affect the liquidity of the Debentures.
NO ASSURANCE OF INCREASED EARNINGS PER SHARE
Although the primary purpose of the Exchange Offer is to reduce the number
of the Company's outstanding shares of Common Stock, thereby offering the
potential for increased earnings per share in the future, the reduction in
equity and corresponding increase in indebtedness could have a negative effect
on earnings per share. In this regard, the table set forth in the Section
entitled "Certain Pro Forma Financial Information", which shows the pro forma
effects of the Exchange Offer on the Company's financial results assuming the
maximum and minimum number of Shares tendered, indicates that earnings per share
from continuing operations for the six months ended June 30, 1998 would have
been unchanged on a pro forma basis whether the maximum or minimum number of
shares were exchanged. For the year ended December 31,
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<PAGE> 12
1997, the table shows that earnings per share from continuing operations would
have decreased in both cases, with a significant decrease assuming the maximum
number of Shares was exchanged. Further, following the Exchange Offer, the
Company expects that the Debentures will be recorded at the fair market value of
the Shares tendered in exchange as of the date the Shares are exchanged, with
the difference being amortized over the term of the Debentures as additional
interest expense, which would have a negative effect on earnings per share.
INCREASED LEVERAGE AND DEBT SERVICE OBLIGATIONS
Following the Exchange Offer, the Company will be more highly leveraged and
will have incurred substantial additional debt service in addition to operating
expenses and planned capital expenditures. At June 30, 1998, as adjusted to give
effect to the issuance of the maximum $32,500,000 principal amount of the
Debentures, the total indebtedness of the Company would have been approximately
$96.3 million. In addition, assuming the issuance of the maximum $32,500,000
principal amount of the Debentures pursuant to the Exchange Offer, the Company
would incur additional debt service of approximately $3,900,000 annually.
The Company's increased level of indebtedness may have several important
effects on its future operations, including, without limitation, (i) a
substantial portion of the Company's cash flow from operations must be dedicated
to the payment of interest and principal on its indebtedness, reducing the funds
available for operations and for capital expenditures, including acquisitions,
(ii) covenants contained in the Indenture will require the Company to meet
certain financial tests, and other restrictions may limit its ability to borrow
additional funds or to dispose of assets, and may affect the Company's
flexibility in planning for, and reacting to, changes in its business, including
possible acquisition activities, (iii) the Company's leveraged position will
substantially increase its vulnerability to adverse changes in general economic,
industry and competitive conditions, (iv) the Company's ability to obtain
additional financing for working capital, capital expenditures, acquisitions,
general corporate and other purposes may be limited, and (v) the Company's
leveraged position and the various covenants contained in the Indenture may
place the Company at a relative competitive disadvantage as compared to certain
of its competitors. The Company's ability to meet its debt service obligations
and to reduce its total indebtedness will be dependent upon the Company's future
performance, which will be subject to general economic, industry and competitive
conditions and to financial, business and other factors affecting the operations
of the Company, many of which are beyond its control, or its ability to raise
additional equity. There can be no assurance that the Company's business will
continue to generate cash flow at or above current levels. If the Company is
unable to generate sufficient cash flow from operations in the future to service
its debt, it may be required, among other things, to seek additional financing
in the debt or equity markets, to refinance or restructure all or a portion of
its indebtedness, including the Debentures, to sell selected assets, or to
reduce or delay planned capital expenditures and growth or business strategies.
There can be no assurance that any such measures would be sufficient to enable
the Company to service its debt, or that any of these measures could be effected
on satisfactory terms, if at all.
If the Company fails to pay any required payment of interest or principal
with respect to the Debentures on a timely basis, such failure will constitute a
default under the terms of the Indenture. An event of default under the
Indenture also may trigger an event of default under certain other existing
obligations of the Company, including its revolving credit facility (the
"Revolving Facility") with General Electric Capital Corporation ("GE Capital").
As a result, the incurrence of additional debt resulting from the Exchange Offer
will increase the risk of possible default by the Company with respect to its
current and future obligations.
SUBORDINATION
The Debentures will be unsecured obligations of the Company and will be
subordinated in right of payment to all existing and future Senior Indebtedness
(as defined in the Indenture), which will include borrowings under the Company's
Revolving Facility with GE Capital and, if the Split-up does not occur, the
Verde Note (as defined herein). The Debentures will rank senior only to other
indebtedness of the Company that expressly provides that it is subordinated in
right of payment to the Debentures, if any. In the event of bankruptcy,
liquidation, insolvency, reorganization or similar proceeding relating to the
Company, the assets of the Company will be available to pay obligations on the
Debentures only after all Senior Indebtedness has
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<PAGE> 13
been paid in full, and there may not be sufficient assets remaining to pay
amounts due on any or all of the Debentures outstanding. The Company may not pay
principal of or interest on the Debentures, make any deposit pursuant to
defeasance provisions or repurchase or redeem or otherwise retire any Debentures
(i) if any payment obligation on Senior Indebtedness is not paid when due or
(ii) if any other event of default on Senior Indebtedness occurs that permits
the holders of such Senior Indebtedness to accelerate the maturity of such
Senior Indebtedness, in accordance with its terms, and the Trustee for the
Debentures receives a notice of such default unless, in either case, the default
has been cured or waived, any such acceleration has been rescinded or such
Senior Indebtedness has been paid in full or, in the case of any default other
than a payment default, 179 days have passed since the default notice is given.
In addition, if there exists an event of default, as such term is defined in any
instrument creating or evidencing any Designated Senior Indebtedness (described
below), on any Designated Senior Indebtedness or if an executive officer of the
Company has actual knowledge of a default on any Designated Senior Indebtedness,
which with notice or lapse of time or both would become an event of default,
then no payment can be made on the Debentures for a period of 179 days from the
date of such event of default or the date that an executive officer of the
Company obtains actual knowledge that there is such a default unless such
default is cured or waived or a representative of such Designated Senior
Indebtedness terminates the payment blockage period. Moreover, even if there is
an event of default with respect to the Debentures and the Debentures are
declared due and payable as a result thereof, no payment can be made on the
Debentures while any Designated Senior Indebtedness is outstanding without the
consent of the Designated Senior Indebtedness. In the event that there is an
event of default under the Designated Senior Indebtedness or an executive
officer of the Company has actual knowledge of a default under Designated Senior
Indebtedness and a payment is made on the Debentures in violation of the above
provisions, holders of Debentures receiving such payment may be required to
return the monies paid for the benefit of the Senior Indebtedness. In addition,
in an insolvency, bankruptcy or liquidation scenario, there is always the risk
that senior creditors would seek to recover any monies paid on the Debentures.
Designated Senior Indebtedness includes the Revolving Facility with GE Capital,
as amended from time to time and any refundings or replacements thereof, as well
as any other Senior Indebtedness designated by the Company from time to time as
Designated Senior Indebtedness. There are no restrictions in the Indenture on
the ability of the Company to designate Senior Indebtedness as Designated Senior
Indebtedness. As of June 30, 1998, without including any indebtedness under the
Debentures, (i) the Company had approximately $72.9 million of indebtedness
outstanding, all of which would be Senior Indebtedness and $41.8 million of
which would be Designated Senior Indebtedness under the Revolving Facility with
GE Capital. However, although there was only $41.8 million outstanding under the
Revolving Facility with GE Capital as of June 30, 1998, the Company may, under
certain circumstances and if certain conditions are satisfied, borrow up to $125
million under that facility. Moreover, there is always the possibility that the
maximum commitment on the facility could be increased. Additional Senior
Indebtedness may be incurred by the Company and its subsidiaries from time to
time, subject to certain restrictions imposed by the Indenture, the Revolving
Facility with GE Capital and other agreements of the Company. See "Description
of the Debentures -- Subordination" and "-- Certain Covenants."
HOLDING COMPANY STRUCTURE; EFFECTS OF ASSET ENCUMBRANCES
The Debentures will be unsecured obligations of the Company and will be
subordinated in right of payment to all existing and future Senior Indebtedness
of the Company. The Debentures will also be structurally subordinated to all
indebtedness and other liabilities of the Company's subsidiaries. Substantially
all of the Company's operating income is generated by its subsidiaries and the
Company from time to time will not hold assets other than the stock of its
subsidiaries. As a result, the Company will rely on dividends and other payments
received from its subsidiaries to provide substantially all of the funds
necessary to meet its debt service obligations, including the payment of
principal of and interest on the Debentures. Certain agreements of the Company
may now or in the future limit the ability of its subsidiaries in certain
situations to pay dividends to the Company or to repay intercompany debt. The
Debentures are not guaranteed by any of the subsidiaries of the Company, and
therefore, should the Company fail to satisfy any payment obligation under the
Debentures, the holders would not have a direct claim therefor against the
subsidiaries. Any indebtedness incurred directly by the subsidiaries of the
Company, including guarantees, will be senior in right
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<PAGE> 14
of payment to the common stock of such subsidiaries. This means that in the
event of any liquidation or bankruptcy of a subsidiary, all debt of such
subsidiary would be entitled to be paid before any amounts would be available to
the Company by virtue of ownership of the common stock. Except as described
above under "Risk Factors -- Restrictions Imposed by Terms of Indebtedness" and
under "Description of the Debentures -- Certain Covenants," the Indenture will
not limit the ability of the Company and its subsidiaries to incur additional
indebtedness, including Senior Indebtedness. Moreover, certain Senior
Indebtedness of the Company is now and may in the future be guaranteed by, and
secured by the assets of, the Company's subsidiaries. In the event of a default
under any such Senior Indebtedness, the lenders thereunder would be entitled to
a claim on the assets securing such indebtedness. Accordingly, because of any or
all of the above, the Company may not have sufficient monies available from its
subsidiaries or from other means, or assets remaining after payment of prior
claims from time to time, to pay amounts due on the Debentures. In addition,
Ugly Duckling Receivables Corporation ("UDRC") and Ugly Duckling Receivables
Corporation II ("UDRC II"), formally known as Champion Receivables Corporation
("CRC") and Champion Receivables Corporation II ("CRC II"), respectively, are
the Company's wholly-owned special purpose "bankruptcy remote" entities. Their
assets, including assets in discontinued operations, are comprised of Residuals
in Finance Receivables Sold and Investments Held In Trust, in the amounts of
approximately $39.9 million and $22.1 million, respectively, at June 30, 1998,
which amounts would not be available to satisfy claims of creditors of the
Company on a consolidated basis.
RISK OF PREPAYMENT
The Debentures are subject to redemption at the option of the Company in
whole at any time or in part from time to time without penalty or premium upon
notice to the holders of the Debentures. As a result, the holders of the
Debentures will be subject to a risk of prepayment at a time when interest rates
may be generally declining. In such case, holders of Debentures that are
redeemed who tendered their Shares to acquire an interest-bearing security will
no longer have the right to receive interest and may be forced to reinvest the
redemption proceeds in securities with a lower rate of interest.
FRAUDULENT TRANSFER STATUTES
Various fraudulent conveyance laws enacted for the protection of creditors
may apply to the issuance of the Debentures. Under federal or state fraudulent
transfer laws, if a court were to find that, at the time the Debentures were
issued, the Company (i) issued the Debentures with the intent of hindering,
delaying or defrauding current or future creditors or (ii) (A) received less
than fair consideration or reasonably equivalent value for incurring the
indebtedness represented by the Debentures and (B) (1) was insolvent or was
rendered insolvent or contemplated insolvency by reason of the issuance of the
Debentures, (2) was engaged, or about to engage, in a business or transaction
for which its assets or capital were unreasonably small or (3) intended to
incur, or believed (or should have believed) it would incur, debts beyond its
ability to pay as such debts mature (as all of the foregoing terms are defined
in or interpreted under such fraudulent transfer statutes), such court could
void all or a portion of the Company's obligations to the holders of the
Debentures, or void or subordinate the Company's obligations to the holders of
the Debentures, and take other action detrimental to the holders of the
Debentures, including in certain circumstances, invalidating the Debentures. In
that event, there would be no assurance that any repayment on the Debentures
would ever be recovered by the holders of the Debentures.
The definition of insolvency for purposes of the foregoing consideration
varies among jurisdictions depending upon the federal or state law that is being
applied in any such proceeding. Generally, however, the Company would be
considered insolvent at the time it incurs the indebtedness constituting the
Debentures, if (i) the fair market value (or fair saleable value) of its assets
is less than the amount required to pay its total existing debts and liabilities
(including the probable liability on contingent liabilities) as they become
absolute or matured or (ii) it is incurring debts beyond its ability to pay as
such debts mature. Based upon financial and other information, the Company
believes that it is solvent and will continue to be solvent after issuing the
Debentures, will have sufficient capital for carrying on its business after such
issuance and will be able to pay its debts as they mature. There can be no
assurance, however, that a court passing on such standards would
12
<PAGE> 15
agree with the Company. There can also be no assurance as to what standard a
court would apply in order to determine whether the Company was "insolvent" as
of the date the Debentures were issued, or that, regardless of the method of
valuation, a court would not determine that the Company was insolvent on that
date or otherwise agree with the Company with respect to the above standards.
CERTAIN UNITED STATES FEDERAL INCOME TAX RISKS
Tax Consequences of Exchange Offer
The exchange of Shares for Debentures by a tendering stockholder pursuant
to the Exchange Offer will be a taxable event treated for United States federal
income tax purposes as either (1) a sale or exchange of the stockholder's Shares
or (2) a deemed distribution of property by the Company with respect to such
Shares.
Sale or exchange treatment will result if a tendering stockholder satisfies
any of three tests under Section 302 of the Code which measure reductions in a
stockholder's overall equity interest. If treated as a sale or exchange, a
stockholder will recognize capital gain or loss in an amount equal to the
difference between the "issue price" of the Debentures and the stockholder's
adjusted tax basis of the Shares exchanged pursuant to the Exchange Offer. In
general, the "issue price" of the Debentures should be the trading value of the
Shares as of the time of the exchange.
If none of the Section 302 tests is satisfied, then to the extent of the
Company's current or accumulated "earnings and profits" (as determined for
federal income tax purposes), a tendering stockholder will be treated as having
received a dividend taxable as ordinary income in an amount equal to the sum of
the cash (if any) plus the fair market value (as of the time of the exchange) of
the Debentures received without reduction for the adjusted tax basis of the
Shares exchanged pursuant to the Exchange Offer. The stockholder's adjusted tax
basis in the Shares exchanged will be added to the stockholder's remaining
Shares; however, if the stockholder retains no Shares following the exchange,
the benefit of such basis will be permanently lost. To the extent, if any, that
the sum of the cash plus the fair market value of the Debentures exceeds the
Company's current and accumulated earnings and profits (as determined for
federal income tax purposes), the excess will be treated first as a tax-free
return of such stockholder's tax basis in the Shares and thereafter as capital
gain. Corporate stockholders receiving a dividend must assess the applicability
of the dividends-received deduction to the extent applicable and the impact of
Section 1059 governing "extraordinary distributions."
In determining whether any one of the Section 302 tests is satisfied, a
tendering stockholder must take into account not only the Shares actually owned
by such stockholder but also Shares which are constructively owned by the
stockholder by reason of attribution rules contained in Section 318 of the Code.
The Company cannot predict whether or to what extent the Exchange Offer will be
oversubscribed. If the Exchange Offer is oversubscribed, proration of the
tenders pursuant to the Exchange Offer will cause the Company to accept fewer
Shares than are tendered. Therefore, a stockholder can be given no assurance
that a sufficient number of such stockholder's Shares will be exchanged pursuant
to the Exchange Offer to ensure that such exchange will satisfy one or more of
the Section 302 tests and be treated as a sale, rather than as a dividend, for
United States federal income tax purposes.
If a stockholder sells Shares to persons other than the Company at or about
the same time such holder also exchanges Shares pursuant to the Exchange Offer
and the various sales effected by the stockholder are part of a plan to reduce
or terminate the stockholder's proportionate equity interest in the Company,
then sales to persons other than the Company may, for United States federal
income tax purposes, be integrated with the stockholder's exchange of Shares
pursuant to the Exchange Offer and, if integrated, should be taken into account
in determining whether a tendering stockholder satisfies any of the Section 302
tests.
See "Certain United States Federal Income Tax Consequences" -- "Certain
Federal Income Tax Consequences to Tendering Stockholders" -- "Characterization
of the Exchange."
Interest on Debentures -- General
In general, interest will be taxable as ordinary income to a holder of a
Debenture at the time such amounts are accrued or received in accordance with
the holder's method of accounting. See "Certain United
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<PAGE> 16
States Federal Income Tax Consequences" -- "Certain Federal Income Tax
Consequences to Tendering Stockholders" -- "Interest on the
Debentures -- General". Depending upon a stockholder's particular circumstances,
the tax consequences of holding Debentures may be less advantageous than the
consequences of holding Shares because, for example, interest payments on the
Debentures will not be eligible for any dividends-received deduction that might
otherwise be available to corporate stockholders.
Original Issue Discount on Debentures
The Debentures may be issued with significant "original issue discount" for
United States federal income tax purposes. Consequently, holders of the
Debentures may be required to recognize significant amounts of income in advance
of receipt of the cash payments to which the income is attributable for United
States federal income tax consequences, regardless of the holders' methods of
accounting. See "Certain United States Federal Income Tax
Consequences" -- "Certain Federal Income Tax Consequences to Prospective Holders
of Debentures" -- "Original Issue Discount on Debentures" and "Taxation of
Original Issue Discount on Debentures."
STOCKHOLDERS CONTEMPLATING AN EXCHANGE OF SHARES FOR DEBENTURES PURSUANT TO
THE EXCHANGE OFFER ARE URGED TO CONSULT THEIR OWN TAX ADVISORS TO DETERMINE THE
SPECIFIC FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF EXCHANGES
MADE BY THEM PURSUANT TO THE EXCHANGE OFFER AS WELL AS THE SPECIFIC FEDERAL,
STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES ASSOCIATED WITH THE OWNERSHIP
OF DEBENTURES RECEIVABLE IN THE EXCHANGE.
FORWARD LOOKING STATEMENTS
This Offering Circular contains certain forward looking statements.
Additional written or oral forward looking statements may be made by the Company
from time to time in filings with the Commission or otherwise. Such statements
may include, but not be limited to, estimates of the value of the Company's
Common Stock, projections of revenues, income, earnings per share, loss, capital
expenditures, plans for future operations, financing needs or plans, the
Company's ability to service its debt obligations, and plans relating to
products or services of the Company as well as assumptions relating to the
foregoing. The words "believe," "expect," "anticipate," "estimate," "project,"
and similar expressions identify forward looking statements. Forward looking
statements are inherently subject to risks and uncertainties, some of which
cannot be predicted or quantified. Future events and actual results could differ
materially from those set forth in, contemplated by, or underlying the forward
looking statements. Statements in this Offering Circular, including those
contained in the section entitled "Risk Factors," and in the section entitled
"Background, Purpose and Effect of the Exchange Offer," describe factors, among
others, that could contribute to or cause such differences. The Company
undertakes no obligation to update any forward looking statements.
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<PAGE> 17
THE EXCHANGE OFFER
GENERAL
The Company hereby offers, upon the terms and subject to the conditions set
forth herein and in the accompanying Letter of Transmittal, to exchange up to
$32,500,000 aggregate principal amount of its Debentures for up to 5,000,000
Shares of its outstanding Common Stock on the basis of $6.50 principal amount of
Debentures for each Share of Common Stock outstanding.
The Exchange Offer is contingent on the tender of at least 1,000,000 Shares
of Common Stock. If less than 1,000,000 shares are duly tendered, the Company
will accept none of the Shares tendered. If more than 5,000,000 Shares are
tendered, the Company will accept no more than 5,000,000 Shares of Common Stock,
with Debentures to be allocated among the tendering stockholders on a pro rata
basis. The Exchange Offer is subject to a number of additional conditions. See
"The Exchange Offer -- Conditions to and Amendment of the Exchange Offer."
Stockholders who do not tender will retain their Shares of Common Stock and
stockholders who tender will receive Debentures with the following rights
compared to those associated with the ownership of Common Stock.
<TABLE>
<CAPTION>
COMMON STOCK DEBENTURES
- -------------------------------------------- --------------------------------------------
<S> <C>
Equity; pro rata claim to assets of the Debt; right to receive specified principal
Company after payment of all debt amount with senior claim to assets of the
obligations, plus right to share in capital Company compared to holders of equity, but
appreciation. subordinated to all other senior debt
obligations of the Company, plus the right
to receive interest, but no right to capital
appreciation.
No interest payable on Common Stock, Interest at 12% year annum, payable
although dividends are possible. semiannually in cash on each April 15 and
October 15, commencing April 15, 1999.
Voting rights on all matters submitted to No voting rights.
stockholders.
Shares are listed on Nasdaq and are subject Debentures will not be listed on any
to established trading market. exchange or automated quotation system; no
assurance of any trading market.
</TABLE>
The foregoing table is set forth for comparative purposes only and does not
take into account all factors relating to a comparison of the Shares to the
Debentures, nor does it take into account any factors relating to the tax
consequences of accepting the Exchange Offer. For a more complete description of
the Debentures and the Common Stock, see "Description of the Debentures" and
"Description of Capital Stock." See also "Certain United States Federal Income
Tax Consequences."
Tendering stockholders will not be obligated to pay brokerage commissions
or fees or, subject to Instruction 9 of the Letter of Transmittal, transfer
taxes with respect to the exchange of Shares for Debentures pursuant to the
Exchange Offer. The Company will pay all charges and expenses of the Exchange
Agent, the Information Agent, and the Trustee in connection with the Exchange
Offer. See "The Exchange Offer -- Payment of Expenses."
EXPIRATION TIME, EXTENSIONS, TERMINATION AND AMENDMENTS
The Exchange Offer will terminate at 5:00 p.m., New York City time, on
Monday, October 19, 1998, unless extended by the Company in its sole discretion.
During any extension of the Exchange Offer, all Shares previously tendered and
not yet exchanged will remain subject to the Exchange Offer (subject to
withdrawal rights specified herein) and may be accepted for exchange by the
Company. The later of 5:00 p.m., New York
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<PAGE> 18
City time, on Monday, October 19, 1998, or the latest time and date to which the
Exchange Offer may be extended, is referred to herein as the "Expiration Time."
The Company expressly reserves the right, at any time or from time to time,
to extend the period of time for which the Exchange Offer is to remain open by
giving oral or written notice to Harris Trust and Savings Bank (the "Exchange
Agent") of such extension prior to 9:00 a.m., New York City time, on the
business day after the previously scheduled Expiration Time. The Company also
expressly reserves the right (i) to terminate the Exchange Offer and not accept
for exchange any Shares not theretofore accepted for exchange upon the
occurrence of any of the events set forth herein under "The Exchange
Offer -- Conditions to and Amendment of the Exchange Offer" or (ii) to amend the
Exchange Offer. Any such extension, termination or amendment will be followed as
promptly as practicable by public announcement thereof, such announcement in the
case of an extension to be issued no later than 9:00 a.m., New York City time,
on the next business day after the previously scheduled Expiration Time. Without
limiting the manner in which the Company may choose to make such public
announcement, the Company shall not, unless otherwise required by law, have an
obligation to publish, advertise or otherwise communicate any such public
announcement other than by making a release to the Dow Jones News Service.
HOW TO TENDER
Except as set forth below, for a stockholder to duly tender Shares pursuant
to the Exchange Offer, certificates representing the Shares (or a confirmation
of a book-entry transfer of the Shares into the Exchange Agent's account at The
Depository Trust Company ("DTC") as described below), together with a properly
completed and duly executed Letter of Transmittal or facsimile thereof, with any
required signature guarantees and any other required documents, must be
transmitted to and received by the Exchange Agent on or prior to the Expiration
Time at one of the addresses specified below under "The Exchange Offer --
Exchange Agent." LETTERS OF TRANSMITTAL AND CERTIFICATES REPRESENTING THE SHARES
SHOULD NOT BE SENT TO UGLY DUCKLING OR TO THE INFORMATION AGENT. Signatures on
Letters of Transmittal need not be guaranteed by a firm which is a member of a
registered national securities exchange or a member of the National Association
of Securities Dealers, Inc. ("NASD") or by a commercial bank or trust company
having an office in the United States ("Eligible Institution"), provided the
Shares tendered pursuant thereto are tendered (i) by a registered holder of the
Shares who has not completed the box entitled "Special Registration
Instructions" or "Special Delivery Instructions" on the Letter of Transmittal or
(ii) for the account of an Eligible Institution. In all other cases, signatures
must be guaranteed by an Eligible Institution. If Shares are registered in the
name of a person other than the signer of the Letter of Transmittal, the
certificates representing the Shares must be endorsed by, or be accompanied by,
a written instrument or instruments of transfer or exchange in form satisfactory
to the Company, duly executed by the registered holder, with the signature
thereon guaranteed as aforesaid.
The Exchange Agent has established an account with respect to the Shares at
DTC and any financial institution which is a participant in the DTC system may
make book-entry delivery of the Shares by causing DTC to transfer such Shares
into the Exchange Agent's account in accordance with DTC's procedure for such
transfer. However, although delivery of Shares may be effected through
book-entry transfer into the Exchange Agent's account at DTC, the Letter of
Transmittal (or facsimile thereof), with any required signature guarantees and
any other required documents, must in any case be transmitted to and received by
the Exchange Agent prior to the Expiration Time at one of the addresses
specified below under "The Exchange Offer -- Exchange Agent", or the guaranteed
delivery procedure described below must be complied with. Delivery of documents
to DTC in accordance with DTC's procedures does not constitute delivery to the
Exchange Agent.
Tendering stockholders are required under federal income tax law to provide
a correct Taxpayer Identification Number on a Substitute Form W-9 which is
included, together with guidelines relating to the form, with the Letter of
Transmittal. Failure to complete and return this Substitute Form W-9 to the
Exchange Agent may subject a stockholder to a $50 penalty imposed by the
Internal Revenue Service and will result in backup withholding of 31% on
interest and other payments with respect to the Debentures and cash in lieu of
fractional interests in the Debentures.
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<PAGE> 19
The method of delivery of certificates representing the Shares and all
other required documents is at the election and risk of the tendering
stockholder but delivery by registered mail with return receipt requested,
properly insured, is recommended.
If a stockholder desires to tender Shares and certificates representing the
Shares are not immediately available or time will not permit such holder's
Letter of Transmittal, certificates representing the Shares or other required
documents to reach the Exchange Agent before the Expiration Time, such holder's
tender may be effected if:
(a) such tender is made through an Eligible Institution;
(b) prior to the Expiration Time, the Exchange Agent has received a
telegram, facsimile transmission or letter from such Eligible Institution
setting forth the name and address of the holder of such Shares and the
number of the Shares tendered and stating that the tender is being made
thereby and guaranteeing that, within three Nasdaq trading days after the
date of such telegram, facsimile transmission or letter, the Letter of
Transmittal, together with certificates representing the Shares (or
confirmation of book-entry transfer of such Shares into the Exchange
Agent's account with DTC as described above) and any other documents
required by the Letter of Transmittal, will be deposited by such Eligible
Institution with the Exchange Agent; and
(c) such Letter of Transmittal and certificates representing the
Shares, in proper form for transfer (or confirmation of book-entry transfer
of such Shares into the Exchange Agent's account at DTC as described
above), and other required documents are received by the Exchange Agent
within three Nasdaq trading days after the date of such telegram, facsimile
transmission or letter.
The acceptance by a stockholder of the Exchange Offer pursuant to one of
the procedures set forth above will constitute an agreement between the
stockholder and the Company in accordance with the terms and subject to the
conditions set forth herein and in the accompanying Letter of Transmittal.
The Company will accept Shares by giving notice thereof to the Exchange
Agent.
All questions as to the form of all documents and the validity (including
time of receipt) and acceptance of all tenders will be determined by the
Company, in its sole discretion, which determination shall be final and binding.
The Company reserves the absolute right to reject any and all tenders not in
proper form or the acceptance of which would, in the opinion of the Company's
counsel, be unlawful. The Company also reserves the absolute right to waive any
of the conditions of the Exchange Offer or any defect or irregularity in the
tender of any of the Shares. The Company's interpretation of the terms and
conditions of the Exchange Offer (including the Letter of Transmittal and the
instructions thereto) will be final. No tender of Shares will be deemed to have
been properly made until all defects and irregularities have been cured or
waived. Neither the Company, the Information Agent, the Exchange Agent nor any
other person shall be under any duty to give notification of any defects or
irregularities in tenders, nor shall any of them incur any liability for failure
to give such notification.
WITHDRAWAL RIGHTS
All tenders duly and validly made are irrevocable, except that Shares
tendered pursuant to the Exchange Offer may be withdrawn prior to the Expiration
Time, and, unless theretofore accepted for exchange as provided in the Exchange
Offer, may also be withdrawn after 5:00 p.m., New York City time, on November
17, 1998.
To be effective, a written, telegraphic or facsimile transmission notice of
withdrawal must be received by the Exchange Agent on a timely basis at one of
the addresses specified under "The Exchange Offer -- Exchange Agent." Any notice
of withdrawal must specify the name of the person having tendered the Shares to
be withdrawn, the names in which the Shares are registered if different from
that of the tendering stockholder and the number of Shares to be withdrawn. If
certificates representing the Shares have been physically delivered to the
Exchange Agent, then prior to the release of such certificates, the tendering
stockholder must also submit the certificate number of the certificates
representing the Shares to be
17
<PAGE> 20
withdrawn and the signature on such holder's notice of withdrawal must be
guaranteed by an Eligible Institution. If certificates representing the Shares
have been delivered pursuant to the book-entry procedures set forth above under
"The Exchange Offer -- How to Tender," any notice of withdrawal must specify the
name and number of the participant's account at DTC to be credited with the
withdrawn Shares. All questions as to validity, form and eligibility (including
time of receipt) of notices of withdrawal will be determined by the Company, in
its sole discretion, which determination shall be final and binding. Any Shares
effectively withdrawn will be deemed not to have been duly tendered for purposes
of the Exchange Offer.
None of the Company, the Information Agent or any other person will be
under any duty to give notification of any defects or irregularities in any
notice of withdrawal or incur any liability for failure to give such
notification. However, the Exchange Agent will attempt to correct any defective
tenders by contacting the tendering stockholder. Withdrawals of tenders of
Shares may not be rescinded, and any Shares properly withdrawn will thereafter
be deemed not validly tendered for purposes of the Exchange Offer. However,
withdrawn Shares may be returned by following one of the procedures described
under "The Exchange Offer -- How to Tender" at any time prior to the Expiration
Time.
ACCEPTANCE OF SHARES FOR EXCHANGE;
DELIVERY OF DEBENTURES TO BE EXCHANGED
Upon the terms and subject to the conditions of the Exchange Offer, the
acceptance for exchange of Shares validly tendered and not withdrawn will be
made promptly after the Expiration Time. For purposes of the Exchange Offer, the
Company will be deemed to have accepted for exchange validly tendered Shares
when, as and if the Company has given oral or written notice thereof to the
Exchange Agent. The Exchange Agent will act as agent for the tendering
stockholders for the purposes of receiving Debentures from the Company and
transmitting such securities to such stockholders. If the Company should extend
the Exchange Offer or be delayed in consummation of the Exchange Offer for any
reason, then, without prejudice to the Company's rights under the Exchange
Offer, the Exchange Agent acting on behalf of the Company may retain tendered
Shares, and such Shares may not be withdrawn, subject to the withdrawal rights
of tendering stockholders set forth above under "The Exchange
Offer -- Withdrawal Rights." Tendered Shares not accepted for exchange by the
Company because of an invalid tender, the termination of the Exchange Offer as a
result of the existence of a condition set forth below under "The Exchange
Offer -- Conditions to and Amendment of the Exchange Offer" or for any other
reason, will be returned without expense to the tendering stockholders (or, in
the case of Shares delivered by book-entry transfer within DTC, will be credited
to the account maintained within DTC by the participant in the DTC system who
delivered such Shares) as promptly as practicable following the expiration or
termination of the Exchange Offer.
Delivery of Debentures in exchange for Shares tendered pursuant to the
Exchange Offer will be made by the Company to the Exchange Agent, as agent for
the tendering stockholders, only after receipt by the Exchange Agent of
certificates representing the tendered Shares (or confirmation of the book-entry
transfer of such Shares into the Exchange Agent's account at DTC), a properly
completed and duly executed Letter of Transmittal (or facsimile thereof), and
any other required documents.
DENOMINATIONS; FRACTIONAL INTERESTS
The Debentures will be issued only in denominations of $1.00 and integral
multiples thereof. Fractional interests with respect to the Debentures will not
be distributed to tendering stockholders. Instead, the Company will pay cash in
lieu of such interests.
PRORATION IF SHARES TENDERED EXCEED MAXIMUM
If stockholders tendering Shares validly tender more than 5,000,000 shares,
the Company will accept for exchange no more than 5,000,000 Shares. In such
event, Debentures will be allocated to tendering
18
<PAGE> 21
stockholders on a pro rata basis based on the number of Shares tendered by each
tendering stockholder. The Company will accept from each tendering stockholder
that number of Shares equal to 5,000,000 multiplied by a fraction, the numerator
of which is the total number of Shares validly tendered by such tendering
stockholder and the denominator of which is the total number of Shares validly
tendered by all tendering stockholders. The number of Shares will be rounded up
or down as nearly as practicable to result in the tender of whole Shares rather
than fractional Shares. Any Shares not accepted by the Company as a result of
the allocation described above will be returned promptly to the tendering
stockholder.
EXCHANGE OFFER SUBJECT TO MINIMUM NUMBER OF SHARES TENDERED
The Exchange Offer is subject to the condition that holders of at least
1,000,000 Shares of Common Stock validly tender Shares in the Exchange Offer. If
less than 1,000,000 Shares are validly tendered by the Expiration Time, the
Company will accept none of Shares tendered and the Exchange Offer will be
terminated.
CONDITIONS TO AND AMENDMENT OF THE EXCHANGE OFFER
The Company may accept up to 5,000,000 Shares validly tendered
(representing approximately 27% of the outstanding Shares of the Company's
Common Stock as of September 15, 1998). If more than 5,000,000 Shares are
tendered, the Company will accept no more than 5,000,000 Shares of Common Stock,
to be allocated among the tendering stockholders on a pro rata basis as
described under "-- Proration if Shares Tendered Exceed Maximum." If less than
1,000,000 Shares are validly tendered by the Expiration Time, the Company will
accept none of the Shares tendered and the Exchange Offer will be terminated.
See "Exchange Offer Subject to Minimum Number of Shares Tendered." The Exchange
Offer is subject to other conditions described below.
An application will be filed with the Commission for qualification of the
Indenture under which the Debentures will be issued under the Trust Indenture
Act of 1939 (the "Trust Indenture Act"). The Exchange Offer is conditioned upon
the Indenture being qualified under the Trust Indenture Act. In addition to the
foregoing conditions, the Company may decline to accept any Shares in exchange
for Debentures and may withdraw the Exchange Offer as to Shares not then
accepted if, before the time of acceptance, there shall have occurred any of the
following events which, in the Company's sole judgment, makes it inadvisable to
proceed with such acceptance:
(a) any government agency or other person shall have instituted or
threatened any action or proceeding before any court or administrative
agency (i) challenging the acquisition of Shares pursuant to the Exchange
Offer or otherwise in any manner relating to the Exchange Offer or (ii)
otherwise materially adversely affecting the Company, or there shall have
occurred any existing action or proceeding with respect to the Company; or
(b) any statute, rule or regulation shall have been proposed or
enacted, or any action shall have been taken by any governmental authority,
which would or might prohibit, restrict or delay consummation of the
Exchange Offer or materially impair the contemplated benefits of the
Exchange Offer to the Company; or
(c) any state of war, national emergency, banking moratorium or
suspension of payments by banks in the State of New York shall have
occurred, or any currency or exchange control laws or regulations or
general suspension of trading or limitation on prices on Nasdaq shall have
been imposed or there shall have occurred a material adverse change in the
securities markets generally; or
(d) any required consents or approvals from third parties or
government regulatory agencies shall not have been obtained; or
(e) the Exchange Offer would result in the Company's Shares being
delisted from the Nasdaq National Market; or
(f) any change, or development involving a prospective change, in or
affecting the business or financial affairs of the Company shall have
occurred.
The Company reserves the right to waive any of the foregoing conditions.
The Company also reserves the right to amend the Exchange Offer by public
announcement of any amendment.
19
<PAGE> 22
EXCHANGE AGENT
Harris Trust and Savings Bank has been appointed as Exchange Agent for the
Exchange Offer. All correspondence in connection with the Exchange Offer and the
Letter of Transmittal should be addressed to the Exchange Agent, as follows:
HARRIS TRUST AND SAVINGS BANK
<TABLE>
<S> <C> <C>
Mailing Address: Facsimile Copy Number (For Hand/Overnight Delivery:
c/o Harris Trust Eligible Institutions Only): Harris Trust and Savings Bank
Company of New York 212-701-7636 c/o Harris Trust Company of
P.O. Box 1010 Confirm Receipt of Fascimile New York
Wall Street Station By Telephone 88 Pine Street, 19th Floor
New York, N.Y. 10268-1010 212-701-7624 New York, NY 10005
</TABLE>
DELIVERY TO AN ADDRESS OTHER THAN AS SET FORTH ABOVE OR TRANSMISSION VIA A
FACSIMILE NUMBER OTHER THAN AS SET FORTH ABOVE WILL NOT CONSTITUTE VALID
DELIVERY.
INFORMATION AGENT
Corporate Investor Communications, Inc. will act as Information Agent in
connection with the Exchange Offer. For further assistance or additional copies
of documents call the Information Agent toll-free at 1-888-673-4478 or write to
the Information Agent at:
<TABLE>
<S> <C> <C>
Mailing Address: Facsimile Copy Number: Hand Delivery:
Corporate Investor 201-804-8693 Corporate Investor
Communications, Inc. Communications, Inc.
111 Commerce Road 111 Commerce Road
Carlstadt, NJ 07072-2586 Carlstadt, NJ 07072-2586
</TABLE>
LETTERS OF TRANSMITTAL AND CERTIFICATES REPRESENTING THE SHARES SHOULD NOT
BE SENT TO THE INFORMATION AGENT. See "The Exchange Offer -- How to Tender."
NO FINANCIAL ADVISOR
No financial advisor has been retained to render, and no financial advisor
has rendered, an opinion as to the fairness of the Exchange Offer to holders of
the Company's Common Stock or to solicit exchanges of Common Stock for
Debentures.
PAYMENT OF EXPENSES
The Exchange Offer is being made by the Company in reliance on the
exemption from the registration requirements of the Securities Act of 1933, as
amended, afforded by Section 3(a)(9) thereof. Therefore, the Company will not
pay any commission or other remuneration to any broker, dealer, salesman or
other person for soliciting tenders of the Shares. However, regular employees of
the Company (who will not be additionally compensated therefor) may solicit
tenders and will answer inquiries concerning the Exchange Offer.
The Company will pay the Exchange Agent and the Information Agent
reasonable and customary fees for their services and will reimburse such parties
for their reasonable out-of-pocket expenses in connection
20
<PAGE> 23
therewith. The Company will also pay brokerage houses and other custodians,
nominees and fiduciaries the reasonable out-of-pocket expenses incurred by them
in forwarding copies of this Offering Circular and related documents to the
beneficial owners of the Shares held of record by such persons and in handling
or forwarding tenders and consents for their customers.
BACKGROUND, PURPOSE AND EFFECT OF THE EXCHANGE OFFER
Ugly Duckling completed its initial public offering in June 1996 with the
sale of 2,300,000 Shares of its Common Stock at a price of $6.75 per share.
Following the initial public offering, the price of the Company's Common Stock
increased significantly, to a high of $25.75 per share in the first quarter of
1997, reflecting a stock market with generally increasing stock prices, a
healthy used car sales and finance industry, and growth in the Company's
revenues and earnings. In recent periods, however, the used car sales and
financing industry has encountered difficulties, with several used car companies
announcing major downward adjustments to their financial statements, violations
of loan covenants, related litigation, and other events. In addition, certain of
these companies have filed for bankruptcy protection. These difficulties have
corresponded with a general decline in the stock prices of companies involved in
this industry. At the same time, stock prices of small-cap companies have
recently experienced a broad-based decline. Consistent with this market decline,
particularly with respect to companies in the used car sales and finance
industry, the price of the Company's Common Stock has decreased to $4.69 as of
September 15, 1998, a price that is at the low end of its 52-week trading range.
The Company does not believe that recent prices reflect the underlying
value of its Common Stock. In this regard, in establishing a tender price that
is significantly higher than the market price of the Shares as of September 15,
1998, the Company considered the following factors, among others.
- The closing price of $4.69 per Share as of September 15, 1998, two
business days prior to the announcement of the Exchange Offer, represents
an 82% decline from its all-time high in the first quarter of 1997 and a
63% decline from its high in 1998. See "Price Range of Common Stock."
- The recent Share price reflects a discount of approximately 53% to the
Company's book value per share as of June 30, 1998. See "Summary Selected
Consolidated Financial Data."
- The Company's recent and historical financial results, including the
Company's increase in revenues ($142.5 million compared to $46.0 million)
and basic earnings per share from continuing operations ($0.34 compared
to $0.17) for the six month period ended June 30, 1998 as compared to the
six month period ended June 30, 1997. See "Summary Selected Consolidated
Financial Data."
The principal purpose of the Exchange Offer is to reduce the number of
Shares of Common Stock outstanding by offering to purchase Shares in the
Exchange Offer, thereby offering the potential for increased earnings per share
in the future. The Company believes that if it is able to increase earnings per
share, this development could have a positive influence on the price of its
Common Stock. The increased indebtedness resulting from the Exchange Offer,
however, will significantly increase the Company's debt service requirements and
could negatively affect earnings per share. See "Risk Factors -- Increased
Leverage and Debt Service Obligations" and "-- No Assurance of Increased
Earnings Per Share."
Holders of Shares of Common Stock electing to participate in the Exchange
Offer will realize the following benefits.
- In exchange for Shares, tendering stockholders will receive a debt
security with a principal amount approximately 39% greater than the
market price of the Shares as of September 15, 1998.
- The Debentures will bear interest at 12% per annum, payable each April 15
and October 15 until the Debentures are paid in full.
- The Debentures, although subordinated in right of payment to all other
existing and future senior indebtedness of the Company, represent a claim
on the Company's assets senior to any claim of the holders of the
Company's Common Stock.
21
<PAGE> 24
Notwithstanding the benefits to tendering stockholders summarized above,
holders of Shares contemplating the Exchange Offer should take into account the
following considerations.
- Tendering stockholders receiving Debentures will relinquish the right to
share in any capital appreciation of the Company's Common Stock.
- Unlike the Shares, the Debentures will not be listed on any exchange or
automated quotation system and there can be no assurance that a trading
market will develop.
- Unlike holders of Common Stock, holders of the Debentures will have no
rights to vote on matters submitted to the Company's stockholders.
- The Company has the right to prepay the Debentures at any time without
penalty or premium by paying the unpaid principal amount and accrued
interest on the Debentures.
- Tendering stockholders will be subject to certain tax consequences that
may differ from those that would be realized if the Shares were sold for
cash.
Finally, holders of Shares contemplating the Exchange Offer should consider
that the Company has not retained any financial advisor or investment banking
firm to assist the Company in determining the price and terms of the Indentures
or whether the consideration offered in the Exchange Offer is adequate to
tendering stockholders. The Company also has not requested any report, opinion,
or appraisal relating to the fairness of the consideration being offered
pursuant to the Exchange Offer. For a discussion of risk factors which should be
taken into account in considering the Exchange Offer, see "Risk Factors."
If the Exchange Offer is completed, the Shares accepted for exchange will
be held by the Company as treasury stock.
22
<PAGE> 25
CAPITALIZATION
The following table sets forth the capitalization of the Company at June
30, 1998 and pro forma to give effect to the exchange of Debentures assuming the
minimum and maximum number of Shares were tendered, respectively, as if such
exchanges had occurred on June 30, 1998 and were valued at $4.70 per share,
which approximates the price of the Company's Common Stock at September 15,
1998.
<TABLE>
<CAPTION>
AS ADJUSTED
----------------------
MAXIMUM MINIMUM
NO. OF NO. OF
SHARES SHARES
ACTUAL EXCHANGED EXCHANGED
-------- --------- ---------
(IN THOUSANDS AND UNAUDITED)
<S> <C> <C> <C>
Debt:
Revolving Facility....................................... $ 41,795 $ 41,795 $ 41,795
Notes Payable............................................ 6,096 6,096 6,096
Subordinated Notes Payable............................... 25,000 25,000 25,000
12% Subordinated Debentures due 2003..................... -- 23,500 4,700
-------- -------- --------
Total Debt....................................... 72,891 96,391 77,591
-------- -------- --------
Stockholders' Equity:
Common Stock; $.001 par value, 100,000,000 shares
authorized, 18,567,000 issued and outstanding (Actual),
13,567,000 and 17,567,000 issued and outstanding,
respectively (As Adjusted)(1)............................ 173,562 149,912 168,712
Retained Earnings........................................ 10,228 10,228 10,228
-------- -------- --------
Total Stockholders' Equity....................... 183,790 160,140 178,940
-------- -------- --------
Total Capitalization............................. $256,681 $256,531 $256,531
======== ======== ========
</TABLE>
- ---------------
(1) Excludes (i) approximately 1,556,000 shares of Common Stock issuable upon
exercise of warrants issued and outstanding, (ii) up to 175,000 shares of
Common Stock issuable upon reaching certain milestones related to the
Reliance transaction, (iii) approximately 1,436,000 shares of Common Stock
issuable upon exercise of stock options issued and outstanding under the
Company's Long-Term Incentive Plan as of September 15, 1998, and (iv)
525,000 shares of Common Stock issuable upon exercise of stock options
issued and outstanding under the 1998 Executive Incentive Plan as of
September 15, 1998.
23
<PAGE> 26
UGLY DUCKLING CORPORATION
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA
The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of, each of the
years in the five-year period ended December 31, 1997, are derived from the
consolidated financial statements of the Company, which consolidated financial
statements have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The selected data presented below for the six-month periods
ended June 30, 1998 and 1997, and as of June 30, 1998 and 1997, are derived from
the unaudited condensed consolidated financial statements of the Company. The
information presented below under the caption "Dealership Operating Data" is
unaudited. In the opinion of management, such unaudited data reflect all
adjustments, consisting only of normally recurring adjustments, necessary to
fairly present the Company's financial position and results of operations for
the periods presented. The results of operations of any interim period are not
necessarily indicative of results to be expected for a full fiscal year. For
additional information, see the Consolidated Financial Statements and notes
thereto of the Company included the Company's proxy statement dated August 4,
1998.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales of Used Cars.............. $142,491 $ 46,013 $123,814 $ 53,768 $47,824 $27,768 $13,969
Less:
Cost of Used Cars Sold........ 81,213 25,890 72,358 31,879 29,733 13,604 6,606
Provision for Credit Losses... 29,308 8,109 22,354 9,657 8,359 8,024 3,292
-------- -------- -------- -------- ------- ------- -------
31,970 12,014 29,102 12,232 9,732 6,140 4,071
-------- -------- -------- -------- ------- ------- -------
Interest Income................. 7,439 4,691 12,559 8,597 8,227 4,683 1,629
Gain on Sale of Loans........... 8,273 4,143 6,721 3,925 -- -- --
Servicing Income................ 7,861 2,649 8,738 1,887 -- -- --
Other Income.................... 293 947 3,587 650 308 556 879
-------- -------- -------- -------- ------- ------- -------
23,866 12,430 31,605 15,059 8,535 5,239 2,508
-------- -------- -------- -------- ------- ------- -------
Income before Operating
Expenses...................... 55,836 24,444 60,707 27,291 18,267 11,379 6,579
Operating Expenses:
Selling and Marketing......... 10,220 3,772 10,538 3,585 3,856 2,402 1,293
General and Administrative.... 31,515 14,074 39,412 12,221 11,677 7,722 3,108
Depreciation and
Amortization................ 2,327 1,266 3,150 1,382 1,225 713 557
-------- -------- -------- -------- ------- ------- -------
44,062 19,112 53,100 17,188 16,758 10,837 4,958
-------- -------- -------- -------- ------- ------- -------
Income before Interest
Expense....................... 11,774 5,332 7,607 10,103 1,509 542 1,621
Interest Expense................ 1,164 440 706 2,429 5,328 2,870 893
-------- -------- -------- -------- ------- ------- -------
Earnings (Loss) before Income
Taxes......................... 10,610 4,892 6,901 7,674 (3,819) (2,328) 728
Income Taxes (Benefit).......... 4,274 1,987 2,820 694 -- (334) 30
-------- -------- -------- -------- ------- ------- -------
Earnings (Loss) from Continuing
Operations.................... $ 6,336 $ 2,905 $ 4,081 $ 6,980 $(3,819) $(1,994) $ 698
Discontinued Operations:
Earnings (Loss) from
Discontinued Operations, net
of income taxes............... (5,254) 4,668 5,364 (1,114) (153) 27 --
-------- -------- -------- -------- ------- ------- -------
Net Earnings (Loss)............. $ 1,082 $ 7,573 $ 9,445 $ 5,866 $(3,972) $(1,967) $ 698
======== ======== ======== ======== ======= ======= =======
</TABLE>
24
<PAGE> 27
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Earnings (Loss) per Common Share
from Continuing Operations:
Basic........................... $ .34 $ 0.17 $ 0.23 $ 0.77 $ (0.69) $ (0.36) $ 0.14
======== ======== ======== ======== ======= ======= =======
Diluted......................... $ .33 $ 0.16 $ 0.22 $ 0.73 $ (0.69) $ (0.36) $ 0.14
======== ======== ======== ======== ======= ======= =======
Net Earnings (Loss) per Common
Share:
Basic........................... $ 0.06 $ 0.44 $ 0.53 $ 0.63 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Diluted......................... $ 0.06 $ 0.43 $ 0.52 $ 0.60 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --
Continuing Operations
Basic Shares.................... 18,570 17,200 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 18,930 17,800 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --Net
Earnings (Loss)
Basic Shares.................... 18,570 17,200 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 18,930 17,800 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Earnings to Fixed Charges(a).... 5.08 6.34 3.91 2.62 (b) (b) 1.69
======== ======== ======== ======== ======= ======= =======
BALANCE SHEET DATA:
Cash and Cash Equivalents....... $ 1,652 $ 41,149 $ 3,537 $ 18,455 $ 1,419 $ 168 $ 79
Finance Receivables, Net........ 55,728 45,177 60,778 14,186 27,732 14,534 7,089
Total Assets.................. 278,845 215,476 275,633 117,629 60,712 29,681 11,936
Subordinated Notes Payable...... 25,000 12,000 12,000 14,000 14,553 18,291 8,941
Total Debt.................... 72,891 20,328 77,171 26,904 49,754 28,233 9,380
Preferred Stock................. -- -- -- -- 10,000 -- --
Common Stock.................... 173,562 171,317 172,622 82,612 127 77 1
Total Stockholders' Equity
(Deficit)................... 183,790 178,597 181,774 82,319 4,884 (1,194) 697
Principal Balances Serviced:
Dealership Sales................ 32,156 42,261 55,965 7,068 34,226 19,881 9,588
Securitized with Servicing
Retained...................... 293,117 160,043 238,025 51,662 -- -- --
Discontinued Operations......... 42,180 29,402 29,965 49,772 13,805 1,620 --
Servicing on Behalf of Others... 79,200 -- 127,322 -- -- -- --
-------- -------- -------- -------- ------- ------- -------
Total Serviced Portfolios..... $446,653 $231,706 $451,277 $108,502 $48,031 $21,501 $ 9,588
======== ======== ======== ======== ======= ======= =======
DEALERSHIP OPERATING DATA
(UNAUDITED):
Average Sales Price per Car..... $ 7,886 $ 7,329 $ 7,443 $ 7,107 $ 6,478 $ 5,269 $ 4,159
Number of Used Cars Sold........ 18,070 6,278 16,636 7,565 7,383 5,270 3,359
Company Dealerships............. 50 22 41 8 8 8 5
Number of Contracts
Originated.................... 17,857 5,819 16,001 6,929 6,129 4,731 3,093
Principal Balances Originated
(000 Omitted)................. $136,616 $ 43,979 $116,830 $ 48,996 $36,568 $23,589 $12,984
Retained Portfolio:
Number of Contracts
Outstanding................... 4,486 8,331 7,993 1,045 8,049 5,515 2,929
Allowance as % of Outstanding
Principal..................... 18.5% 23.3% 18.5% 23.0% 21.9% 30.4% 30.0%
Average Principal Balance
Outstanding................... $ 7,168 $ 5,073 $ 7,002 $ 6,764 $ 4,252 $ 3,605 $ 3,273
Average Yield on Contracts...... 25.7% 27.9% 26.7% 29.2% 28.0% 28.2% 26.4%
Delinquencies -- Retained
Portfolio:
Principal Balances 31 to 60
Days.......................... 1.1% 4.0% 2.2% 2.3% 4.2% 5.1% 10.5%
Principal Balances over 60
Days.......................... 2.2% 1.4% 0.6% 0.6% 1.1% 1.3% 15.0%
</TABLE>
- ---------------
25
<PAGE> 28
(a) For the purposes of these computations, "earnings" are defined as the sum of
pre-tax income from continuing operations plus fixed charges of the Company
and its subsidiaries, adjusted to exclude the amount of any interest
capitalized during the period, but adding the amount of previously
capitalized interest amortized during the period; "fixed charges" consist of
interest on debt, amortization of debt discount, premium, and expense, and
that portion of rents which is representative of the interest factor.
(b) Earnings did not cover fixed charges by $3.9 million and $2.5 million in the
years ended December 31, 1995 and 1994, respectively.
26
<PAGE> 29
CERTAIN PRO FORMA FINANCIAL INFORMATION
The table set forth below shows the pro forma effects the Exchange Offer
would have had on the adjusted financial condition and results of operations of
the Company for the year ended December 31, 1997 and for the six months ended
June 30, 1998, assuming the maximum and minimum number of Shares had been
exchanged on the first day of the respective periods and are valued at $4.70 per
share, which approximates the price of the Company's Common Stock at September
15, 1998.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998 YEAR ENDED DECEMBER 31, 1997
---------------------------------------- ----------------------------------------
PRO FORMA PRO FORMA
----------------------------- -----------------------------
MAXIMUM MINIMUM MAXIMUM MINIMUM
NO. OF SHARES NO. OF SHARES NO. OF SHARES NO. OF SHARES
ACTUAL EXCHANGED EXCHANGED ACTUAL EXCHANGED EXCHANGED
-------- ------------- ------------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Sales of Used Cars.............. $142,491 $142,491 $142,491 $123,814 $123,814 $123,814
Less:
Cost of Used Cars Sold........ 81,213 81,213 81,213 72,358 72,358 72,358
Provision for Credit Losses... 29,308 29,308 29,308 22,354 22,354 22,354
-------- -------- -------- -------- -------- --------
31,970 31,970 31,970 29,102 29,102 29,102
-------- -------- -------- -------- -------- --------
Interest Income................. 7,439 7,439 7,439 12,559 12,559 12,559
Gain on Sale of Finance
Receivables................... 8,273 8,273 8,273 6,721 6,721 6,721
Servicing Income................ 7,861 7,861 7,861 8,738 8,738 8,738
Other Income.................... 293 293 293 3,587 3,587 3,587
-------- -------- -------- -------- -------- --------
23,866 23,866 23,866 31,605 31,605 31,605
-------- -------- -------- -------- -------- --------
Income before Operating
Expenses...................... 55,836 55,836 55,836 60,707 60,707 60,707
Operating Expenses:
Selling and Marketing......... 10,220 10,220 10,220 10,538 10,538 10,538
General and Administrative.... 31,515 31,515 31,515 39,412 39,412 39,412
Depreciation and
Amortization................ 2,327 2,327 2,327 3,150 3,150 3,150
-------- -------- -------- -------- -------- --------
44,062 44,062 44,062 53,100 53,100 53,100
-------- -------- -------- -------- -------- --------
Operating Income................ 11,774 11,774 11,774 7,607 7,607 7,607
Interest Expense................ 1,164 4,014(1) 1,734(1) 706 6,406(1) 1,846(1)
-------- -------- -------- -------- -------- --------
Earnings before Income Taxes.... 10,610 7,760 10,040 6,901 1,201 5,761
Income Taxes.................... 4,274 3,134(2) 4,046(2) 2,820 491(2) 2,354(2)
-------- -------- -------- -------- -------- --------
Earnings from Continuing
Operations.................... 6,336 4,626 5,994 4,081 710 3,407
======== ======== ======== ======== ======== ========
Earnings per Common Share from
Continuing Operations:
Basic......................... $ 0.34 $ 0.34 $ 0.34 $ 0.23 $ 0.06 $ 0.20
======== ======== ======== ======== ======== ========
Diluted....................... $ 0.33 $ 0.33 $ 0.33 $ 0.22 $ 0.05 $ 0.20
======== ======== ======== ======== ======== ========
Shares Used in Computation:
Basic......................... 18,570 13,570 17,570 17,832 12,832 16,832
======== ======== ======== ======== ======== ========
Diluted....................... 18,930 13,930 17,930 18,234 13,234 17,234
======== ======== ======== ======== ======== ========
</TABLE>
27
<PAGE> 30
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998 YEAR ENDED DECEMBER 31, 1997
---------------------------------------- ----------------------------------------
PRO FORMA PRO FORMA
----------------------------- -----------------------------
MAXIMUM MINIMUM MAXIMUM MINIMUM
NO. OF SHARES NO. OF SHARES NO. OF SHARES NO. OF SHARES
ACTUAL EXCHANGED EXCHANGED ACTUAL EXCHANGED EXCHANGED
-------- ------------- ------------- -------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents....... $ 1,652 $ 1,652 $ 1,652 $ 3,537 $ 3,537 $ 3,537
Finance Receivables, Net........ 55,728 55,728 55,728 60,778 60,778 60,778
Total Assets.................. 278,845 278,845 278,845 275,633 275,633 275,633
Subordinated Notes Payable...... 25,000 48,500(3) 29,700(3) 12,000 35,500(3) 16,700(3)
Total Debt.................... 72,891 96,391 77,591 77,171 100,671 81,871
Preferred Stock................. -- -- -- -- -- --
Common Stock.................... 173,562 149,912(3) 168,712(3) 172,622 148,972(3) 167,772(3)
Total Stockholders' Equity.... 183,790 160,140 178,940 181,774 158,124 176,924
Common Shares Outstanding....... 18,567 13,567 17,567 18,521 13,521 17,521
Book Value per share............ 9.90 11.80 10.19 9.81 11.69 10.10
</TABLE>
- ---------------
(1) To reflect the effect of the additional debt service and discount amortized
over the life of the debentures.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998 YEAR ENDED DECEMBER 31, 1997
-------------------------------- ------------------------------
MAXIMUM MINIMUM MAXIMUM MINIMUM
NO. OF SHARES NO. OF SHARES NO. OF SHARES NO. OF SHARES
EXCHANGED EXCHANGED EXCHANGED EXCHANGED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Par Value of Debentures Issued... $32,500 $6,500 $32,500 $6,500
======= ====== ======= ======
Interest Incurred During the
Period at 12%.................. $ 1,950 $ 390 $ 3,900 $ 780
Amortization of the Discount of
$9,000,000 and $1,800,000 for
the Maximum and Minimum Shares
Exchanged, Respectively........ 900 180 1,800 360
------- ------ ------- ------
Interest Expense Adjustment...... $ 2,850 $ 570 $ 5,700 $1,140
======= ====== ======= ======
</TABLE>
(2) To record the income tax effects of the interest expense adjustment.
(3) To reflect the exchange of subordinated debentures for common stock.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1998 YEAR ENDED DECEMBER 31, 1997
------------------------------- ------------------------------
MAXIMUM MINIMUM MAXIMUM MINIMUM
NO. OF SHARES NO. OF SHARES NO. OF SHARES NO. OF SHARES
EXCHANGED EXCHANGED EXCHANGED EXCHANGED
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Par Value of Subordinated
Debentures......................... $32,500 $6,500 $32,500 $6,500
Less: Discount....................... 9,000 1,800 9,000 1,800
------- ------ ------- ------
Carrying Value of Subordinated Notes
Payable............................ 23,500 4,700 23,500 4,700
Estimated Stock Acquisition Costs.... 150 150 150 150
------- ------ ------- ------
Common Stock Acquired................ $23,650 $4,850 $23,650 $4,850
======= ====== ======= ======
</TABLE>
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PRICE RANGE OF COMMON STOCK
The Company's Common Stock trades on the Nasdaq Stock Market under the
symbol "UGLY." The Company's initial public offering was effected on June 17,
1996 at a price of $6.75 per share. The high and low closing sales prices of the
Common Stock as reported by Nasdaq since that date are reported below.
<TABLE>
<CAPTION>
MARKET PRICE
----------------
HIGH LOW
------ ------
<S> <C> <C>
FISCAL YEAR 1996:
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............................................... $25.75 $16.25
Second Quarter.............................................. $18.06 $13.13
Third Quarter............................................... $17.00 $12.50
Fourth Quarter.............................................. $16.75 $ 7.69
FISCAL YEAR 1998:
First Quarter............................................... $10.88 $ 6.31
Second Quarter.............................................. $12.70 $ 8.00
Third Quarter (through September 15, 1998).................. $ 9.13 $ 4.63
</TABLE>
On September 15, 1998, there were approximately 200 holders of record of
the Company's Common Stock.
Ugly Ducking's capital stock consists of 100,000,000 shares of Common
Stock, of which approximately 18,535,000 shares were outstanding as of September
15, 1998 and 10,000,000 shares of Preferred Stock, none of which were issued and
outstanding as of September 15, 1998.
DIVIDENDS
Cash dividends have never been paid on Ugly Duckling's Common Stock. The
Company presently intends to retain earnings and does not anticipate that cash
dividends will be paid on its Common Stock in the foreseeable future. Under the
terms of the Revolving Facility with GE Capital, the Company may not declare or
pay dividends in excess of 15% of each year's net earnings available for
distribution.
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<PAGE> 32
BUSINESS
The Company operates a chain of Buy Here-Pay Here used car dealerships in
the United States and underwrites, finances and services retail installment
contracts generated from the sale of used cars by its Company dealerships and by
third party dealers located in selected markets throughout the country. As part
of its financing activities, the Company has initiated its Cygnet Dealer
Program, pursuant to which the Company provides qualified independent used car
dealers with warehouse purchase facilities and operating credit lines primarily
secured by the dealer's retail installment contract portfolio. In addition, the
Company purchases loan portfolios in bulk and services loan portfolios on behalf
of third parties. 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.
As described in the Company's Proxy Statement, a copy of which accompanies
this Offering Circular, the Company has proposed and the stockholders have
approved the separation of the Company's non-dealership operations into a
separate publicly-traded company (the "Split-up"). If all conditions to the
Split-up are satisfied, the Company will transfer to Cygnet Financial
Corporation, a newly-formed Delaware corporation ("Cygnet"), its bulk purchase
and servicing operations, its third party dealer finance operations (excluding
the branch office network operations that Ugly Duckling closed in the first
quarter of 1998), and substantially all assets and certain liabilities acquired
pursuant to transactions with First Merchants Acceptance Corporation ("FMAC")
and Reliance Acceptance Group, Inc. ("Reliance"). The Company also has completed
certain other transactions and acquired other assets relating to its
non-dealership operations and intends to transfer to Cygnet these assets and
related liabilities as part of the Split-up. In connection with the Split-up,
Cygnet currently is conducting a Rights Offering pursuant to which holders of
Ugly Duckling's Common Stock as of August 17, 1998 were distributed Rights to
purchase shares of Cygnet's Common Stock at a price of $7.00 per share as
described in Cygnet's Prospectus dated August 26, 1998. The Rights Offering is
scheduled to terminate on September 21, 1998, although it may be extended,
withdrawn or abandoned by the Company in its sole discretion. If the Rights
Offering is completed and the Split-Up is consummated as described in the Proxy
Statement, the Company will continue to operate its chain of Buy-Here-Pay Here
used car dealerships and underwrite, finance and service retail installment
contracts generated from the sale of used cars by its Company dealerships, and
Cygnet will acquire and operate the bulk purchase and servicing operations, the
third party dealer finance operations, and substantially all of the assets and
certain liabilities acquired pursuant to the transactions with FMAC and
Reliance. If the Rights Offering is not completed and the Split-up is not
consummated, Ugly Duckling would retain both its dealership and non-dealership
operations.
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<PAGE> 33
DESCRIPTION OF THE DEBENTURES
The Debentures will be issued under an Indenture, as supplemented and
amended by the First Supplemental Indenture thereto (collectively, the
"Indenture"), by and between the Company and Harris Trust and Savings Bank, as
Trustee (the "Trustee"). The following summary of certain provisions of the
Indenture does not purport to be complete and is subject to, and is qualified in
its entirety by reference to, the Trust Indenture Act, and to all of the
provisions of the Indenture, including the definitions of certain terms therein
and those terms made a part of the Indenture by reference to the Trust Indenture
Act as in effect on the date of the Indenture. A copy of the Indenture
substantially in the form in which it is to be executed will be filed with the
Commission as an exhibit to the Form T-3 filed in connection with the
qualification of the Indenture under the Trust Indenture Act. For purposes of
this "Description of the Debentures," references to the "Company" mean only Ugly
Duckling Corporation and not its subsidiaries.
The Indenture allows the issuance of debt securities of the Company ("Debt
Securities"), in one or more series, in an aggregate principal amount up to
$100,000,000. The First Supplemental Indenture establishes the Debentures as a
series of Debt Securities under the Indenture.
PRINCIPAL, MATURITY AND INTEREST
The Debentures are limited in aggregate principal amount to $32,500,000 and
will mature on the fifth anniversary of their date of issuance. Interest on the
Debentures will accrue from the date of original issuance at the rate of 12% per
annum and will be payable semiannually in cash on each April 15 and October 15
(each, an "Interest Payment Date"), commencing on April 15, 1999, to the
registered holders of the Debentures ("Holders") at the close of business on the
April 1 and October 1 immediately preceding the applicable Interest Payment
Date. Interest is payable on the Debentures from the most recent date to which
interest has been paid or, if no interest has been paid, from and including the
date of issuance.
The Debentures will be unsecured obligations of the Company and will not be
entitled to the benefit of any mandatory sinking fund.
PAYMENT AND PAYING AGENTS
Payment of interest on a Debenture on any Interest Payment Date will be
made to the Person in whose name such Debenture (or one or more Predecessor
Debentures) is registered at the close of business on the Regular Record Date
for such interest. (Section 307).
Principal of and interest on the Debentures will be payable at the office
of such Paying Agent or Paying Agents as the Company may designate for such
purpose from time to time, except that at the option of the Company payment of
any interest may be made by check mailed to the address of the Person entitled
thereto as such address appears in the Security Register. (Section 307). The
corporate trust office of the Trustee in Chicago, Illinois will be designated as
the Company's Paying Agent for payments with respect to the Debentures. The
Company may at any time designate additional Paying Agents or rescind the
designation of any Paying Agent or approve a change in the office through which
any Paying Agent acts, except that the Company will be required to maintain a
Paying Agent in each Place of Payment for the Debentures. (Section 1002).
All moneys paid by the Company to a Paying Agent for the payment of the
principal of or any premium or interest on any Debentures which remain unclaimed
at the end of two years after such principal, premium, or interest has become
due and payable will be repaid to the Company, subject to certain publication
requirements, and the Holder of such Debentures thereafter may look only to the
Company for payment thereof. (Section 1003).
FORM, EXCHANGE, AND TRANSFER
The Debentures will be issuable only in fully registered form without
coupons and in denominations of $1.00 and any integral multiple thereof.
(Section 302).
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<PAGE> 34
At the option of the Holder, subject to the terms of the Indenture,
Debentures will be exchangeable for other Debentures, of any authorized
denomination and of like tenor and aggregate principal amount. (Section 305).
Subject to the terms of the Indenture, Debentures may be presented for exchange
as provided above or for registration of transfer (duly endorsed or with the
form of transfer endorsed thereon duly executed) at the office of any transfer
agent designated by the Company for such purpose. No service charge will be made
for any registration of transfer or exchange of Debentures, but, with certain
limited exceptions, the Company may require payment of a sum sufficient to cover
any tax or other governmental charge payable in connection therewith. The
Company has appointed the Trustee as Security Registrar and transfer agent for
the Debentures. (Section 305). The Company may at any time designate additional
transfer agents or rescind the designation of any transfer agent or approve a
change in the office through which any transfer agent acts, except that the
Company will be required to maintain a transfer agent in each Place of Payment
for the Debentures. (Section 1002).
If the Debentures are to be redeemed, the Company will not be required to
(i) issue, register the transfer of, or exchange any Debentures during a period
beginning at the opening of business 15 days before the day of mailing of a
notice of redemption of any such Debentures that may be selected for redemption
and ending at the close of business on the day of such mailing or (ii) register
the transfer of or exchange any Debenture so selected for redemption, in whole
or in part, except the unredeemed portion of any such Debenture being redeemed
in part. (Section 305).
REDEMPTION
The Debentures will be redeemable, at the Company's option, in whole at any
time or in part from time to time, upon not less than 30 nor more than 60 days'
notice, at the principal amount to be redeemed, plus, in each case, accrued and
unpaid interest thereon, if any, to the date of redemption.
SELECTION AND NOTICE OF REDEMPTION
In the event that less than all of the Debentures are to be redeemed at any
time, selection of such Debentures for redemption will be made by the Trustee,
on a pro rata basis, by lot or by such method as the Trustee shall deem fair and
appropriate. Notice of redemption shall be mailed by first-class mail at least
30 but not more than 60 days before the redemption date to each Holder of
Debentures to be redeemed at its registered address. If any Debenture is to be
redeemed in part only, the notice of redemption that relates to such Debenture
shall state the portion of the principal amount thereof to be redeemed. A new
Debenture in a principal amount equal to the unredeemed portion thereof will be
issued in the name of the Holder thereof upon cancellation of the original
Debenture. On and after the redemption date, interest will cease to accrue on
Debentures or portions thereof called for redemption as long as the Company has
deposited with the Paying Agent funds in satisfaction of the applicable
redemption price pursuant to the Indenture. Each notice of redemption may
include a statement that such redemption shall be conditional upon the receipt
by the Trustee on or prior to the Redemption Date of amounts sufficient to pay
principal of, and interest on, the Debentures to be redeemed, and that if such
amounts shall not have been so received, said notice shall be of no force and
effect, the Debentures to be redeemed will not become due and payable on the
Redemption Date, and the Company shall not be required to redeem such Debentures
on such date. If such a Conditional Notice is given, failure by the Company to
deposit money necessary to effect the redemption on or prior to the Redemption
Date will not result in a default under the Indenture.
SUBORDINATION
The payment of all obligations on the Debentures is subordinated in right
of payment to the prior payment in full of all obligations on Senior
Indebtedness. Upon any payment or distribution of assets of the Company of any
kind or character, whether in cash, property or securities, to creditors upon
any liquidation, dissolution, winding up, assignment for the benefit of
creditors or marshaling of assets of the Company or in a bankruptcy,
reorganization, insolvency, receivership or other similar proceeding relating to
the Company or its property, whether voluntary or involuntary, all Obligations
(as hereafter defined) due or to become due upon all Senior Indebtedness shall
first be paid in full, or such payment duly provided for to the satisfaction of
the
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<PAGE> 35
holders of Senior Indebtedness, before any payment or distribution of any kind
or character is made on account of any Obligations on the Debentures, or for the
acquisition of any of the Debentures for cash or property or otherwise. If any
default occurs and is continuing in the payment when due, whether at maturity,
upon any redemption, by acceleration or otherwise, of any principal of, premium
or interest on any Senior Indebtedness, no payment of any kind or character
shall be made by or on behalf of the Company or any other Person on its behalf
with respect to any Obligations on the Debentures or to acquire any of the
Debentures for cash or property or otherwise.
In addition, if any other event of default occurs and is continuing with
respect to any Senior Indebtedness, other than the Designated Senior
Indebtedness (as hereafter defined), as such event of default is defined in the
instrument creating or evidencing such Senior Indebtedness, permitting the
holders of such Senior Indebtedness then outstanding to immediately accelerate
the maturity thereof and if a representative for such issue of Senior
Indebtedness gives written notice of the event of default to the Trustee (a
"Default Notice"), then, unless and until all events of default with respect to
such Senior Indebtedness have been cured or waived in writing or have ceased to
exist or the Trustee receives notice from such representative for the respective
issue of Senior Indebtedness terminating the Blockage Period (as defined below),
during the 179 days after the delivery of such Default Notice (the "Blockage
Period"), neither the Company nor any other Person on its behalf shall (x) make
any payment of any kind or character with respect to any Obligations on the
Debentures or (y) acquire any of the Debentures for cash or property or
otherwise. Notwithstanding the above, in no event will a Blockage Period extend
beyond 179 days from the date the payment on the Debentures was due and only one
such Blockage Period may be commenced within any 365 consecutive days
irrespective of the number of defaults with respect to Senior Indebtedness
during such period. In no event may the total number of days during which any
Blockage Period is or Blockage Periods are in effect exceed 179 days in the
aggregate during any consecutive 365 day period. No event of default which
existed or was continuing on the date of the commencement of any Blockage Period
with respect to the Senior Indebtedness shall be, or be made, the basis for
commencement of a second Blockage Period by a representative of such Senior
Indebtedness unless such event of default shall have been cured or waived for a
period of not less than 90 consecutive days. However, any subsequent action, or
any breach of any financial covenants for a period commencing after the date of
commencement of such Blockage Period that, in either case, would give rise to an
event of default pursuant to any provisions under which an event of default
previously existed or was continuing shall constitute a new event of default for
this purpose.
In addition, if any event of default (as defined in the instrument creating
or evidencing any Designated Senior Indebtedness) occurs and is continuing with
respect to any Designated Senior Indebtedness or an executive officer of the
Company has actual knowledge of a default under any Designated Senior
Indebtedness, which with notice or lapse of time or both would result in an
event of default under such Designated Senior Indebtedness, then the Company
shall give notice thereof to the Trustee and, regardless of the giving of such
notice, no payment of any kind or character shall be made by or on behalf of the
Company or any other Person on its behalf with respect to any Obligations on the
Debentures or to acquire any of the Debentures for cash or property or otherwise
for a period of 179 days from the date of each such event of default or the date
that an executive officer obtains actual knowledge that there is such a default
(a "Designated Senior Indebtedness Blockage Period"), unless and until all such
events of defaults or defaults with respect to such Designated Senior
Indebtedness have been cured or waived in writing pursuant to the Designated
Senior Indebtedness or have ceased to exist or the Trustee receives notice from
a representative for the applicable issue of Designated Senior Indebtedness
terminating the Designated Senior Indebtedness Blockage Period. In the event any
Debenture is declared due and payable before its expressed maturity under
Section 502 of the Indenture, (i) the Company will give prompt notice in writing
of such happening to the holders of Designated Senior Indebtedness and (ii) no
payment of any kind or character shall be made by or on behalf of the Company or
any other Person on its behalf with respect to any obligations on the Debentures
or to assume any of the Debentures for cash or property or otherwise without the
consent of the Designated Senior Indebtedness.
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<PAGE> 36
By reason of such subordination, in the event of the insolvency of the
Company, creditors of the Company who are not holders of Senior Indebtedness,
including the Holders of the Debentures, may recover less, ratably, than holders
of Senior Indebtedness. See also "Risk Factors -- Subordination."
For purposes of the subordination provisions of the Debentures, the
following definitions apply:
"Capitalized Lease Obligation" means, as to any Person, the obligations of
such Person under a lease that are required to be classified and accounted for
as capital lease obligations under GAAP and, for purposes of this definition,
the amount of such obligations at any date shall be the capitalized amount of
such obligations at such date, determined in accordance with GAAP.
"Credit Agreement" means the Amended and Restated Motor Vehicle Installment
Contract Loan and Security Agreement dated as of August 15, 1997 among the
Company, General Electric Capital Corporation, and certain other parties, as
such agreement may be amended, restated, modified, renewed, refunded, replaced
or refinanced from time to time, including any notes, guarantees, security or
pledge agreements, letters of credit and other documents or instruments executed
pursuant thereto and any exhibits or schedules to any of the foregoing.
"Designated Senior Indebtedness" means (i) all Indebtedness outstanding
under the Credit Agreement and (ii) any other Senior Indebtedness designated by
the Company as "Designated Senior Indebtedness" from time to time.
"Indebtedness" means with respect to any Person, without duplication, (i)
all Obligations of such Person for borrowed money, (ii) all Obligations of such
Person evidenced by bonds, debentures, notes or other similar instruments, (iii)
all Capitalized Lease Obligations of such Person, (iv) all obligations of such
Person issued or assumed as the deferred purchase price of property, all
conditional sale obligations and all Obligations under any title retention
agreement (but excluding trade accounts payable and other similar accrued
liabilities arising in the ordinary course of business and payable in accordance
with customary terms), (v) all obligations for the reimbursement of any obligor
on any letter of credit, banker's acceptance or similar credit transaction, (vi)
guarantees and other contingent obligations in respect of Indebtedness referred
to in clauses (i) through (v) above and clause (viii) below, (vii) all
obligations of any other Person of the type referred to in clauses (i) through
(vi) which are secured by any lien on any property or asset of such Person, the
amount of such obligation being deemed to be the lesser of the fair market value
of such property or asset or the amount of the obligation so secured, and (viii)
all obligations under currency agreements and interest swap agreements of such
Person.
"Obligations" means all obligations for principal, premium, interest,
penalties, fees, indemnifications, reimbursements, damages and other liabilities
payable under the documentation governing any Indebtedness.
"Senior Indebtedness" means all Obligations on any Indebtedness of the
Company, whether outstanding on the date of original issuance of the Debentures
or thereafter created, incurred or assumed, unless, in the case of any
particular Indebtedness, the instrument creating or evidencing the same or
pursuant to which the same is outstanding expressly provides that such
Indebtedness shall not be senior in right of payment to the Debentures.
Notwithstanding the foregoing, "Senior Indebtedness" shall not include (i) any
Indebtedness of the Company to a Subsidiary of the Company, (ii) Indebtedness
to, or guaranteed on behalf of, any shareholder, director, officer or employee
of the Company (including, without limitation, amounts owed for compensation),
(iii) any liability for federal, state, local or other taxes owed or owing by
the Company, and (iv) Indebtedness which, when incurred and without respect to
any election under Section 1111(b) of Title 11, United States Code, is without
recourse to the Company.
Except to the extent described below under "Certain Covenants," the
Indenture does not limit the aggregate amount of Senior Indebtedness that the
Company or its subsidiaries may issue. As of June 30, 1998, outstanding Senior
Indebtedness of the Company and its consolidated subsidiaries aggregated
approximately $72.9 million.
The Company also has outstanding a $10 million subordinated note payable to
Verde Investments, Inc., an affiliate of the Company (the "Verde Note"). As
described in the Proxy Statement that accompanies this
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<PAGE> 37
Offering Circular, if the Split-up is successfully concluded, the Company
intends to utilize a portion of the cash proceeds from the Split-up to repay the
Verde Note in full. Alternatively, the Company may accept the Verde Note for
cancellation in lieu of a portion of the cash payment that would otherwise be
required. See "Summary -- The Proposals -- Proposal No. 4 -- The Cash Payment"
in the Proxy Statement. Nothing in the Indenture or the Debentures will prohibit
any such repayment or cancellation. However, in the event that the Split-up does
not occur by the Expiration Time, the Verde Note will be senior in right of
payment to the Debentures.
The subordination provisions apply only to Debentures that are Outstanding.
Debentures will not be deemed to be Outstanding if, among other circumstances,
money in the necessary amount has been deposited with the Trustee or any Paying
Agent (other than the Company) in trust, or set aside and segregated in trust by
the Company (if it acts as its own Paying Agent) for the redemption of such
Debentures and notice of redemption has been given as required in the Indenture
or provision therefor satisfactory to the Trustee has been made. In addition,
upon the effectiveness of any Defeasance or Covenant Defeasance as described
below under the heading "Defeasance and Covenant Defeasance," the Debentures
then Outstanding shall cease to be subordinated under the Indenture.
CERTAIN COVENANTS
The Indenture will contain, among others, the following covenants provided
for the Debentures:
Consolidated Leverage Ratios. The Company will not allow its Consolidated
Leverage Ratio to exceed 6.0 to 1.0. "Consolidated Leverage Ratio" means, as of
any date of determination, the ratio of (i) the total liabilities of the Company
and its consolidated Subsidiaries (determined in accordance with generally
accepted accounting principles ("GAAP")), excluding all Junior Subordinated
Obligations, to (ii) the Consolidated Net Worth of the Company. "Junior
Subordinated Obligation" means any indebtedness of the Company that by its terms
is expressly subordinated in right of payment to the Debentures. "Consolidated
Net Worth" means, as of any date of determination, the consolidated
stockholders' equity of the Company and its consolidated Subsidiaries
(determined in accordance with GAAP), plus all Junior Subordinated Obligations
of the Company.
Minimum Equity. The Company will at all times maintain Consolidated Net
Worth (defined above) of at least $100,000,000.
EVENTS OF DEFAULT
Each of the following will constitute an Event of Default under the
Indenture with respect to Debt Securities of any series: (a) failure to pay
principal of or any premium on any Debt Securities of that series when due; (b)
failure to pay any interest on any Debt Securities of that series when due,
continued for 30 days; (c) failure to deposit any sinking fund payment, when
due, in respect of any Debt Securities of that series; (d) failure to perform
any other covenant of the Company in the Indenture (other than a covenant
included in the Indenture solely for the benefit of a series other than that
series), that continues for 90 days after written notice has been given by the
Trustee, or the Holders of at least 25% in principal amount of the Outstanding
Debt Securities of that series, as provided in the Indenture; (e) certain events
in bankruptcy, insolvency, or reorganization, and (f) any other Event of Default
specified for such series in the supplemental indenture or Board Resolution
creating or governing such series. (Section 501). There are no additional Events
of Default provided for the Debentures.
If an Event of Default (other than an Event of Default described in clause
(e) above) with respect to the Debt Securities of any series at the time
Outstanding shall occur and be continuing, either the Trustee or the Holders of
at least 25% in aggregate principal amount of the Outstanding Debt Securities of
that series by notice as provided in the Indenture may declare the principal
amount of the Debt Securities of that series (or, in the case of any Debt
Security that is an Original Issue Discount Security or the principal amount of
which is not then determinable, such portion of the principal amount of such
Debt Security, or such other amount in lieu of such principal amount, as may be
specified in the terms of such Debt Security) to be due and payable immediately.
If an Event of Default described in clause (e) above with respect to the Debt
Securities of any
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<PAGE> 38
series at the time Outstanding shall occur, the principal amount of all the Debt
Securities of that series (or, in the case of any such Original Issue Discount
Security or other Debt Security, such specified amount) will automatically, and
without any action by the Trustee or any Holder, become immediately due and
payable. After any such acceleration, but before a judgment or decree based on
acceleration, the Holders of a majority in aggregate principal amount of the
Outstanding Debt Securities of that series may rescind and annul such
acceleration if all Events of Default, other than the non-payment of accelerated
principal (or other specified amount), have been cured or waived as provided in
the Indenture and payment of all overdue interest and certain other payments are
made by the Company. (Section 502). For information as to waiver of defaults,
see "Modification and Waiver."
Subject to the provisions of the Indenture relating to the duties of the
Trustee, in case an Event of Default shall occur and be continuing, the Trustee
will be under no obligation to exercise any of its rights or powers under the
Indenture at the request or direction of any of the Holders, unless such Holders
shall have offered to the Trustee reasonable indemnity. (Section 603). Subject
to such provisions for the indemnification of the Trustee and to certain other
conditions, the Holders of a majority in principal amount of the Outstanding
Debt Securities of any series will have the right to direct the time, method,
and place of conducting any proceeding for any remedy available to the Trustee,
or exercising any trust or power conferred on the Trustee, with respect to the
Debt Securities of that series. (Section 512).
No Holder of a Debt Security of any series will have any right to institute
any proceeding with respect to the Indenture, or for the appointment of a
receiver or a trustee, or for any other remedy thereunder, unless (i) such
Holder has previously given to the Trustee written notice of a continuing Event
of Default with respect to the Debt Securities of that series, (ii) the Holders
of at least 25% in aggregate principal amount of the Outstanding Debt Securities
of that series have made written request, and such Holder or Holders have
offered reasonable indemnity, to the Trustee to institute such proceeding as
trustee, and (iii) the Trustee has failed to institute such proceeding, and has
not received from the Holders of a majority in aggregate principal amount of the
Outstanding Debt Securities of that series a direction inconsistent with such
request, within 60 days after such notice, request, and offer. (Section 507).
However, such limitations do not apply to a suit instituted by a Holder of a
Debt Security for the enforcement of payment of the principal of or any premium
or interest on such Debt Security on or after the applicable due date specified
in such Debt Security. (Section 508).
The Company will be required to furnish to the Trustee annually a statement
by certain of its officers as to whether or not the Company, to their knowledge,
is in default in the performance or observance of any of the terms, provisions,
and conditions of the Indenture and, if so, specifying all such known defaults.
(Section 1004).
If a default occurs under the Indenture with respect to Debt Securities of
any series, the Trustee shall give the Holders of Securities of such series
notice of such default as required by the Trust Indenture Act, provided that in
the case of a default described in clause (d) in the first paragraph under
"Events of Default" herein, no such notice to Holders shall be given until at
least 30 days after the occurrence of such default.
MODIFICATION AND WAIVER
Modifications and amendments of the Indenture may be made by the Company
and the Trustee at any time and from time to time without the consent of the
Holders of any of the Debt Securities in certain limited cases. (Section 901).
In addition, modifications and amendments of the Indenture may be made by the
Company and the Trustee with the consent of the Holders of not less than a
majority in aggregate principal amount of the Outstanding Debt Securities of
each series affected by such modification or amendment; provided, however, that
no such modification or amendment may, without the consent of the Holder of each
Outstanding Debt Security affected thereby, (a) change the Stated Maturity of
the principal of, or any installment of principal of or interest on, any Debt
Security, (b) reduce the principal amount of, or any premium or interest on, any
Debt Security, (c) reduce the amount of principal of an Original Issue Discount
Security or any other Debt Security payable upon acceleration of the Maturity
thereof, (d) change the place or currency of payment of principal of, or any
premium or interest on, any Debt Security, (e) impair the right
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<PAGE> 39
to institute suit for the enforcement of any payment on or with respect to any
Debt Security, (f) reduce the percentage in principal amount of Outstanding Debt
Securities of any series, the consent of whose Holders is required for
modification or amendment of the Indenture, reduce the percentage in principal
amount of Outstanding Debt Securities of any series necessary for waiver of
compliance with certain provisions of the Indenture or for waiver of certain
defaults, or modify such provisions with respect to modification and waiver.
(Section 902).
The Holders of not less than a majority in aggregate principal amount of
the Outstanding Debt Securities of any series may waive compliance by the
Company with certain restrictive provisions of the Indenture. (Section 1008).
The Holders of a majority in principal amount of the Outstanding Debt Securities
of any series may waive any past default under the Indenture with respect to
such series, except a default in the payment of principal, premium, or interest
and certain covenants and provisions of the Indenture which cannot be amended
without the consent of the Holder of each Outstanding Debt Security of such
series affected. (Section 513).
The Indenture provides that in determining whether the Holders of the
requisite principal amount of the Outstanding Debt Securities have given or
taken any request, demand, authorization, direction, notice, consent, waiver, or
other action under the Indenture as of any date, (i) the principal amount of an
Original Issue Discount Security that will be deemed to be Outstanding will be
the amount of the principal thereof that would be due and payable as of such
date upon acceleration of the Maturity thereof to such date, (ii) if, as of such
date, the principal amount payable at the Stated Maturity of a Debt Security is
not determinable (for example, because it is based on an index), the principal
amount of such Debt Security deemed to be Outstanding as of such date will be an
amount determined in the manner prescribed for such Debt Security, and (iii) the
principal amount of a Debt Security denominated in one or more foreign
currencies or currency units that will be deemed to be Outstanding will be the
U.S. dollar equivalent, determined as of such date in the manner prescribed for
such Debt Security, of the principal amount of such Debt Security (or, in the
case of a Debt Security described in clause (i) or (ii) above, of the amount
described in such clause). Certain Debt Securities, including those for whose
payment or redemption money has been deposited or set aside in trust for the
Holders and those that have been fully defeased pursuant to Section 1302 of the
Indenture, will not be deemed to be Outstanding. (Section 101).
Except in certain limited circumstances, the Company will be entitled to
set any day as a record date for the purpose of determining the Holders of
Outstanding Debt Securities of any series entitled to give or take any request,
demand, authorization, direction, notice, consent, waiver, or other action under
the Indenture, in the manner and subject to the limitations provided in the
Indenture. In certain limited circumstances, the Trustee will be entitled to set
a record date for action by Holders. If a record date is set for any action to
be taken by Holders of a particular series, such action may be taken only by
persons who are Holders of Outstanding Debt Securities of that series on the
record date. To be effective, such action must be taken by Holders of the
requisite principal amount of such Debt Securities within a specified period
following the record date. For any particular record date, this period will be
180 days or such other shorter period as may be specified by the Company (or the
Trustee, if it sets the record date), and may be shortened or lengthened (but
not beyond 180 days) from time to time. (Section 104).
DEFEASANCE AND COVENANT DEFEASANCE
The provisions of Section 1302, relating to defeasance and discharge of
indebtedness, and Section 1303, relating to defeasance of certain restrictive
covenants in the Indenture, will apply to the Debentures.
Defeasance and Discharge. Pursuant to Section 1302, the Company will be
discharged from all its obligations with respect to the Debentures (except for
certain obligations to exchange or register the transfer of Debentures, to
replace stolen, lost, or mutilated Debentures, to maintain paying agencies, and
to hold moneys for payment in trust) upon satisfaction of certain conditions,
including the deposit in trust for the benefit of the Holders of Debentures of
money or U.S. Government Obligations, or both, which, through the
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payment of principal and interest in respect thereof in accordance with their
terms, will provide money in an amount sufficient to pay the principal of and
any premium and interest on the Debentures on the respective Stated Maturities
or on any Redemption Date established for the Debentures in accordance with the
terms of the Indenture and such Debentures. Such defeasance or discharge may
occur only if, among other things, the Company has delivered to the Trustee an
Opinion of Counsel to the effect that the Company has received from, or there
has been published by, the Internal Revenue Service a ruling, or there has been
a change in tax law, in either case to the effect that Holders of the Debentures
will not recognize gain or loss for federal income tax purposes as a result of
such deposit, defeasance, and discharge and will be subject to federal income
tax on the same amount, in the same manner, and at the same times as would have
been the case if such deposit, defeasance, and discharge were not to occur.
(Sections 1302 and 1304).
Defeasance of Certain Covenants. Pursuant to Section 1303, if certain
conditions are satisfied, the Company may omit to comply with certain
restrictive covenants in the Indenture, and the occurrence of certain Events of
Default, which are described above in clause (d) (with respect to such
restrictive covenants) under "Events of Default," will be deemed not to be or
result in an Event of Default and the provisions of Article Fourteen relating to
subordination will cease to be effective, in each case with respect to the
Debentures. The Company, in order to exercise such option, will be required to
deposit, in trust for the benefit of the Holders of the Debentures, money or
U.S. Government Obligations, or both, which, through the payment of principal
and interest in respect thereof in accordance with their terms, will provide
money in an amount sufficient to pay the principal of and any premium and
interest on the Debentures on the respective Stated Maturities or on any
Redemption Dates established for the Debentures in accordance with the terms of
the Indenture and the Debentures. The Company will also be required, among other
things, to deliver to the Trustee an Opinion of Counsel to the effect that
Holders of the Debentures will not recognize gain or loss for federal income tax
purposes as a result of such deposit and defeasance of certain obligations and
will be subject to federal income tax on the same amount, in the same manner,
and at the same times as would have been the case if such deposit and defeasance
were not to occur. In the event the Company exercised this option with respect
to the Debentures and the Debentures were declared due and payable because of
the occurrence of any Event of Default, the amount of money and U.S. Government
Obligations so deposited in trust would be sufficient to pay amounts due on the
Debentures at the time of their respective Stated Maturities, but may not be
sufficient to pay amounts due on the Debentures upon any acceleration resulting
from such Event of Default. In such case, the Company would remain liable for
such payments. (Sections 1303 and 1304).
SATISFACTION AND DISCHARGE
The Indenture will also be deemed to be satisfied and discharged, except as
to certain limited provisions, as to Debentures that have become due and payable
or will become due and payable at their Stated Maturity within one year from the
date of determination or are to be called for redemption within one year under
arrangements satisfactory to the Trustee, but only if the Company deposits money
in an amount sufficient to pay the entire principal, premium, and interest to
the date of deposit (as to Debentures that have become due and payable) or to
the Stated Maturity or Redemption Date, as the case may be, and certain other
conditions are satisfied. (Section 401). See also "Defeasance and Covenant
Defeasance."
NOTICES
Notices to Holders of Debentures will be given by mail to the addresses of
such Holders as they may appear in the Security Register. (Sections 101 and
106).
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TITLE
The Company, the Trustee, and any agent of the Company or the Trustee may
treat the Person in whose name a Debenture is registered as the absolute owner
thereof (whether or not such an Debenture may be overdue) for the purpose of
making payment and for all other purposes. (Section 308).
GOVERNING LAW
The Indenture and the Debt Securities will be governed by, and construed in
accordance with, the law of the State of Arizona (Section 112).
REGARDING THE TRUSTEE
The Trustee under the Indenture is Harris Trust and Savings Bank. The
Company maintains normal banking arrangements with the Trustee, which include
the use of an affiliated company, Harris Trust Company of California, as the
transfer agent for the Common Stock.
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DESCRIPTION OF CAPITAL STOCK
The Company is a Delaware corporation and its affairs are governed by its
Certificate of incorporation and Bylaws and the Delaware General Corporation
Law. The following description of the Company's capital stock, which is complete
in all material respects, is qualified in its entirety by reference to the
provisions of the Company's Certificate of Incorporation and Bylaws, as amended.
The authorized capital stock of the Company consists of 100,000,000 shares
of Common Stock, par value $.001 per share, and 10,000,000 shares of Preferred
Stock, par value $.001 per share. At September 15, 1998, approximately
18,535,000 shares of Common Stock were issued and outstanding. As of September
15, 1998, there were no issued and outstanding shares of Preferred Stock. As of
September 15, 1998, the Company's officers and directors beneficially owned
approximately 30% of the outstanding Shares of the Company's Common Stock, with
Mr. Ernest Garcia II, the Company's Chairman of the Board and Chief Executive
Officer, beneficially owning approximately 25%. The Company's executive officers
and directors have advised the Company that they do not intend to participate in
the Exchange Offer. Assuming the maximum number of Shares is exchanged in the
Exchange Offer, the Company's officers and directors will beneficially own
approximately 42% of the Company's outstanding shares of Common Stock (with Mr.
Garcia owning approximately 35%), and assuming the minimum number of shares of
Common Stock is exchanged in the Exchange Offer, the Company's officers and
directors will own approximately 32% of the Company's outstanding shares of the
Common Stock (with Mr. Garcia owning approximately 27%).
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held of
record on all matters on which stockholders are entitled to vote. Holders of
Common Stock do not have cumulative voting rights, and therefore holders of a
majority of the shares voting for the election of directors can elect all of the
directors. In such event, the holders of the remaining shares will not be able
to elect any directors.
Holders of Common Stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. The Company does not anticipate paying cash dividends in the
foreseeable future. See "Dividend Policy." In the event of liquidation,
dissolution, or winding up of the Company, the holders of Common Stock are
entitled to share ratably in any corporate assets remaining after payment of all
debts, subject to any preferential rights of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive, conversion, or redemption
rights and are not subject to further calls or assessments by the Company. All
of the outstanding shares of Common Stock are validly issued, fully paid, and
nonassessable.
PREFERRED STOCK
The Board of Directors of the Company has the authority, without further
action by the Company's stockholders, to issue from time to time up to
10,000,000 shares of Preferred Stock in one or more series and to fix the number
of shares, designations, voting powers, preferences, optional and other special
rights, and the restrictions or qualifications thereof. The rights, preferences,
privileges, and restrictions or qualifications of different series of Preferred
Stock may differ with respect to dividend rates, amounts payable on liquidation,
voting rights, conversion rights, redemption provisions, sinking fund
provisions, and other matters. The issuance of Preferred Stock could: (i)
decrease the amount of earnings and assets available for distribution to holders
of Common Stock; (ii) adversely affect the rights and powers, including voting
rights, of holders of Common Stock; and (iii) have the effect of delaying,
deferring, or preventing a change in control of the Company.
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CERTAIN UNITED STATES FEDERAL INCOME TAX CONSEQUENCES
GENERAL
The following discussion summarizes certain United States federal income
tax consequences associated with the Exchange Offer and the ownership of
Debentures. The discussion is intended only as a summary and does not purport to
be a complete analysis of all potential tax considerations that may be relevant
in connection with the Exchange Offer. The discussion is based upon the Internal
Revenue Code of 1986, as amended to the date hereof (the "Code"), existing and
proposed United States Treasury regulations promulgated thereunder, current
administrative pronouncements and judicial decisions, changes to any of which
could materially affect the continued validity of the discussion herein and
could be made on a retroactive basis. No rulings will be sought from the
Internal Revenue Service with respect to the treatment of the Exchange Offer and
no assurance may be given that contrary positions may not be taken by the
Internal Revenue Service or by a court of law.
SCOPE
The discussion relating to stockholders who participate in the Exchange
Offer addresses only stockholders who are "United States persons" and who hold
Shares as capital assets within the meaning of Section 1221 of the Code, and
does not address all of the tax consequences that may be relevant to particular
stockholders in light of their personal circumstances, or to certain types of
stockholders (such as certain financial institutions, dealers in securities or
commodities, insurance companies, tax-exempt organizations, persons who acquired
Shares as compensation and persons who hold Shares as a position in a "straddle"
or as a part of a "hedging" or "conversion" transaction for United States
federal income tax purposes). In the context of the discussion pertaining to the
Debentures, the discussion describes certain tax consequences applicable only to
original holders of the Debentures. The discussion does not include any
description of the tax laws of any state, local, or non-U.S. government that may
be applicable to a particular stockholder. As used herein, a "United States
person" means (i) a citizen or resident of the United States, (ii) a
corporation, partnership or other entity created or organized in or under the
laws of the United States, any State or any political subdivision thereof, (iii)
an estate, the income of which is subject to United States federal income
taxation regardless of its source, or (iv) a trust if a court within the United
States is able to exercise primary supervision of the administration of the
trust and one or more United States persons have the authority to control all
substantial decisions of the trust.
THE SUMMARY DISCUSSION SET FORTH HEREIN IS INCLUDED FOR GENERAL INFORMATION
ONLY. THE TAX CONSEQUENCES OF AN EXCHANGE OF SHARES FOR DEBENTURES PURSUANT TO
THE EXCHANGE OFFER MAY VARY DEPENDING UPON, AMONG OTHER THINGS, THE PARTICULAR
SITUATION AND CIRCUMSTANCES OF THE TENDERING STOCKHOLDER. ALL STOCKHOLDERS ARE
URGED TO CONSULT THEIR OWN TAX ADVISORS TO DETERMINE THE SPECIFIC FEDERAL,
STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF EXCHANGES MADE BY THEM
PURSUANT TO THE EXCHANGE OFFER, INCLUDING THE EFFECT OF THE STOCK OWNERSHIP
ATTRIBUTION RULES DESCRIBED HEREIN.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES TO TENDERING STOCKHOLDERS
Characterization of the Exchange
An exchange of Shares for Debentures by a stockholder pursuant to the
Exchange Offer will be a taxable transaction for United States federal income
tax purposes. The United States federal income tax consequences of such exchange
to a Stockholder may vary depending upon the Stockholder's particular facts and
circumstances. Depending on such facts and circumstances, the exchange will be
treated as either a sale or a distribution for United States federal income tax
purposes.
Under Section 302 of the Code, an exchange of Shares for Debentures
pursuant to the Exchange Offer will be treated as a "sale or exchange" of such
Shares for United States federal income tax purposes (rather
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than as a deemed distribution by the Company with respect to Shares continued to
be held (or deemed to be held) by the tendering stockholder) if the receipt of
Debentures upon such exchange (i) is "substantially disproportionate" with
respect to the stockholder, (ii) results in a "complete termination" of the
stockholder's interest in the Company, or (iii) is "not essentially equivalent
to a dividend" with respect to the stockholder. These tests (the "Section 302
tests") are explained more fully below. See "Section 302 Tests" below.
If any of the Section 302 tests is satisfied and the exchange of the
tendered Shares is, therefore, treated as a "sale or exchange" of such Shares
for United States federal income tax purposes, the tendering stockholder will
recognize capital gain or loss equal to the difference between the "issue price"
of the Debentures and the stockholder's adjusted tax basis in the Shares
exchanged pursuant to the Exchange Offer. (For the definition of the "issue
price" of the Debentures, see "Issue Price of Debentures Defined" below). Such
capital gain or loss will generally be long-term capital gain or loss if the
tendering stockholder held the tendered Shares for more than 12 months. Under
current law, any such gain or loss recognized by individuals, trusts or estates
will be subject to a maximum 20 percent tax rate if the Shares have been held
for more than 12 months.
If none of the Section 302 tests is satisfied, then, to the extent of the
Company's current and accumulated earnings and profits (as determined for
federal income tax purposes), the tendering stockholder will generally be
treated as having received a dividend taxable as ordinary income in an amount
equal to the sum of the cash plus the fair market value of the Debentures (as of
the time of the exchange) received by the stockholder pursuant to the Exchange
Offer (without reduction for the adjusted tax basis of the Shares tendered
pursuant to the Exchange Offer), no loss will be recognized, and (subject to
reduction as described below for corporate stockholders eligible for the
dividends-received deduction) the tendering stockholder's adjusted tax basis in
the Shares exchanged pursuant to the Exchange Offer will be added to such
stockholder's adjusted tax basis in the stockholder's remaining Shares, if any.
If a tendering stockholder does not retain any Shares, such stockholder may lose
tax basis entirely. If the exchange of Shares by a stockholder is not treated as
a sale or exchange for federal income tax purposes, the amount (if any) by which
the sum of the cash plus the fair market value of the Debentures exceeds the
current or accumulated earnings and profits of the Company (as determined for
federal income tax purposes) will be treated, first, as a nontaxable return of
capital to the extent of the stockholder's basis in the Shares, and thereafter,
as taxable capital gain.
Constructive Ownership of Stock
In determining whether any of the Section 302 tests is satisfied, a
stockholder must take into account not only the Shares which are actually owned
by the stockholder, but also Shares which are constructively owned by the
stockholder by reason of the attribution rules contained in Section 318 of the
Code. Under Section 318 of the Code, a stockholder may be treated as owning (i)
Shares that are actually owned, and in some cases constructively owned, by
certain related individuals or entities in which the stockholder owns an
interest, or, in the case of stockholders that are entities, by certain
individuals or entities that own an interest in the stockholder and (ii) Shares
which the stockholder has the right to acquire by exercise of an option or a
conversion right contained in another instrument held by the stockholder.
Section 302 Tests
One of the following tests must be satisfied in order for the exchange of
Shares pursuant to the Exchange Offer to be treated as a sale or exchange for
federal income tax purposes.
a. Substantially Disproportionate Test. The exchange of Shares for
Debentures by a stockholder will be "substantially disproportionate" if
the percentage of the outstanding Shares actually and constructively
owned by the stockholder immediately following the exchange of Shares
pursuant to the Exchange Offer (treating as not being outstanding all
Shares exchanged pursuant to the Exchange Offer) is less than 80% of the
percentage of the outstanding Shares actually and constructively owned
by such stockholder immediately before the exchange of Shares pursuant
to the Exchange Offer (treating as outstanding all Shares exchanged
pursuant to the Exchange Offer). Stockholders should consult their own
tax advisors with respect to the application of the "substantially
disproportionate" test to their particular situation and circumstances.
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b. Complete Termination Test. The exchange of Shares for Debentures will
be a "complete termination" of a stockholder's interest in the Company
if either (i) all of the Shares actually and constructively owned by the
stockholder are exchanged pursuant to the Exchange Offer or (ii) all of
the Shares actually owned by the stockholder are exchanged pursuant to
the Exchange Offer and, with respect to the Shares constructively owned
by the stockholder which are not exchanged pursuant to the Exchange
Offer, the stockholder is eligible to waive (and effectively waives)
constructive ownership of all such Shares under procedures described in
Section 302(c) of the Code. Stockholders considering making such a
waiver should do so in consultation with their own tax advisors.
c. Not Essentially Equivalent to a Dividend Test. Even if the exchange of
Shares for Debentures fails to result in satisfaction of the
"substantially disproportionate" test and the "complete termination"
test, a stockholder may nevertheless satisfy the "not essentially
equivalent to a dividend" test if the stockholder's exchange of Shares
pursuant to the Exchange Offer results in a "meaningful reduction" in
the stockholder's proportionate interest in the Company. Whether the
receipt of Debentures by a stockholder who exchanges Shares pursuant to
the Exchange Offer will be "not essentially equivalent to a dividend"
will depend upon the stockholder's particular facts and circumstances.
The Internal Revenue Service has indicated in published revenue rulings
that even a small reduction in the proportionate interest of a small
minority stockholder in a publicly held corporation who exercises no
control over corporate affairs may constitute such a "meaningful
reduction." The Internal Revenue Service held, for example, in Rev. Rul.
76-385, 1976-2 C.B. 92, that a reduction in the percentage ownership
interest of a stockholder in a publicly held corporation from .0001118%
to .0001081% (a reduction of only 3.3% in the stockholder's prior
percentage ownership interest) would constitute a "meaningful
reduction." Stockholders expecting to rely on the "not essentially
equivalent to a dividend" test should consult their own tax advisors as
to its application to their particular situation and circumstances.
The Company cannot predict whether or to what extent the Exchange Offer
will be oversubscribed. If the Exchange Offer is oversubscribed, proration of
the tenders pursuant to the Exchange Offer will cause the Company to accept
fewer Shares than are tendered. Therefore, a stockholder can be given no
assurance that a sufficient number of such stockholder's Shares will be
exchanged pursuant to the Exchange Offer to ensure that such exchange will
satisfy one or more of the Section 302 tests and be treated as a sale, rather
than as a dividend, for United States federal income tax purposes pursuant to
the rules discussed above.
Contemporaneous dispositions or acquisitions of Shares by a stockholder or
related individuals or entities may be deemed to be part of a single integrated
transaction which will be taken into account in determining whether any of the
Section 302 tests has been satisfied in connection with Shares exchanged
pursuant to the Exchange Offer. Thus, for example, if a stockholder sells Shares
to persons other than the Company at or about the time such stockholder also
exchanges Shares pursuant to the Exchange Offer, and the various sales effected
by the stockholder are part of an overall plan to reduce or terminate such
stockholder's proportionate interest in the Company, then the sales to persons
other than the Company may, for United States federal income tax purposes, be
integrated with the stockholder's exchange of Shares pursuant to the Exchange
Offer and, if integrated, should be taken into account in determining whether
the holder satisfies any of the three tests described above.
STOCKHOLDERS CONTEMPLATING AN EXCHANGE OF DEBENTURES FOR SHARES ARE URGED
TO CONSULT THEIR OWN TAX ADVISORS REGARDING THE SECTION 302 TESTS, INCLUDING THE
EFFECT OF THE ATTRIBUTION RULES AND THE POSSIBILITY THAT A SUBSTANTIALLY
CONTEMPORANEOUS SALE OF SHARES TO PERSONS OTHER THAN THE COMPANY MAY ASSIST IN
SATISFYING ONE OR MORE OF THE SECTION 302 TESTS, AS WELL AS THE SPECIFIC
FEDERAL, STATE, LOCAL, FOREIGN AND OTHER TAX CONSEQUENCES OF EXCHANGES MADE BY
THEM PURSUANT TO THE EXCHANGE OFFER.
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Corporate Stockholder Dividend Treatment
If an exchange of Shares pursuant to the Exchange Offer by a corporate
stockholder is treated as a dividend, the corporate stockholder (other than an S
corporation) may be entitled to claim the dividends-received deduction
(generally 70%, but 80% under certain circumstances) with respect to the gross
dividend under Section 243 of the Code, subject to applicable limitations. With
respect to specific limitations on claiming the dividends-received deduction,
corporate stockholders should consider the effect of Section 246(c) of the Code,
which disallows the dividends-received deduction with respect to any dividend on
any share of stock that is held for 45 days or less during the 90-day period
beginning on the date which is 45 days before the date on which such share
becomes ex-dividend with respect to such dividend. For this purpose, the length
of time a taxpayer is deemed to have held stock may be reduced by periods during
which the taxpayer's risk of loss with respect to the stock is diminished by
reason of the existence of certain options or other hedging transactions.
Additionally, corporate stockholders that have incurred indebtedness directly
attributable to an investment in Shares should consider the effect of Section
246A of the Code which reduces the dividends-received deduction by a percentage
generally computed based on the amount of such indebtedness and the
stockholder's total adjusted tax basis in the Shares.
In addition, any amount received by a corporate stockholder pursuant to the
Exchange Offer that is treated as a dividend may constitute an "extraordinary
dividend" under Section 1059 of the Code. Accordingly, a corporate stockholder
may be required under Section 1059(a) of the Code to reduce its adjusted tax
basis (but not below zero) in its Shares by the non-taxed portion of the
extraordinary dividend (i.e. the portion of the dividend for which a deduction
is allowed), and, if such portion exceeds the stockholder's adjusted tax basis
in its Shares, to treat the excess as gain from the sale of such Shares in the
year in which the dividend is received. These basis reductions and gain
recognition rules would be applied by taking account only the stockholder's
adjusted tax basis in the Shares that were exchanged, without regard to other
Shares that the stockholder may continue to own. CORPORATE STOCKHOLDERS SHOULD
CONSULT THEIR OWN TAX ADVISORS AS TO THE APPLICATION OF SECTION 1059 OF THE CODE
TO THE EXCHANGE OFFER AND ANY DIVIDENDS WHICH MAY BE TREATED AS PAID WITH
RESPECT TO SHARES EXCHANGED PURSUANT TO THE EXCHANGE OFFER.
"Issue Price" of Debentures Defined
If the Shares are traded on an established securities market within the 60
day period ending 30 days after the Expiration Time, as is likely, the "issue
price" of each Debenture should be the fair market value of the Shares exchanged
therefor as of the time of the Exchange Offer (i.e., the trading value of the
Shares as of the time of the exchange). If the Shares are not traded on an
established securities market within the applicable period, the "issue price" of
the Debentures should be their "stated redemption price at maturity" (generally,
the face value of the Debentures) unless either (i) the Debentures do not bear
"adequate stated interest" within the meaning of Section 1274 of the Code, which
is unlikely, or (ii) also unlikely, the Debentures are issued in a so-called
"potentially abusive situation" as defined in the Treasury Regulations under
Section 1274 of the Code, in which case the "issue price" of the Debentures
would be the present value of all payments to be made on the Debenture,
discounted at the applicable federal rate.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES TO PROSPECTIVE HOLDERS OF DEBENTURES
Interest on the Debentures -- General
With respect to stockholders who exchange Shares for Debentures in the
Exchange Offer, interest on the Debentures will, except as provided below (See
"Original Issue Discount on Debentures" and "Taxation of Original Issue
Discount"), be taxable as ordinary interest income at the time such amounts are
accrued or received in accordance with the holder's method of accounting for
United States federal income tax purposes.
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Original Issue Discount on Debentures
If the "stated redemption price at maturity" of the Debentures exceeds the
"issue price" of the Debentures by more than a de minimis amount (0.25% of the
"stated redemption price at maturity" multiplied by the number of years to
maturity), the Debentures will be treated as having original issue discount
("OID") to the extent of such excess.
The "stated redemption price at maturity" of the Debentures will equal the
total of all payments under the Debentures, other than payments of "qualified
stated interest." "Qualified stated interest" generally is stated interest that
is unconditionally payable in cash or other property (other than an additional
debt instrument of the issuer) at least annually at a single fixed rate.
The "issue price" of the Debentures is defined generally above under the
caption "Issue Price of Debentures Defined" and should equal the fair market
value of the Shares as of the time of the exchange (i.e., the trading value of
the Shares as of the time of the exchange). On the other hand, it is possible
that in the context of the receipt of Debentures by a stockholder in a
transaction treated as other than a sale or exchange for federal income tax
purposes (See "Certain Federal Income Tax Consequences to Tendering
Stockholders" -- "Characterization of the Exchange"), the "issue price" of the
Debentures for purposes of computing OID could equal the face value of the
Debentures. Such a result would produce a divergence in the "issue price" of the
Debentures for purposes of computing OID based on the status of the exchange of
Shares for Debentures as either a sale or exchange or a distribution for federal
income tax purposes. Because such a result appears anomalous and would generate
substantial administrative difficulties, the Company intends to treat the "issue
price" of the Debentures in all cases as the fair market value of the Shares as
of the time of the exchange so long as the Shares continue to be traded on an
established securities market. See "Issue Price of Debentures Defined."
The "stated redemption price at maturity" of the Debentures should be $6.50
for each Share tendered by a stockholder. As noted above, $6.50 was
approximately 39% greater than the trading price of the Shares as of September
15, 1998. See "Summary of Exchange Offer -- Background, Purpose and Effect of
the Exchange Offer." If a similar disparity exists between the "stated
redemption price at maturity" of the Debentures and the fair market value of the
Shares as of the time of the exchange, the amount of OID with respect to the
Debentures will be significant.
Taxation of Original Issue Discount on Debentures
Each holder of a Debenture with OID will be required to include in gross
income an amount equal to the sum of the "daily portions" of the OID for all
days during the taxable year in which such holder holds the Debenture regardless
of the holder's method of accounting and even though the cash to which such
income is attributable may not be received until the sale, redemption, or
maturity of the Debenture. The daily portions of OID required to be included in
a holder's gross income in a taxable year will be determined under a constant
yield method by allocating to each day during the taxable year in which the
holder holds the Debenture a pro rata portion of the OID thereon which is
attributable to the accrual period in which such day is included. The amount of
the OID attributable to each accrual period will be the "adjusted issue price"
of the Debenture at the beginning of such accrual period multiplied by the
"yield to maturity" of the Debenture (properly adjusted for the length of the
accrual period). The adjusted issue price of a Debenture at the beginning of an
accrual period will be the original issue price of the Debenture plus the
aggregate amount of OID that accrued in all prior accrual periods, less any cash
payments on the Debenture. The "yield to maturity" is the discount rate that,
when used in computing the present value of all principal and interest payments
to be made under the Debentures, produces an amount equal to the issue price of
the Debentures.
The Company will furnish annually to the Internal Revenue Service and to
record holders of the Debentures information relating to the OID, if any,
accruing during the calendar year. Such information will be based on the amount
of OID that would have accrued to a holder who acquired the Debentures in the
Exchange Offer.
45
<PAGE> 48
If a stockholder receives Debentures in a transaction treated as other than
a sale or exchange for federal income tax purposes (See "Certain Federal Income
Tax Consequences to Tendering Stockholders" -- "Characterization of the
Exchange") and the fair market value of the Debentures exceeds the "issue price"
of the Debentures (generally, the trading value of the shares (See "Issue Price
of Debentures Defined")), the stockholder could, in connection with the receipt
and holding of the Debentures, recognize ordinary income (excluding "qualified
stated interest") in an aggregate amount in excess of the face amount of the
Debentures received. In such case, the OID recognition would result in an
increase to the initial tax basis of the Debentures (See "Redemption or Sale of
Debentures" below) and could provide the stockholder with a taxable loss at the
time of the sale or redemption of the Debentures; however, such loss could be a
capital loss the deductibility of which may be limited under the Code. It is not
known whether the fair market value of the Debentures will exceed the "issue
price" of the Debentures at the time of the exchange. Alternatively, if the
"issue price" of a Debenture received in a transaction treated as other than a
sale or exchange for federal income tax purpose is the face value of such
Debenture (See "Original Issue Discount on Obligations"), any such taxable loss
may not occur.
BECAUSE THE RULES GOVERNING OID MAY REQUIRE HOLDERS OF DEBENTURES TO PAY
FEDERAL INCOME TAXES ON INCOME IN ADVANCE OF RECEIPT OF THE CASH ATTRIBUTABLE TO
SUCH INCOME, STOCKHOLDERS CONTEMPLATING AN EXCHANGE OF SHARES FOR DEBENTURES
PURSUANT TO THE EXCHANGE OFFER ARE URGED TO CONSULT THEIR OWN TAX ADVISORS.
Bond Premium
If the "issue price" of a Debenture exceeds its stated principal amount,
the Debenture may be treated as having been issued with amortizable bond
premium, in which case a holder thereof may be entitled to amortize such bond
premium over the life of the Debenture if an election under Section 171 of the
Code is made or is already in effect. An election under Section 171 of the Code
is available only if the Debenture is held as a capital asset. This election is
revocable only with the consent of the Internal Revenue Service and applies to
all obligations owned or subsequently acquired by the holder on or after the
first day of the taxable year to which the election applies. To the extent the
excess is deducted as amortizable bond premium, the holder's adjusted tax basis
in the Debentures will be reduced. The amortizable bond premium is treated as an
offset to interest income on the Debentures rather than as a separate deduction
item.
Redemption or Sale of Debentures
Generally, any redemption or sale of the Debentures by a holder will result
in taxable gain or loss equal to the difference between the sum of the amount of
cash and the fair market value of the other property received (except to the
extent attributable to accrued but previously untaxed interest, which portion of
the consideration would be taxed as ordinary income) and the holder's adjusted
basis in the Debentures. The initial tax basis of a holder's Debentures will
generally equal the excess of the "issue price" of the Debentures; however, in
the case of a stockholder who receives the Debentures in a transaction treated
as other than a sale or exchange, the initial tax basis of a holder's Debentures
will be the fair market value of the Debentures as of the time of the exchange.
A holder's initial tax basis in the Debentures will be increased by any OID with
respect to the Debenture included in the holder's income prior to sale or
redemption of the Debenture and will be reduced by the amount of any amortizable
bond premium applied against the holder's income prior to sale or redemption of
the Debenture and by any cash payments other than payments of qualified stated
interest. Such gain or loss will be long-term capital gain or loss if the
holder's holding period for the Debentures exceeds twelve months and if the
Debenture is held as a capital asset by the holder.
Backup Withholding
Backup withholding at a rate of 31% may apply to interest payments and the
proceeds from a redemption of the Debentures unless the holder (i) is a
corporation or comes within certain other exempt categories and demonstrates
such fact or (ii) provides a correct taxpayer identification number, certifies
as to no loss of exemption from backup withholding, and otherwise complies with
all applicable requirements of the
46
<PAGE> 49
backup withholding rules. The backup withholding tax is not an additional tax
and may be credited against a holder's United States federal income tax
liability provided that correct information is provided to the Internal Revenue
Service. Stockholders may furnish their correct taxpayer identification number
and otherwise comply with the backup withholding rules by completing and
returning the Substitute Form W-9, included as a part of the Letter of
Transmittal.
TAX CONSEQUENCES TO COMPANY
The Company will recognize no gain or loss in connection with the
acquisition of Shares in exchange for Debentures.
47
<PAGE> 1
LETTER OF TRANSMITTAL
TO TENDER
SHARES OF COMMON STOCK
OF
UGLY DUCKLING CORPORATION
PURSUANT TO THE OFFERING CIRCULAR DATED SEPTEMBER 17, 1998
THE EXCHANGE OFFER WILL EXPIRE AT
5:00 P.M., NEW YORK CITY TIME,
ON OCTOBER 19, 1998, UNLESS EXTENDED.
<TABLE>
<S> <C> <C>
THE EXCHANGE AGENT:
Harris Trust and Savings Bank
BY MAIL: BY FACSIMILE: BY HAND/OVERNIGHT DELIVERY:
Harris Trust and Savings Bank Harris Trust and Savings Bank Harris Trust and Savings Bank
c/o Harris Trust Company c/o Harris Trust Company c/o Harris Trust Company
of New York of New York of New York
P.O. Box 1010 212-701-7636 88 Pine Street
Wall Street Station Confirm Receipt of Facsimile By 19th Floor
New York, New York 10268-1010 Telephone to 212-701-7624 New York, New York 10005
--------------- --------------- ---------------
</TABLE>
DELIVERY OF THIS INSTRUMENT TO AN ADDRESS OTHER THAN
AS SET FORTH ABOVE DOES NOT CONSTITUTE A VALID DELIVERY.
This Letter of Transmittal is to be completed by holders of Common Stock of
Ugly Duckling Corporation either if Certificates representing Shares of Common
Stock ("Common Stock Certificates") are to be forwarded herewith or if delivery
of Common Stock is to be made by book-entry transfer to the account maintained
by the Exchange Agent at The Depository Trust Company ("DTC") pursuant to the
procedures set forth in the Offering Circular under "The Exchange Offer -- How
to Tender." Stockholders whose Common Stock Certificates are not immediately
available or who cannot transmit their Common Stock Certificates (or confirm a
book-entry transfer of such Common Stock into the Exchange Agent's account at
DTC) and transmit any other documents required hereby to the Exchange Agent so
that they are received prior to the Expiration Time (as defined in the Exchange
Offer) must tender their Common Stock according to the guaranteed delivery
procedures set forth in the Offering Circular under "The Exchange Offer -- How
to Tender." See Instruction 2 to this Letter of Transmittal.
[ ] CHECK HERE IF COMMON STOCK IS BEING DELIVERED BY BOOK-ENTRY TRANSFER MADE TO
THE ACCOUNT MAINTAINED BY THE EXCHANGE AGENT AT DTC AND COMPLETE THE
FOLLOWING (ONLY PARTICIPANTS IN DTC MAY DELIVER COMMON STOCK BY BOOK-ENTRY
TRANSFER):
Name of Tendering Institution
-------------------------------------------------------------------------
DTC Account Number
-------------------------------------------------------------------------
Transaction Code Number
-------------------------------------------------------------------------
[ ] CHECK HERE IF THE COMMON STOCK IS BEING DELIVERED PURSUANT TO A NOTICE OF
GUARANTEED DELIVERY PREVIOUSLY SENT TO THE EXCHANGE AGENT.
<PAGE> 2
<TABLE>
<CAPTION>
<S> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------
DESCRIPTION OF COMMON STOCK TENDERED
- ---------------------------------------------------------------------------------------------------------------------------
NAME(S) AND ADDRESS(ES) OF HOLDER(S) COMMON STOCK TENDERED
(PLEASE FILL IN, IF BLANK) (ATTACH ADDITIONAL LIST, IF NECESSARY)
- ---------------------------------------------------------------------------------------------------------------------------
CERTIFICATE TOTAL SHARES REPRESENTED NUMBER OF SHARES
NUMBER(S)* BY CERTIFICATE(S) TENDERED**
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
---------------------------------------------------------------------------------
TOTAL NUMBER OF SHARES TENDERED
- ---------------------------------------------------------------------------------------------------------------------------
* Need not be completed by Stockholders who deliver Common Stock by book-entry transfer.
** Unless otherwise indicated, the total number of shares represented by Certificate will be deemed to have been tendered.
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
EXCHANGE RATIO FOR DEBENTURES
$6.50 PRINCIPAL AMOUNT OF 12% SUBORDINATED DEBENTURES DUE 2003 (BEARING INTEREST
AT 12% PER ANNUM FROM DATE OF ISSUANCE, PAYABLE SEMIANNUALLY ON EACH APRIL 15
AND OCTOBER 15, COMMENCING APRIL 15, 1999, UNTIL THE DEBENTURES ARE PAID IN
FULL) FOR EACH SHARE OF COMMON STOCK
- -------------------------------------------------------------------------------
SPECIAL REGISTRATION
INSTRUCTIONS
(SEE INSTRUCTIONS 8, 9 AND 11)
To be completed ONLY if Common Stock not exchanged and/or Debentures or
any checks (in respect of payments of fractional interests of Debentures) are
to be issued in the name of and sent to someone other than the undersigned:
Issue
and
Send
to:
Name -------------------------------------------------------------------------
(Please Print)
Address ----------------------------------------------------------------------
------------------------------------------------------------------------------
Zip Code
------------------------------------------------------------------------------
Tax Identification or Social Security No.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
SPECIAL DELIVERY
INSTRUCTIONS
(SEE INSTRUCTIONS 8, 9 AND 11)
To be completed ONLY if Common Stock not exchanged and/or Debentures or
any checks (in respect of payments of fractional interests of Debentures)
issued in the name of the undersigned are to be sent to someone other than the
undersigned or to the undersigned at an address other than that shown above.
Mail
to:
Name -------------------------------------------------------------------------
(Please Print)
Address ----------------------------------------------------------------------
------------------------------------------------------------------------------
Zip Code
- -------------------------------------------------------------------------------
2
<PAGE> 3
STOCKHOLDERS SIGN HERE
(SEE INSTRUCTION 1)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SIGNATURE(S) OF OWNER(S)
DATED:
- --------------------------------------------------------------------------------
MUST BE SIGNED BY HOLDER(S) AS NAME(S) APPEAR(S) ON COMMON STOCK
CERTIFICATE(S) OR BY PERSON(S) AUTHORIZED TO BECOME HOLDER(S) BY ENDORSEMENTS
AND OTHER DOCUMENTS TRANSMITTED. IF SIGNATURE IS BY TRUSTEE, EXECUTOR,
ADMINISTRATOR, GUARDIAN, OFFICER OR OTHER PERSON ACTING IN A FIDUCIARY OR
REPRESENTATIVE CAPACITY, PLEASE SET FORTH FULL TITLE. SEE INSTRUCTION 8.
NAME(S)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
PLEASE PRINT
CAPACITY
- --------------------------------------------------------------------------------
ADDRESS
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
INCLUDE ZIP CODE
AREA CODE AND TEL. NO.
- --------------------------------------------------------------------------------
TAX IDENTIFICATION OR SOCIAL SECURITY NO.
- --------------------------------------------------------------------------------
SIGNATURE GUARANTEE
(IF REQUIRED BY INSTRUCTION 8)
AUTHORIZED SIGNATURE
- --------------------------------------------------------------------------------
NAME OF FIRM
- --------------------------------------------------------------------------------
PLEASE PRINT
DATED:
- --------------------------------------------------------------------------------
IMPORTANT TAX INFORMATION
Under the federal income tax law, a Stockholder whose tendered Common Stock
is accepted for exchange is required to provide the Exchange Agent with such
Stockholder's correct TIN on Substitute Form W-9. If such Stockholder is an
individual, the TIN is his social security number. If the Exchange Agent is not
provided with the correct TIN, the Stockholder may be subject to a $50 penalty
imposed by federal law. In addition, interest payments with respect to the
Debentures and any cash paid in lieu of the issuance of fractional interests in
Debentures may be subject to backup withholding of 31% of any payments made to
the Stockholder. Backup withholding is not an additional tax. Rather, the
federal income tax liability of persons subject to backup withholding will be
reduced by the amount of tax withheld. If withholding results in an overpayment
of taxes, a refund may be obtained.
Certain holders of securities (including, among others, all corporations
and certain foreign individuals) are not subject to backup withholding. In order
for a foreign person to qualify as an exempt recipient, that Stockholder must
attest under penalties of perjury to that person's exempt status. Other exempt
recipients can establish their exemptions from backup withholding in the manner
described in the enclosed Guidelines for Certification of Taxpayer
Identification Number on Substitute Form W-9.
3
<PAGE> 4
PURPOSE OF SUBSTITUTE FORM W-9
To prevent backup withholding on payments that are made to a Stockholder
with respect to Debentures acquired pursuant to the Exchange Offer, the
Stockholder is required to notify the Exchange Agent of his correct TIN (or that
such Stockholder is awaiting a TIN) by completing and signing the Substitute
Form W-9.
WHAT NUMBER TO GIVE THE EXCHANGE AGENT
The Stockholder is required to give the Exchange Agent the TIN of the
record owner of the Common Stock. If the Common Stock is in more than one name
or is not in the name of the actual owner, consult the enclosed "Guidelines for
Certification of Taxpayer Identification Number on Substitute Form W-9" for
additional guidance on which number to report. If "Special Registration
Instructions" above have been completed, the TINs of the person(s) in whose name
the Debentures are to be registered and the payee of the check for fractional
interests, as specified therein, are required to be given to the Exchange Agent.
4
<PAGE> 5
- --------------------------------------------------------------------------------
SUBSTITUTE FORM W-9
PAYER'S REQUEST FOR TAXPAYER IDENTIFICATION NUMBER
(PLEASE READ GUIDELINES FOR CERTIFICATION OF TAXPAYER IDENTIFICATION NUMBER ON
SUBSTITUTE FORM W-9
("GUIDELINES") BEFORE COMPLETING THIS FORM)
AFTER COMPLETING THE FORM, RETURN TO TRANSFER AGENT
- --------------------------------------------------------------------------------
Name (If joint names, list first and circle name of the person or entity whose
number you enter in Part I below.)
- --------------------------------------------------------------------------------
Address
- --------------------------------------------------------------------------------
City, State, and ZIP Code
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------
PART I TAXPAYER IDENTIFICATION NUMBER PART II
- ------------------------------------------------------------------------------ ------------
<S> <C> <C>
Enter your taxpayer identification number in the --------------------------- -------------------
appropriate box. For individuals, this is your SOCIAL SECURITY NUMBER FOR PAYEES EXEMPT FROM
social security number. However, if you are a BACKUP WITHHOLDING (SEE
resident alien OR a sole proprietor, see GUIDELINES)
Guidelines. For other entities, it is your employer ---------------------------
identification number. If you do not have a number,
see Guidelines.
OR
---------------------------
NOTE: If the account is in more than one name, see EMPLOYER IDENTIFICATION
Guidelines for instructions on whose number to NUMBER
enter.
---------------------------
</TABLE>
<TABLE>
<S> <C>
PART III CERTIFICATION
- -------------------------------------------------------------------------------------
</TABLE>
Under penalties of perjury, I certify that:
(1) The number shown on this form is my correct taxpayer identification number
(or I am waiting for a number to be issued to me) and
(2) I am not subject to backup withholding because (a) I am exempt from backup
withholding, or (b) I have not been notified by the Internal Revenue
Service (the "IRS") that I am subject to backup withholding as a result of
a failure to report all interest or dividends, or (c) the IRS has notified
me that I am no longer subject to backup withholding.
CERTIFICATION INSTRUCTIONS - You must cross out item (2) above if you have
been notified by the IRS that you are currently subject to backup withholding
because you have failed to report all interest or dividends on your tax
return.
------------------------------------------------------------------------------
Sign here
------------------------------------------------------------------------------
5
<PAGE> 6
Ladies and Gentlemen:
The Common Stockholder(s) whose signature(s) appear(s) hereon (the
"Stockholder") hereby tenders to Ugly Duckling Corporation, Inc., a Delaware
corporation (the "Company"), Common Stock pursuant to the Company's offer as
contained in the Offering Circular dated September 17, 1998 (the "Exchange
Offer"), receipt of which is hereby acknowledged, and in this Letter of
Transmittal (which together constitute the "Offer"), in exchange for 12%
Subordinated Debentures due 2003 (the "Debentures") on the basis of $6.50
principal amount of Debentures for each Share of Common Stock (and a payment in
respect of fractional Debenture interests as set forth in the Offering Circular
under "The Exchange Offer -- Denominations; Fractional Interests"). Capitalized
terms not defined herein have the meanings set forth in the Offering Circular.
Upon the terms and subject to the conditions of the Exchange Offer, the
Stockholder deposits with you the above-described Common Stock. The Stockholder
hereby sells, assigns and transfers to, or upon the order of, the Company all
right, title and interest in and to such Shares of Common Stock as are being
tendered hereby (and any and all shares of capital stock or other securities
issued or issuable in respect of such Common Stock) after the acceptance for
exchange of such Shares of Common Stock. The Stockholder hereby irrevocably
constitutes and appoints the Exchange Agent the true and lawful agent and
attorney-in-fact of the Stockholder (with full knowledge that such Exchange
Agent also acts as the agent of the Company) with respect to such Shares of
Common Stock and any such securities with full power of substitution (such power
of attorney being deemed to be an irrevocable power coupled with an interest) to
(a) deliver such Shares of Common Stock or transfer ownership of such Shares of
Common Stock on the account books maintained by DTC, together in either case
with all accompanying evidences of transfer and authenticity to or upon the
order of the Company upon receipt by the Exchange Agent as the Stockholder's
agent of the Debentures in the exchange ratio specified above for exchange and
(b) receive all benefits (including without limitation, all interest, shares and
other securities resulting from any distribution, combination or exchange
involving such Shares of Common Stock) and otherwise exercise all rights of
beneficial ownership of such Shares of Common Stock and any such securities, all
in accordance with the terms of the Exchange Offer.
The Stockholder hereby represents and warrants that the Stockholder has
full power and authority to tender, sell, assign and transfer the Shares of
Common Stock tendered hereby (and such shares of capital stock or other
securities issued in respect thereof) and that the Company will acquire good and
unencumbered title thereto, free and clear of all liens, restrictions, charges
and encumbrances and not subject to any adverse claim when the same are
purchased by the Company. The Stockholder will, upon request, execute and
deliver any additional documents deemed by the Exchange Agent or the Company to
be necessary or desirable to complete the sale, assignment and transfer of the
Shares of Common Stock and any such securities tendered hereby.
All authority herein conferred or agreed to be conferred shall survive the
death or incapacity of the Stockholder and every obligation of the Stockholder
hereunder shall be binding upon the heirs, personal representatives, successors
and assigns of the Stockholder. Except as stated in the Offering Circular, this
tender is irrevocable.
The Stockholder understands that acceptance of the Exchange Offer will
constitute an agreement between the Stockholder and the Company upon the terms
and subject to the conditions of the Exchange Offer only when either (a) a duly
executed and properly completed copy of this Letter of Transmittal, or facsimile
thereof, accompanied by Common Stock Certificates (or confirmation of a
book-entry transfer of such Common Stock into the Exchange Agent's account at
DTC) is received by the Exchange Agent, or (b) (i) such tender is made by or
through an Eligible Institution (as defined in Instruction 2 of this Letter of
Transmittal), (ii) prior to the Expiration Time the Exchange Agent has received
a telegram, facsimile transmission or letter from such Eligible Institution
setting forth the name and address of the holder of such Common Stock and the
number of Shares of Common Stock tendered and stating that the tender is being
made thereby and that, within three National Association of Securities Dealers
Automated Quotation System ("Nasdaq") trading days after the date of such
telegram, facsimile transmission or letter, the Letter of Transmittal, together
with the Common Stock Certificates (or confirmation of a book-entry transfer of
such Common Stock into the Exchange Agent's account at DTC) and any other
documents required by the Letter of Transmittal, will be deposited by such
Eligible Institution with the Exchange Agent, and (iii) such Letter of
Transmittal and Common Stock Certificates, in proper form for transfer (or
confirmation of a book-entry transfer of such Common Stock into the Exchange
Agent's account at DTC) and other required documents are received by the
Exchange Agent within three Nasdaq trading days after the date of
6
<PAGE> 7
such telegram, facsimile transmission or letter, all as provided in the Offering
Circular under "The Exchange Offer -- How to Tender."
Unless otherwise indicated in the box entitled "Special Registration
Instructions," please deliver Debentures (and, if applicable, Common Stock not
exchanged in an over-subscription) registered in the name of the Stockholder and
make any check on account of fractional interests payable to the Stockholder.
Similarly, unless otherwise indicated in the box entitled "Special Delivery
Instructions," please send Debentures (and, if applicable, Common Stock not
exchanged in an over-subscription), as well as any check on account of
fractional interests, to the Stockholder at the address shown below the
signature of the Stockholder. The Stockholder recognizes that the Company has no
obligation pursuant to the Special Registration Instructions and Special
Delivery Instructions to transfer any Common Stock from the name of the
registered holder thereof if the Company accepts none of the Common Stock for
exchange.
7
<PAGE> 8
INSTRUCTIONS
FORMING PART OF THE TERMS AND CONDITIONS OF THE EXCHANGE OFFER
1. DELIVERY OF LETTER OF TRANSMITTAL AND COMMON STOCK. Common Stock
Certificates (or confirmation of a book-entry transfer of such Common Stock into
the Exchange Agent's account at DTC), together with a properly completed and
duly executed Letter of Transmittal or facsimile thereof, and any other
documents required by this Letter of Transmittal should be transmitted to the
Exchange Agent at the appropriate address set forth herein and must be received
by the Exchange Agent prior to the Expiration Time (as defined in the Offering
Circular).
2. GUARANTEE OF DELIVERY. The acceptance by the Company of tenders of
Common Stock pursuant to the Exchange Offer will constitute an agreement between
the Stockholder and the Company, upon the terms and subject to the conditions of
the Exchange Offer, only when a properly completed and duly executed Letter of
Transmittal and any other required documents are received by the Exchange Agent
or a telegram, facsimile transmission or letter from an Eligible Institution as
provided below is received by the Exchange Agent. For purposes of the Exchange
Offer, the Company shall be deemed to have accepted for exchange validly
tendered Common Stock when, as and if the Company has given oral or written
notice thereof to the Exchange Agent.
Stockholders whose Common Stock Certificates are not immediately available
or who cannot deliver their Common Stock Certificates (or confirm a book-entry
transfer of such Common Stock into the Exchange Agent's account at DTC) and
deliver all other documents required hereby may tender their Common Stock by
tendering through a firm which is a member of a registered national securities
exchange or a member of the National Association of Securities Dealers, Inc., or
by a commercial bank or trust company having an office in the United States (an
"Eligible Institution") pursuant to the guaranteed delivery procedures set forth
in the Offering Circular under "The Exchange Offer -- How to Tender." Pursuant
to such procedures: (i) such tender must be made by or through an Eligible
Institution; (ii) prior to the Expiration Time, the Exchange Agent must have
received a telegram, facsimile transmission or letter from such Eligible
Institution setting forth the name and address of the holder of such Common
Stock and the number of Shares of Common Stock tendered and stating that the
tender is being made thereby and guaranteeing that, within three Nasdaq trading
days after the date of such telegram, facsimile transmission or letter, the
Letter of Transmittal, together with the Common Stock Certificates (or
confirmation of book-entry transfer of such Common Stock into the Exchange
Agent's account at DTC), and any other documents required by the Letter of
Transmittal will be deposited by such Eligible Institution with the Exchange
Agent; and (iii) such Letter of Transmittal and Common Stock Certificates in
proper form for transfer (or confirmation of a book-entry transfer of such
Common Stock into the Exchange Agent's account at DTC) and other required
documents must be received by the Exchange Agent within three Nasdaq trading
days after the date of such notice of guaranteed delivery, all as provided in
the Offering Circular under "The Exchange Offer -- How to Tender."
Issuance of Debentures in exchange for Common Stock tendered and accepted
for exchange pursuant to the Exchange Offer will be made only against timely
deposit of Common Stock Certificates (or confirmation of a book entry transfer
of such Common Stock into the Exchange Agent's account at DTC), a properly
completed and duly executed Letter of Transmittal, and any other required
documents.
3. METHOD OF DELIVERY OF LETTER OF TRANSMITTAL AND CERTIFICATES. The
method of delivery of this Letter of Transmittal, the Common Stock Certificates
(or confirmation of a book-entry transfer of such Common Stock into the Exchange
Agent's account at DTC), and any other required documents is at the option and
risk of the Stockholder but, except as otherwise provided in Instruction 2
above, the delivery will be deemed made only when actually received by the
Exchange Agent. If such delivery is by mail, it is suggested that registered
mail with return receipt requested, properly insured, be used.
4. NO CONDITIONAL TENDERS. The Company is not obligated to accept any
alternative, conditional, irregular or contingent tenders.
5. INADEQUATE SPACE. If the space provided in the box entitled
"Description of Common Stock Tendered" of this Letter of Transmittal is
inadequate, the Common Stock Certificate numbers and number of shares should be
listed on a separate signed schedule to be affixed hereto.
8
<PAGE> 9
6. PARTIAL TENDERS. Issuance of Debentures in exchange for Shares of
Common Stock will be made only against deposit of tendered Shares of Common
Stock. If less than the entire number of Shares of Common Stock evidenced by a
submitted Common Stock Certificate is tendered, the tendering Stockholder should
fill in the number of Shares of Common Stock tendered in the appropriate boxes
above entitled "Number of Shares Tendered." The Exchange Agent will then issue
and send to the tendering holder (unless otherwise requested by the holder under
"Special Issuance and Payment Instructions" and "Special Delivery Instructions"
in this Letter of Transmittal), a newly issued Common Stock Certificate for
Shares of Common Stock submitted but not tendered, together with any tendered
Shares of Common Stock that were not accepted for exchange because of proration
or otherwise. The entire number of all Shares of Common Stock deposited with the
Exchange Agent will be deemed to have been tendered unless otherwise indicated.
Tendered Shares of Common Stock not accepted for exchange by the Company,
including as a result of proration, if any, will be returned without expense to
the tendering holder of such Shares of Common Stock (or, in the case of the
Shares of Common Stock tendered by book-entry transfer into the Exchange Agent's
account at DTC, such Shares of Common Stock will be credited to an account
maintained at DTC) as promptly as practicable following the Expiration Time,
subject to delays, if any, resulting from proration.
7. DENOMINATIONS: FRACTIONAL INTERESTS. The Debentures will be issued
only in denominations of $1.00 and any integral multiple thereof. The Company
will pay cash in lieu of such interests all as provided in the Offering Circular
under "The Exchange Offer -- Denominations; Fractional Interests," and subject
to the conditions and exceptions set forth therein.
8. SIGNATURES ON LETTER OF TRANSMITTAL AND ENDORSEMENTS; GUARANTEE OF
SIGNATURES. If the Letter of Transmittal is signed by the holder of the Common
Stock tendered hereby, the signature must correspond with the name as written on
the face of the Common Stock Certificates without alteration, enlargement or any
change whatsoever.
If the Shares of Common Stock tendered hereby are owned of record by two or
more joint owners, all such owners must sign this Letter of Transmittal.
When this Letter of Transmittal is signed by the holder or holders of the
Common Stock Certificates transmitted hereby, no endorsement of Common Stock
Certificates is required. If, however, the Debentures are to be issued, or the
Common Stock reissued, or checks for fractional interests are to be payable to a
person other than the holder, then endorsements of Common Stock Certificates
transmitted hereby are required.
If this Letter of Transmittal is signed by a person other than the holder
or holders of the Common Stock Certificates tendered hereby, the Common Stock
Certificates must be endorsed and signed exactly as the name or names of the
holder or holders appear on the Common Stock Certificates.
If this Letter of Transmittal or any Common Stock Certificates are signed
by trustees, executors, administrators, guardians, attorneys-in-fact, officers
of corporations or others acting in a fiduciary or representative capacity, such
persons should so indicate when signing, and proper evidence satisfactory to the
Company of their authority so to act must be submitted.
Signatures on Common Stock Certificates required by this Instruction 8 must
be guaranteed by an Eligible Institution.
Signatures on this Letter of Transmittal need not be guaranteed by an
Eligible Institution, provided the Common Stock Certificates are tendered (i) by
a holder of such Shares who has not completed the box entitled "Special
Registration Instructions" or "Special Delivery Instructions" on this Letter of
Transmittal or (ii) for the account of an Eligible Institution.
9. TRANSFER TAXES. The Company will pay any transfer taxes applicable to
the transfer of Common Stock to it or its order pursuant to the Exchange Offer.
If, however, delivery of Debentures is to be made to, or is to be registered or
issued in the name of any person other than the holder of the Common Stock
tendered hereby, or if the Common Stock tendered hereby is registered in the
name of any person other than the person signing this Letter of Transmittal, or
if for any other reason other than the transfer of Common Stock to the Company
or its order pursuant to the Exchange Offer a transfer tax is imposed, the
amount of any such transfer taxes (whether imposed on the holder or any other
person) will be payable by the tendering Stockholder. If satisfactory evidence
of payment of such taxes or exemption therefrom is not submitted herewith, the
amount of such transfer taxes due will be billed directly to such tendering
Stockholder.
9
<PAGE> 10
Except as provided in this Instruction 9, it will not be necessary for
transfer tax stamps to be affixed to the Common Stock Certificates listed in
this Letter of Transmittal.
10. SUBSTITUTE FORM W-9. The tendering Stockholder is required to provide
the Exchange Agent with a correct Taxpayer Identification Number ("TIN") on
Substitute Form W-9, unless an exemption applies. Failure to provide the
information on the form may subject the tendering Stockholder to backup
withholding tax of 31% on interest payments with respect to the Debentures and
any cash paid in lieu of the issuance of fractional interests in the Debentures.
If the tendering Stockholder has not been issued a TIN and has applied for a
number (or intends to apply for a number in the near future), the tendering
Stockholder should write "Applied for" on the face of the Substitute Form W-9.
If the Exchange Agent is not provided with a TIN within 60 days, the Exchange
Agent will withhold 31% of all such payments in respect of interest thereafter
until a TIN is provided to the Exchange Agent. See "Important Tax Information"
on the enclosed "Guidelines for Certification of Taxpayer Identification Number
on Substitute Form W-9" for additional information concerning Substitute Form
W-9 and 31% backup withholding, including information on exemptions from backup
withholding.
11. SPECIAL REGISTRATION AND DELIVERY INSTRUCTIONS. If Debentures and/or
Shares of Common Stock and/or a check for payment for fractional interests in
respect of Debentures are to be issued in the name of or delivered to a person
other than the signer of the Letter of Transmittal or to an address other than
that shown above, the appropriate boxes on the Letter of Transmittal should be
completed.
12. WAIVER OF CONDITIONS. The Company reserves the absolute right to
waive any of the specified conditions in the Exchange Offer in the case of any
Shares of Common Stock tendered.
13. REQUESTS FOR ASSISTANCE OR ADDITIONAL COPIES. Requests for assistance
or additional copies of the Offering Circular and the Letter of Transmittal may
be directed to the Information Agent at the address and telephone number set
forth below or to your broker, dealer, commercial bank or trust company.
IMPORTANT: This Letter of Transmittal or a facsimile thereof (together with
Common Stock Certificates or confirmation of a book-entry transfer of such
Common Stock into the account of the Exchange Agent at The Depository Trust
Company) and all other required documents must be received by the Exchange Agent
or a notice of guaranteed delivery must be received by the Exchange Agent, prior
to the Expiration Time, all as defined in the Offering Circular.
THE INFORMATION AGENT IS:
CORPORATE INVESTOR
COMMUNICATIONS, INC.
111 COMMERCE ROAD
CARLSTADT, NEW JERSEY 07072-2586
------------------------
TOLL FREE: 1-888-673-4478
10
<PAGE> 1
Logo
Dear Stockholder:
We have enclosed materials regarding our upcoming Annual Meeting. In
addition to ordinary course proposals, we are asking you to vote on a very
important matter -- the separation of our dealership and non-dealership
operations.
The proposal entails forming a new company, Cygnet Financial Corporation
("Cygnet"), which will operate substantially all of our third party servicing
and dealer finance operations. Ugly Duckling will transfer these assets to
Cygnet for an amount equal to the greater of the appraised value and the book
value of the assets (in each case net of assumed liabilities) determined as of
the closing of the transaction. Cygnet will pay the purchase price for the
assets with $40 million of preferred stock and a cash payment for the balance,
which is expected to range from $10 million to $20 million. We will also
capitalize the new company through a rights offering to our stockholders. Under
the rights offering, stockholders of the Company of record on August 17, 1998
will have the opportunity to acquire 1 share in the new company for every 4
shares that you own in Ugly Duckling for $7.00 per share. In addition,
stockholders will be able to acquire additional shares if other stockholders do
not exercise their rights. This proposal is contingent upon at least 75% of the
rights to acquire stock in Cygnet being subscribed. If we achieve this 75% level
of interest, the new company will be capitalized with approximately $23.1
million (apart from the value of the transferred assets), which we believe will
allow Cygnet to address a number of current market opportunities.
We encourage you to vote for the proposal. We believe the separation of our
operations will enable management of each operation to better focus on their
respective businesses, and will enable the investment community to better
understand these distinct business operations. Under the proposal, I will remain
Chairman of each Company, and will become CEO of Cygnet. Greg Sullivan, who is
President of the Company, will also assume the CEO position of Ugly Duckling, a
limited number of officers of the Company will move to Cygnet, and the rest of
the Ugly Duckling team will continue to focus on growing our dealership
operations.
I am personally committed to this endeavor. I will exercise all of my
rights to acquire approximately $8.2 million of Cygnet stock and may acquire up
to an additional $5 million in Cygnet stock. I will also commit additional
personal funds to purchase stock of Cygnet to the extent necessary to meet the
75% level of interest referenced above. Officers and directors of the Company
(other than myself), who together own approximately 4% of the outstanding common
stock of the Company, have informed the Company that they intend to vote their
stock in favor of the proposal. I have agreed to vote my approximately 25.2 % of
the outstanding common stock of the Company in the same proportion as all other
stock is voted on the proposal at the meeting.
Please read the enclosed materials carefully. We look forward to seeing you
at the upcoming Annual Meeting.
Sincerely,
Signature of Ernest C. Garica II
Ernest C. Garcia, II
Chairman of the Board and
Chief Executive Officer
Phoenix, Arizona
August 4, 1998
<PAGE> 2
UGLY DUCKLING CORPORATION
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
------------------------
NOTICE AND PROXY STATEMENT FOR 1998 ANNUAL MEETING
OF STOCKHOLDERS HELD ON AUGUST 31, 1998
------------------------
To the Holders of Common Stock of Ugly Duckling Corporation:
The 1998 Annual Meeting of Stockholders ("Annual Meeting") of Ugly Duckling
Corporation ("Company") will be held at 4:00 p.m. (Arizona Time) on August 31,
1998, at The Phoenician, 6000 East Camelback Road, Phoenix, Arizona 85251 for
the following purposes:
1. To elect six directors for one-year terms;
2. To approve certain technical amendments to the Company's Long-Term
Incentive Plan (no increase in shares available for issuance is being
requested);
3. To approve the Company's 1998 Executive Incentive Plan;
4. To approve a proposal (the "Split-up Proposal"), pursuant to which
the Company would transfer substantially all of its non-dealership
operations (including its third party dealer finance and certain servicing
operations) to a newly-formed company, Cygnet Financial Corporation
("Cygnet"), at the greater of the appraised value or the book value of the
assets to be transferred (in each case net of assumed liabilities), in
exchange for $40 million of preferred stock of Cygnet and a cash payment
for the balance, which is expected to range from $10 million to $20
million. In addition to the preferred stock, Cygnet would be capitalized
through a rights offering to the stockholders of the Company; and
5. To transact such other business as may properly come before the
Annual Meeting or any adjournments thereof.
The foregoing items of business are more fully described in the Proxy
Statement accompanying this Notice. The Company urges you to read this
information carefully. The Company is presently aware of no other business to
come before the Annual Meeting. Your Board of Directors unanimously believes
that the four items proposed by the board are in the best interests of the
Company and its stockholders, and, accordingly recommends a vote FOR Item Nos.
1, 2, 3, and 4 on the enclosed proxy card.
Each outstanding share of the Company's Common Stock entitles the holder of
record at the close of business on July 9, 1998 to receive notice of and to vote
at the Annual Meeting and any adjournments or postponements thereof. Shares of
Common Stock can be voted at the Annual Meeting only if the holder is present at
the Annual Meeting in person or by valid proxy. A list of stockholders of record
will be available at the meeting and for ten (10) days prior to the meeting at
Ugly Duckling Corporation, 2525 East Camelback Road, Suite 1150, Phoenix,
Arizona 85016. The Proxy Statement and form of proxy for the Annual Meeting are
first being mailed with this Notice on or about the date hereof.
All stockholders are cordially invited to attend the Annual Meeting in
person.
By Order of the Board of Directors,
Signature of Ernest C. Garica II
ERNEST C. GARCIA II
Chairman of the Board and
Chief Executive Officer
Phoenix, Arizona
August 4, 1998
<PAGE> 3
YOUR VOTE IS IMPORTANT:
WHETHER OR NOT YOU EXPECT TO ATTEND THE ANNUAL MEETING, STOCKHOLDERS ARE
REQUESTED TO PROMPTLY SIGN, DATE, AND MAIL THE ENCLOSED PROXY. A POSTAGE-PAID
ENVELOPE IS PROVIDED FOR MAILING IN THE UNITED STATES.
THERE MAY BE CERTAIN TAX CONSEQUENCES TO YOU IF THE RIGHTS OFFERING DESCRIBED
HEREIN IS EFFECTED. TO AVOID THE POSSIBILITY OF THE RECOGNITION OF ORDINARY
INCOME AND THE CREATION OF A POTENTIALLY DEFERRED OR NONDEDUCTIBLE CAPITAL LOSS,
IT WILL, IN MANY INSTANCES, BE IN THE INTERESTS OF HOLDERS OF COMPANY COMMON
STOCK RECEIVING RIGHTS TO EITHER EXERCISE OR SELL THE RIGHTS, RATHER THAN TO
ALLOW THE RIGHTS TO LAPSE. PLEASE READ THE ENCLOSED MATERIALS CONCERNING THE
RIGHTS OFFERING CAREFULLY.
THE INFORMATION INCLUDED HEREIN SHOULD BE REVIEWED IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS, NOTES TO CONSOLIDATED FINANCIAL STATEMENTS,
INDEPENDENT AUDITORS' REPORT, AND OTHER INFORMATION INCLUDED IN THE COMPANY'S
ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997 THAT IS
BEING MAILED WITH THIS PROXY STATEMENT TO ALL STOCKHOLDERS OF RECORD ON THE
RECORD DATE. IN DETERMINING WHETHER TO VOTE IN FAVOR OF THE SPLIT-UP PROPOSAL
(ITEM NO. 4), THE FINANCIAL INFORMATION CONTAINED HEREIN AND IN THE ENCLOSED
PROSPECTUS OF CYGNET SHOULD BE CAREFULLY CONSIDERED.
<PAGE> 4
UGLY DUCKLING CORPORATION
------------------------
PROXY STATEMENT
1998 ANNUAL MEETING OF STOCKHOLDERS
AUGUST 31, 1998
------------------------
This Proxy Statement is furnished to the holders of Ugly Duckling
Corporation, a Delaware corporation (the "Company"), common stock, par value
$.001 per share ("Common Stock"), in connection with the solicitation of proxies
to be used in voting at the Company's Annual Meeting of Stockholders to be held
on August 31, 1998 beginning at 4:00 p.m. (Arizona Time) at The Phoenician, 6000
East Camelback Road, Phoenix, Arizona 85251, and at any adjournments or
postponements thereof (the "Annual Meeting"). The enclosed proxy is solicited by
the Board of Directors of the Company. The proxy materials relating to the
Annual Meeting were mailed on or about August 4, 1998 to stockholders of record
of the Common Stock at the close of business on July 9, 1998 (the "Record
Date").
Four proposals (the "Proposals") are being presented to the stockholders
for approval at the Annual Meeting, including a proposal to elect directors, a
proposal to adopt certain technical amendments to the Company's Long Term
Incentive Plan, a proposal to adopt the Ugly Duckling 1998 Executive Incentive
Plan, and a proposal relating to separation of the Company's dealership and
non-dealership operations (the "Split-Up Proposal"). Each holder of record of
Common Stock on the Record Date shall be entitled to one vote in person or by
proxy for each such share held. The affirmative vote of a plurality of shares
entitled to vote for election of directors is required to elect directors. The
affirmative vote of a majority of the shares present in person or by proxy at
the Annual Meeting and entitled to vote is required to approve the other 3
proposals, including the Split-Up Proposal. Ernest C. Garcia, II, the Company's
Chairman of the Board, Chief Executive Officer, and the holder of approximately
25.2% of the outstanding Common Stock has informed the Company that he intends
to vote his shares on the Split-Up Proposal in the same proportion as all other
stock voted at the Annual Meeting. BASED UPON THE RECOMMENDATION OF THE
INDEPENDENT DIRECTORS (ALL DIRECTORS EXCEPT ERNEST C. GARCIA, II) AS TO PROPOSAL
NO. 4, THE BOARD OF DIRECTORS OF THE COMPANY HAS APPROVED (BY UNANIMOUS VOTE OF
THOSE DIRECTORS PRESENT AT THE MEETING) THE PROPOSALS AND RECOMMENDS THAT THE
STOCKHOLDERS VOTE FOR THE PROPOSALS.
The purpose of the Split-Up Proposal is to separate the Company and its
existing subsidiaries into two publicly-held companies (the "Split-up"). The
Company will transfer to Cygnet Financial Corporation ("Cygnet"), a newly-formed
Delaware corporation and wholly-owned subsidiary of the Company, its bulk
purchasing and servicing operations, its third party dealer finance operations
(excluding the branch office network operations that were closed in the first
quarter of 1998), and substantially all of the assets and liabilities acquired
in the Company's First Merchants Acceptance Corporation and Reliance Acceptance
Corporation transactions. In exchange for such assets, the Company will receive
$40 million of Cygnet's cumulative, convertible preferred stock and a cash
payment. The sum of the preferred stock and the cash payment will be equal to
the greater of the appraised value or book value of the assets transferred (in
each case net of assumed liabilities). Cygnet may also effect certain additional
transactions prior to the Split-up as generally described herein.
After the Split-up, the Company and Cygnet will be two separate,
independent companies with separate management. Cygnet will operate
substantially all of the third party dealer finance operations currently
conducted by the Company including the bulk purchasing and collateralized dealer
finance program, and certain of its servicing operations. The Company will
continue to operate its buy-here, pay-here dealerships ("Company Dealerships"),
and to service the finance receivables generated by the Company Dealerships.
If the Split-up Proposal is approved by the stockholders, then, subject to
certain contingencies, Cygnet would be further capitalized through a rights
offering to the Company stockholders ("Rights Offering"). In the Rights
Offering, each Company stockholder would receive a right to purchase 1 share of
the common stock, $.001 par value, of Cygnet ("Cygnet Common Stock") for every 4
shares of Company Common Stock
<PAGE> 5
held by such stockholder. The Rights would allow the stockholder to purchase the
Cygnet Common Stock for a subscription price of $7.00 per share. Stockholders
would have 20 days to exercise the Rights and may also subscribe for additional
shares of Cygnet Common Stock out of the pool of shares underlying unexercised
Rights at the end of the 20 day exercise period.
The Split-up is contingent on, among other conditions, the purchase of at
least 75% of the Cygnet Common Stock offered in the Rights Offering (the
"Required Purchase Amount"). Mr. Ernest C. Garcia, II will purchase sufficient
Cygnet Common Stock to achieve the Required Purchase Amount.
Cygnet has filed a Registration Statement on Form S-1 (the "Cygnet
Registration Statement") pursuant to the Securities Act of 1933, as amended, and
the rules and regulations promulgated thereunder (the "Securities Act"),
covering the Rights and underlying shares of Cygnet Common Stock to be issued
pursuant to the Rights Offering. A copy of the Cygnet Prospectus, which has been
filed as part of the Cygnet Registration Statement, accompanies this Proxy
Statement and should be read in its entirety in connection herewith.
The Information Agent for the Rights Offering is Corporate Investor
Communications, Inc. ("CIC"). Questions concerning the Rights Offering may be
addressed to CIC at 1-888-673-4478.
STOCKHOLDERS SHOULD CONSIDER CERTAIN FACTORS DISCUSSED UNDER "RISK
FACTORS," AS WELL AS THE OTHER INFORMATION SET FORTH HEREIN, BEFORE ACTING ON
THE PROPOSALS.
<PAGE> 6
PROXY STATEMENT
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Summary..................................................... 1
Summary Selected Consolidated Financial Data................ 11
Risk Factors................................................ 14
Voting Securities Outstanding and Voting Rules.............. 20
Proposal No. 1 -- Election of Directors..................... 20
Proposal No. 2 -- Amendments to the Ugly Duckling
Corporation Long-Term Incentive Plan...................... 21
Proposal No. 3 -- Adoption of the Ugly Duckling Corporation
1998 Executive Incentive Plan............................. 26
Proposal No. 4 -- Approval of Split-up of the Company and
Its Subsidiaries into Two Publicly-Held Corporate
Groups.................................................... 29
Federal Income Tax Consequences of the Rights Offering and
Collateral Transactions................................... 46
Summary Selected Consolidated Financial Data................ 52
Management's Discussion and Analysis of Results of
Operations and Financial Condition of the Continuing
Company Businesses........................................ 55
Business of the Company after the Split-up.................. 76
Management of the Company................................... 82
Compensation of Directors and Executive Officers, Benefits,
and Related Matters....................................... 89
Experts..................................................... 101
Other Matters............................................... 101
Index to Consolidated Financial Statements.................. F-1
</TABLE>
<PAGE> 7
SUMMARY
The following is a summary of certain information contained in this Proxy
Statement. This summary is not intended to be complete and is qualified in its
entirety by reference to the more detailed information included elsewhere in
this Proxy Statement.
THE ANNUAL MEETING
Date, Time and Place of the
Annual Meeting.............. The Annual Meeting will be held on August 31,
1998 beginning at 4:00 p.m. (Arizona Time) at
The Phoenician, 6000 East Camelback Road,
Phoenix, Arizona 85251.
Purpose of the Annual
Meeting....................... The Annual Meeting is being held for the
purpose of considering and voting on the
Proposals described herein. Approval of the
Proposals will constitute approval of each of
the components of the Proposals.
Record Date................... The Record Date for the Annual Meeting is July
9, 1998.
Voting........................ At the Annual Meeting, each holder of record of
Company Common Stock on the Record Date will be
entitled to one vote for each share of Company
Common Stock held as of the Record Date. The
affirmative vote of a plurality of the shares
of Common Stock present in person or by proxy
at the Annual Meeting and entitled to vote in
the election of directors (Proposal No. 1) is
required to elect directors. Approval of each
of Proposal No. 2, Proposal No. 3, and Proposal
No. 4 requires the affirmative vote of a
majority of the shares of Company Common Stock
present in person or by proxy at the Annual
Meeting and entitled to vote on such matters.
Ernest C. Garcia, II, the Company's Chairman of
the Board, Chief Executive Officer, and the
holder of approximately 25.2% of the
outstanding Company Common Stock of the Company
has informed the Company that he will vote his
stock on Proposal No. 4 in the same proportion
as all other stock voted on that Proposal at
the Annual Meeting.
Appraisal Rights.............. Stockholders of the Company will not be
entitled to appraisal rights in connection with
the Proposals.
THE PROPOSALS
Proposal No. 1:
Election of Directors....... To elect six directors. All director candidates
are incumbent directors, except that Gregory B.
Sullivan, President of the Company, is
nominated to replace Arturo R. Moreno who
resigned his position as a director of the
Company effective June 30, 1998 because of time
constraints relating to family and other
business interests.
Proposal No. 2:
Technical Amendments to
Long-Term Incentive
Plan.......................... To adopt certain technical amendments to the
Ugly Duckling Corporation Long-Term Incentive
Plan. The amendments would
1
<PAGE> 8
not increase the number of shares of Company
Common Stock available for issuance under the
Incentive Plan.
Proposal No. 3:
Adoption of New Incentive
Plan........................ To adopt the Ugly Duckling Corporation 1998
Executive Incentive Plan. 800,000 shares of
Company Common Stock would be available for
issuance under the 1998 Plan. Options to
purchase 525,000 shares of Company Common Stock
have been granted as of January 15, 1998 under
the 1998 Plan to certain officers of the
Company, subject to stockholder approval. See
"Proposal No. 3 -- Grants Under the 1998
Plan -- Existing Grants."
Proposal No. 4:
Split-Up of Operations...... To approve the separation of the Company and
its existing subsidiaries into two
publicly-held corporate groups. The Company's
existing operations and the Split-up are
generally summarized below.
Current Business
Operations.................. The Company operates a chain of Buy Here-Pay
Here used car dealerships in the United States
and underwrites, finances and services retail
installment contracts generated from the sale
of used cars by its Company dealerships and by
third party dealers located in selected markets
throughout the country. As part of its
financing activities, the Company has initiated
its Cygnet Dealer Program, pursuant to which
the Company provides qualified independent used
car dealers with warehouse purchase facilities
and operating credit lines primarily secured by
the dealers' retail installment contract
portfolio. In addition, the Company purchases
loan portfolios in bulk and services loan
portfolios on behalf of third parties. 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.
Transfer of Assets.......... The Company would transfer to Cygnet Financial
Corporation, a newly-formed Delaware
corporation ("Cygnet"), its bulk purchase and
servicing operations, its third party dealer
finance operations (excluding the branch office
network operations that were closed in the
first quarter of 1998), and substantially all
assets and certain liabilities acquired
pursuant to transactions with First Merchants
Acceptance Corporation ("FMAC") and Reliance
Acceptance Group, Inc. ("Reliance"). The
Company may also enter into other transactions
and acquire other assets prior to the effective
date of the Split-up (the "Effective Date")
similar to those described above and may
transfer to Cygnet the assets and related
liabilities so acquired. All transferred assets
and related liabilities may be collectively
referred to as the "Split-up Businesses" or the
"Transferred Assets." In consideration for such
assets, Cygnet would issue to the Company $40
million of its cumulative, convertible
preferred stock (the "Cygnet Preferred Stock"),
and would make a cash or equivalent payment of
the balance (the "Cash Payment") as described
below under "The Cash Payment." Together the
Cygnet Preferred Stock and the Cash Payment
would equal the
2
<PAGE> 9
greater of the appraised value or the book
value of the Transferred Assets (the "Transfer
Value").
Interim Transactions........ Cygnet may purchase or enter into servicing
agreements with respect to portfolios of loan
receivables, may purchase debt secured by
portfolios of receivables, may purchase other
assets, may agree to service or assume
servicing obligations regarding receivables,
may make loans to or obtain warrants or
investment rights in another entity, and may
enter into other similar transactions ("Interim
Transactions") prior to the Effective Date. To
effect any Interim Transactions, Cygnet may
borrow money from a third party lender ("Third
Party Loans"), or from the Company ("Interim
Company Loans"). Third Party Loans made to
Cygnet prior to the Effective Date may be
guaranteed by the Company. The Company and
Cygnet will seek to have any such guarantee
released as of the Effective Date, with Cygnet
likely providing a replacement guarantee.
Interim Company Loans may become due and
payable on the Effective Date. If any such
Interim Transactions are effected or Cygnet
otherwise has operations prior to the Effective
Date, on the business day immediately preceding
the Effective Date, Cygnet will distribute to
the Company all earnings accrued to such date.
In addition, Cygnet will pay to the Company the
excess, if any, of the aggregate appraised
value of the assets and rights and related
liabilities acquired by Cygnet in Interim
Transactions (the "Interim Assets"), as of the
Effective Date, over the aggregate book value
of the Interim Assets (the "Interim
Consideration"). The Company may agree to other
terms with respect to how Interim Transactions
will be structured or treated if the Company
believes that such structure or treatment
results in adequate consideration to the
Company at the time of the Split-up with
respect to the Interim Assets. The purpose for
the payment by Cygnet to the Company of the
Interim Consideration is to place both parties
in substantially the same economic position
each would be in if the Interim Transactions
were effected by the Company rather than Cygnet
and the resulting assets and liabilities were
transferred to Cygnet. For a description of
certain Interim Transactions currently
contemplated or recently completed by Cygnet,
see "Business -- New Developments" in the
Cygnet Prospectus.
Retained Company
Operations.................... Following the Split-up, the Company would
retain its used car dealership operations, its
securitization program and its interests in the
bankruptcy remote subsidiaries that own the
residual interests in all prior
securitizations, all existing servicing
operations for all receivable portfolios other
than those acquired or to be acquired pursuant
to the FMAC and Reliance transactions, and
certain collateral operations (collectively,
the "Continuing Company Businesses").
Anticipated Benefits........ The Split-up Businesses and the Continuing
Company Businesses have distinct financial,
investment, and operating characteristics. The
Company's Board of Directors believes that
splitting such businesses will allow the
adoption of strategies and the pursuit of
objectives appropriate to each business
separately without regard to
3
<PAGE> 10
the effect such strategies and objectives may
have on the other. In addition, the Company's
Board believes that the Split-up would allow
investors to better evaluate the performance
and investment characteristics of each business
group, enhancing the likelihood that each will
achieve appropriate market recognition of its
performance.
The Cygnet Preferred
Stock....................... The Company would receive 40,000 shares of
Cygnet Preferred Stock in partial consideration
for the Transferred Assets. In the event of
dissolution or liquidation of Cygnet, the
Cygnet Preferred Stock would be entitled to
receive in preference to the Cygnet Common
Stock, $1,000 per share (the "Base Liquidation
Amount"), plus accrued dividends thereon. The
Cygnet Preferred Stock would accrue dividends
at the initial rate of 7% per annum on the Base
Liquidation Amount and increasing 1% per annum
thereafter to a maximum rate of 11% per annum.
The Cygnet Preferred Stock will be redeemable
by Cygnet in whole or in part at any time,
provided, however, that no such redemption will
be authorized unless, in the reasonable
judgment of the Company and Cygnet, the
redemption proceeds would be treated for
federal income tax purposes as proceeds from
sales of such stock and not as dividends paid
with respect to such stock. The Cygnet
Preferred Stock will be convertible into Cygnet
Common Stock, as described herein, after three
years following the date of issuance or prior
thereto if an amount equal to six quarterly
dividend payments on the Cygnet Preferred Stock
has accrued and is unpaid until the payment in
full thereof. If the Cygnet Preferred Stock
were converted to Cygnet Common Stock at the
subscription price of $7.00 per share, the
Company would obtain 5,714,286 shares, or
approximately 61.6% of the then outstanding
shares of Cygnet, assuming the sale by Cygnet
pursuant to the Rights Offering of 3,562,500
shares of Cygnet Common Stock (the Required
Purchase Amount) and that no additional shares
of Cygnet Common Stock are issued either on the
Effective Date of the Split-up or thereafter.
If the Cygnet Preferred Stock were converted to
Cygnet Common Stock at the subscription price
of $7.00 per share, and assuming the sale by
Cygnet of 4,750,000 shares of Cygnet Common
Stock pursuant to the Rights Offering and the
sale of the full 714,286 Additional Cygnet
Shares (defined below) to Ernest C. Garcia, II
and the full 214,286 shares available for
purchase by officers and directors of Cygnet
(other than Mr. Garcia) and that no additional
shares of Cygnet Common Stock are then
outstanding, the Company would obtain
approximately 50.2% of the then outstanding
shares of Cygnet.
The Cygnet Preferred Stock and the Cygnet
Common Stock into which the Cygnet Preferred
Stock is convertible are not registered under
the Securities Act and may not be sold by the
Company unless such securities are registered
or unless an exemption from registration is
available. Cygnet will register at its expense
the resale of the Cygnet Common Stock issued
upon conversion of the Cygnet Preferred Stock
under the Securities Act, at the request of the
Company.
4
<PAGE> 11
For further information concerning the Cygnet
Preferred Stock, see "Proposal No.
4 -- Approval of the Split-up of the Company
and its Subsidiaries into Two Publicly-Held
Corporate Groups -- Cygnet Preferred Stock and
the Cash Payment."
The Cash Payment............ The excess of the Transfer Value on the
Effective Date over $40 million will be paid by
Cygnet to the Company through the Cash Payment.
Cygnet would also be required to repay to the
Company any Interim Company Loans, would pay
the Interim Consideration, and would distribute
to the Company any earnings accrued prior to
the Effective Date. The Company may also
require the release of any guarantee of Third
Party Loans to Cygnet. Alternatively, the
Company and Cygnet may agree as to other
treatment of the Interim Transactions. The
Company intends to utilize a portion of the
Cash Payment to repay in full its $10 million
subordinated note to Verde Investments, Inc.
("Verde"), an affiliate of the Company,
wholly-owned by Mr. Garcia (the "Verde Note"),
subject to the receipt of certain required
consents. Alternatively, Verde may deposit the
Verde Note or any part thereof with Cygnet in
payment of all or any portion of the
Subscription Price for exercise of Rights
acquired by Verde from Mr. Garcia or otherwise,
the related Over-Subscription Privilege
(defined below), and the Standby Purchase
Obligation (defined below). In such case,
Cygnet would transfer the Verde Note to the
Company for cancellation in lieu of the payment
of a portion of the Cash Payment. See "Proposal
No. 4 -- Approval of the Split-up of the
Company and its Subsidiaries into Two
Publicly-Held Corporate Groups -- Cygnet
Preferred Stock and the Cash Payment" and
"-- Repayment of Verde Subordinated Debt."
Executive Officers and
Directors................... If the Split-up is successfully concluded, Mr.
Garcia would remain on the Board of Directors
of the Company. Gregory B. Sullivan, the
Company's current President and Chief Operating
Officer, would assume the role of Chief
Executive Officer. In addition, certain other
executive officers of the Company would move to
Cygnet. See "Proposal No. 4 -- Approval of the
Split-up of the Company and its Subsidiaries
into Two Publicly-Held Corporate
Groups -- Management of the Company and Cygnet;
Employees and Employee Issues."
The Rights Offering......... Cygnet would be further capitalized through a
rights offering to stockholders of the Company
(the "Rights Offering"). Each stockholder of
the Company on August 17, 1998, the record date
for the Rights Offering (the "Rights Record
Date"), would receive one (1) transferrable
Right for every four (4) shares of Company
Common Stock held by him. Each Right would
allow the holder to purchase one (1) share of
Cygnet Common Stock at a subscription price of
$7.00 per share (the "Subscription Price"). The
Rights would be exercisable for a limited
period of 20 days unless extended (the
"Offering Period"). Holders of Rights who
exercise all of their Rights may also subscribe
for an additional number of shares of Cygnet
Common Stock at the Subscription Price out of
the pool of shares underlying unexercised
Rights on the expiration date of the Rights
Offering (the "Unexercised Pool"), up to the
5
<PAGE> 12
number of shares purchased upon exercise of
such holder's Rights, subject to allocation as
described herein (the "Over-Subscription
Privilege"). See "Proposal No. 4 -- Approval of
the Split-up of the Company and its
Subsidiaries into Two Publicly-Held Corporate
Groups -- The Over-Subscription Privilege."
Information Agent........... The Information Agent for the Rights Offering
is Corporate Investor Communications, Inc.
("CIC"). Questions concerning the Rights
Offering may be addressed to CIC at
1-888-673-4478.
Standby Purchase
Commitment.................. The Split-up is contingent on the purchase
pursuant to the Rights, the Over-Subscription
Privilege, or the Standby Purchase Obligation
(defined below) of at least 75% of the Cygnet
Common Stock being offered pursuant to the
Rights Offering (the "Required Purchase
Amount"). To ensure achievement of this
condition, Ernest C. Garcia, II, Chairman of
the Board and Chief Executive Officer of the
Company, has agreed to serve as a standby
purchaser. Mr. Garcia will be obligated (the
"Standby Purchase Obligation") either through
the Over-Subscription Privilege associated with
his Rights or pursuant to his back-up purchase
obligations to purchase additional shares of
Cygnet Common Stock at the Subscription Price
from the Unexercised Pool up to the Required
Purchase Amount. In addition, Mr. Garcia may,
at his election, purchase up to an additional
$5 million of Cygnet Common Stock at the
Subscription Price over and above the Standby
Purchase Obligation (the "Additional Cygnet
Shares"). Cygnet would issue to Mr. Garcia
warrants to purchase 500,000 shares of Cygnet
Common Stock (the "Cygnet Standby Warrants") at
an exercise price of $8.40 per share for a
period of 5 years following the Effective Date
in consideration for Mr. Garcia's obligations
as standby purchaser. Neither the Cygnet
Standby Warrants nor the underlying Cygnet
Common Stock into which they are exercisable
are registered under the Securities Act and
such securities may not be sold by Mr. Garcia
unless such securities are registered or unless
an exemption from registration is available.
Cygnet will register at its expense the resale
of the Cygnet Common Stock issued upon exercise
of the Cygnet Standby Warrants at the request
of Mr. Garcia at any time after one year
following the Effective Date. Mr. Garcia's
rights and obligations in connection with the
Rights Offering may be exercised through his
affiliates.
Additional Purchase and
Lending Commitments....... In addition to Cygnet Common Stock issuable
pursuant to the Rights Offering and the
Additional Cygnet Shares purchasable by Mr.
Garcia, on the Effective Date of the Split-up,
directors and employees of the Company who have
or will become directors or employees of Cygnet
will have the right to purchase an aggregate of
up to $1.5 million of Cygnet Common Stock for
$7.00 per share ("Employee Shares"). Cygnet has
secured a subordinated loan of $5 million from
a third party lender for a three-year term, and
on the Effective Date of the Split-up is
required to issue to the lender warrants to
purchase up to 115,000 shares of Cygnet Common
Stock at an exercise price of $8.40 per share,
subject to a call feature by Cygnet if the
closing price of the Cygnet Common
6
<PAGE> 13
Stock equals or exceeds $13.44 per share for a
period of 20 consecutive trading days. The loan
is guaranteed by the Company. On the Effective
Date, the Company's guarantee will be released.
If the Split-up has not occurred by December
31, 1998, and the loan is not repaid, the
Company will be required to issue warrants to
purchase 115,000 shares of Company Common Stock
at an exercise price of 120% of the average
trading price for the Company Common Stock for
the 20 consecutive trading days prior to the
issuance of such warrants, and subject to a
call feature if the closing price of the
Company Common Stock equals or exceeds 160% of
the warrant exercise price for a period of 20
consecutive trading days.
Interested Transactions..... As described above, officers and directors of
the Company have certain significant interests
in the Split-up transaction including (i) Mr.
Garcia's rights and obligations as Standby
Purchaser, which may enable Mr. Garcia to
purchase significant amounts of Cygnet Common
Stock at the Subscription Price to the extent
such stock is not purchased upon exercise of
the Rights or pursuant to the Over-Subscription
Privilege by holders of the Rights, (ii) Mr.
Garcia's right to purchase the Additional
Cygnet Shares (up to 714,286 shares) at the
Subscription Price, (iii) the right of officers
and directors of the Company who are officers
and directors of Cygnet on the Effective Date
to purchase the Employee Shares (up to 214,286
shares) at the Subscription Price, (iv) the
issuance of the Cygnet Standby Warrants to
purchase 500,000 shares of Cygnet Common Stock
at $8.40 per share for a period of 5 years
following the Effective Date to Mr. Garcia in
consideration for his obligations as Standby
Purchaser, and (v) the use of a portion of the
Cash Payment by the Company to repay the Verde
Note to a corporation wholly-owned by Mr.
Garcia. Cygnet will also assume the employment
agreements of and will replace Company options
with Cygnet options for certain executive
officers of the Company who will become
executive officers of Cygnet. In addition,
Messrs. Johnson, Splaver, and Ciccolini, each
of whom is an executive officer of Cygnet, will
receive a total of 36,429 shares of Cygnet
Common Stock pursuant to restricted stock
grants (with an estimated aggregate value of
$255,000 as of the Effective Date) and new
options to purchase a total of 50,000 shares of
Cygnet Common Stock at the Subscription Price.
Conditions to the Split-up
and Rights Offering....... The Split-up is contingent on the purchase of
the Required Purchase Amount pursuant to the
Rights Offering and the Standby Purchase
Obligation. In addition, both the Rights
Offering and the Split-up are contingent on the
satisfaction of numerous other conditions. See
"Proposal No. 4 -- Approval of the Split-up of
the Company and its Subsidiaries into Two
Publicly-Held Corporate Groups -- Contingencies
to the Split-up and the Closing Thereof." The
Board of Directors of the Company may abandon,
postpone, or modify the Rights Offering and/or
the Split-up at any time.
Accounting Treatment........ The historical consolidated financial
statements of the Company have been
retroactively restated to reflect the Company's
discon-
7
<PAGE> 14
tinued operations, including the Split-up
Businesses and the Company's third party dealer
branch office network which was closed in the
first quarter of 1998. See the restated
Consolidated Financial Statements included
herein. The Company's historical consolidated
financial statements prior to the
reclassification of the discontinued operations
are included herewith in the Company's December
31, 1997 Annual Report on Form 10-K.
Trading Market.............. The Company's Common Stock is expected to
continue to be listed on the Nasdaq National
Market System ("Nasdaq"). The trading price of
the Company's Common Stock may be affected by
the Split-up. The Rights and the Cygnet Common
Stock have been approved for listing on Nasdaq
upon notice of issuance thereof. See "Risk
Factors -- Possible Failure to Consummate the
Split-up," "-- Listing and Trading of Company
Common Stock" and "-- Market Perception
Issues."
Federal Income Tax
Consequences to Holders of
Company Common Stock.......... In the opinion of Snell & Wilmer L.L.P. ("Tax
Counsel"), holders of Company Common Stock will
generally recognize dividend income (taxable as
ordinary income) in an amount equal to the fair
market value, if any, of the Rights as of the
date of their distribution. In the opinion of
Willamette Management Associates, an
independent appraisal firm engaged by the
Company in connection with the Rights Offering
and the Split-up (the "Appraiser"), dated July
21, 1998, the fair market value of the Rights
as of the date of their distribution should be
zero. However, the Appraiser's opinion is not
binding on the Internal Revenue Service. For
example, the Internal Revenue Service may
assert that the price at which the Rights trade
during the 20-day trading period of the Rights
is indicative of the fair market value of the
Rights on the date of their distribution.
Accordingly, there can be no assurance as to
the precise amount of dividend income, if any,
a holder of Company Common Stock will recognize
upon the receipt of the Rights. If the Rights
are trading for value on the date of their
distribution, the Company may, in its
discretion, report to holders of Company Common
Stock the receipt of dividend income in an
amount equal to the average of the high and low
trading prices of the Rights on such date.
To avoid the possibility of the recognition of
ordinary income and the creation of a
potentially deferred or nondeductible capital
loss, it will, in many instances, be in the
interests of holders of Company Common Stock
receiving Rights to either exercise or sell the
Rights, rather than to allow the Rights to
lapse.
Federal Income Tax
Consequences to Company:
Distribution of Rights...... The Company will recognize gain on the
distribution of the Rights in an amount equal
to the greater of (1) the fair market value, if
any, of the Rights as of the date of their
distribution or (2) the sum of (a) the
aggregate amount, if any, by which (i) the fair
market value of each Transferred Asset as of
the Effective Date exceeds (ii) the amount paid
by Cygnet for such Transferred Asset plus
(b)the aggregate amount, if any, by which (i)
the fair market value of each Interim Asset as
of the Effective Date exceeds (ii) the adjusted
tax basis of such Interim Asset.
8
<PAGE> 15
In the opinion of the Appraiser, the fair
market value of the Rights on the date of their
distribution should be zero. Additionally,
because Cygnet is obligated to pay
consideration to the Company for the
Transferred Assets in an amount equal to the
greater of the appraised value (as determined
by the Appraiser) or the book value of the
Transferred Assets, each as of the Effective
Date, and because such consideration is
allocable to each Transferred Asset to the
extent of its appraised value, management of
the Company believes that the fair market value
of each of the Transferred Assets as of the
Effective Date should not exceed the amount
deemed paid by Cygnet for each of the
Transferred Assets. Lastly, because Cygnet is
obligated to pay the Interim Consideration to
the Company, thereby creating a liability equal
to the aggregate amount by which the fair
market value of the Interim Assets exceeds
their adjusted tax basis, management of the
Company believes that the fair market value of
each of the Interim Assets should not exceed
their adjusted tax basis as of the Effective
Date.
The Appraiser's opinion with respect to the
Rights is not binding on the Internal Revenue
Service. For example, the Internal Revenue
Service may assert that the price at which the
Rights trade during the 20-day trading period
of the Rights will be indicative of the fair
market value of the Rights on the date of their
distribution. Further, the Appraiser's
valuations of the Transferred Assets and the
Interim Assets may not be endorsed by the
Internal Revenue Service. For example, the
Internal Revenue Service may establish that the
fair market value of the Transferred Assets or
the Interim Assets exceeds the respective
values thereof determined by the Appraiser.
Accordingly, there can be no assurance that the
Company will not recognize gain on the
distribution of the Rights.
If any tax liabilities are triggered by the
Company's recognition of gain on the
distribution of the Rights, such tax
liabilities will be borne solely by the
Company.
Federal Income Tax
Consequences to Company:
Sale of Transferred
Assets........................ If the consideration paid by Cygnet for any of
the Transferred Assets (including the allocable
portion of any Company liabilities assumed by
Cygnet) exceeds the adjusted tax basis of such
asset, gain will be recognized by the Company
consolidated group to the extent of such
excess. Based on the Appraiser's valuation of
the Transferred Assets as of June 30, 1998, the
amount by which the consideration payable by
Cygnet and allocated among the Transferred
Assets will exceed the adjusted bases of such
assets should be limited in amount. Further,
based on the Appraiser's valuation of the
Cygnet Preferred Stock, the value of such stock
transferable to the Company on the Effective
Date in connection with the sale of the
Transferred Assets will not exceed its issue
price. As a consequence, management of the
Company believes that the gain recognized in
connection with the sale of the Transferred
Assets should be immaterial.
Neither of the aforementioned appraisals of
value conducted by the Appraiser is binding on
the Internal Revenue Service. Further, the fair
market value of the Transferred Assets may
increase during the period between June 30,
1998 and the Effective Date and result in the
9
<PAGE> 16
payment by Cygnet of greater consideration.
Accordingly, there can be no assurance that the
Company's gain on the sale of the Transferred
Assets would be immaterial.
If any tax liabilities are triggered by the
Company's recognition of gain on the sale of
the Transferred Assets, such tax liabilities
will be borne solely by the Company.
Federal Income Tax
Consequences to Company:
Receipt of Interim
Consideration............... The receipt of Interim Consideration by the
Company from Cygnet will generate taxable
income to the Company to the extent of the
amount received. Tax liabilities triggered by
such receipt will be borne solely by the
Company.
Federal Income Tax
Consequences to Company:
Redemptions of Preferred
Stock......................... Although redemptions of Cygnet Preferred Stock
owned by the Company are intended to be treated
for federal income tax purposes as sales of the
redeemed shares generally resulting in no gain
or loss to the Company, ownership of Cygnet
Common Stock by any person or entity owning 50%
of more of the value of the outstanding Company
stock, either directly or indirectly through
application of various attribution rules, may
cause the proceeds of such redemptions to be
treated as taxable dividends generally
resulting in income to the Company to the
extent of the redemption proceeds. If any tax
liabilities are triggered in connection with
redemptions of the Cygnet Preferred Stock held
by the Company, such tax liabilities will be
borne solely by the Company. The foregoing
descriptions of the tax consequences to the
Company are premised upon the analysis of in-
house Company personnel in consultation with
its professional advisors.
The Cygnet Prospectus......... Further information regarding Cygnet, the
Split-up Businesses, the Cygnet Common Stock,
and the Rights is set forth in the Cygnet
Prospectus which accompanies this Proxy
Statement. The Cygnet Prospectus should be read
in its entirety.
Recommendation of the Board of
Directors of the Company.... The Board of Directors of the Company has
approved (by unanimous vote of those directors
present at the meeting) all four Proposals and
recommends that stockholders vote FOR Proposal
Nos. 1, 2, 3 and 4.
10
<PAGE> 17
UGLY DUCKLING CORPORATION
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of, each of the
years in the five-year period ended December 31, 1997, are derived from the
consolidated financial statements of the Company, which consolidated financial
statements have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The consolidated financial statements as of December 31,
1997 and 1996 and for each of the years in the three-year period ended December
31, 1997, and the report thereon, are included elsewhere in this Proxy. The
selected data presented below for the three-month periods ended March 31, 1998
and 1997, and as of March 31, 1998 and 1997, are derived from the unaudited
condensed consolidated financial statements of the Company included elsewhere in
this proxy. The information presented below under the caption "Dealership
Operating Data" is unaudited. In the opinion of management, such unaudited data
reflect all adjustments, consisting only of normally recurring adjustments,
necessary to fairly present the Company's financial position and results of
operations for the periods presented. The results of operations of any interim
period are not necessarily indicative of results to be expected for a full
fiscal year. For additional information, see the Consolidated Financial
Statements and notes thereto of the Company included elsewhere in this proxy
statement. The following table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations of the
Continuing Company Business."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales of Used Cars................ $72,972 $18,211 $123,814 $ 53,768 $47,824 $27,768 $13,969
Less:
Cost of Used Cars Sold.......... 40,363 9,939 72,358 31,879 29,733 13,604 6,606
Provision for Credit Losses..... 15,034 3,261 22,354 9,657 8,359 8,024 3,292
------- ------- -------- -------- ------- ------- -------
17,575 5,011 29,102 12,232 9,732 6,140 4,071
------- ------- -------- -------- ------- ------- -------
Interest Income................... 3,879 1,512 12,559 8,597 8,227 4,683 1,629
Gain on Sale of Loans............. 4,614 1,131 6,721 3,925 -- -- --
Servicing Income.................. 3,837 1,014 8,738 1,887 -- -- --
Other Income...................... 146 428 3,587 650 308 556 879
------- ------- -------- -------- ------- ------- -------
12,476 4,085 31,605 15,059 8,535 5,239 2,508
------- ------- -------- -------- ------- ------- -------
Income before Operating
Expenses........................ 30,051 9,096 60,707 27,291 18,267 11,379 6,579
Operating Expenses:
Selling and Marketing........... 5,326 1,532 10,538 3,585 3,856 2,402 1,293
General and Administrative...... 16,669 5,604 39,412 12,221 11,677 7,722 3,108
Depreciation and Amortization... 1,152 529 3,150 1,382 1,225 713 557
------- ------- -------- -------- ------- ------- -------
23,147 7,665 53,100 17,188 16,758 10,837 4,958
------- ------- -------- -------- ------- ------- -------
Income before Interest Expense.... 6,904 1,431 7,607 10,103 1,509 542 1,621
Interest Expense.................. 647 177 706 2,429 5,328 2,870 893
------- ------- -------- -------- ------- ------- -------
Earnings (Loss) before Income
Taxes........................... 6,257 1,254 6,901 7,674 (3,819) (2,328) 728
Income Taxes (Benefit)............ 2,511 499 2,820 694 -- (334) 30
------- ------- -------- -------- ------- ------- -------
Earnings (Loss) from Continuing
Operations...................... 3,746 755 4,081 6,980 (3,819) (1,994) 698
Discontinued Operations:
Earnings (Loss) from Discontinued
Operations, net of income
taxes........................... (785) 2,507 5,364 (1,114) (153) 27 --
Loss on Disposal of Discontinued
Operations, net of income
taxes........................... (4,827) -- -- -- -- -- --
------- ------- -------- -------- ------- ------- -------
Net Earnings (Loss)............... $(1,866) $ 3,262 $ 9,445 $ 5,866 $(3,972) $(1,967) $ 698
======= ======= ======== ======== ======= ======= =======
Earnings (Loss) per Common Share
from Continuing Operations:
Basic............................. $ .20 $ 0.05 $ 0.23 $ 0.77 $ (0.69) $ (0.36) $ 0.14
======= ======= ======== ======== ======= ======= =======
Diluted........................... $ .20 $ 0.05 $ 0.22 $ 0.73 $ (0.69) $ (0.36) $ 0.14
======= ======= ======== ======== ======= ======= =======
</TABLE>
11
<PAGE> 18
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings (Loss) per Common
Share
Basic........................... $ (0.10) $ 0.21 $ 0.53 $ 0.63 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Diluted......................... $ (0.10) $ 0.20 $ 0.52 $ 0.60 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --
Continuing Operations
Basic Shares.................... 18,557 15,904 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 19,093 16,580 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --
Net Earnings (Loss)
Basic Shares.................... 18,557 15,904 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 19,093 16,580 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
BALANCE SHEET DATA:
Cash and Cash Equivalents....... $ 514 $ 73,237 $ 3,537 $ 18,455 $ 1,419 $ 168 $ 79
Finance Receivables, Net........ 53,009 41,328 60,778 14,186 27,732 14,534 7,089
Total Assets........... 288,863 172,553 275,633 117,629 60,712 29,681 11,936
Subordinated Notes Payable...... 27,000 12,000 12,000 14,000 14,553 18,291 8,941
Total Debt............. 90,304 20,400 77,171 26,904 49,754 28,233 9,380
Preferred Stock................. -- -- -- -- 10,000 -- --
Common Stock.................... 173,724 171,274 172,622 82,612 127 77 1
Total Stockholders'
Equity (Deficit)..... 181,010 167,191 181,774 82,319 4,884 (1,194) 697
DEALERSHIP OPERATING DATA
(UNAUDITED):
Average Sales Price per Car..... $ 7,731 $ 7,367 $ 7,443 $ 7,107 $ 6,478 $ 5,269 $ 4,159
Number of Used Cars Sold........ 9,439 2,472 16,636 7,565 7,383 5,270 3,359
Company Dealerships............. 46 14 41 8 8 8 5
Number of Contracts
Originated.................... 9,339 2,110 16,001 6,929 6,129 4,731 3,093
Principal Balances Originated
(000 Omitted)................. $ 69,708 $ 47,345 $116,830 $ 48,996 $36,568 $23,589 $12,984
Retained Portfolio:
Number of Contracts
Outstanding................... 4,497 6,657 7,993 1,045 8,049 5,515 2,929
Allowance as % of Outstanding
Principal..................... 18.5% 28.4% 18.5% 23.0% 21.9% 30.4% 30.0%
Average Principal Balance
Outstanding................... $ 7,397 $ 4,852 $ 7,002 $ 6,764 $ 4,252 $ 3,605 $ 3,273
Average Yield on Contracts...... 26.0% 28.0% 26.7% 29.2% 28.0% 28.2% 26.4%
Delinquencies -- Retained
Portfolio:
Principal Balances 31 to 60
Days.......................... 1.2% 2.3% 2.2% 2.3% 4.2% 5.1% 10.5%
Principal Balances over 60
Days.......................... 3.6% 1.7% 0.6% 0.6% 1.1% 1.3% 15.0%
LOAN SERVICING DATA:
(000 OMITTED)
Principal Balances Serviced:
Dealership Sales................ 33,265 32,298 55,965 7,068 34,226 19,881 9,588
Securitized with Servicing
Retained...................... 276,231 100,377 238,025 51,662 -- -- --
Discontinued Operations......... 53,877 36,459 29,965 49,772 13,805 1,620 --
Servicing on Behalf of Others... 98,787 -- 127,322 -- -- -- --
-------- -------- -------- -------- ------- ------- -------
Total Serviced
Portfolios........... $462,160 $169,134 $451,277 $108,502 $48,031 $21,501 $ 9,588
======== ======== ======== ======== ======= ======= =======
</TABLE>
12
<PAGE> 19
RECENT DEVELOPMENTS
The selected data presented below for the six-month periods ended June 30,
1998 and 1997, and as of June 30, 1998 and 1997, are derived from the unaudited
condensed consolidated financial statements of the Company. In the opinion of
management, such unaudited data reflect all adjustments, consisting only of
normally recurring adjustments, necessary to fairly present the Company's
financial position and results of operations for the periods presented. The
results of operations of any interim period are not necessarily indicative of
results to be expected for a full fiscal year.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
1998 1997
----------- -----------
(IN THOUSANDS, EXCEPT
EARNINGS PER SHARE AMOUNTS)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales of Used Cars.......................................... $142,491 $ 46,013
Less:
Cost of Used Cars Sold.................................... 81,213 25,890
Provision for Credit Losses............................... 29,308 8,109
-------- --------
31,970 12,014
-------- --------
Interest Income............................................. 7,439 4,691
Gain on Sale of Loans....................................... 8,273 4,143
Servicing and other Income.................................. 8,154 3,596
-------- --------
23,866 12,430
-------- --------
Income before Operating Expenses............................ 55,836 24,444
Operating Expenses.......................................... 44,062 19,112
-------- --------
Income before Interest Expense.............................. 11,774 5,332
Interest Expense............................................ 1,164 440
-------- --------
Earnings before Income Taxes................................ 10,610 4,892
Income Taxes................................................ 4,274 1,987
-------- --------
Earnings from Continuing Operations......................... 6,336 2,905
Discontinued Operations:
Earnings (Loss) from Discontinued Operations, net of income
taxes..................................................... (5,254) 4,668
-------- --------
Net Earnings................................................ $ 1,082 $ 7,573
======== ========
Earnings per Common Share from Continuing Operations:
Basic....................................................... $ 0.34 $ 0.17
======== ========
Diluted..................................................... $ 0.33 $ 0.16
======== ========
Net Earnings per Common Share:
Basic....................................................... $ 0.06 $ 0.44
======== ========
Diluted..................................................... $ 0.06 $ 0.43
======== ========
Shares used in Computation -- Continuing Operations:
Basic....................................................... 18,570 17,200
======== ========
Diluted..................................................... 18,930 17,800
======== ========
Shares used in Computation -- Net Earnings:
Basic....................................................... 18,570 17,200
======== ========
Diluted..................................................... 18,930 17,800
======== ========
BALANCE SHEET DATA:
Cash and Cash Equivalents................................... 1,652 41,149
Finance Receivables, Net.................................... 27,310 32,627
Total Assets....................................... 278,845 215,476
Subordinated Notes Payable.................................. 25,000 12,000
Total Debt......................................... 72,891 20,328
Preferred Stock............................................. -- --
Common Stock(1)............................................. 173,562 171,317
Total Stockholders' Equity......................... 185,753 178,597
</TABLE>
- ---------------
(1) 18,567,097 shares of the Company's Common Stock were issued and outstanding
at June 30, 1998.
13
<PAGE> 20
RISK FACTORS
Stockholders should consider the following factors, as well as the other
information set forth herein and in the Cygnet Prospectus before acting on the
Split-up Proposal. The following considerations discuss certain matters that
relate to risks inherent in the Split-up and Rights Offering. Risks relating to
the Continuing Company Businesses are discussed in the Company's Annual Report
on Form 10-K being delivered to stockholders along with this Proxy Statement and
in other Company filings under the Securities Exchange Act of 1934, as amended
(the "Exchange Act") made subsequent to the filing of the Form 10-K. Risks
relating to the business of Cygnet and its subsidiaries following the proposed
Split-up are discussed in the Cygnet Prospectus.
POSSIBLE FAILURE TO CONSUMMATE THE SPLIT-UP
There are numerous conditions to both the making of the Rights Offering and
the successful conclusion of the Split-up following the Offering Period. Among
other things, these transactions require numerous consents from parties to
various existing agreements of the Company and its subsidiaries. It is possible
that certain consents can be obtained only if the Company remains contingently
liable on the underlying transactions. In addition, various regulatory approvals
and licenses must be obtained for the consummation of the transactions and the
operation of the transferred businesses by Cygnet and its subsidiaries. Although
the Company and/or Cygnet intends to timely initiate application for all
required licenses, obtaining such approvals and licenses is subject to the
procedures of the applicable governmental licensing entity. There can be no
assurance that all required approvals, licenses or conditions will be obtained
or achieved in a timely manner. Moreover, either the Rights Offerings or the
effectuation of the Split-up may be abandoned or postponed at any time for any
reason in the sole discretion of the Company's or Cygnet's Board of Directors.
For a description of additional contingencies to the Rights Offering and the
Split-up, see "Proposal No. 4 -- Approval of the Split-up of the Company and its
Subsidiaries into Two Publicly-Held Corporate Groups -- Contingencies to the
Split-up and the Closing Thereof."
Uncertainties concerning the progress and ultimate outcome of the Split-up
could cause fluctuation and instability in the market price of the Company's
Common Stock and of the Rights if and when the Rights Offering is commenced. If
the Rights Offering is made but the Split-up does not occur, the Rights will not
be exercised for Cygnet Common Stock and all subscription funds will be returned
without interest.
RISKS RELATING TO THE CYGNET PREFERRED STOCK
The Cygnet Preferred Stock provides for certain cumulative dividends.
However, dividends on the Cygnet Preferred Stock are payable only out of funds
legally available therefor when and as declared by the Cygnet Board of
Directors. If dividends are not paid for a specified period, the Company will
have the right to elect two members of the Cygnet Board of Directors (in
addition to the then existing number of directors) at the next following meeting
of stockholders of Cygnet and thereafter until all accrued dividends are paid in
full. However, such directors will constitute a minority of Cygnet's Board of
Directors.
Currently, the Company owns the Transferred Assets that would be
transferred to Cygnet if the Split-up is successfully concluded and,
accordingly, has control over the risks and liabilities inherent in such assets.
Following the Split-up, although a substantial portion of the Company's assets
and net worth will be embodied in the Cygnet Preferred Stock, the Company will
no longer have control over the Transferred Assets and associated risks, but
must rely on Cygnet and its management for expected returns on the Cygnet
Preferred Stock.
Although the Cygnet Preferred Stock will be senior in right of payment to
all Cygnet Common Stock, Cygnet's Certificate of Incorporation authorizes its
Board of Directors to issue up to 500,000 shares of its preferred stock.
Additional issuances of preferred stock by Cygnet may be pari passu in right of
payment with the Cygnet Preferred Stock. The Cygnet Preferred Stock will also be
junior in right of payment to all indebtedness of Cygnet. There are no
restrictions in the Cygnet Preferred Stock on the ability of Cygnet to incur
indebtedness.
14
<PAGE> 21
For certain risks relating to the tax treatment of the Cygnet Preferred
Stock, see "Risk Factors -- Potential Federal Income Tax Consequences of the
Rights Offering and Sale of the Transferred Assets -- Redemptions of Preferred
Stock."
LOSS OF DIVERSIFICATION AND EARNINGS ON THE TRANSFERRED ASSETS
The effectuation of the Split-up will reduce the diversification of current
Company operations, could increase the seasonal fluctuation in sales and
earnings of the Continuing Company Businesses, and could increase the
susceptibility of the Continuing Company Businesses to economic fluctuations
inherent in business cycles. The Company's used car sales business is inherently
more subject to seasonal fluctuations than are the Split-up Businesses being
transferred to Cygnet. This is principally due to seasonal buying patterns
resulting in part from the fact that many of the Company's customers receive
income tax refunds during the first half of the year, which are a primary source
of down payments on used car purchases. Moreover, because the Company generally
sells more cars during the first half of the year, it will have more contracts
to securitize during that period, and securitizations have historically been a
primary source of earnings for the Company. A large percentage of the 1997
reported earnings of the Company consolidated group is comprised of gain from
the sale of the Owned Contracts (defined below under "Risks to the Company
Relating to the FMAC Transaction") in the FMAC transaction as well as interest
income on loans made by the Company under the DIP Facility (defined below under
"Risks to the Company Relating to the FMAC Transaction") and on the Senior Bank
Debt (defined below under "Risks to the Company Relating to the FMAC
Transaction") in the FMAC transaction, the remaining future earnings, if any,
under which would be transferred to Cygnet.
LOSS OF SERVICES OF SENIOR MANAGEMENT
The Company's future success may be adversely affected by the loss of the
services of certain of the Company's senior management to Cygnet if the Split-up
is effected. Following the Split-up, Ernest C. Garcia, II would no longer serve
as Chief Executive Officer of the Company although he would retain his position
as Chairman of the Board of Directors of the Company. In addition, Steven P.
Johnson, the Company's current Senior Vice President and General Counsel, Donald
L. Addink, the Company's current Vice President -- Senior Analyst, and Eric J.
Splaver, the Company's current Controller, will no longer act in such capacities
with the Company. The loss of the services of such individuals may cause
disruption on a temporary basis as new individuals take over executive
management responsibilities for the Company in such positions.
LISTING AND TRADING OF COMPANY COMMON STOCK
It is expected that, after the Effective Date of the Split-up, the Company
Common Stock will continue to be listed and traded on Nasdaq. However, the
Company's financial results will no longer be consolidated with the results of
the businesses of Cygnet, which may affect the trading price of the Company's
Common Stock.
The prices at which the shares of the Company's Common Stock will trade
after the Split-up will be determined by the marketplace and may be influenced
by many factors, including, among others, the proportional value of the
Company's asset base, stream of cash flows, profits, or other measure of value
in relation to the prices of the Company Common Stock prior to the Split-up, the
depth and liquidity of the market for such shares, investor perceptions of the
Company and the industries in which its businesses participate, and general
economic and market conditions. The trading price of the Company Common Stock
after the Split-up may be less than, equal to, or greater than the trading
prices of the Company Common Stock prior to the Split-up.
MARKET PERCEPTION ISSUES
Although one purpose of the separation of the Continuing Company Businesses
from those being transferred to Cygnet is to allow investors, lenders, and
others to more easily evaluate the performance and investment characteristics of
each business group and to enhance the likelihood that each will achieve
appropriate market recognition of its performance, there will, at least for a
significant period of time, continue to be ties between the two companies that
may prove confusing to the market. For example, although the Transferred Assets
will include substantially all of the assets and liabilities of the Company in
connection with
15
<PAGE> 22
the FMAC transaction, the Company will retain certain contingent liabilities
with respect to that transaction and may in the future issue the Stock Option
Shares (defined below under "Risks to the Company Relating to the FMAC
Transaction") and the Reliance Warrants (defined below under "Risks to the
Company Relating to the Reliance Transaction") in connection with assets
transferred to Cygnet. In addition, a substantial portion of the Company's
assets and net worth will be embodied in the Cygnet Preferred Stock.
RISKS TO THE COMPANY RELATING TO THE FMAC TRANSACTION
If the Split-up is effectuated, the Transferred Assets will include
substantially all assets (except cash received by the Company prior to the
Effective Date) and liabilities relating to the FMAC transaction. See "Proposal
No. 4 Approval of Split-up of the Company and its Subsidiaries into Two
Publicly-Held Corporate Groups -- Transfer of Assets Pursuant to the Split-up."
See also "Transactions with First Merchants Acceptance Corporation" in the
Cygnet Prospectus. The liabilities being transferred to Cygnet include certain
funding obligations of the Company to provide "debtor-in-possession" financing
to FMAC (the "DIP Facility"). As of July 1, 1998, the maximum commitment under
the DIP Facility was $12.4 million, of which $9.8 million was outstanding. The
DIP Facility is a revolving facility and, except for payments made from the
proceeds of tax refunds received by FMAC, will be permanently paid down only
from distributions on certain residual interests (the "B Pieces") in the various
securitized loan pools of FMAC (the "Securitized Pools") after payment of
certain other amounts.
In addition, the liabilities being transferred to Cygnet include a
guarantee of a specified return on certain contracts (the "Owned Contracts")
sold to a third party purchaser (the "Contract Purchaser") in connection with
the FMAC transaction, subject to a maximum guarantee amount of $10 million (the
"Owned Contract Guarantee"). Although, as between the Company and Cygnet, Cygnet
will be responsible for the DIP Facility and Owned Contract Guarantee, the
Company will not be released from such obligations and will continue to be
directly liable on these obligations. Therefore, if Cygnet does not fulfill such
obligations, the Company must do so.
During the pendency of the FMAC bankruptcy proceedings, the Company
purchased approximately 78% of FMAC's senior bank debt (the "Senior Bank Debt")
held by seven members (the "Selling Banks") of FMAC's original nine-member bank
group for approximately $69 million, which represented a discount of 10% (the
"Discount") of the outstanding principal amount of such debt. Under agreements
with the Selling Banks, the Company has agreed to pay the Selling Banks
additional consideration up to the amount of the Discount (the "Additional
Consideration") if and to the extent the FMAC plan of reorganization provides
for and FMAC or any other party subsequently makes a cash payment or issues
notes at market rates to certain unsecured creditors and equity holders of FMAC
on account of their allowed claims worth an amount in excess of 10% of their
allowed claims (collectively, the "Excess Cash"). Following the Effective Date,
the Company would retain the obligation to pay any Additional Consideration to
the Selling Banks.
One source of cash payments that may in the future be made to unsecured
creditors of FMAC is from recoveries on the Owned Contracts and the B Pieces
after payment of certain prior amounts. Under FMAC's plan of reorganization,
such excess recoveries will be shared on the basis of 82 1/2% for the benefit of
FMAC and 17 1/2% for the benefit of the Company (or Cygnet following the
Effective Date) (the "Excess Collection Split"), subject to certain
contingencies that may reduce or eliminate the Company's (or Cygnet's)
percentage share therein. However, the Company has the option, to be exercised
one time, to distribute shares of Common Stock of the Company (the "Stock Option
Shares") to FMAC or, at the request of FMAC and pursuant to its instructions,
directly to the unsecured creditors of FMAC, in exchange for FMAC's right to
receive all or a portion of distributions under the Excess Collections Split in
cash (including both recoveries under the Excess Collections Split from the
Owned Contracts and the B Pieces) (the "Stock Option"). To the extent exercised,
payments to FMAC's unsecured creditors and equity holders would be reduced,
which would reduce the risk of payment of the Additional Consideration to the
Selling Banks. The number of Stock Option Shares that the Company will issue
would be based on the Company's estimate of the cash distributions expected to
be received on FMAC's share of the Excess Collection Split. For purposes of the
election, the Stock Option Shares would be valued at 98% of the average of the
closing prices for the previous
16
<PAGE> 23
10 trading days of Company Common Stock on Nasdaq or such other market on which
such stock may be traded (the "Stock Option Value"), which must average at least
$8.00 per share.
After issuance and delivery of the Stock Option Shares, the Company will be
entitled to receive FMAC's share of cash distributions under the Excess
Collections Split (including both recoveries under the Excess Collections Split
from the Owned Contracts and the B Pieces) from and after the Exercise Date
until the Company has received such distributions equal to the Stock Option
Value. These distributions would be in addition to the Company's right to
receive its share under the Excess Collections Split that is to be transferred
to Cygnet. Once the Company has received cash distributions equal to the Stock
Option Value, FMAC will retain the remaining portion of its share of cash
distributions under the Excess Collections Split, if any, in excess of the Stock
Option Value.
After the Effective Date, Cygnet will service the FMAC contract portfolios
relating to the Owned Contracts and the B Pieces. To facilitate the Company's
decision as to whether to exercise the Stock Option, under the Capitalization
Agreement, Cygnet will advise the Company at least 7 days prior to the date that
cash distributions under the Excess Collections Split are likely to begin and of
its estimate as to the likely amount and timing of such cash distributions.
Cygnet will allow the Company reasonable access to its books and records to
allow the Company to verify such estimate, and to cooperate with the Company in
determining the amount and timing of the Company's issuance of the Stock Option
Shares. In addition, Cygnet will pay over to the Company all of FMAC's share of
cash distributions under the Excess Collections Split up to the Stock Option
Value following any issuance by the Company of the Stock Option Shares.
Despite these arrangements with Cygnet, the FMAC transaction will pose
continuing risks to the Company. In this regard, the ability of the Company to
issue the Stock Option Shares is subject to certain contingencies, including the
market price of the Company's Common Stock, which is not within the control of
the Company, and the ability of the Company to maintain or effect the
registration of such shares under the Securities Act. Moreover, even if the
Company is able to issue Stock Option Shares, the number of Stock Option Shares
issued may not be in a sufficient amount to prevent the Additional Consideration
being payable to the Selling Banks. On the other hand, if the Company
overestimates the number of Stock Option Shares to be issued, it will cause
dilution to the Company's Common Stock without concurrent consideration being
received by the Company. Moreover, even if the Stock Option Shares are issued
and the cash payments to FMAC's unsecured creditors and equity holders are
reduced, there can be no assurance that the Selling Banks will not assert a
right to the Additional Consideration.
In addition, the Company has agreed in a contingent sharing agreement to
pay 10% of the Excess Collections Split received by the Company to Financial
Security Assurance ("FSA"), the insurer of certain obligations to holders of the
senior certificates representing interests in the Securitized Pools in exchange
for FSA's consent to amendments to documents governing servicing of the
Securitized Pools (the "FSA Obligation"). Although, as between the Company and
Cygnet, Cygnet will be obligated to fulfill the FSA Obligation, if Cygnet does
not do so, the Company will be liable to FSA to pay the required monies.
In connection with the transfer of servicing rights to Cygnet in relation
to the FMAC transaction, the Company may be required or choose to enter into a
subservicing arrangement with Cygnet as to certain pools, in which case the
Company would remain contingently liable.
RISKS TO THE COMPANY RELATING TO THE RELIANCE TRANSACTION
The Company has been involved in the bankruptcy proceedings of Reliance and
has entered into a servicing agreement with Reliance (the "Servicing
Agreement"), pursuant to which the Company will service certain receivables of
Reliance. Reliance's plan of reorganization was confirmed on June 29, 1998 in
open court and will become effective on July 31, 1998. The bankruptcy court
executed the formal order confirming the plan on July 2, 1998. The Servicing
Agreement requires the Company to issue warrants to purchase Company Common
Stock ("Reliance Warrants") to Reliance in certain amounts at various times. See
"Management's Discussion and Analysis of Results of Operations and Financial
Condition of the Continuing Company Businesses -- Reliance Transaction" for a
description of the amount and times at which Reliance Warrants would be issued.
The Servicing Agreement is expected to be transferred to Cygnet on the Effective
Date. However, the Company will retain the obligation to issue the Reliance
Warrants.
17
<PAGE> 24
Pursuant to the Capitalization Agreement, following the Effective Date, the
Company will use its best efforts to issue the Reliance Warrants at the request
of Cygnet from time to time when required, and Cygnet will pay to the Company an
amount of consideration upon each such issuance equal to the fair value of the
Reliance Warrants (as determined by the Company for financial accounting
purposes) on the date of issuance of the Reliance Warrants. The issuance of the
Reliance Warrants may result in dilution of the Company's Common Stock and in
market confusion based upon an ongoing tie between the Company and Cygnet.
Moreover, the consent of Reliance may be required in order to transfer servicing
and other rights relating to the Reliance transaction from the Company to Cygnet
and there can be no assurance that such consent will be obtained.
POTENTIAL FEDERAL INCOME TAX CONSEQUENCES OF THE RIGHTS OFFERING AND SALE OF THE
TRANSFERRED ASSETS
Tax Consequences to Holders of Company Common Stock. Holders of Company
Common Stock will generally recognize dividend income (taxable as ordinary
income) in an amount equal to the fair market value, if any, of the Rights as of
the date of their distribution. In the opinion of the Appraiser, dated July 21,
1998, the fair market value of the Rights on the date of their distribution
should be zero. However, the opinion of the Appraiser is not binding on the
Internal Revenue Service. For example, the Internal Revenue Service may assert
that the price at which the Rights trade during the 20-day trading period of the
Rights will be indicative of the fair market value of the Rights on the date of
their distribution. Accordingly, there can be no assurance as to the exact
amount of dividend income, if any, a holder of Company Common Stock will
recognize upon the receipt of Rights. If the Rights are trading for value on the
date of their distribution, the Company may, in its discretion, report to
holders of Company Common Stock the receipt of dividend income in an amount
equal to the average of the high and low trading prices of the Rights on such
date.
To avoid the possibility of the recognition of ordinary income and the
creation of a potentially deferred or nondeductible capital loss, it will, in
many instances, be in the interests of holders of Company Common Stock receiving
Rights to either exercise or sell the Rights, rather than to allow the Rights to
lapse.
See "Certain Federal Income Tax Consequences of the Rights Offering and
Collateral Transactions -- Tax Consequences to Holders of Company Common Stock."
Tax Consequences to Company Consolidated Group of Distribution of Rights.
Distribution of Rights. The Company will recognize gain on the
distribution of the Rights in an amount equal to the greater of (1) the fair
market value, if any, of the Rights as of the date of their distribution or (2)
the sum of (a) the aggregate amount, if any, by which (i) the fair market value
of each Transferred Asset as of the Effective Date exceeds (ii) the amount paid
by Cygnet for such Transferred Asset plus (b) the aggregate amount, if any, by
which the fair market value of each Interim Asset as of the Effective Date
exceeds (ii) the adjusted tax basis of such Interim Asset.
In the opinion of the Appraiser, the fair market value of the Rights on the
date of their distribution should be zero. Additionally, because Cygnet is
obligated to pay consideration to the Company for the Transferred Assets in an
amount equal to the greater of the appraised value (as determined by the
Appraiser) or the book value of the Transferred Assets, each as of the Effective
Date, and because such consideration is allocable to each Transferred Asset to
the extent of its appraised value, management of the Company believes that the
fair market value of each of the Transferred Assets as of the Effective Date
should not exceed the amount deemed paid by Cygnet for each of the Transferred
Assets. Lastly, because Cygnet is obligated to pay the Interim Consideration to
the Company, thereby creating a liability equal to the aggregate amount by which
the fair market value of the Interim Assets preliminarily exceeds their adjusted
tax basis, management of the Company believes that as a consequence, the fair
market value of each of the Interim Assets should not exceed their adjusted tax
basis as of the Effective Date.
The Appraiser's opinion with respect to the Rights is not binding on the
Internal Revenue Service. For example, the Internal Revenue Service may assert
that the price at which the Rights trade during the 20-day trading period of the
Rights will be indicative of the fair market value of the Rights on the date of
their distribution. Further, the Appraiser's valuations of the Transferred
Assets and the Interim Assets may not be
18
<PAGE> 25
endorsed by the Internal Revenue Service. For example, the Internal Revenue
Service may establish that the fair market value of the Transferred Assets or
the Interim Assets exceeds the respective values thereof determined by the
Appraiser. Accordingly, there can be no assurance that the Company will not
recognize gain on the distribution of the Rights.
If any tax liabilities are triggered by the Company's recognition of gain
on the distribution of the Rights, such tax liabilities will be borne solely by
the Company.
Sales of Transferred Assets. If the consideration paid by Cygnet to the
Company for any of the Transferred Assets (including the allocable portion of
any Company liabilities assumed by Cygnet) exceeds the adjusted tax basis of
such asset, gain will be recognized by the Company consolidated group to the
extent of such excess. Based on the Appraiser's valuation of the Transferred
Assets as of June 30, 1998, the amount by which the consideration payable by
Cygnet and allocated among the Transferred Assets will exceed the adjusted bases
of such assets should be limited in amount. Further, based on the Appraiser's
valuation of the Cygnet Preferred Stock, the value of such stock transferable to
the Company on the Effective Date in connection with the sale of the Transferred
Assets will not exceed its issue price. As a consequence, management of the
Company believes that the gain recognized in connection with the sale of the
Transferred Assets should be immaterial.
Neither of the aforementioned appraisals of value conducted by the
Appraiser is binding on the Internal Revenue Service. Further, the fair market
value of one or more the Transferred Assets may increase during the period
between June 30, 1998 and the Effective Date and result in the payment by Cygnet
of greater consideration. Accordingly, it cannot be stated with complete
assurance that the Company's gain on the sale of the Transferred Assets would be
immaterial.
If any tax liabilities are triggered by the Company's recognition of gain
on the sale of the Transferred Assets, such tax liabilities will be borne solely
by the Company.
Receipt of Interim Consideration. The receipt of Interim Consideration by
the Company from Cygnet will generate taxable income to the Company to the
extent of the amount received. Tax liabilities triggered by such receipt will be
borne solely by the Company.
Redemptions of Preferred Stock. Although redemptions of Cygnet Preferred
Stock owned by the Company Preferred Stock are intended to be treated for
federal income tax purposes as sales of the redeemed shares generally resulting
in no gain or loss to the Company, ownership of Cygnet Common Stock by any
person or entity owning 50% or more of the value of the outstanding Company
stock, either directly or indirectly through application of various attribution
rules, may cause the proceeds of such redemptions to be treated as taxable
dividends generally resulting in income to the Company to the extent of the
redemption proceeds. If any tax liabilities are triggered in connection with
redemptions of Cygnet Preferred Stock held by the Company, such tax liabilities
will be borne solely by the Company.
19
<PAGE> 26
VOTING SECURITIES OUTSTANDING AND VOTING RULES
GENERAL VOTING RULES AND REQUIREMENTS
As of the Record Date, there were 18,598,057 shares of Common Stock
outstanding. Common Stock is the only class of voting securities of the Company.
Stockholders are entitled to one vote for each share of Common Stock held of
record on each matter of business to be considered at the Annual Meeting. Only
holders of record of Common Stock at the close of business on the Record Date
will be entitled to vote at the Annual Meeting, either in person or by valid
proxy. The presence, in person or by proxy, of the holders of a majority of the
shares entitled to vote at the Annual Meeting is necessary to constitute a
quorum. Ballots cast at the Annual Meeting will be counted by the Inspector of
Elections and determinations of whether a quorum exists and whether the
proposals are approved will be announced at the Annual Meeting. The Inspector of
Elections will treat abstentions and broker "non-votes" received as shares that
are present and entitled to vote for purposes of determining a quorum with
respect to a particular matter but such shares will not be counted as voting for
that matter. A broker non-vote occurs when a nominee holding shares of Common
Stock for a beneficial owner does not vote on a particular proposal because the
nominee does not have discretionary voting power with respect to that item and
has not received instructions from the beneficial owner.
The affirmative vote of a plurality of the shares of Common Stock present
in person or by proxy at the Annual Meeting and entitled to vote in the election
of directors (Proposal No. 1) is required to elect directors. Accordingly, if a
quorum is present at the Annual Meeting, the six persons receiving the greatest
number of votes will be elected to serve as directors. Therefore, withholding
authority to vote for one or more directors and non-voted shares with respect to
the election of directors will not affect the outcome of the election of
directors. If a quorum is present at the Annual Meeting, approval of the
amendment to the Company's Long-Term Incentive Plan (Proposal No. 2), adoption
of the Company's new 1998 Executive Incentive Plan (Proposal No. 3), and
approval of the Split-up Proposal (Proposal No. 4) each require the affirmative
vote of a majority of the shares of Common Stock present in person or by proxy
at the Annual Meeting and entitled to vote on those matters. An abstention or
broker non-vote with respect to any such matter has the legal effect of a vote
against that matter. The Board of Directors does not know of any other matters
to be brought before the Annual Meeting.
VOTE OF PROXIES
A proxy in the accompanying form which is properly executed, returned, and
not revoked will be voted in accordance with the instructions indicated. If a
stockholder returns a properly signed and dated proxy card but does not mark any
choices on a particular item, the stockholder's shares will be voted in
accordance with the recommendations of the Board of Directors as to such item.
PLEASE SIGN, DATE, AND PROMPTLY RETURN YOUR PROXY CARD IN THE ENVELOPE
PROVIDED.
REVOCABILITY OF PROXIES
A stockholder has the power to revoke a proxy at any time before it is
exercised by: (i) attending the Annual Meeting and voting in person; (ii) duly
executing and delivering a proxy bearing a later date; or (iii) sending written
notice of revocation to the Secretary of the Company at 2525 East Camelback
Road, Suite 1150, Phoenix, Arizona 85016.
PROPOSAL NO. 1
ELECTION OF DIRECTORS
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE DIRECTOR NOMINEES NAMED
IN THIS PROPOSAL.
The directors of the Company are elected each year for a term of one year.
At the Annual Meeting, stockholders will be asked to elect six directors for
terms that will expire at the 1999 Annual Meeting of Stockholders. The Board of
Directors has nominated Ernest C. Garcia II, Robert J. Abrahams, Christopher D.
Jennings, John N. MacDonough, Gregory B. Sullivan, and Frank P. Willey for
election to the Board
20
<PAGE> 27
of Directors. Except for Mr. Sullivan, all are incumbent directors and were
elected by the stockholders at the 1997 Annual Meeting. Arturo R. Moreno, the
Company's other incumbent director resigned from the Board effective June 30,
1998 because of time constraints relating to family and other business interests
and Mr. Sullivan has been nominated as a director in his place. If any of such
persons become unavailable for any reason or if a vacancy should occur before
the election (which events are not anticipated), the shares represented by the
enclosed proxy may be voted for such other person or persons as may be
determined by the holders of such proxy. Each director elected will serve until
the following year's annual meeting, until his successor is duly elected and
qualified, or until retirement, resignation, or removal. See "Management of the
Company -- Information Concerning Directors and Executive Officers" and
"-- Security Ownership of Certain Beneficial Owners and Management" for other
information on the nominees. Stockholders can withhold authority to vote for all
nominees for director or for certain nominees for director. Shares that are
withheld and broker non-votes will have no effect on the outcome of the election
of directors because directors are elected by a plurality of the shares voted
for directors. Unless otherwise noted by instruction of the voting stockholder
on the enclosed proxy, the shares represented by the enclosed proxy will be
voted for the election of Messrs. Garcia, Abrahams, Jennings, MacDonough,
Sullivan, and Willey as directors of the Company.
IN ORDER TO BE ELECTED, A NOMINEE MUST RECEIVE THE VOTE OF A PLURALITY OF
THE OUTSTANDING SHARES OF COMMON STOCK VOTED FOR DIRECTORS. SEE "VOTING
SECURITIES OUTSTANDING AND VOTING RULES."
PROPOSAL NO. 2
AMENDMENTS TO THE UGLY DUCKLING CORPORATION LONG-TERM INCENTIVE PLAN
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE AMENDMENTS TO THE UGLY
DUCKLING CORPORATION LONG-TERM INCENTIVE PLAN.
On April 21, 1998, the Board of Directors unanimously approved, subject to
approval by the Company's stockholders, certain amendments to the Ugly Duckling
Corporation Long-Term Incentive Plan ("Incentive Plan"). The Compensation
Committee of the Board similarly approved these amendments. The amendments to
the Incentive Plan, if approved by the stockholders, have an effective date of
January 15, 1998. The proposed amendments are technical in nature and will not
result in an increase in the number of shares of Common Stock available for
issuance under the Incentive Plan. The changes to the Incentive Plan are
primarily designed to:
- Meet strict requirements of Section 162(m) of the Internal Revenue Code
of 1986, as amended (the "Code"), regarding performance-based
compensation so that compensation in excess of $1 million will be tax
deductible. In this regard, the changes set forth the allowable
performance goals, performance criteria, and performance period in
connection with performance-based compensation. The changes also conform
or add certain definitions that are consistent with Section 162(m) of the
Code (i.e., definitions of "covered employee" and "outside director");
and
- Meet strict requirements of Rule 16b-3 under the Exchange Act, which rule
was recently revised. In this regard, the changes (a) require that each
member of the Compensation Committees be a non-employee director, and (b)
add a definition of "non-employee director" that is consistent with the
revised Rule 16b-3.
Under Section 162(m) of the Code, no deduction is allowed in any taxable
year of the Company for compensation in excess of $1 million paid to each of its
chief executive officer and its four other most highly paid executive officers
who are serving in such capacities as of the last day of such taxable year. An
exception to this rule applies to certain performance-based compensation as to
which the stockholders have approved the performance criteria, the maximum
amount payable to any given individual in a specified period, and certain other
performance-based compensation factors. Among the items of performance-based
compensation that can be deducted without regard to amount (assuming stockholder
approval and other applicable requirements are satisfied) is compensation
associated with the exercise price of a stock option so long as the option has
an exercise price equal to or greater than the fair market value of the
underlying stock at the time of the option grant. Stock options are inherently
performance-based, since they provide value to employees only if the stock
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<PAGE> 28
price appreciates. Section 162(m) generally became effective with respect to
compensation payable after 1993. The Company has, thus far, granted only stock
options under the Incentive Plan, which have all been qualified under Section
162(m) and, therefore, are deductible by the Company to the extent allowed under
other sections of the Code and its rules and regulations. Now, however, the
Company would like the flexibility to make future grants of restricted stock
awards and performance share awards, which are presently allowed under the
Incentive Plan, and have these types of awards qualified as "performance-based
compensation" under Section 162(m) of the Code. As noted above, Rule 16b-3 was
recently revised and the Company proposes that certain conforming changes be
made to the Incentive Plan to be consistent with the revised rule.
TO BE APPROVED, THE PROPOSED AMENDMENT REQUIRES THE AFFIRMATIVE VOTE OF THE
HOLDERS OF A MAJORITY OF THE SHARES OF COMMON STOCK PRESENT IN PERSON OR
REPRESENTED BY PROXY AT THE ANNUAL MEETING AND ENTITLED TO VOTE THEREON. SEE
"VOTING SECURITIES OUTSTANDING AND VOTING RULES."
The following is a summary of the material provisions of the Incentive
Plan, as amended by the proposed amendment, which amended plan is attached as
Appendix A to this Proxy Statement and is incorporated by reference into this
summary description. This summary is qualified in its entirety by reference to
the Incentive Plan. Any capitalized terms which are used in this summary
description but not defined in this Proxy Statement have the meanings assigned
to them in the Incentive Plan.
INTRODUCTION AND GENERAL INFORMATION ABOUT THE INCENTIVE PLAN
The Incentive Plan authorizes grants of incentive stock options ("ISOs"),
non-qualified stock options ("NQSOs"), stock appreciation rights ("SARs"),
performance stock, restricted stock, dividend equivalents, and performance-based
awards to employees, consultants, and advisors of the Company and its
subsidiaries. The Board of Directors believes that use of long-term incentives
authorized under the Incentive Plan is beneficial to the Company as a means of
promoting the success and enhancing the value of the Company by linking the
personal interests of its employees and, in certain cases, its consultants and
advisors to those of its stockholders and by providing employees and such other
persons with an incentive for outstanding performance. These incentives also
provide the Company flexibility in its ability to attract and retain the
services of employees and others upon whose judgment, interest, and special
effort the successful conduct of the Company's business is largely dependent. As
of July 30, 1998, the closing price of the Company's Common Stock on Nasdaq was
$7.66 per share.
ADMINISTRATION OF THE INCENTIVE PLAN
The Plan is administered by either the Board of Directors or a committee
appointed by the Board consisting of at least two (2) non-employee directors who
also qualify as "outside directors" under Section 162(m) of the Code (i.e., the
Compensation Committee). The Compensation Committee has the exclusive authority
and discretion to administer the Incentive Plan, including the power to
determine eligibility, the types and sizes of awards, and the timing of awards.
Accordingly, future grants under the Incentive Plan are not determinable at this
time. As of July 1, 1998, total options outstanding under the Incentive Plan
were approximately 1,677,758 and there remain approximately 122,242 available
for grant. See "Compensation of Directors and Executive Officers, Benefits, and
Related Matters."
ELIGIBILITY
Persons eligible to participate in the Incentive Plan include all
employees, officers, and executives of, and consultants and advisors to, the
Company and its subsidiaries, as determined by the Compensation Committee,
including employees who are members of the Board, but excluding directors who
are not employees.
LIMITATION ON AWARDS AND SHARES AVAILABLE UNDER THE INCENTIVE PLAN
The maximum number of shares of the Company's Common Stock that may be
issued under the Incentive Plan is 1,800,000, subject to adjustment as provided
for in the plan. If Common Stock underlying a grant is not issued, those shares
of Common Stock will again be available for inclusion in future grants.
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<PAGE> 29
Additionally, there is available for issuance under the Incentive Plan any
Common Stock subject to options or other awards that are cancelled, terminated,
or otherwise settled without the issuance of the Company's Common Stock. The
Incentive Plan provides a grant limit to a single participant equal to no more
than 250,000 shares of Common Stock during any single calendar year. Common
Stock issued pursuant to the Incentive Plan may be either treasury stock or
newly issued stock. If there is a stock split, stock dividend, recapitalization,
or other relevant change affecting the Company's Common Stock, appropriate
adjustments would be made in the number of shares of Common Stock that could be
issued in the future and in the number of shares of Common Stock underlying, and
the exercise price of, all outstanding grants made before the event. It is
contemplated that, in connection with the Split-up, except in certain limited
cases, all of the outstanding options of officers and employees of the Company
who become employees of Cygnet on the Effective Date will be cancelled and
replaced with options issued by Cygnet under the Cygnet Financial Corporation
1998 Stock Incentive Plan. The Common Stock of the Company underlying such
replaced and cancelled options will again be available for award under the
Incentive Plan. See "Proposal No. 4 -- Approval of Split-up of the Company and
its Subsidiaries into Two Publicly-Held Corporate Groups -- Management of the
Company and Cygnet; Employees and Employee Issues."
GRANTS UNDER THE INCENTIVE PLAN
STOCK OPTIONS. The Compensation Committee may grant ISOs and NQSOs to
participants. Subject to the per person limit described above, the Compensation
Committee has the discretion to determine the number of shares of Common Stock
to be awarded to each participant. To date, the Company has limited stock awards
that have been granted under the Incentive Plan to stock options, which are
described below. Generally, options issued under the Incentive Plan have been
subject to vesting over a five-year period, with 20% of the options becoming
exercisable by the holder thereof on each successive anniversary date of the
grant. To date, the exercise price of all options granted under the Incentive
Plan has been equal to the fair market value of the Common Stock on the date of
the grant.
Incentive Stock Options. An ISO is a stock option that satisfies the
requirements specified in Section 422 of the Code. Under the Code, ISOs may only
be granted to employees. In order for an option to qualify as an ISO, the
option's exercise price must equal or exceed the fair market value of the stock
at the date of the grant, the option must lapse no later than 10 years from the
date of the grant, and the stock subject to ISOs that are first exercisable by
an employee in any calendar year must not have a value of more than $100,000 as
of the date of grant. Certain other requirements must also be met. The
Compensation Committee determines the consideration to be paid to the Company
upon exercise of any options. The form of payment may include cash, Common
Stock, or other property.
Non-Qualified Stock Options. A NQSO is any stock option other than an ISO.
Such options are referred to as "non-qualified" because they do not meet the
requirements of, and are not eligible for, the favorable tax treatment provided
by Section 422 of the Code.
STOCK APPRECIATION RIGHTS. The Compensation Committee may grant SARs that
entitle the grantee to receive an amount equal to the excess of the then fair
market value of the Common Stock with respect to which the SAR is being
exercised over the price fixed by the Compensation Committee at the time the SAR
was granted. Payment is made in cash, in Common Stock, or a combination of the
two as the Compensation Committee determines. The Compensation Committee will
determine the time or times at which a SAR may be exercised.
RESTRICTED STOCK AWARDS. The Compensation Committee may also issue Common
Stock under a restricted stock grant, subject to the satisfaction of any
applicable conditions thereon, such as continued employment for a specified
period or the attainment of stated performance objectives. The grant would set
forth a restriction period (including a period related to the attainment of
goals) during which the shares of restricted stock granted would remain subject
to forfeiture. The grantee of an award of restricted stock generally may not
dispose of the shares prior to the expiration of the restriction period. During
this period, a grantee of restricted stock would generally have all of the
rights of a stockholder, including the right to vote the Common Stock.
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<PAGE> 30
PERFORMANCE SHARE AWARDS. A performance share award is a contingent right
to receive a pre-determined amount if certain performance goals are met,
determined at the close of a period over which performance is measured. The
payment value of performance units will depend on the degree to which the
specified performance goals are achieved. Payment of earned performance shares
will be made in accordance with the terms set by the Compensation Committee
after the end of the measurement period for the performance unit. The amount of
payments made to any employee will be the value of the performance share for the
level of performance achieved multiplied by the number of performance shares
granted or earned by the participant.
PERFORMANCE-BASED AWARDS. Grants of performance-based awards under the
Incentive Plan enable the Compensation Committee to treat restricted stock and
performance share awards granted under the Incentive Plan as "performance-based
compensation" under Section 162(m) of the Code and preserve the deductibility of
these awards for federal income tax purposes. Only "covered employees," as
defined by Section 162(m), are eligible to receive performance-based awards.
Covered employees include the Company's Chief Executive Officer and the four
other most highly compensated officers.
Participants for any given performance period are only entitled to receive
payment for a performance-based award for such period to the extent that
pre-established performance goals set by the Compensation Committee for the
period are satisfied. These pre-established performance goals must be based on
one or more of the following performance criteria: pre- or after-tax net
earnings, sales growth, operating earnings, operating cash flow, return on net
assets, return on stockholders' equity, return on assets, return on capital,
Common Stock price growth, stockholder return, gross or net profit margin,
earnings per share, price per share, and market share. These performance
criteria may be measured in absolute terms, or as compared to any incremental
increase, or as compared to results of a peer group. With regard to a particular
performance period, the Compensation Committee will have the discretion to
select the length of the performance period, the type of performance-based
awards to be granted, and the goals that will be used to measure the performance
for the period. In determining the actual size of any individual
performance-based award for a performance period, the Compensation Committee may
reduce or eliminate (but not increase) the award. Generally, a participant will
have to be employed on the last day of the performance period in order to be
eligible for a performance-based award for that period. The maximum
performance-based award that may be payable to any one participant during a
performance period is 250,000 shares of Common Stock or an amount of cash equal
to 250,000 times the fair market value of the Common Stock on the first day of
the performance period.
TERMINATION OF EMPLOYMENT UNDER THE INCENTIVE PLAN
In the event of termination of employment, an ISO will lapse upon
termination for Cause or for any other reason, other than the participant's
death or Disability, unless the Compensation Committee determines in its
discretion to extend the exercise period for any vested and otherwise
exercisable ISOs for no more than 90 days after termination of employment. In
the event of termination of employment, restricted stock that is at the time
subject to restrictions will be forfeited by the participant. Termination or
forfeiture of other grants under the Incentive Plan may be determined by the
Compensation Committee at the time of the grant of an award or thereafter. In
certain instances the Compensation Committee may waive in whole or in part
restrictions or forfeiture conditions relating to grants and awards, other than
performance-based awards.
CHANGE OF CONTROL PROVISIONS UNDER THE INCENTIVE PLAN
The Incentive Plan provides that the Board of Directors or the Compensation
Committee (whichever entity is administering the Incentive Plan at the time)
may, in its sole and absolute discretion, provide participants with certain
rights and benefits in the event of a Change of Control, including, without
limitation (1) allowing all grants to become exercisable and all restrictions on
outstanding grants to lapse and allowing each participant the right to exercise
the grants prior to the occurrence of the Change of Control event; or (2)
providing that every grant outstanding under the Incentive Plan terminates,
provided that the surviving or resulting entity tenders grants to participants
that substantially preserve the rights and benefits of any grant then
outstanding under the Incentive Plan. A "Change of Control" under the Incentive
Plan may be any
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<PAGE> 31
consolidation or merger of the Company in which the Company is not the
continuing or surviving entity, or pursuant to which stock would be converted
into cash, securities, or other property; any sale, lease, exchange, or other
transfer of more than 40% of the assets or earning power of the Company; the
approval by stockholders of any plan or proposal for liquidation or dissolution
of the Company; or any person (other than a current stockholder of the Company,
or affiliate thereof, or any employee benefit plan of the Company or any
subsidiary of the Company) becomes the beneficial owner of 20% or more of the
Company's outstanding stock. The Board of Directors and the Committee have not
exercised their discretion to provide Change of Control rights and benefits
under the Incentive Plan as a result of the transactions contemplated as part of
the Split-up Proposal. See "Proposal No. 4 -- Approval of Split-up of the
Company and its Subsidiaries into Two Publicly-Held Corporate
Groups -- Management of the Company and Cygnet; Employees and Employee Issues."
CERTAIN FEDERAL INCOME TAX CONSEQUENCES UNDER THE INCENTIVE PLAN
INCENTIVE STOCK OPTIONS. An optionee will not be treated as receiving
taxable income upon either the grant of an ISO or upon the exercise of an ISO.
However, the difference between the exercise price and the fair market value on
the date of exercise will be an item of tax preference at the time of exercise
in determining liability for the alternative minimum tax, assuming that the
Common Stock is either transferable or subject to a substantial risk of
forfeiture under Section 83 of the Code.
If Common Stock acquired by the exercise of an ISO is not sold or otherwise
disposed of within two years from the date of its grant and is held for at least
one year after the date such Common Stock is transferred to the optionee, any
gain or loss resulting from its disposition will be treated as a mid- or
long-term capital gain or loss. If such Common Stock is disposed of before the
expiration of the above-mentioned holding periods, a "disqualifying disposition"
will occur. If a disqualifying disposition occurs, the optionee will realize
ordinary income in the year of the disposition in an amount equal to the
difference between the fair market value of the Common Stock on the date of
exercise and the exercise price, or the selling price of the Common Stock and
the exercise price, whichever is less. The balance of the optionee's gain on a
disqualifying disposition, if any, will be taxed as capital gain.
In the event an optionee exercises an ISO using Common Stock acquired by a
previous exercise of an ISO, unless the stock exchange occurs after the required
holding periods, such exchange shall be deemed a disqualifying disposition of
the stock exchanged.
NON-QUALIFIED STOCK OPTIONS. No taxable income will be realized by an
optionee upon the grant of a NQSO, nor is the Company entitled to a tax
deduction by reason of such grant. Upon the exercise of a NQSO, the optionee
will realize ordinary income in an amount equal to the excess of the fair market
value of the Common Stock on the date of exercise over the exercise price and
the Company will be entitled to a corresponding tax deduction.
Upon a subsequent sale or other disposition of Common Stock acquired
through exercise of a NQSO, the optionee will realize capital gain or loss to
the extent of any intervening appreciation or depreciation. Such a resale by the
optionee will have no tax consequence to the Company.
STOCK APPRECIATION RIGHTS. A recipient who receives a SAR award is not
subject to tax at the time of the grant and the Company is not entitled to a tax
deduction by reason of such grant. At the time such award is exercised, the
recipient must include in income the appreciation inherent in the SAR (i.e., the
difference between the fair market value of the Common Stock on the date of
grant and the fair market value of the Common Stock on the date the SAR is
exercised). The Company is entitled to a corresponding tax deduction in the
amount equal to the income includible by the recipient in the year in which the
recipient recognizes taxable income with respect to the SAR.
RESTRICTED STOCK AWARDS. A recipient of a restricted stock award will
recognize ordinary income equal to the fair market value of the Common Stock at
the time the restrictions lapse. The Company is entitled to a tax deduction
equal to the amount of income recognized by the recipient in the year in which
the restrictions lapse.
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<PAGE> 32
Instead of postponing the income tax consequences of a restricted stock
award, the recipient may elect to include the fair market value of the Common
Stock in income in the year the award is granted. This election is made under
Section 83(b) of the Code. This Section 83(b) election is made by filing a
written notice with the Internal Revenue Service office with which the recipient
files his or her federal income tax return. The notice must be filed within 30
days of the date of grant and must meet certain technical requirements.
The tax treatment of the subsequent disposition of restricted stock will
depend upon whether the recipient has made a Section 83(b) election to include
the value of the Common Stock in income when awarded. If the recipient makes a
Section 83(b) election, any disposition thereafter will result in a capital gain
or loss equal to the difference between the selling price of the Common Stock
and the fair market value of the Common Stock on the date of grant. The
character of such capital gain or loss will depend upon the period the
restricted stock is held. If no Section 83(b) election is made, any disposition
thereafter will result in a capital gain or loss equal to the difference between
the selling price of the Common Stock and the fair market value of the Common
Stock on the date the restrictions lapsed.
PERFORMANCE SHARES. A recipient of a performance share award will not
realize taxable income at the time of grant, and the Company will not be
entitled to a deduction by reason of such grant. Instead, a recipient of
performance shares will recognize ordinary income equal to the fair market value
of the Common Stock at the time the performance goals related to the performance
shares are attained and paid to the recipient. The Company is entitled to a tax
deduction equal to the amount of income recognized by the recipient in the year
in which the performance goals are achieved.
OTHER INCENTIVE PLAN INFORMATION
The Board may terminate, amend, or modify the Incentive Plan at any time
but such termination, amendment, or modification shall not affect any stock
options, SARs, or restricted stock awards then outstanding under the Incentive
Plan. Also, any such termination, amendment, or modification is subject to any
stockholder approval required under applicable law or by any national securities
exchange or association on which the Common Stock is then listed or reported.
Unless terminated by action of the Board of Directors, the Incentive Plan will
continue in effect until June 30, 2005, but awards granted prior to such date
will continue in effect until they expire in accordance with their terms. The
Compensation Committee may amend the term of any award or option theretofore
granted, retroactively or prospectively, but no such amendment shall adversely
affect any such award or option without the holder's consent.
PROPOSAL NO. 3
ADOPTION OF THE UGLY DUCKLING CORPORATION 1998 EXECUTIVE INCENTIVE PLAN
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" APPROVAL OF THE UGLY
DUCKLING CORPORATION 1998 EXECUTIVE INCENTIVE PLAN.
The Board of Directors of the Company has unanimously approved, and
recommends that the stockholders approve, the adoption of the Ugly Duckling
Corporation 1998 Executive Incentive Plan (the "1998 Plan") for employees,
officers, and executives of, and consultants and advisors to, the Company and
any subsidiary. The 1998 Plan authorizes grants of ISOs, NQSOs, SARs, restricted
stock, performance shares, and performance-based awards. Although the 1998 Plan
allows broad based awards to be granted and thus is similar to the Incentive
Plan, the Company currently intends to utilize the 1998 Plan primarily for
performance-based awards to executives and key employees of the Company.
The Board believes that using long-term incentives under the 1998 Plan will
be beneficial to the Company as a means to promote the success and enhance the
value of the Company by linking the personal interests of its employees,
officers, executives, consultants, and advisors to those of its stockholders and
by providing such individuals with an incentive for outstanding performance.
These incentives also provide the Company flexibility in its ability to attract
and retain the services of individuals upon whose judgment, interest, and
special effort the successful conduct of the Company's business is largely
dependent. The 1998
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<PAGE> 33
Plan, if approved by the stockholders, will have an effective date of January
15, 1998. As of July 30, 1998, the closing price of the Company's Common Stock
on Nasdaq was $7.66 per share.
ADOPTION OF THE 1998 PLAN REQUIRES APPROVAL BY THE HOLDERS OF A MAJORITY OF
THE OUTSTANDING SHARES OF COMMON STOCK PRESENT IN PERSON OR REPRESENTED IN PROXY
AT THE ANNUAL MEETING AND ENTITLED TO VOTE THEREON. SEE "VOTING SECURITIES
OUTSTANDING AND VOTING RULES."
The following is a summary of the material provisions of the 1998 Plan,
which is attached as Appendix B to this Proxy Statement and is incorporated by
reference into this summary description. This summary is qualified in its
entirety by reference to the 1998 Plan. Any capitalized terms which are used in
this summary description but not defined in this Proxy Statement have the
meanings assigned to them in the 1998 Plan.
ADMINISTRATION OF 1998 PLAN
The 1998 Plan will be administered by either the Board or a Compensation
Committee appointed by the Board consisting of at least two (2) non-employee
directors who also qualify as "outside directors" under Section 162(m) of the
Code. If the Board at any time does not appoint a Compensation Committee, any
reference herein to the Compensation Committee shall be to the Board.
The Compensation Committee will have the exclusive authority to administer
the 1998 Plan, including the power to determine eligibility, the types and sizes
of awards, the price and timing of awards, and the acceleration or waiver of any
vesting restriction, provided that the Compensation Committee will not have the
authority to waive any performance restrictions with respect to any
performance-based awards.
ELIGIBILITY
Persons eligible to participate in the 1998 Plan include all employees,
officers, and executives of, and consultants and advisors to, the Company and
its subsidiaries, as determined by the Compensation Committee, including
employees who are members of the Board, but excluding directors who are not
employees. As of July 1, 1998, there were approximately 20 officers and
executives and 2,280 employees of the Company and its subsidiaries.
LIMITATION ON AWARDS AND SHARES AVAILABLE UNDER THE 1998 PLAN
An aggregate of 800,000 shares of the Company's Common Stock is available
for grant under the 1998 Plan. The maximum number of shares of Common Stock that
may be subject to one or more awards to a single participant under the 1998 Plan
during any fiscal year is 400,000. The maximum number of shares of Company
Common Stock payable in the form of performance-based awards for a performance
period is 400,000 or if such performance-based compensation is payable in cash,
the maximum amount payable will be determined by multiplying 400,000 by the fair
market value of one share of Common Stock on the first day of the performance
period.
GRANTS UNDER THE 1998 PLAN
The 1998 Plan authorizes grants of ISOs, NQSOs, SARs, restricted stock,
performance shares, and performance-based awards. For a description of all such
types of awards, see "Proposal No. 2 -- Amendments to the Ugly Duckling
Corporation Long-Term Incentive Plan -- Grants Under the Incentive Plan."
EXISTING GRANTS. The Compensation Committee, has awarded certain grants
under the 1998 Plan effective as of January 15, 1998, subject to approval of the
1998 Plan by stockholders of the Company at the Annual Meeting (the "Existing
Grants"). All such awards consist of options with an exercise price of $8.25 per
share, the market value of the Common Stock on the effective date of the grant
(January 15, 1998). The Existing Grants will vest in equal increments over five
years subject to continued employment with the Company or its subsidiaries and
will also be subject to additional vesting hurdles based on the market value of
the Company's Common Stock as traded on Nasdaq (or the exchange on which the
Common Stock is then traded). The price hurdle for the first year of the grants
is a 20% increase in such market value over the exercise price of the options,
with the price hurdles increased for the next four years in additional 20%
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<PAGE> 34
increments over the exercise price of the options (e.g., the stock price hurdle
for the fifth year equals an increment of 100% over the exercise price of the
options). In order for the price hurdles to be met, the Common Stock must trade
at the targeted value for a period of 10 consecutive trading days. The price
hurdles can be met at any time before or after the time vesting requirements are
satisfied, and will be completely met at such time as the Common Stock trades at
100% in excess of the exercise price of the options for 10 consecutive trading
days. As of July 1, 1998, the price hurdles for the first two (2) time vesting
periods had already been satisfied. In any event, the Existing Grants will
become fully vested on January 15, 2005, unless sooner exercised or forfeited.
Following is a table that sets forth the Existing Grants:
1998 EXECUTIVE INCENTIVE PLAN
EXISTING GRANTS
<TABLE>
<CAPTION>
NAME AND POSITION DOLLAR VALUE($)(1) NUMBER OF OPTIONS(#)
- ----------------- ------------------ ---------------------
<S> <C> <C>
Ernest C. Garcia, II..................................... -0- -0-
Chairman of the Board and Chief Executive Officer
Gregory B. Sullivan...................................... $1,317,500(2) 250,000(2)
President and Chief Operating Officer
Steven T. Darak.......................................... 263,500 50,000
Senior Vice President, Chief Financial Officer, and
Treasurer
Walter T. Vonsh(3)....................................... -0- -0-
Senior Vice President -- Credit
Donald L. Addink(4)...................................... 131,750 25,000
Vice President -- Senior Analyst
All current executive officers, as a group(4)............ 2,239,750 425,000
All current directors who are not executive officers, as
a group(5) ............................................ -0- -0-
All employees, including all current officers who are not
executive officers, as a group(4)...................... 527,000 100,000
</TABLE>
- ---------------
(1) Based upon a value of $5.27 per granted option. The value was computed using
the Black-Scholes option-pricing model with the following assumptions:
expected dividend yield 0%, risk-free interest rate of 5.70%, expected
volatility of 57.6%, and an expected life of 7 years.
(2) In addition to the 250,000 options under the 1998 Plan, Mr. Sullivan was
also granted an additional 250,000 options as of January 15, 1998 under the
Incentive Plan.
(3) Effective as of March 16, 1998, Mr. Vonsh resigned his office as Senior Vice
President -- Credit for the Company. Mr. Vonsh continues to be employed by
the Company in another capacity.
(4) If the Split-up is effected, Mr. Addink and certain other officers and
employees of the Company will become officers or employees of Cygnet or its
subsidiaries. The options issued to such persons under the 1998 Plan will be
cancelled and will be replaced with options issued by Cygnet under the
Cygnet Financial Corporation 1998 Stock Incentive Plan. The Common Stock of
the Company underlying such cancelled options will again be available for
award under the 1998 Plan.
(5) Directors who are not employees of the Company are not eligible to
participate in the 1998 Plan.
Additional grants that may be made from time to time under the 1998 Plan to
the above named persons or others are not determinable.
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<PAGE> 35
AMENDMENT AND TERMINATION UNDER THE 1998 PLAN
The Compensation Committee, subject to approval of the Board, may
terminate, amend, or modify the 1998 Plan at any time; provided, however, that
stockholder approval is required for any amendment to the extent necessary or
desirable to comply with any applicable law, regulation, or stock exchange or
association rule.
CHANGE OF CONTROL PROVISIONS UNDER THE 1998 PLAN
In the event of a "Change of Control" of the Company: (i) all options and
other share-based awards granted under the 1998 Plan will become immediately
exercisable; (ii) any restriction periods and restrictions imposed on restricted
stock will lapse; and (iii) the target value attainable under all performance
units and other performance-based awards shall be deemed to have been fully
earned, unless, in each case, the surviving entity agrees to assume the awards
in a manner that substantially preserves the participants' rights and benefits.
Under the 1998 Plan, a Change in Control occurs upon any of the following
events: (a) any person (other than a current stockholder or any employee benefit
plan) becoming the beneficial owner of 20% or more of the Company's Common
Stock; (b) during any two-year period, the persons who are on the Company's
Board of Directors at the beginning of such period and any new person elected by
two-thirds of such directors cease to constitute a majority of the persons
serving on the Board of Directors; or (c) the Company's stockholders approve (1)
a merger or consolidation of the Company with another corporation where the
Company is not the surviving entity other than a merger in which the Company's
stockholders before the merger have the same proportionate ownership after the
merger, (2) a plan of complete liquidation or dissolution, or (3) any sale,
lease, or other transfer of 40% or more of the Company's assets, other than
pursuant to a sale-leaseback, structured finance, or other form of financing
transaction or pursuant to any separating of the Company's assets into two or
more publicly held companies as announced in the Company's press release dated
April 28, 1998. The transactions contemplated in the Split-up Proposal (Proposal
No. 4) will not result in a Change of Control under the 1998 Executive Incentive
Plan because of the specific exclusion in the plan for such transactions.
CERTAIN FEDERAL INCOME TAX CONSEQUENCES UNDER THE 1998 EXECUTIVE INCENTIVE PLAN
For a description of the federal income tax consequences of the various
types of awards that may be granted under the 1998 Plan, see "Proposal No.
2 -- Amendments to the Ugly Duckling Compensation Long-Term Incentive
Plan -- Certain Federal Income Tax Consequences Under the Incentive Plan."
PROPOSAL NO. 4
APPROVAL OF SPLIT-UP OF THE COMPANY AND
ITS SUBSIDIARIES INTO TWO PUBLICLY-HELD CORPORATE GROUPS
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE SPLIT-UP PROPOSAL.
THE SPLIT-UP PROPOSAL
The stockholders of the Company are being asked to consider a proposal (the
"Split-up Proposal") to approve the separation of the Company and its existing
subsidiaries into two publicly-held corporate groups (the "Split-up"). The
Split-up Proposal involves the transfer of assets from the Company and Company
subsidiaries to Cygnet Financial Corporation, a newly-organized Delaware
corporation and wholly-owed subsidiary of the Company ("Cygnet"), and Cygnet
subsidiaries, in exchange for preferred stock of Cygnet and a cash or equivalent
payment, and the further capitalization of Cygnet through certain transactions,
including a rights offering (the "Rights Offering") to stockholders of the
Company as of August 17, 1998, the Rights Record Date. The Split-up Proposal is
described in detail in the following pages.
ALTHOUGH THE COMPANY BELIEVES THAT STOCKHOLDER APPROVAL IS NOT REQUIRED FOR
THE SPLIT-UP, THE COMPANY WILL NOT MAKE THE RIGHTS OFFERING AND WILL NOT EFFECT
THE SPLIT-UP UNLESS THE SPLIT-UP PROPOSAL IS APPROVED BY THE AFFIRMATIVE VOTE OF
A MAJORITY OF THE SHARES OF COMPANY COMMON STOCK PRESENT IN PERSON OR BY PROXY
AT
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<PAGE> 36
THE ANNUAL MEETING AND ENTITLED TO VOTE THEREON. ERNEST C. GARCIA, II, THE
COMPANY'S CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER, AND THE HOLDER OF
APPROXIMATELY 25.2% OF THE OUTSTANDING COMMON STOCK OF THE COMPANY HAS INFORMED
THE COMPANY THAT HE WILL VOTE HIS STOCK ON PROPOSAL NO. 4 IN THE SAME PROPORTION
AS ALL OTHER STOCK VOTED ON THAT PROPOSAL AT THE ANNUAL MEETING.
STOCKHOLDERS SHOULD CONSIDER CERTAIN FACTORS DISCUSSED ABOVE UNDER "RISK
FACTORS," AS WELL AS THE OTHER INFORMATION SET FORTH HEREIN, BEFORE ACTING ON
THE SPLIT-UP PROPOSAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES
AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROXY STATEMENT. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
BACKGROUND AND REASONS FOR THE SPLIT-UP
In the third quarter of 1997, the Company announced a strategic evaluation
of its third party dealer operations, including the possible sale or spin-off of
these operations. In February 1998, the Company announced its intention to close
its third party dealer contract buying office ("Branch Office") network, and to
focus instead on its Cygnet finance program, which offers warehouse purchase
facilities and lines of credit to selected independent used car dealers, and the
bulk purchase and/or servicing of large contract portfolios. The Company further
announced that it was continuing to evaluate alternatives for these third party
dealer operations. The Split-up Proposal, which will formally separate such
operations from the Company's dealership operations, is the result of these
evaluations.
The Company's Board of Directors believes that the separation of the
Company into two publicly traded companies would be beneficial to each of the
Company's current businesses, because, among other things:
- It would separate businesses with distinct financial, investment, and
operating characteristics so that each could adopt strategies and pursue
objectives more appropriate to its specific operations than is possible
under the Company's present combined structure.
- It would allow each separate business group to attract and compensate
qualified employees with stock-based compensation and incentive plans
directly related to the performance of its business.
- It would allow investors, lenders, and employees to better evaluate the
performance and investment characteristics of each business group,
enhancing the likelihood that each will achieve appropriate market
recognition of its performance.
TRANSFER OF ASSETS PURSUANT TO THE SPLIT-UP
If the Split-up Proposal is approved and certain other conditions are
satisfied (see "Contingencies to the Split-up and the Closing Thereof"), on the
effective date of the Split-up (the "Effective Date"), the Company and its
subsidiaries will transfer to Cygnet and subsidiaries of Cygnet certain assets
and liabilities (the "Transferred Assets"). The Transferred Assets will include
(i) the Company's bulk purchase and servicing operations with respect to
contracts originated by independent used car dealerships ("Third Party
Dealers"); (ii) the assets of Cygnet Finance, Inc., a wholly-owned subsidiary of
the Company through which the Company provides qualified Third Party Dealers
with warehouse purchase facilities and operating credit lines primarily secured
by the dealer's retail installment contract portfolios (the "Cygnet Dealer
Program"); (iii) substantially all of the Company's rights and obligations
pursuant to certain transactions with First Merchants Acceptance Corporation
("FMAC"), described in detail in the Cygnet Prospectus, including the servicing
platform and rights and certain other rights and residual interests, and the
assumption by Cygnet of certain funding obligations and guarantees of the
Company in connection with the FMAC transaction but excluding certain rights and
liabilities retained by the Company as described under "Risk Factors -- Risks to
the Company Relating to the FMAC Transaction"; and (iv) substantially all of the
Company's rights and obligations pursuant to certain transactions with Reliance
Acceptance Group, Inc. ("Reliance"), described generally above under "Risk
Factors -- Risks to the Company Relating to the Reliance Transaction" and in
"Management's Discussion and Analysis of Results of Operations and Financial
Condition of the Continuing
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<PAGE> 37
Company Businesses -- Reliance Transaction," including the servicing platform
and certain servicing and transition servicing arrangements. The Transferred
Assets will not include cash received by the Company prior to the Effective
Date. The Transferred Assets had a net book value of approximately $54.7 million
and a net appraised value of approximately $54.9 million as of June 30, 1998.
However, it is expected that the book value of the Transferred Assets will
increase prior to the transfer contemplated herein as additional contracts are
acquired under warehouse purchase facilities or additional advances are made
under operating credit lines through the Cygnet Dealer Program.
Cygnet is currently evaluating a certain transaction for the acquisition or
management of an operating insurance agency. For a description of certain
additional transactions that may be or have been effected by Cygnet prior to the
Split-up ("Interim Transactions"), see "Recent Developments" in the Cygnet
Prospectus.
The Company would retain its used car dealership operations, its
securitization program, the servicing rights and its interests in the bankruptcy
remote subsidiaries that own residual interests in all securitization
transactions previously effected by the Company, and its rent-a-car franchise
business which is generally inactive. The Company would continue to service,
through its loan servicing and collection facilities located in Phoenix,
Arizona, San Antonio, Texas, Dallas, Texas, and Tampa, Florida, the automobile
receivables in its various securitized pools, receivables purchased through its
Branch Office network that was closed in the first quarter of 1998 (whether
securitized or retained), as well as the receivables serviced pursuant to the
transactions effected in September 1997 with Kars-Yes Holdings, Inc. and related
companies ("Kars"). In September, 1997, the Company purchased substantially all
of the dealership and loan servicing assets of Kars, including twelve
dealerships. Although the Company did not acquire the contract portfolio of
Kars, it did acquire the Kars' loan servicing assets and began servicing Kars'
retained portfolio and portfolios previously securitized by Kars, which
aggregated approximately $98.8 million at March 31, 1998. The Company would also
retain certain rights and direct obligations relating to the FMAC and Reliance
transactions. See "Risk Factors -- Risks to the Company Relating to the FMAC
Transaction" and "-- Risks to the Company Relating to the Reliance Transaction."
References herein to the "Continuing Company Businesses" shall mean those
businesses of the Company that the Company would continue to own and operate if
the Split-up is successfully effected and concluded.
CYGNET PREFERRED STOCK AND THE CASH PAYMENT
As consideration for the Transferred Assets, on the Effective Date, Cygnet
would issue to the Company 40,000 shares of Cumulative Convertible Preferred
Stock, Series A, $.001 par value per share (the "Cygnet Preferred Stock"), with
an aggregate liquidation preference of $40 million and make a cash or equivalent
payment (the "Cash Payment") equal to the difference between the greater of the
appraised value or the book value of the Transferred Assets (except with respect
to one intangible asset with a current book value of approximately $575,000 as
to which no value has been assigned by the parties) and the $40 million of
Cygnet Preferred Stock. Cygnet may also be required to repay to the Company any
Interim Company Loans, would pay the excess, if any, of the aggregate appraised
value, as of the Effective Date, of the assets and rights and related liability
acquired by Cygnet in any Interim Transactions ("Interim Assets") over the
aggregate book value of such Interim Assets (the "Interim Consideration"), and
would distribute to the Company any earnings accrued prior to the Effective
Date. The Company may also require the release of any guarantee of Third Party
Loans to Cygnet. Alternatively, the Company and Cygnet may agree as to other
treatment of the Interim Transactions if the Company believes that such other
treatment results in adequate consideration to the Company as the time of the
Split-up with respect to the Interim Assets. The purpose for the payment by
Cygnet to the Company of the Interim Consideration is to place both parties in
substantially the same economic position each would be in if the Interim
Transactions were effected by the Company rather than Cygnet and the resulting
assets and liabilities were transferred to Cygnet.
The Cygnet Preferred Stock, in preference to the Cygnet Common Stock, would
be entitled to receive cumulative cash dividends, from the Effective Date
through the first anniversary of such date, at the initial annual rate of 7% of
the Base Liquidation Amount (defined below), and escalating 1% per annum on each
anniversary thereafter to a maximum rate of 11% per annum on the aggregate Base
Liquidation Amount, in each case payable quarterly in arrears on the first day
of March, June, September, and December of each year,
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<PAGE> 38
beginning December 1, 1998, when and as declared by the Board of Directors of
Cygnet out of funds legally available for such payment. The Cygnet Preferred
Stock, in preference to the Cygnet Common Stock, will be entitled to receive, in
the event of dissolution or liquidation of Cygnet, $1,000 per share (the "Base
Liquidation Amount") plus accrued and unpaid dividends thereon (the "Liquidation
Preference Amount").
The Cygnet Preferred Stock will be redeemable at Cygnet's option in whole
or in part at a redemption price of $1,000 per share, plus dividends accrued and
unpaid thereon to the redemption date; provided, however, that no such
redemption will be authorized unless, in the reasonable judgment of the Company
and Cygnet, the proceeds of such redemption would be treated for federal income
tax purposes as proceeds from a sale of such stock and not as a dividend paid
with respect to such stock. The Cygnet Preferred Stock will be convertible in
whole or in part at any time after the third anniversary following issuance at
the option of the Company into that number of shares of Cygnet Common Stock
determined by dividing the Liquidation Preference Amount of the shares of Cygnet
Preferred Stock to be converted by the lower of (a) the Subscription Price or
(b) 80% of the average Market Price (defined below) for the 10 consecutive
trading days ending 2 business days prior to the date notice of conversion is
given, subject to adjustment upon certain extraordinary events. In addition, the
Cygnet Preferred Stock will be convertible during any period following the date
that an amount equal to six quarterly dividend payments on the Cygnet Preferred
Stock has accrued and is unpaid, until the payment in full of all accrued
dividends. For purposes of the conversion of the Cygnet Preferred Stock, "Market
Price" means (i) if the Common Stock is quoted on the Nasdaq National Market or
the Nasdaq SmallCap Market or on a national securities exchange, the daily per
share closing price of the Cygnet Common Stock as quoted on the Nasdaq National
Market or the Nasdaq SmallCap Market or on the principal stock exchange on which
it is listed on the trading day in question, as the case may be, whichever is
the higher, or (ii) if the Cygnet Common Stock is traded in the over-the-counter
market and not quoted on the Nasdaq National Market or the Nasdaq SmallCap
Market or on any national securities exchange, the closing bid price of the
Cygnet Common Stock on the trading day in question, as reported by Nasdaq or an
equivalent generally accepted reporting service. The Cygnet Preferred Stock will
not have any pre-emptive or other subscription rights.
Except as described below, holders of the Cygnet Preferred Stock will not
be entitled to vote for the election of directors or for other matters on which
holders of the Cygnet Common Stock are entitled to vote. In the event that an
amount equal to two quarterly dividend payments on the Cygnet Preferred Stock
shall have accrued and be unpaid, the holders of the Cygnet Preferred Stock will
have the right, voting separately as a class, to elect two members to the Board
of Directors of Cygnet (in addition to the then authorized number of directors)
at the next meeting of stockholders of Cygnet and thereafter until all accrued
dividends on the Cygnet Preferred Stock have been paid in full. The Cygnet
Preferred Stock shall also have voting rights on certain extraordinary matters
as described in the Cygnet Prospectus. In such case, each share of Cygnet
Preferred Stock shall have one vote per Base Liquidation Amount.
If the Cygnet Preferred Stock were converted to Cygnet Common Stock at the
subscription price of $7.00 per share, the Company would obtain 5,714,286
shares, or approximately 61.6% of the then outstanding shares of Cygnet,
assuming the sale by Cygnet pursuant to the Rights Offering of 3,562,500 shares
of Cygnet Common Stock (the Required Purchase Amount) and that no additional
shares of Cygnet Common Stock are issued either on the Effective Date of the
Split-up or thereafter. If the Cygnet Preferred Stock were converted to Cygnet
Common Stock at the subscription price of $7.00 per share, and assuming the sale
by Cygnet of 4,750,000 shares of Cygnet Common Stock pursuant to the Rights
Offering and the sale of the full 714,286 Additional Cygnet Shares (defined
below) to Ernest C. Garcia, II and the full 214,286 shares available for
purchase by officers and directors of Cygnet (other than Mr. Garcia) and that no
additional shares of Cygnet Common Stock are then outstanding, the Company would
obtain approximately 50.2% of the then outstanding shares of Cygnet.
The Cygnet Preferred Stock and the Cygnet Common Stock into which it is
convertible are not registered under the Securities Act and may not be sold by
the Company unless such securities are registered or unless an exemption from
registration is available. Cygnet will register the resale of the Cygnet Common
Stock issued upon conversion of the Cygnet Preferred Stock under the Securities
Act, at its expense at the request of the Company.
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<PAGE> 39
For a description of certain risks relating to the Cygnet Preferred Stock,
see "Risk Factors -- Risks Relating to the Cygnet Preferred Stock."
REPAYMENT OF VERDE SUBORDINATED DEBT
The Company has incurred subordinated indebtedness to Verde Investments,
Inc. ("Verde"), an affiliate of the Company wholly-owned by Mr. Garcia. See
"Management of the Company -- Certain Relationships and Related Transactions"
herein. As of July 1, 1998, the balance of such indebtedness was $10 million.
The Company intends to utilize a portion of the Cash Payment to repay the Verde
indebtedness in full. Alternatively, Verde may deposit the Verde Note or any
part thereof with Cygnet in payment of all or any portion of the Subscription
Price for exercise of Rights acquired from Mr. Garcia or otherwise, the related
Over-Subscription Privilege (defined below), and the Standby Purchase Obligation
(defined below). In such case, Cygnet would transfer the Verde Note to the
Company for cancellation in lieu of the payment of a portion of the Cash
Payment. The Company believes that the terms of the Verde Note are equivalent to
those that could have been obtained through arm's length negotiations.
USE OF PROCEEDS
The Cash Payment, which is expected to range from $10 million to $20
million, will be used to (i) first, repay the $10 million Verde indebtedness,
which carries an interest rate of 10% per annum, and (ii) the balance (estimated
to be zero to $10 million), will be utilized by the Company to pay down the
Company's revolving credit facility with General Electric Capital Corporation,
which bears interest at 30-day LIBOR plus 3.15% (8.81% at July 1, 1998).
THE RIGHTS OFFERING
In addition to the Transferred Assets and through certain collateral
transactions described below, Cygnet will be capitalized through the Rights
Offering, involving the issuance of transferable rights (the "Rights") to
purchase approximately 4,750,000 shares of Cygnet Common Stock (the "Offered
Shares"). In the event that the Company's stockholders approve the Split-up
Proposal and all other conditions thereto are satisfied, and unless the
Company's Board of Directors exercises its right, in its sole discretion without
stockholder approval, to abandon, defer (to a date certain or indefinitely), or
modify the Rights Offering, the Rights Offering will be made to stockholders of
record of the Company as of the Rights Record Date. On the commencement date of
the Rights Offering (the "Commencement Date"), which is expected to be on or
about September 1, 1998, Cygnet would distribute the Rights to stockholders of
record of the Company on the Rights Record Date pro rata in accordance with the
ownership of the Company's Common Stock on the Rights Record Date. Each holder
of record of the Company's Common Stock on the Rights Record Date would receive
one (1) Right for every four (4) shares of Company Common Stock. Only Rights to
purchase whole shares of Cygnet Common Stock will be issued. When the number of
shares of Company Common Stock held by a Company stockholder of record is not
divisible by four, the number of Rights to be issued to such stockholder will be
rounded upward to the nearest whole Right. Holders of record of Company Common
Stock as of the Rights Record Date will be instructed to allocate the Rights
received by them among the beneficial owners of the Company Common Stock to
which such Rights relate by rounding upward or downward to the nearest whole
Right. A record holder may request additional Rights if necessary to effect such
an allocation among beneficial owners. Each Right would entitle the holder to
purchase one (1) share of Cygnet Common Stock at a subscription price of $7.00
per share (the "Subscription Price"). The Subscription Price would be deposited
into an escrow account (the "Escrow Account") established by Cygnet with Norwest
Bank Minnesota, National Association, as escrow agent (the "Escrow Agent").
Norwest Bank Minnesota, National Association will also act as the distribution
agent for the Rights Offering. Procedures for exercise of the Rights are
described in the Cygnet Prospectus. Except as provided in the next sentence
below or in the Cygnet Prospectus, in order to exercise the Rights, the full
Subscription Price for all exercised Rights must be paid on or prior to the
Expiration Date (defined below). Notwithstanding the above, Mr. Garcia and his
affiliates may exercise their Rights by payment of the Subscription Price
directly to Cygnet on or prior to the Effective Date. No interest will be paid
on Subscription Funds in the Escrow Account.
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Each Right would be exercisable only for a limited period (the "Offering
Period") beginning on the Commencement Date and ending at 5:00 p.m. (Minnesota
time) on the date that is 20 days following the Commencement Date or such other
date to which the Rights Offering is extended (the "Expiration Date"). The
Company will give notice of any extension of the Offering Period. The Company
may determine to extend the Offering Period in the event that the Company
believes a longer offering period is advisable in order to allow a more
diversified pool of holders to exercise the Rights or for any other reason.
During the Offering Period, the Rights would be freely transferable. The Rights
and Cygnet Common Stock have been approved for listing on Nasdaq, subject to
official notice of issuance.
On, or as soon as practicable after, the Effective Date, the Transfer Agent
will mail certificates for shares of Cygnet Common Stock to those holders of
Rights who have validly elected to purchase Cygnet Common Stock.
THE OVER-SUBSCRIPTION PRIVILEGE
Each holder of Rights who elects to exercise all of his Rights may also
subscribe for an additional number of shares of Cygnet Common Stock out of the
pool of shares underlying unexercised Rights on the Expiration Date, if any (the
"Unexercised Pool"), equal up to the number of shares purchased upon exercise of
such holder's Rights (the "Over-Subscription Privilege"), subject to allocation
as described herein. Shares purchased through the Over-Subscription Privilege
will be purchased at the Subscription Price. For example, if a holder holds and
validly exercises 1,000 Rights, such holder may also subscribe for an additional
1,000 shares of Cygnet Common Stock out of the Unexercised Pool at the
Subscription Price of $7.00 per share. If there are more shares subscribed for
pursuant to the Over-Subscription Privilege than are available in the
Unexercised Pool, the available shares will be allocated pro rata among all
holders of Rights exercising the Over-Subscription Privilege as described in the
Cygnet Prospectus. Except as described in the next sentence below or in the
Cygnet Prospectus, the full amount of the Subscription Price for all exercised
Rights and shares subscribed for pursuant to the Over-Subscription Privilege
must be paid into the Escrow Account on or prior to the Expiration Date in order
to validly exercise the Over-Subscription Privilege. Notwithstanding the above,
because of his obligations as Standby Purchaser (described below under "The
Standby Purchase Obligation"), Mr. Garcia and his affiliates may pay monies
necessary to exercise the Over-Subscription Privilege with respect to their
Rights at the same time that they pay monies to fulfill Mr. Garcia's Standby
Purchase Obligation (described below). Such payments will be made directly to
Cygnet.
THE STANDBY PURCHASE OBLIGATION
Ernest C. Garcia, II, the Company's Chairman of the Board, Chief Executive
Officer, and the holder of approximately 25.2% of the outstanding Common Stock
of the Company will act as standby purchaser for the Rights Offering (the
"Standby Purchaser"). The successful conclusion of the Split-up is contingent on
the purchase of at least 75% of the Offered Shares (the "Required Purchase
Amount"). Mr. Garcia has agreed to purchase his full 25.2% pro rata share of the
Offered Shares pursuant to the Rights Offering. In addition, pursuant to that
certain Rights Exercise and Standby Purchase Agreement to be executed prior to
the Commencement Date between Cygnet and Mr. Garcia (the "Standby Purchase
Agreement"), through the Over-Subscription Privilege associated with his Rights
or pursuant to his Standby Purchase Obligation, Mr. Garcia will purchase
additional shares of Cygnet Common Stock from the Unexercised Pool to the extent
necessary to satisfy the Required Purchase Amount. If following the Expiration
Date, validly exercised Rights and the Over-Subscription Privilege do not result
in proper and valid subscriptions for the Required Purchase Amount, then Mr.
Garcia will be required to purchase additional Offered Shares pursuant to the
Standby Purchase Obligation in an amount necessary to achieve the Required
Purchase Amount. Mr. Garcia will pay additional subscription funds required
pursuant to the Standby Purchase Obligation directly to Cygnet on or prior to
the Effective Date. Mr. Garcia's Standby Purchase Obligation may be satisfied by
any company or entity wholly-owned by Mr. Garcia or any of his affiliates.
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THE STANDBY CYGNET WARRANTS
In consideration for the obligations incurred by Mr. Garcia under the
Standby Purchase Agreement, on the Effective Date, Cygnet would grant to Mr.
Garcia warrants (the "Cygnet Standby Warrants") entitling Mr. Garcia to purchase
up to 500,000 shares of Cygnet Common Stock at an exercise price equal to 120%
of the Subscription Price, or $8.40 per share (the "Issue Price"), at any time
within five years following the Effective Date.
ADDITIONAL CAPITALIZATION
In addition to Cygnet Common Stock that Mr. Garcia will purchase through
exercise of his Rights, the Over-Subscription Privilege associated with his
Rights, and the Standby Purchase Obligation, on the Effective Date, Mr. Garcia
or any of his affiliates will have the right at his election to purchase up to
an additional $5 million of Cygnet Common Stock at the Subscription Price (the
"Additional Cygnet Shares"). In addition, on the Effective Date, existing
employees and directors of the Company (who will also be employees and/or
directors of Cygnet), other than Mr. Garcia, will have the right to purchase
additional shares of Cygnet Common Stock for $7.00 per share, up to an aggregate
of $1.5 million. Further, Cygnet will be required to issue warrants (the "Lender
Warrants") to purchase 115,000 shares of Cygnet Common Stock at an exercise
price of $8.40 per share and subject to a call feature by Cygnet if the closing
price of the Cygnet Common Stock equals or exceeds $13.44 per share for a period
of 20 consecutive trading days, as incentive for a loan made to Cygnet by a
third-party lender of $5 million in subordinated indebtedness for a three-year
term. The Lender Warrants will have a term of three years from the date of
issuance. Neither the Cygnet Standby Warrants nor the Lender Warrants nor the
underlying Cygnet Common Stock into which they are exercisable are registered
under the Securities Act and such securities may not be sold unless they are
registered or unless an exemption from registration is available. Cygnet has
agreed to register at its expense the resale of the Cygnet Common Stock
underlying the Cygnet Standby Warrants and the Lender Warrants on demand of the
holder thereof at any time after one year following the Effective Date.
INTERESTED TRANSACTIONS
As described above, officers and directors of the Company have certain
significant interests in the Split-up transaction including (i) Mr. Garcia's
rights and obligations as Standby Purchaser, which may enable Mr. Garcia to
purchase significant amounts of Cygnet Common Stock at the Subscription Price to
the extent such stock is not purchased upon exercise of the Rights or pursuant
to the Over-Subscription Privilege by holders of the Rights, (ii) Mr. Garcia's
right to purchase the Additional Cygnet Shares (up to 714,286 shares) at the
Subscription Price, (iii) the right of officers and directors of the Company who
are officers and directors of Cygnet on the Effective Date to purchase the
Employee Shares (up to 214,286 shares) at the Subscription Price, (iv) the
issuance of the Cygnet Standby Warrants to purchase 500,000 shares of Cygnet
Common Stock at $8.40 per share for a period of 5 years following the Effective
Date to Mr. Garcia in consideration for his obligations as Standby Purchaser,
and (v) the use of a portion of the Cash Payment by the Company to repay the
Verde Note to a corporation wholly-owned by Mr. Garcia. Cygnet will also assume
the employment agreements of and will replace Company options with Cygnet
options for certain executive officers of the Company who will become executive
officers of Cygnet.
TRADING MARKET
There has been no prior trading market in the Cygnet Common Stock or the
Rights. Cygnet has applied for listing of the Cygnet Common Stock and the
associated Rights on Nasdaq. The transfer agent for the Cygnet Common Stock will
be Norwest Bank Minnesota, National Association (the "Cygnet Transfer Agent").
MANAGEMENT OF THE COMPANY AND CYGNET; EMPLOYEES AND EMPLOYEE ISSUES
BOARD OF DIRECTORS AND EXECUTIVE OFFICERS OF CYGNET. The directors of
Cygnet are Ernest C. Garcia, II, Robert J. Abrahams, Christopher D. Jennings,
Gary L. Trujillo and Frank P. Willey. Ernest C. Garcia, II is
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the Chairman of the Board and Chief Executive Officer of Cygnet. In addition,
certain other executive officers of the Company have been appointed as executive
officers of Cygnet and, on the Effective Date, will resign as executive officers
of the Company. A chart showing the current directors and executive officers of
the Company, the persons who will be directors and executive officers of the
Company following the Split-up, and the persons who will be directors and
executive officers of Cygnet following the Split-up follows:
<TABLE>
<CAPTION>
COMPANY DIRECTORS AND CYGNET DIRECTORS AND
CURRENT COMPANY DIRECTORS EXECUTIVE OFFICERS EXECUTIVE OFFICERS
AND EXECUTIVE OFFICERS FOLLOWING SPLIT-UP FOLLOWING SPLIT-UP
------------------------- ------------------------- -------------------------
<S> <C> <C> <C>
Directors: Ernest C. Garcia, II Ernest C. Garcia, II Ernest C. Garcia, II
Chairman Chairman Chairman
Robert J. Abrahams Robert J. Abrahams Robert J. Abrahams
Christopher D. Jennings Christopher D. Jennings Christopher D. Jennings
John N. MacDonough John N. MacDonough Gary L. Trujillo
Frank P. Willey Gregory B. Sullivan Frank P. Willey
Frank P. Willey
Executive Officers: Ernest C. Garcia, II Gregory B. Sullivan Ernest C. Garcia, II
Chief Executive President and Chief President and Chief
Officer Executive Officer Executive Officer
Gregory B. Sullivan Steven T. Darak Steven P. Johnson
President and Chief Executive Vice Senior Vice
Operating Officer President, Chief President,
Steven P. Johnson Financial Officer General Counsel
Senior Vice and Treasurer and Secretary
President, Russell J. Grisanti Donald L. Addink
General Counsel Executive Vice Senior Vice President
and Secretary President -- and Senior Analyst
Russell J. Grisanti Servicing Operations Eric J. Splaver
Executive Vice Peter G. Levas Chief Financial
Executive Vice Officer
President -- Operations President -- Gregory R. Ciccolini
Steven T. Darak Sales Operations Chief Information
Senior Vice Steven A. Tesdahl Officer
President and Chief Executive Vice
Financial Officer President
Steven A. Tesdahl and Chief Information
Senior Vice President Officer
and Chief Information Peter R. Fratt
Officer Vice President --
Donald L. Addink Real Estate
Vice President --
Senior Analyst
Peter R. Fratt
Vice President --
Real Estate
Eric J. Splaver
Corporate Controller
</TABLE>
For further information concerning the current directors and executive
officers of the Company and their business experience, see "Management of the
Company -- Information Concerning Directors and Executive Officers." For further
information concerning the persons who will be directors and executive officers
of Cygnet and its subsidiaries following the Split-up, see the Cygnet
Prospectus. For a description of certain risks to the Company relating to the
loss of certain of its executive officers, see "Risk Factors -- Loss of Services
of Senior Management."
EMPLOYEES OF CYGNET. On the Effective Date, Cygnet is expected to have
approximately 280 employees. These employees will consist primarily of employees
of the Company who operate the Cygnet Dealer Program or
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<PAGE> 43
who currently service the contracts associated with the FMAC transaction out of
facilities located in Dallas, Texas, Denver, Colorado, and Nashville, Tennessee.
The Company will retain substantially all of its approximately 1,900 remaining
employees.
EFFECT OF RIGHTS OFFERING ON EXISTING COMPANY PLANS AND EMPLOYMENT
CONTRACTS. The Split-up will not result in a "Change of Control" under the
Company's Incentive Plan or its 1998 Plan. See "Proposal No. 2 -- Amendments To
The Ugly Duckling Corporation Long-Term Incentive Plan -- Change of Control
Provisions Under The Incentive Plan" and "Proposal No. 3 -- Adoption of The Ugly
Duckling Corporation 1998 Executive Incentive Plan -- Change of Control
Provisions Under The 1998 Plan."
It is contemplated that, except in certain limited cases, outstanding
options (whether granted under the Incentive Plan or the 1998 Plan) of existing
employees of the Company who become employees of Cygnet on the Effective Date
will be cancelled and new options to purchase Cygnet Common Stock will be issued
to such employees under the Cygnet 1998 Stock Incentive Plan. The Company Common
Stock underlying the cancelled options will then become available to support
additional awards under the Incentive Plan or the 1998 Plan, as the case may be.
CONTINGENCIES TO THE SPLIT-UP AND THE CLOSING THEREOF
The making of the Rights Offering and the closing of the Split-up are
subject to certain contingencies in addition to stockholder approval of the
Split-up Proposal and the requisite investment being made in Cygnet either
through the Rights Offering or otherwise, as described herein. Various consents,
waivers, and approvals are required to be obtained by the Company or its
subsidiaries prior to either the initiation of the Rights Offering or the
effectuation of the Split-up. These include, without limitation, (i) the consent
of certain parties that are required in order to allow a subsidiary of Cygnet to
service the contracts currently being serviced pursuant to the FMAC and Reliance
transactions, and (ii) the consent of General Electric Capital Corporation ("GE
Capital") as the primary lender to the Company under the Company's revolving
credit facility (see "Management's Discussion and Analysis of Financial
Condition and Results of Operations of the Continuing Company
Businesses -- Liquidity and Capital Resources -- Revolving Facility"). In
addition, Cygnet will be required to obtain certain regulatory approvals and
licenses. The Effective Date of the Split-up is expected to occur shortly
following the Expiration Date of the Rights Offering but may be delayed to a
date not later than 30 days following the Expiration Date. The Company has
prepared or is in the process of preparing such consents and has contacted or is
contacting various third parties to obtain such consents. The Company will
attempt to obtain all required consents before the Annual Meeting. However,
there can be no assurance that all required consents will be obtained by such
date or at all.
More specifically, the issuance of the Rights following the requisite
approval by the stockholders of the Split-up Proposal is conditioned upon, among
other things, (i) the execution and delivery of the Capitalization Agreement
described below under "Principal Agreements Relating to the Rights Offering" and
other required intercompany agreements; (ii) the Cygnet Registration Statement
having been filed with the Securities and Exchange Commission (the "Commission")
and having become effective and no stop order being in effect with respect
thereto; (iii) all required authorizations, consents, approvals, and clearances
of all federal, state, local, and foreign governmental agencies and all other
persons required therefor having been obtained and in effect, without any
conditions being imposed that would have a material adverse effect; (iv) no
preliminary or permanent injunction or other order or decree, ruling issued in a
court of competent jurisdiction or by a governmental, regulatory, or
administrative agency or commission, and no statute, rule, regulation, or
executive order promulgated or enacted by any governmental authority, being in
effect preventing the Rights Offering; (v) the satisfactory resolution of all
legal and regulatory issues; and (vi) the Rights being deliverable in accordance
with the applicable law. Even if all of the above conditions are satisfied, the
Rights Offering may be abandoned or postponed, or conditions thereto waived, at
any time prior to the Commencement Date or thereafter for any reason in the sole
discretion of the Company's Board of Directors.
Similarly, the effectuation of the Split-up following the Rights Offering
and the achievement of the requisite investment in Cygnet is conditioned upon,
among other things, (i) certain transactions contemplated by the Capitalization
Agreement having been consummated in all material respects; (ii) all required
authorizations, consents, approvals, and clearances of all federal, state,
local, and foreign governmental
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<PAGE> 44
agencies and all other persons required to permit the valid consummation of the
transactions contemplated by the Capitalization Agreement having been obtained,
without any conditions being imposed that would have a material adverse effect;
(iii) no preliminary or permanent injunction or other order, decree, or ruling
issued by a court of competent jurisdiction or by a government, regulatory, or
administrative agency or commission, and no statute, rule, regulation, or
executive order promulgated or enacted by any governmental authority, being in
effect preventing the Split-up; (iv) the Cygnet Common Stock being deliverable
in accordance with applicable law; (v) the execution and delivery of the
required intercompany agreements; and (vi) both the Company and Cygnet having in
place separate financing facilities and capital resources that will, in the
judgment of the Board of Directors of each such entity, be sufficient to allow
the continuing operations of each such entity without material disruption of
business operations. These conditions may be waived by the Board of Directors of
the Company and/or Cygnet at any time. Even if all the above conditions are
satisfied, the Capitalization Agreement may be amended or terminated, and the
closing of the Split-up may be abandoned, or conditions thereto may be waived,
at any time prior to the Expiration Date or thereafter for any reason in the
sole discretion of the Company's Board of Directors.
The Company does not expect to effect the Split-up if the Rights Offering
is not consummated.
PRINCIPAL AGREEMENTS RELATING TO THE RIGHTS OFFERING
In order to effectuate the Split-up, it is contemplated that at least the
following major agreements will be required. Each such agreement will be
executed in substantially the form described below. The descriptions of such
agreements contained herein are summaries only and are qualified in their
entirety by reference to the agreements which will be filed as exhibits to the
Cygnet Registration Statement. Such agreements are expected to be substantially
in the forms so filed but may be revised prior to or following the effectuation
of the Split-up.
CAPITALIZATION AGREEMENT.
Prior to the Commencement Date, the Company and Cygnet will enter into the
Capitalization Agreement. The Capitalization Agreement sets forth, among other
things, and assuming the satisfaction or waiver of specified contingencies, (i)
the obligation of Cygnet to issue the Rights, (ii) the obligation of Cygnet to
issue the Cygnet Common Stock on the Effective Date upon exercise of the Rights,
the Over-Subscription Privilege, and the Standby Purchase Obligation, (iii) the
obligation of the Company and its subsidiaries to transfer the Transferred
Assets to Cygnet and its subsidiaries on the Effective Date, (iv) the obligation
of Cygnet to issue the Cygnet Preferred Stock to the Company and to make the
Cash Payment, (v) the obligation of Cygnet to issue other capital stock and
warrants as described herein, (vi) the operational arrangements and agreements
between the Company and Cygnet during a transition period, including
arrangements for the sharing of certain assets, leases, licenses, and employees,
(vii) agreements between the Company and Cygnet relating to employee matters,
including the issuance or adjustment of stock options under employee benefit
plans, (viii) tax sharing and indemnity matters, and (ix) certain agreements
between the Company and Cygnet relating to the FMAC and Reliance transactions
and any Interim Transactions.
STANDBY PURCHASE AGREEMENT.
The Standby Purchase Agreement would be entered into between Cygnet and
Ernest C. Garcia, II prior to commencement of the Rights Offering. The Standby
Purchase Agreement sets forth the obligation of Mr. Garcia or his affiliates to
exercise their Rights and to purchase shares of Cygnet Common Stock from the
Unexercised Pool of Rights either through the Over-Subscription Privilege
associated with their Rights or pursuant to the Standby Purchase Obligation. See
"The Standby Purchase Obligation" above. The Standby Purchase Agreement would
also require the issuance of the Cygnet Standby Warrants to Mr. Garcia.
ESCROW AGREEMENT.
The Escrow Agreement would be entered into between Cygnet and Norwest Bank
Minnesota, National Association, as Escrow Agent prior to the commencement of
the Rights Offering and would govern the holding and distribution of the
subscription monies received from holders (other than Mr. Garcia) who elect to
exercise their Rights or the Over-Subscription Privilege.
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<PAGE> 45
OPINION OF FINANCIAL ADVISOR
In reaching a decision to undertake the Split-up, the Company's Board of
Directors (the "board") considered, among other things, the advice of its
financial advisor, CIBC Oppenheimer Corporation ("CIBC Oppenheimer"). Summaries
of the opinion rendered by CIBC Oppenheimer with respect to the Split-up are set
forth below. The opinion rendered by CIBC Oppenheimer assumes that the Split-up
is consummated substantially as described in this Proxy Statement.
CIBC Oppenheimer was engaged as financial advisor to the Company on June
17, 1998 to, among other things, provide financial advice to the Company with
respect to the Split-up. In rendering such advice, CIBC Oppenheimer assisted the
Company's management in determining the structuring of the Split-up and the
consideration received by the Company in exchange for the assets to be
transferred to Cygnet. Although CIBC Oppenheimer evaluated the Split-up from a
financial point of view to the Company shareholders, CIBC Oppenheimer was not
requested to, and did not, recommend specific consideration payable in the
Split-up, which consideration was determined through negotiation between the
Company and Cygnet. The Company did not place any limitations on CIBC
Oppenheimer with respect to the investigations made or procedures followed by
CIBC Oppenheimer in rendering its opinion. At the request of the Company, CIBC
Oppenheimer rendered an oral opinion on July 16, 1998, subsequently affirmed by
written opinion dated July 20, 1998 to the Company's Board that, as of such date
and based upon and subject to the assumptions and limitations set forth therein,
the Split-up is fair, from a financial point of view, to the holders of the
Company Common Stock. CIBC Oppenheimer's opinion is addressed to the Company
Board in connection with the Split-up and addresses only the fairness, from a
financial point of view, of the Split-up to the holders of the Company Common
Stock. CIBC Oppenheimer's opinion does not address any other aspect of the
Split-up or any related transaction, is not a recommendation to any stockholder
of the Company as to how such stockholder should vote at the Annual Meeting with
respect to the Split-up Proposal, and does not constitute an opinion or estimate
as to the trading prices of the Company Common Stock or the Cygnet Common Stock
following the Split-up. The full text of the opinion of CIBC Oppenheimer, which
sets forth certain assumptions made, matters considered and limitations on the
review undertaken, is attached as Appendix C hereto and is incorporated herein
by reference and should be read in its entirety. The summary of CIBC
Oppenheimer's opinion set forth herein is qualified in its entirety by reference
to the full text of such opinion. CIBC Oppenheimer has consented to inclusion of
its opinion and the summary of its opinion in this Proxy Statement.
In connection with its opinion, CIBC Oppenheimer reviewed, among other
things, the terms of the Split-up as set forth in the proposed Capitalization
Agreement, historical and pro forma financial information and certain business
information relating to the Company and Cygnet, including information contained
in this Proxy Statement, the historical stock prices of the Company Common
Stock, as well as certain financial forecasts and other data provided by the
Company and Cygnet relating to the businesses and prospects of the Company and
Cygnet. CIBC Oppenheimer also conducted discussions with the Company's
management and with Cygnet's management with respect to the businesses and
prospects of the Company and Cygnet, and conducted such financial studies and
analyses as CIBC Oppenheimer deemed appropriate in rendering its opinion.
In preparing its opinion, CIBC Oppenheimer did not assume responsibility
for independent verification of any information, whether publicly available or
furnished to it, concerning the Company or Cygnet, including, without
limitation, any financial information, forecasts or projections, considered by
it in connection with the rendering of its opinion. Accordingly, CIBC
Oppenheimer assumed and relied upon the accuracy and completeness of all such
information and did not prepare an evaluation or appraisal of any of the assets
or liabilities of the Company or Cygnet. CIBC Oppenheimer reviewed the Appraisal
by Willamette Management Associates and considered the appraised values
contained therein in the context of all the other information concerning the
Split-up furnished to or otherwise considered by it. CIBC Oppenheimer assumed
that the financial forecasts and projections made available by the Company and
Cygnet to CIBC Oppenheimer and used in its analyses were reasonably prepared on
bases reflecting the best available information, estimates and judgments of the
managements of the Company and Cygnet as to the matters covered thereby and, in
rendering its opinion, CIBC Oppenheimer expressed no view as to the
reasonableness of such forecasts and
39
<PAGE> 46
projections or the assumptions on which they are based. CIBC Oppenheimer's
opinion is necessarily based upon economic, market and other conditions as in
effect on, and the information made available to it as of, the date of its
opinion.
The following is a summary of the material analyses performed by CIBC
Oppenheimer in connection with its opinion:
Comparison of Selected Securities. The Preferred Stock to be issued
by Cygnet is not expected to be rated by any of the recognized U.S. rating
agencies and CIBC Oppenheimer assumed for purposes of its opinion that it
would be rated below investment grade. CIBC Oppenheimer reviewed and
compared certain terms of 48 selected issues of non-investment grade
subordinated debt, preferred stock and convertible preferred stock issued
during 1998 on a before-tax and an after-tax yield basis to corporate
investors. The subordinated debt securities reviewed by CIBC Oppenheimer
had an average before-tax yield range of 8.06% (rated BB) to 10.58% (rated
CCC and below) and an average after-tax yield range of 4.84% to 6.35%. The
average after-tax yield for all of such subordinated debt issues was 5.73%.
The selected convertible preferred stock issues had an average before-tax
yield to investors of 7.06% and an average after-tax yield of 6.21% which
assumes a 70% dividends received deduction for corporate investors. The
average conversion premium for the convertible preferred stock issues was
121% of the price of the issuer's common stock at the time of issuance. The
convertible preferred stocks reviewed generally have call protection for
three years. CIBC Oppenheimer compared the aforementioned yields and
conversion premiums with the Preferred Stock to be issued by Cygnet to the
Company. In this regard, the Preferred Stock will have an initial dividend
of 7.0% increasing annually by 1.0% until reaching a maximum of 11.0% in
year five. The Preferred Stock generally will be convertible upon the third
anniversary of the issuance (without call protection) at the lesser of 100%
of the Cygnet Common Stock issuance price or 80% of the price Cygnet's
Common Stock measured over a ten day period prior to conversion.
Comparison of Receivables Asset Acquisition Transactions. CIBC
Oppenheimer reviewed publicly available information regarding autofinance
acquisitions in the United States which had been announced since July 29,
1996. A review of publicly available information regarding ten comparable
autofinance receivable asset acquisitions, including Associates First's
acquisition of Emergent Group assets, Monaco Finance/Pacific USA, Bacon
Acceptance/ACE Cash Express, The Finance Co/ACE Cash Express, Greenwich
Capital/First Merchants Acceptance, Search Capital/MS Financial, Search
Capital/Eagle Finance, Search Capital/US Lending, and Undisclosed/AutoInfo,
indicated a price to receivables range of 0.55 times to 1.11 times book
value. In this analysis, CIBC Oppenheimer noted that due to competitive
pressures and accounting issues in the subprime autofinance sector, many of
the selected receivable asset acquisitions involved the purchase of
underperforming assets from distressed companies, which would affect the
comparability of pricing to the Split-up. The Split-up calls for the
valuation of the assets to be established as the greater of the net
appraised value (as defined by an independent third party) or the net book
value of the assets.
No transaction or security used in the above analyses as a comparison
is identical to either the assets being transferred to Cygnet or to the
Company. Accordingly, an analysis of the results of the foregoing
necessarily involves complex considerations and judgments concerning
differences in financial and operating characteristics of the issuing
companies or the assets purchased and other factors that could affect the
value of the comparisons.
Comparison of Selected Companies. CIBC Oppenheimer reviewed and
compared certain public market multiples and publicly available relevant
data for the peer auto finance companies which CIBC Oppenheimer deemed
relevant to the Split-up. The group of selected autofinance companies
consisted of AmeriCredit Corp., Consumer Portfolio, Credit Acceptance,
First Investors, Arcadia Financial, Union Acceptance, WFS Financial and the
Company.
The financial and operating information reviewed in such analyses
included, among other things, closing stock market prices as of July 16,
1998, total owned and managed assets, liabilities, common
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<PAGE> 47
equity, net income for the most recently reported trailing 12-month period,
and estimated net income for 1998 and 1999.
Based on a review of this information, the selected companies held the
following characteristics: (i) price to book value multiples in a range of
0.81 to 4.03 times, (ii) price to estimated 1998 earnings per share ("EPS")
range of 8.97 to 20.16 times, (iii) price to estimated 1999 EPS (the first
full year of Cygnet operations) range of 7.43 to 15.9 times, (iv) median
price to estimated 1999 EPS of 10.22 times, and (v) median price to book
value of 1.34 times. Relevant consensus earnings estimates are compiled
from Nelson Publications and CIBC Oppenheimer Research and, in the case of
Cygnet, from estimates prepared by Cygnet's management. Financial data was
extracted from documents filed with the Securities and Exchange Commission.
Based on the consensus earnings for Cygnet's peer group, CIBC
Oppenheimer calculated the range of the implied price of Cygnet Common
Stock based on managements projections to be $6.98 to $34.83 per share.
Based on the median and mean consensus earnings multiples, the implied
price range spans from $9.56 to $10.17 per share. CIBC Oppenheimer noted
that the peer group consisted of public companies with generally longer
operating histories than Cygnet.
Comparison of Selected Merger and Corporate Acquisition
Transactions. A review of publicly available information regarding
thirteen transactions involving the acquisitions of autofinance companies,
including AutoOne Acceptance's acquisition of Gulf States, GECC/Bank
ProKredit, Mason-Dixon Bancshares/Rose Shanis, California Federal
Bank/AutoOne Acceptance, Household International/ACC Consumer Finance,
GMAC/LSI Holdings, Sovereign Bancorp/Fleet Automobile Finance Division,
Norwest/Fidelity Acceptance, GECC/Vega Lease, Imperial Credit
Industries/Auto Marketing Network, Search Capital/MS Financial and Barnett
Banks/Oxford Resources, provided a range of value of a high of 6.11 times
book value and 29 times trailing twelve months net income to a low of 0.55
times book value and negative or not meaningful price to earnings
multiples. This analysis implies a range of value for Cygnet Common Stock
of between $4.76 and $52.85 per share based on managements' base estimates
of Cygnet's September 1998 book value (which assumes, the completion of the
Split-Up and a successful Rights Offering). CIBC Oppenheimer notes that
this methodology generates a range that is sufficiently broad as to provide
limited assistance in determining value.
No company or transaction used in the above analyses as a comparison
is identical to either the assets being transferred to Cygnet or to UDC or
Cygnet. Accordingly, an analysis of the results of the foregoing
necessarily involves complex considerations and judgments concerning
differences in financial and operating characteristics of the companies and
other factors that could affect the value of the companies to which they
are being compared. Mathematical analysis (such as determining the median)
is not, in itself, a meaningful method of using comparable data.
Discounted Cash Flow Analysis. Using a discounted cash flow ("DCF")
analysis, CIBC Oppenheimer estimated the net present value of the future
streams of after-tax cash flows that Cygnet is expected to generate. These
cash flows were analyzed to determine (i) Cygnet's expected ability to pay
the Preferred Stock dividends, and (ii) to determine an approximate implied
equity value range for Cygnet as an independent entity.
CIBC Oppenheimer performed DCF analyses using three sets of
assumptions for the performance of Cygnet: (a) managements' projections,
(b) low growth projections, and (c) high growth projections. In addition,
CIBC Oppenheimer assumed three different scenarios for the total number of
shares issued by Cygnet as a result of the Rights Offering: the minimum
(3.49 million shares), base estimate (4.65 million shares), and the maximum
(5.58 million shares). The assumed discount rates vary from 17% to 29% in
accordance with the weighted average cost of capital for comparable
companies and the relatively high degree of risk associated with the
subprime autofinance sector. The terminal value multiples assumed by CIBC
Oppenheimer range from 4.0 to 10.0 times after-tax EPS.
As a result of the analyses, CIBC Oppenheimer noted that the after-tax
cash flows (i) appear adequate to pay the Preferred Stock dividends, and
(ii) indicated an implied equity value reference range
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<PAGE> 48
for the Cygnet Common Stock of $4.35 per share (low growth
projections/maximum shares) to $24.51 per share (high growth
projections/minimum shares). As indicated above, this analysis did not
purport to be indicative of actual future results and did not purport to
reflect the prices at which shares of Cygnet Common Stock may trade. A DCF
analysis was included because it is a widely used valuation methodology,
but the results of such methodology are highly dependent upon the numerous
assumptions that must be made, including earnings growth rates, dividend
payout rates, terminal values, and discount rates.
The summary set forth above does not purport to be a complete description
of the analyses of data presented by CIBC Oppenheimer. The preparation of a
fairness opinion is a complex process and is not necessarily susceptible to
partial analysis or summary description. CIBC Oppenheimer believes that the
summary set forth above and its analyses must be considered as a whole and that
selecting portions thereof, without considering all of its analyses, could
create an incomplete view of the processes underlying its analyses and opinion.
CIBC Oppenheimer based its analyses on assumptions that it deemed reasonable,
including assumptions concerning general business and economic conditions and
industry-specific factors. No company or transaction used by CIBC Oppenheimer in
its analyses is identical to UDC, Cygnet or the Split-up. The other principal
assumptions upon which CIBC Oppenheimer based its analyses are set forth above
under the description of each such analysis. CIBC Oppenheimer's analyses are not
necessarily indicative of actual values or actual future results that might be
achieved, which values may be higher or lower than those indicated. Moreover,
CIBC Oppenheimer's analyses are not and do not purport to be appraisals or
otherwise reflective of the prices at which businesses actually could be bought
or sold.
CIBC Oppenheimer is an internationally recognized investment banking firm
that is regularly engaged in the valuations of businesses and securities in
connection with acquisitions and mergers, underwritings, secondary distributions
of securities, private placements and valuations for other purposes among other
things. The Company selected CIBC Oppenheimer based on such experience and its
familiarity with the Company and the industries in which it operates. In the
ordinary course of its business, CIBC Oppenheimer and its affiliates may
actively trade securities of the Company and those of Cygnet for their own
account and for the accounts of customers and, accordingly, may at any time hold
a long or short position in such securities.
In connection with the Split-up, the Company has agreed to pay CIBC
Oppenheimer a fee of not less than $500,000 which was paid upon delivery of CIBC
Oppenheimer's fairness opinion. In addition, the Company has agreed, among other
things, to reimburse CIBC Oppenheimer for reasonable fees and disbursements of
counsel and other reasonable out-of-pocket expenses incurred in connection with
the services provided by CIBC Oppenheimer in an amount not to exceed $35,000 in
the aggregate unless otherwise agreed to by the Company. The Company has also
agreed to indemnify and hold harmless CIBC Oppenheimer and certain of its
related parties from and against certain liabilities, including certain
liabilities under the Federal securities laws, incurred in connection with the
firm's engagement by the Company.
OPINION OF APPRAISER
In connection with the Split-up, the Board of Directors of the Company
engaged Willamette Management Associates ("Willamette" or the "Appraiser") to
estimate the fair market value of the Transferred Assets, the Preferred Stock,
and the Rights and requested that Willamette render an appraisal (the
"Appraisal") regarding the fair market value of each. Willamette delivered its
oral opinion to the Boards of Directors of the Company and Cygnet on July 16,
1998, subsequently confirmed in writing on July 21, 1998, to the effect that,
based upon and subject to the factors and assumptions set forth in such opinion,
the fair market value of the Transferred Assets, as of June 30, 1998, is $54.9
million, the fair market value of the Preferred Stock on the date of its
issuance will be $40 million, and the Rights will have no value as of the date
of their distribution.
Willamette believes the Appraisal was prepared in conformity with the
Uniform Standards of Professional Appraisal Practice as promulgated by The
Appraisal Foundation and endorsed by the American Society of Appraisers. No
limitations were imposed by the Company or Cygnet with respect to the
investigations made or the procedures followed by Willamette in rendering its
Appraisal. Willamette's Appraisal indicates that it is provided for the use of
the Company's and Cygnet's Boards of Directors in their determination of the
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<PAGE> 49
consideration to be paid by Cygnet for the Transferred Assets and for assessing
the likely consequences of the sale of the Transferred Assets for federal income
tax purposes. Willamette's Appraisal and presentation to the Boards of Directors
of UDC and Cygnet were among the many factors taken into consideration by the
Boards in making their determination to approve, and of the Company's Board to
recommend that the Company stockholders approve, the Split-up. Willamette has
consented to inclusion of this summary in this Proxy Statement.
In making its Appraisal, Willamette reviewed certain information, including
drafts of this Notice and Proxy Statement and the Cygnet Prospectus, financial
analyses of certain bulk portfolios of FMAC and Reliance, and internal financial
analyses and forecasts of the Company and Cygnet prepared by management.
Willamette also had discussions with members of the senior managements of Cygnet
and the Company to discuss the Split-up and has considered other matters deemed
relevant to its inquiry. In performing its analysis, Willamette made numerous
assumptions with respect to industry performance, general business and economic
conditions, and the performance of the Transferred Assets, such as the rate of
industry growth, inflation, interest rates, charge-off rates, and recovery
rates, many of which are beyond the control of the Company and Cygnet. The
analyses performed by Willamette are not necessarily indicative of actual values
or actual future results which may be significantly more or less favorable than
those suggested by such analyses.
In connection with its analysis, Willamette assumed and relied upon the
accuracy and completeness of the foregoing information and did not assume any
responsibility for independent verification of such information. With respect to
portfolio forecasts, Willamette assumed that the forecasts and assumptions
provided to Willamette had been reasonably prepared on bases reflecting the best
currently available estimates and judgments of the management of the Company and
Cygnet, as the case may be, as to the future financial performance of the
respective portfolios, and that they provided a reasonable basis upon which
Willamette could form an opinion. The projections are based on numerous
variables and assumptions which are inherently unpredictable and must be
considered not certain of occurrence as projected. Accordingly, actual results
could vary significantly from those set forth in such projections. Willamette
also assumed that there had been no material changes to the Transferred Assets
since the respective dates of the last financial statement made available to
Willamette and that no material adverse change will subsequently occur to the
Transferred Assets. In addition, Willamette also assumed that the Split-up would
be consummated in accordance with the terms set forth in this Notice and Proxy
Statement. Willamette did not assume responsibility for making a physical
inspection of the Transferred Assets. Willamette will update its appraisal of
the Transferred Assets as of the Effective Date.
Transferred Assets. In the context of the appraisal of the Transferred
Assets, Willamette employed various valuation methodologies. For example,
Willamette used a discounted cash flow analysis with respect to the market value
of certain loan servicing contracts which contain back-end collection incentives
using a discounted cash flow analysis. This analysis involved (i) the projection
of future cash flows generated by the underlying portfolios of sub-prime
automobile finance receivables, (ii) the required distribution of projected
portfolio collections to creditors of the contract owners, (iii) the payment of
certain servicing, auditing, and insurance fees, and (iv) an allocation of any
residual cash flows based on the terms and conditions of the governing servicing
agreement. Where possible, Willamette based its discounted cash flow assumptions
on the historical financial activity of the loan portfolios underlying the loan
servicing contracts.
With respect to loans securitized by FMAC, Willamette calculated the range
of net residual cash flows, based on varying assumptions, including projected
charge-offs, recoveries, prepayments, loan servicing and collection costs, and
distributions, if any, of net cash flows to the creditors of FMAC (including
with respect to a credit facility to be transferred to Cygnet at the Effective
Date, which at June 30, 1998 had a balance of $9.8 million), to be $12.9 to
$34.4 million, with a most likely result of $17.2 million. Willamette concluded
that the net present value of the residual cash flows of the FMAC portfolio
allocable to Cygnet is $77,133 in excess of the book value.
With respect to contracts owned by FMAC, sold to a third party and in which
Cygnet maintains a residual interest, Willamette calculated the range of net
residual cash flows, based on varying assumptions, including projected
charge-offs, recoveries, prepayments, loan servicing and collection costs, and
distributions,
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<PAGE> 50
if any, of net cash flows to the current owner, to be $5.5 to $13.2 million,
with a most likely result of $9.5 million. Willamette concluded that the net
present value of the residual cash flows allocable to Cygnet, is $2,003 in
excess of the book value of the Company's residual interest.
With respect to the Reliance loan portfolio, Willamette calculated the
range of net residual cash flows, based on varying assumptions including
projected charge-offs, recoveries, prepayments, loan servicing and collection
costs, and distributions, if any, of net cash flows to creditors of Reliance, to
be negative $12.5 to positive $15.9 million, with a most likely result of
$683,756. Willamette concluded that the net present value of the residual cash
flows of the Reliance portfolio allocable to Cygnet, less the value of the
warrants issued in connection with the Reliance transaction, is $143,713 in
excess of the book value.
With respect to assets of a short-term nature that have a book value on the
June 30, 1998 financial statements of Cygnet that represent a net cash
realizable value, Willamette relied on the opinion of management of the Company
and Cygnet that the companies have adequately reserved for net credit losses on
such assets. Willamette estimated that the book value of such assets is
reasonably representative of fair market value.
The following table summarizes the book value and the appraised value of
the Transferred Assets as of June 30, 1998 (in thousands):
<TABLE>
<CAPTION>
BOOK APPRAISED
VALUE VALUE DIFFERENCE
----- --------- ----------
<S> <C> <C> <C>
Assets:
Cash and Cash Equivalents................................... $ 232 $ 232 $ --
Finance Receivables......................................... 26,333 26,333 --
Notes Receivables........................................... 23,027 23,027 --
Property and Equipment...................................... 2,335 2,335
Goodwill.................................................... 1,138 1,138 --
Other Assets................................................ 4,338 4,560 222(1)
Assumed Liabilities:
Accrued Expenses and Other Liabilities...................... 2,464 2,464 --
Note Payable................................................ 298 298 --
------- ------- ----
Transferred Assets................................ $54,641 $54,863 $222(1)
======= ======= ====
</TABLE>
(1) The difference between the appraised value and the book value of Other
Assets is due to an appraised value of $222,000 for incentive fees under
loan servicing agreements which have a book value of $0.
Preferred Stock. In the context of the appraisal of the Preferred Stock,
Willamette employed a dividend capitalization method, concluding that the most
important factor in the value of a preferred stock is the dividend rate.
Willamette estimated the fair market value of the Preferred Stock by comparing
certain pro forma financial and market information for Cygnet with the
corresponding publicly available data and statistics of 77 publicly traded
convertible preferred stocks, such as dividend and interest coverage ratios,
liquidation coverage ratio, interest expense coverage ratio, fixed charged
ratio, earnings before interest, taxes and return on total capital. Based on
this comparison, Willamette selected an appropriate preferred dividend
capitalization yield to apply to the indicated annual dividend of the Preferred
Stock.
Willamette reviewed a number of preferred stock issues rated by the Value
Line Convertible Survey and S&P Stock Guide in analyzing the Preferred Stock.
The selected preferred stock issues reviewed by Willamette had median before-tax
yields to investors of 3.61% (rated C and D by Value Line), 6.19% (rated E),
7.18% (rated F), 6.91 (rated G), and 7.90% (rated H and I), with an overall
median yield of 6.69%. The selected preferred stock issues had median dividend
and interest coverage ratios of 3.97% (rated C and D), 3.41% (rated E), 2.12%
(rated F), 2.52 (rated G), and 2.44% (rated H and I), with an overall median
ratio of 2.79%. In addition, the selected preferred stock issues had median
liquidation interest coverage ratios of 7.84% (rated C and D), 3.04% (rated E),
3.18% (rated F), 3.07 (rated G), and 1.37% (rated H and I), with an overall
median ratio of 4.25%. Willamette noted that, although the Preferred Stock to be
issued by
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<PAGE> 51
Cygnet is not expected to be rated by any of the recognized U.S. rating
agencies, the characteristics of Cygnet and the Preferred Stock were most
similar to the preferred stock issues rated F and G.
Based on its analysis, Willamette estimated that an appropriate dividend
capitalization yield for the Preferred Stock is 7.0% and determined that the
fair market value of the Preferred Stock should equal $40 million on the
Effective Date based upon such analysis.
Rights. With respect to the valuation of the Rights, Willamette concluded
that although analysts commonly rely on a variety of option pricing models to
determine the value of rights and other instruments to purchase common stock,
such option pricing models were inappropriate in connection with the Rights. For
example, a standard option provides the option holder with the ability to
observe the current trading price of the underlying common before deciding to
exercise the option. If the exercise price of the option is greater than the
current trading price of the underlying common stock, the option is generally
regarded as "out-of-the-money" and the option holder will not exercise the
option. If, however, the current trading price of the underlying common stock is
greater than the exercise price of the option, the option is regarded as being
"in-the-money" and the option holder will exercise such option. In contrast,
holders of Rights will be unable to observe the underlying Cygnet Common Stock
price before deciding whether to exercise Rights.
Willamette, therefore, determined that the Rights would be valuable only to
the extent that a Rights holder was able to acquire the underlying Cygnet Common
Stock at a price below its market value. Taking into consideration the value of
the Transferred Assets, the purchase price payable therefor by Cygnet, and
taking into consideration the proceeds from the sale of the projected shares of
Cygnet Common Stock, Willamette concluded that the Rights will merely provide
the Rights holders with the ability to acquire the Cygnet Common Stock at its
fair market value. As a consequence, Willamette found the Rights to have no
intrinsic value.
While the foregoing summary describes all analyses and examinations that
Willamette deems material to its Appraisal, it is not a comprehensive
description of all analyses and examinations actually conducted by Willamette.
The preparation of an appraisal necessarily is not susceptible to partial
analysis or summary description. Willamette believes that such analyses and the
summary set forth above must be considered as a whole and that selecting
portions of such analyses and of the factors considered without considering all
such analyses and factors would create an incomplete view of the process
underlying the analyses set forth in its presentation to the Boards of Directors
of the Company and Cygnet.
Willamette is a nationally recognized independent business valuation and
financial advisory firm regularly engaged in the valuation of publicly traded
and closely held investment securities in connection with mergers and
acquisitions, divestitures, employee stock ownership plans, public offerings,
gift and estate taxes, corporate and partnership recapitalizations, private
placements, and similar transactions. Willamette was selected by the Company to
perform the Appraisal because of its prior experience, reputation, and expertise
in valuation and corporate finance. Willamette has not provided any appraisal or
other services to the Company or Cygnet within the past two years, but could
provide such services to the Company or affiliates in the future.
In connection with Willamette's engagement, the Company will pay Willamette
a fee of $75,000. In addition, the Company has agreed to reimburse Willamette
for all reasonable out-of-pocket expenses incurred in connection with the
services provided by Willamette, and to indemnify and hold harmless Willamette
to the full extent lawful from and against certain liabilities, which may be
construed to include certain liabilities under the federal securities laws, in
connections with its engagement. Willamette is independent of the parties to the
Split-up, and its fee is not contingent in any way upon the completion or
ultimate outcome of the Split-up.
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<PAGE> 52
FEDERAL INCOME TAX CONSEQUENCES
OF THE RIGHTS OFFERING AND COLLATERAL TRANSACTIONS
FEDERAL INCOME TAX CONSEQUENCES TO RECIPIENTS OF RIGHTS
The following is a summary of the material federal income tax consequences,
based upon current law, which is subject to prospective or retroactive change at
any time, of the distribution and ownership of Rights, the exercise of Rights,
the acquisition of Cygnet Common Stock incident to the exercise of Rights, and
the transfer and lapse of Rights without exercise or transfer. These tax
consequences may vary depending upon a Rights holder's particular situation.
Certain Rights holders (including the Standby Purchaser, insurance companies,
tax-exempt organizations, financial institutions, broker-dealers, foreign
corporations and persons who are not citizens or residents of the United States)
may be subject to special rules not discussed below. THIS SUMMARY IS FOR GENERAL
INFORMATION PURPOSES ONLY. ACCORDINGLY, EACH RIGHTS HOLDER SHOULD CONSULT HIS
OWN TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OF THESE
TRANSACTIONS, INCLUDING THE APPLICABILITY AND EFFECT OF ALL FEDERAL, STATE,
LOCAL, AND FOREIGN TAX LAWS.
The Company has been advised by Tax Counsel that under current
interpretations of case law, the Code, and applicable regulations, all of which
are subject to prospective or retroactive change at any time, it is the opinion
of Tax Counsel that the federal income tax consequences to holders of Company
Common Stock with respect to the Rights will be as set forth below. No rulings
will be sought from the Internal Revenue Service with respect to the treatment
of the Rights. The opinion of Tax Counsel represents its best legal judgment and
has no binding effect or official status of any kind. The opinion of Tax Counsel
assumes that the Rights Offering will be effected in accordance with the
description thereof in this Proxy Statement and the applicable provisions of the
Capitalization Agreement. No assurance can be given that contrary positions may
not be taken by the Internal Revenue Service or by any court of law. Because of
the predominantly factual nature of the fair market value of the Rights, Tax
Counsel expresses no opinion with respect to the fair market value of the Rights
for purposes of the discussion below or elsewhere in this document.
Distribution of Rights to Holders of Company Common Stock. The transfer
from Cygnet to the holders of Company Common Stock of the Rights, representing
the right to acquire shares of Cygnet Common Stock, will be treated, for federal
income tax purposes, as (1) a distribution of the Rights by Cygnet to the
Company, followed by (2) a distribution of the Rights from the Company to the
holders of Company Common Stock. Holders of Company Common Stock will recognize
dividend income (taxable as ordinary income) on the date of the distribution in
an amount equal to the fair market value, if any, of the Rights as of the date
of distribution, but only to the extent that the amount of the distribution is
properly sourced in the Company's current or accumulated earnings and profits
(as determined for federal income tax purposes) in its taxable year of the
distribution. That portion, if any, by which the fair market value of the Rights
exceeded the Company's current or accumulated earnings and profits would be
treated as a return of capital to the extent of the holder's tax basis in his
Company Common Stock and, then, as gain from the sale of such stock to the
extent of any remaining excess.
Corporate holders of Company Common Stock (other than S corporations)
receiving Rights and recognizing dividend income would be entitled to the
dividends-received deduction for corporations (generally 70%, but 80% under
certain circumstances) with respect to such dividends, to the extent applicable,
taking into consideration all limitations on the claiming of the
dividends-received deduction. With respect to specific limitations on claiming
the dividends-received deduction, corporate holders of Company Common Stock
should consider the effect of Code Section 246(c) which disallows the
dividends-received deduction with respect to any dividend on any share of stock
that is held for 45 days or less during the 90-day period beginning on the date
which is 45 days before the date on which such stock becomes ex-dividend with
respect to such dividend. Additionally, corporate holders of Company Common
Stock that have incurred indebtedness directly attributable to an investment in
Company Common Stock should consider the effect of Code Section 246A which
reduces the dividends-received deduction by a percentage generally computed
based on the amount of such indebtedness and the holder's total adjusted tax
basis in the shares.
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<PAGE> 53
The Appraiser has determined, pursuant to its opinion, dated July 21, 1998,
that the value of the Rights as of the date of the distribution of the Rights
should be zero. However, the opinion of the Appraiser is not binding on the
Internal Revenue Service. For example, the Internal Revenue Service may assert
that the price at which the Rights trade during the 20-day trading period of the
Rights is indicative of the fair market value of the Rights on the date of their
distribution. Accordingly, there can be no assurance as to the exact amount of
dividend income, if any, a holder of Company Common Stock will recognize upon
the receipt of the Rights. If the Rights are trading for value on the date of
their distribution, the Company may, in its discretion, report to holders of
Company Common Stock the receipt of dividend income in an amount equal to the
average of the high and low trading prices of the Rights on such date.
Ownership of Rights. Each holder of Company Common Stock who receives
Rights will have a tax basis in the Rights equal to the fair market value
thereof. Further, each holder of Rights will have a holding period for his
Rights that begins on the date of receipt of the Rights.
Exercise of Rights. Holders of Rights, whether corporate or noncorporate,
will recognize nether gain nor loss upon the exercise of Rights. A holder of
Rights who receives shares of Cygnet Common Stock upon exercise of the Rights
will acquire a tax basis in such shares equal to the sum of the Subscription
Price paid under the Rights Offering and the tax basis (if any) of the holder of
Rights in the Rights.
Transfer of Rights. The transferable nature of the Rights will permit a
holder of Rights to sell Rights prior to exercise. Pursuant to Code Section
1234, a Rights holder who sells Rights prior to exercise will be entitled to
treat the difference between the amount received for the Rights and the adjusted
tax basis (if any) of the holder of Rights in the Rights as a short-term capital
gain or capital loss, provided that the Cygnet Common Stock subject to the
Rights would have been a capital asset in the hands of the holder had it been
acquired by such holder. The gain or loss so recognized will be short-term since
the Rights will have been held for less than twelve months.
Non-Exercise of Rights. The federal income tax treatment applicable to
holders of Rights who fail to exercise or transfer their Rights prior to the
expiration date also is set forth in Code Section 1234. Holders of Rights who
allow their Rights to lapse will be deemed under the Code to have sold their
Rights on the date on which the Rights expire. Since no consideration will be
received by a holder of Rights upon such lapse and since the Rights will have
been held for less than twelve months, a short-term capital loss equal to the
tax basis (if any) in the Rights will be sustained by the holder on such lapse,
provided that the Cygnet Common Stock subject to the Rights would have been a
capital asset in the hands of the holder had it been acquired by such holder.
Short-term capital losses incurred by non-corporate taxpayers may be used
to offset short-term or long-term capital gains realized, plus up to $3,000
($1,500 in the case of a married individual filing a separate return).
Non-corporate taxpayers may carry forward indefinitely, but may not carry back,
unused net capital losses. When carried forward by non-corporate taxpayers,
short-term capital losses retain their short-term character and are treated as
sustained in the taxable year to which they are carried forward. Short-term
capital losses incurred by corporations may be used only to offset short-term or
long-term capital gains. Unused capital losses, however, generally may be
carried back by corporate taxpayers to the three taxable years preceding the
loss year and carried forward to the five succeeding taxable years. When carried
back or carried forward, short-term capital losses retain their character as
short-term and are treated as sustained in the taxable year to which they are
carried. Accordingly, certain holders of Rights who allow their Rights to lapse
may recognize ordinary income upon receipt of the Rights and a potentially
deferred or nondeductible capital loss upon the lapse of such Rights. FOR THIS
REASON, IN MOST INSTANCES, IT WILL BE IN A RIGHTS HOLDER'S INTEREST TO EITHER
EXERCISE OR SELL RIGHTS RATHER THAN TO ALLOW RIGHTS TO LAPSE.
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<PAGE> 54
FEDERAL INCOME TAX CONSEQUENCES TO COMPANY CONSOLIDATED GROUP
Under current interpretations of case law, the Code, and applicable
regulations, all of which are subject to prospective or retroactive change at
any time, the material federal income tax consequences to the Company
consolidated group of the transfer of the Rights to the holders of Company
Stock, the sale of the Transferred Assets to Cygnet and or the Cygnet
subsidiaries, and the ownership of the Cygnet Preferred Stock will be as
summarized below. No rulings will be sought from the Internal Revenue Service.
The summary below has no binding effect or official status of any kind and no
assurance can be given that contrary positions may not be taken by the Internal
Revenue Service or by any court of law. The summary assumes that the Rights
Offering, the sale of the Transferred Assets, the issuance and disposition of
the Cygnet Preferred Stock, and all other contemplated transactions will be
effected in accordance with the descriptions thereof in this Proxy Statement and
the applicable provisions of the Capitalization Agreement. Additionally, the
summary assumes that the book value of the Transferred Assets will be
approximately equal to the adjusted tax bases of such assets. Further, the
summary is based on representations by the Company's personnel that none of the
Transferred Assets was previously transferred among members of the Company
consolidated group; that none of the Company subsidiaries selling the
Transferred Assets to Cygnet will have an "excess loss account" as of the
Effective Date; and that no gain will otherwise be recognized as a consequence
of operation of the federal consolidated return regulations by reason of the
disaffiliation by Cygnet and the Cygnet subsidiaries from the Company
consolidated group, the sale of the Transferred Assets, or the remaining
contemplated transactions.
Distribution of Rights. As noted above, the transfer from Cygnet to the
holders of Company Common Stock of the Rights, representing the right to acquire
shares of Cygnet Common Stock, will be treated, for federal income tax purposes,
as (1) a distribution of the Rights by Cygnet to the Company, followed by (2) a
distribution of the Rights from the Company to the holders of Company Common
Stock. The Company will recognize gain under Code Section 311(b) on the
distribution of the Rights in an amount equal to the greater of (1) the fair
market value, if any, of the Rights as of the date of their distribution or (2)
the sum of (a) the aggregate amount, if any, by which (i) the fair market value
of each Transferred Asset as of the Effective Date exceeds (ii) the amount paid
by Cygnet for such Transferred Asset plus (b) the aggregate amount, if any, by
which (i) the fair market value of each Interim Asset as of the Effective Date
exceeds (ii) the adjusted tax basis of such Interim Asset.
In the opinion of Appraiser, dated July 21, 1998, the fair market value of
the Rights on the date of their distribution should be zero. Additionally,
because Cygnet is obligated to pay consideration to the Company for the
Transferred Assets in an amount equal to the greater of the appraised value (as
determined by the Appraiser) or the book value of the Transferred Assets, each
as of the Effective Date, and because such consideration is allocable to each
Transferred Asset to the extent of its fair market value, management of the
Company believes that the fair market value of each of the Transferred Assets as
of the Effective Date should not exceed the amount deemed paid by Cygnet for
each of the Transferred Assets. Lastly, because Cygnet is obligated to pay the
Interim Consideration to the Company, thereby creating a liability equal to the
aggregate amount by which the fair market value of the Interim Assets
preliminarily exceeds their adjusted tax basis, management of the Company
believes that as a consequence, the fair market value of each of the Interim
Assets should not exceed their adjusted tax bases as of the Effective Date.
However, the Appraiser's opinion with respect to the Rights is not binding
on the Internal Revenue Service. For example, the Internal Revenue Service may
assert that the price at which the Rights trade during the 20-day trading period
of the Rights will be indicative of the fair market value of the Rights on the
date of their distribution. Further, the Appraiser's valuations of the
Transferred Assets and the Interim Assets may not be endorsed by the Internal
Revenue Service. For example, the Internal Revenue Service may establish that
the fair market value of the Transferred Assets or the Interim Assets exceeds
the respective values thereof determined by the Appraiser. Accordingly, it
cannot be stated with complete assurance that the Company will not recognize
gain on the distribution of the Rights.
If any tax liabilities are triggered by the Company's recognition of gain
on the distribution of the Rights, such tax liabilities will be borne solely by
the Company.
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<PAGE> 55
Sales of Transferred Assets. If the consideration paid by Cygnet to the
Company or any Company subsidiary for any of the Transferred Assets (including
the allocable portion of any Company liabilities assumed by Cygnet) exceeds the
adjusted tax basis of such asset, gain will be recognized by the Company
consolidated group to the extent of such excess. Based on the Appraiser's
valuation of the Transferred Assets as of June 30, 1998, the amount by which the
consideration payable by Cygnet and allocated among the Transferred Assets will
exceed the adjusted bases of such assets should be limited in amount. Further,
based on the Appraiser's valuation of the Cygnet Preferred Stock, the value of
such stock transferable to the Company on the Effective Date in connection with
the sale of the Transferred Assets will not exceed its issue price. As a
consequence, management of the Company believes that the gain recognized in
connection with the sale of the Transferred Assets should be immaterial.
Neither of the aforementioned appraisals of value conducted by the
Appraiser is binding on the Internal Revenue Service. Further, the fair market
value of the Transferred Assets may increase during the period between June 30,
1998 and the Effective Date and result in the payment by Cygnet of greater
consideration. Accordingly, there can be no assurance that the Company's gain on
the sale of the Transferred Assets would be immaterial.
If any tax liabilities are triggered by the Company's recognition of gain
on the sale of the Transferred Assets, such tax liabilities will be borne solely
by the Company.
Receipt of Interim Consideration
The receipt of the Interim Consideration by the Company from Cygnet will
generate taxable income to the Company to the extent of the amount received. Tax
liabilities triggered by such receipt will be borne solely by the Company.
Taxation of Cygnet Preferred Stock to Company Consolidated Group
General. Dividends paid with respect to the Cygnet Preferred Stock held by
the Company or Company subsidiaries (collectively for the remainder of this
section, the "Company") will be taxable to the Company consolidated group as
ordinary income to the extent of Cygnet's current or accumulated earnings and
profits (as determined for federal income tax purposes). To the extent that the
amount of distributions on the Cygnet Preferred Stock exceeds Cygnet's current
or accumulated earnings and profits (as determined for federal income tax
purposes), the distributions will be treated as returns of capital, thus
reducing the Company's adjusted tax basis in such stock and increasing the
amount of gain (or reducing the amount of loss) which may be realized by the
Company consolidated group upon a later sale or exchange, including the
redemption of the Cygnet Preferred Stock held by the Company. The amount of any
distribution which exceeds the Company's adjusted tax basis in the Preferred
Stock will be taxed as capital gain. For purposes of the remainder of this
discussion, the term "dividend" refers to a distribution paid out of Cygnet's
current or accumulated earnings and profits (as determined for federal income
tax purposes) unless the context indicates otherwise.
Dividends-Received Deduction. Subject to the following, dividends paid to
the Company with respect to the Cygnet Preferred Stock following the Effective
Date should be eligible for the 70 percent dividends-received deduction under
Code Section 243. On February 2, 1998, the Clinton Administration, as part of
its fiscal year 1999 budget package, announced a proposal to eliminate entirely
the dividends-received deduction for "nonqualified preferred stock."
Nonqualified preferred stock would be defined for this purpose as preferred
stock if, among other attributes, the issuer or a related person possessed the
right to redeem or purchase the stock and if, as of the issue date, it was more
likely than not that such right would be exercised. Although unclear, the Cygnet
Preferred Stock might qualify as "nonqualified preferred stock" for this
purpose. The Clinton proposal would apply to dividends paid with respect to
stock issued after the date of enactment. A similar proposal was included in the
Administration's fiscal year 1998 budget proposal but was not enacted. The prior
proposal applied to dividends paid with respect to such stock after the date of
enactment, irrespective of the date of issuance of the stock.
Alternative Minimum Tax. For purpose of determining its alternative
minimum tax, dividends eligible for the dividends-received deduction, if any,
will be included in the Company consolidated group's "adjusted
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<PAGE> 56
current earnings." If such adjusted current earnings exceed the Company's
alternative minimum taxable income (determined without regard to the adjustments
for adjusted current earnings or the alternative net operating loss deduction),
75% of the excess will be added to the Company consolidated group's alternative
minimum taxable income.
Conversion of Preferred Stock. No gain or loss will be recognized by the
Company consolidated group upon the conversion of the Preferred Stock to Cygnet
Common Stock. The Company's tax basis in the Cygnet Common Stock acquired upon
such conversion will equal the Company's adjusted tax basis in the Preferred
Stock immediately preceding the conversion.
Redemption of Preferred Stock. A redemption of all or a portion of the
outstanding shares of Cygnet Preferred Stock held by the Company cannot be
effected unless in the reasonable judgment of Cygnet and the Company, the
proceeds of such redemption will not be treated as a distribution of property to
which Code Section 301 applies. As a consequence, redemptions of the Cygnet
Preferred Stock owned by the Company may be limited and may be confined to a
single redemption of all of the outstanding Cygnet Preferred Stock owned by the
Company.
If the redemption proceeds associated with any redemption are not treated
as a distribution to which Code Section 301 applies, any such redemption will be
treated as a sale of the Cygnet Preferred Stock redeemed for an amount equal to
the redemption proceeds, resulting in gain or loss (if any) to the Company in an
amount equal to the difference between the amount of the redemption proceeds and
the adjusted tax basis of the redeemed shares.
If the redemption proceeds associated with any redemption are treated as a
distribution to which Code Section 301 applies, the redemption proceeds will be
treated as a dividend to the extent of Cygnet's current or accumulated earnings
(as determined for federal income tax purposes). The amount of the distribution,
if any, in excess of Cygnet's current or accumulated earnings and profits (as
determined for federal income tax purposes) will reduce the Company's basis in
the redeemed shares and to the extent the distribution exceeds such basis, will
result in capital gain. If the Company is left with basis in the Cygnet
Preferred Stock, such basis will be transferred to any remaining Cygnet stock
holdings held by the Company.
Under Code Section 1059, if a stock redemption is "not pro rata as to all
shareholders," then any portion of the redemption proceeds that is treated as a
dividend is treated as an "extraordinary dividend" without regard to the period
the taxpayer held such stock or the size of the deemed dividend. Accordingly, in
the context of a redemption of the Cygnet Preferred Stock that is treated in
whole or in part as a dividend, it may not be possible to obtain the benefits of
the dividends-received deduction, if any, with respect to the resulting dividend
without otherwise encountering the sanctions of Code Section 1059. If Code
Section 1059 applies, the basis of the redeemed shares of Cygnet Preferred Stock
would be reduced (but not below zero) by the non-taxed portion of the dividend,
if any. If, because of the limitation on reducing basis below zero, any amount
of the non-taxed portion was not applied to reduce basis, such amount would be
treated as gain from the sale or exchange of the Preferred Stock in the year of
the redemption. Because Code Section 1059 applies to stock redemptions that are
"not pro rata to all shareholders," it may be possible to argue that the
provision is inapplicable if the focus on shareholders for purposes of the
statute is on shareholders of the same class of stock that is redeemed, assuming
that the Company is the sole holder of Cygnet Preferred Stock at the time of the
redemption. Regulations under Code Section 1059 have yet to address the issue.
In determining whether or not the proceeds of any redemption of Cygnet
Preferred Stock will be treated as a distribution to which Code Section 301
applies, the Certificate of Designations of the Cygnet Preferred Stock mandates
that there be taken into consideration only the Company's shares of Cygnet
Preferred Stock, the Company's shares of Cygnet Common Stock acquired by the
Company upon formation of Cygnet (the "Original Common Shares") and the
Company's shares of Cygnet Common Stock acquired upon the conversion of Cygnet
Preferred Stock to Common Stock (the "Converted Shares"). If other shares of
Cygnet Company Stock are owned either by (i) the Company or (ii) any person or
entity owning, directly or indirectly through the application of various
attribution rules, fifty percent (50%) or more of the value of the stock of the
Company, it is possible that a redemption of Cygnet Preferred Stock could be
treated as a distribution to which Section 301 applies. For this reason,
management of the Company intends to refrain
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<PAGE> 57
from acquisitions of additional shares of Cygnet Common Stock to the extent that
acquisitions of Cygnet Common Stock might otherwise cause redemptions of Cygnet
Preferred Stock to be treated as dividends to the Company. Further, persons or
entities with concentrated holdings of Company that, directly and indirectly,
may approach 50% of the value of the stock of the Company are urged to avoid
acquisitions of shares of Cygnet Common Stock.
If any tax liabilities are triggered in connection with redemptions of the
Cygnet Preferred Stock held by the Company, such tax liabilities will be borne
solely by the Company.
Sales of Preferred Stock. Certain sales of Cygnet Preferred Stock by the
Company may result in the treatment of all or a portion of the sales proceeds as
a dividend in accordance with principles similar to that discussed above in the
context of redemptions. Management of the Company intends to refrain from sales
of Cygnet Preferred Stock that would result in dividend treatment.
The foregoing summary of the tax consequences to the Company is premised
upon the analysis of in-house Company personnel in consultation with its
professional advisers.
51
<PAGE> 58
UGLY DUCKLING CORPORATION
SUMMARY SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of, each of the
years in the five-year period ended December 31, 1997, are derived from the
consolidated financial statements of the Company, which consolidated financial
statements have been audited by KPMG Peat Marwick LLP, independent certified
public accountants. The consolidated financial statements as of December 31,
1997 and 1996 and for each of the years in the three-year period ended December
31, 1997, and the report thereon, are included elsewhere in this Proxy. The
selected data presented below for the three-month periods ended March 31, 1998
and 1997, and as of March 31, 1998 and 1997, are derived from the unaudited
condensed consolidated financial statements of the Company included elsewhere in
this proxy. The information presented below under the caption "Dealership
Operating Data" is unaudited. In the opinion of management, such unaudited data
reflect all adjustments, consisting only of normally recurring adjustments,
necessary to fairly present the Company's financial positions and results of
operations for the periods presented. The results of operations of any interim
period are not necessarily indicative of results to be expected for a full
fiscal year. For additional information, see the Consolidated Financial
Statements and notes thereto of the Company included elsewhere in this proxy
statement. The following table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations of the
Continuing Company Business."
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales of Used Cars.............. $ 72,972 $ 18,211 $123,814 $ 53,768 $47,824 $27,768 $13,969
Less:
Cost of Used Cars Sold........ 40,363 9,939 72,358 31,879 29,733 13,604 6,606
Provision for Credit Losses... 15,034 3,261 22,354 9,657 8,359 8,024 3,292
-------- -------- -------- -------- ------- ------- -------
17,575 5,011 29,102 12,232 9,732 6,140 4,071
-------- -------- -------- -------- ------- ------- -------
Interest Income................. 3,879 1,512 12,559 8,597 8,227 4,683 1,629
Gain on Sale of Loans........... 4,614 1,131 6,721 3,925 -- -- --
Servicing Income................ 3,837 1,014 8,738 1,887 -- -- --
Other Income.................... 146 428 3,587 650 308 556 879
-------- -------- -------- -------- ------- ------- -------
12,476 4,085 31,605 15,059 8,535 5,239 2,508
-------- -------- -------- -------- ------- ------- -------
Income before Operating
Expenses...................... 30,051 9,096 60,707 27,291 18,267 11,379 6,579
Operating Expenses:
Selling and Marketing......... 5,326 1,532 10,538 3,585 3,856 2,402 1,293
General and Administrative.... 16,669 5,604 39,412 12,221 11,677 7,722 3,108
Depreciation and
Amortization................ 1,152 529 3,150 1,382 1,225 713 557
-------- -------- -------- -------- ------- ------- -------
23,147 7,665 53,100 17,188 16,758 10,837 4,958
-------- -------- -------- -------- ------- ------- -------
Income before Interest
Expense....................... 6,904 1,431 7,607 10,103 1,509 542 1,621
Interest Expense................ 647 177 706 2,429 5,328 2,870 893
-------- -------- -------- -------- ------- ------- -------
Earnings (Loss) before Income
Taxes......................... 6,257 1,254 6,901 7,674 (3,819) (2,328) 728
Income Taxes (Benefit).......... 2,511 499 2,820 694 -- (334) 30
-------- -------- -------- -------- ------- ------- -------
Earnings (Loss) from Continuing
Operations.................... 3,746 755 4,081 6,980 (3,819) (1,994) 698
Discontinued Operations:
Earnings (Loss) from
Discontinued Operations, net
of income taxes............... (785) 2,507 5,364 (1,114) (153) 27 --
Loss on Disposal of Discontinued
Operations, net of income
taxes......................... (4,827) -- -- -- -- -- --
-------- -------- -------- -------- ------- ------- -------
Net Earnings (Loss)............. $ (1,866) $ 3,262 $ 9,445 $ 5,866 $(3,972) $(1,967) $ 698
======== ======== ======== ======== ======= ======= =======
Earnings (Loss) per Common Share
from Continuing Operations:
Basic........................... $ .20 $ 0.05 $ 0.23 $ 0.77 $ (0.69) $ (0.36) $ 0.14
======== ======== ======== ======== ======= ======= =======
Diluted......................... $ .20 $ 0.05 $ 0.22 $ 0.73 $ (0.69) $ (0.36) $ 0.14
======== ======== ======== ======== ======= ======= =======
</TABLE>
52
<PAGE> 59
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, YEARS ENDED DECEMBER 31,
------------------- -------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- ------- ------- -------
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net Earnings (Loss) per Common
Share
Basic........................... $ (0.10) $ 0.21 $ 0.53 $ 0.63 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Diluted......................... $ (0.10) $ 0.20 $ 0.52 $ 0.60 $ (0.72) $ (0.35) $ 0.14
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --
Continuing Operations
Basic Shares.................... 18,557 15,904 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 19,093 16,580 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Shares Used in Computation --
Net Earnings (Loss)
Basic Shares.................... 18,557 15,904 17,832 7,887 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
Diluted Shares.................. 19,093 16,580 18,234 8,298 5,522 5,584 5,011
======== ======== ======== ======== ======= ======= =======
BALANCE SHEET DATA:
Cash and Cash Equivalents....... $ 514 $ 73,237 $ 3,537 $ 18,455 $ 1,419 $ 168 $ 79
Finance Receivables, Net........ 53,009 41,328 60,778 14,186 27,732 14,534 7,089
Total Assets........... 288,863 172,553 275,633 117,629 60,712 29,681 11,936
Subordinated Notes Payable...... 27,000 12,000 12,000 14,000 14,553 18,291 8,941
Total Debt............. 90,304 20,400 77,171 26,904 49,754 28,233 9,380
Preferred Stock................. -- -- -- -- 10,000 -- --
Common Stock.................... 173,724 171,274 172,622 82,612 127 77 1
Total Stockholders'
Equity (Deficit)..... 181,010 167,191 181,774 82,319 4,884 (1,194) 697
DEALERSHIP OPERATING DATA
(UNAUDITED):
Average Sales Price per Car..... $ 7,731 $ 7,367 $ 7,443 $ 7,107 $ 6,478 $ 5,269 $ 4,159
Number of Used Cars Sold........ 9,439 2,472 16,636 7,565 7,383 5,270 3,359
Company Dealerships............. 46 14 41 8 8 8 5
Number of Contracts
Originated.................... 9,339 2,110 16,001 6,929 6,129 4,731 3,093
Principal Balances Originated
(000 Omitted)................. $ 69,708 $ 47,345 $116,830 $ 48,996 $36,568 $23,589 $12,984
Retained Portfolio:
Number of Contracts
Outstanding................... 4,497 6,657 7,993 1,045 8,049 5,515 2,929
Allowance as % of Outstanding
Principal..................... 18.5% 28.4% 18.5% 23.0% 21.9% 30.4% 30.0%
Average Principal Balance
Outstanding................... $ 7,397 $ 4,852 $ 7,002 $ 6,764 $ 4,252 $ 3,605 $ 3,273
Average Yield on Contracts...... 26.0% 28.0% 26.7% 29.2% 28.0% 28.2% 26.4%
Delinquencies -- Retained
Portfolio:
Principal Balances 31 to 60
Days.......................... 1.2% 2.3% 2.2% 2.3% 4.2% 5.1% 10.5%
Principal Balances over 60
Days.......................... 3.6% 1.7% 0.6% 0.6% 1.1% 1.3% 15.0%
LOAN SERVICING DATA:
(000 OMITTED)
Principal Balances Serviced:
Dealership Sales................ 33,265 32,298 55,965 7,068 34,226 19,881 9,588
Securitized with Servicing
Retained...................... 276,231 100,377 238,025 51,662 -- -- --
Discontinued Operations......... 53,877 36,459 29,965 49,772 13,805 1,620 --
Servicing on Behalf of Others... 98,787 -- 127,322 -- -- -- --
-------- -------- -------- -------- ------- ------- -------
Total Serviced
Portfolios........... $462,160 $169,134 $451,277 $108,502 $48,031 $21,501 $ 9,588
======== ======== ======== ======== ======= ======= =======
</TABLE>
53
<PAGE> 60
RECENT DEVELOPMENTS
The selected data presented below for the six-month periods ended June 30,
1998 and 1997, and as of June 30, 1998 and 1997, are derived from the unaudited
condensed consolidated financial statements of the Company. In the opinion of
management, such unaudited data reflect all adjustments, consisting only of
normally recurring adjustments, necessary to fairly present the Company's
financial position and results of operations for the periods presented. The
results of operations of any interim period are not necessarily indicative of
results to be expected for a full fiscal year.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------------
1998 1997
----------- -----------
(IN THOUSANDS, EXCEPT
EARNINGS PER SHARE AMOUNTS)
<S> <C> <C>
STATEMENT OF OPERATIONS DATA:
Sales of Used Cars.......................................... $142,491 $ 46,013
Less:
Cost of Used Cars Sold.................................... 81,213 25,890
Provision for Credit Losses............................... 29,308 8,109
-------- --------
31,970 12,014
-------- --------
Interest Income............................................. 7,439 4,691
Gain on Sale of Loans....................................... 8,273 4,143
Servicing and other Income.................................. 8,154 3,596
-------- --------
23,866 12,430
-------- --------
Income before Operating Expenses............................ 55,836 24,444
Operating Expenses.......................................... 44,062 19,112
-------- --------
Income before Interest Expense.............................. 11,774 5,332
Interest Expense............................................ 1,164 440
-------- --------
Earnings before Income Taxes................................ 10,610 4,892
Income Taxes................................................ 4,274 1,987
-------- --------
Earnings from Continuing Operations......................... 6,336 2,905
Discontinued Operations:
Earnings (Loss) from Discontinued Operations, net of income
taxes..................................................... (5,254) 4,668
-------- --------
Net Earnings................................................ $ 1,082 7,573
======== ========
Earnings per Common Share from Continuing Operations:
Basic....................................................... $ 0.34 $ 0.17
======== ========
Diluted..................................................... $ 0.33 $ 0.16
======== ========
Net Earnings per Common Share:
Basic....................................................... $ 0.06 $ 0.44
======== ========
Diluted..................................................... $ 0.06 $ 0.43
======== ========
Shares used in Computation -- Continuing Operations:
Basic....................................................... 18,570 17,200
======== ========
Diluted..................................................... 18,930 17,800
======== ========
Shares used in Computation -- Net Earnings:
Basic....................................................... 18,570 17,200
======== ========
Diluted..................................................... 18,930 17,800
======== ========
BALANCE SHEET DATA:
Cash and Cash Equivalents................................... 1,652 41,149
Finance Receivables, Net.................................... 27,310 32,627
Total Assets....................................... 278,845 215,476
Subordinated Notes Payable.................................. 25,000 12,000
Total Debt......................................... 72,891 20,328
Preferred Stock............................................. -- --
Common Stock(1)............................................. 173,562 171,317
Total Stockholders' Equity......................... 185,753 178,597
</TABLE>
- ---------------
(1) 18,567,097 shares of the Company's Common Stock were issued and outstanding
at June 30, 1998.
54
<PAGE> 61
MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS
OF OPERATIONS AND FINANCIAL CONDITION OF
THE CONTINUING COMPANY BUSINESSES
The following Management's Discussion and Analysis of Results of Operations
and Financial Condition relates to the Continuing Company Businesses. A separate
Management's Discussion and Analysis of Results of Operations and Financial
Condition for Cygnet is presented in the Cygnet Prospectus.
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, except as they relate to the Rights Offering, including
particularly, the sale of Cygnet Common Stock upon exercise of the Rights, are
within the meaning of that term in Section 27A of the Securities Act and of
Section 21E of 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,"
"intend," "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 Company undertakes no
obligation to publicly update or revise any forward looking statements, whether
as a result of new information, future events, or otherwise. The following
disclosures, as well as other statements in this Proxy Statement, and in the
Notes to the Company's Consolidated Financial Statements and the Company's other
filings with the Securities and Exchange Commission, 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 operates a chain of Buy Here-Pay Here used car
dealerships in the United States and underwrites, finances and services retail
installment contracts generated from the sale of used cars by its Company
Dealerships and by Third Party Dealers located in selected markets throughout
the country. As part of its financing activities, the Company has initiated its
Cygnet Dealer Program, pursuant to which the Company provides qualified
independent used car dealers with warehouse purchase facilities and operating
credit lines primarily secured by the dealers' retail installment contract
portfolio. In addition, the Company purchases loan portfolios in bulk and
services loan portfolios on behalf of third parties. 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 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 Company Dealership in Gilbert, Arizona (the "Gilbert Dealership"). In July
1996, the Company opened an additional dealership in Arizona. In January 1997,
the Company acquired selected assets of Seminole Finance Corporation and related
companies ("Seminole"), a group of companies engaged in the business of selling
and financing used motor vehicles, including four dealerships located in the
Tampa Bay/St. Petersburg market. In March 1997, the Company opened its first
used car dealership in the Las Vegas market. In April 1997, the Company acquired
selected assets of E-Z Plan, Inc. ("EZ Plan"), a company in the business of
selling and financing used motor vehicles, including seven dealerships located
in the San Antonio market. In August 1997, the Company closed a dealership in
Prescott, Arizona. In September 1997, the Company acquired selected assets of a
company in the business of selling used motor vehicles, including six
55
<PAGE> 62
dealerships in the Los Angeles market, two in the Miami market, two in the
Atlanta market and two in the Dallas market ("Kars"). In addition, the Company
opened two additional dealerships in the Albuquerque market and three additional
dealerships in the Phoenix market, one additional dealership in the Tampa/St.
Petersburg market, and four additional dealerships in the Atlanta market during
1997. Further, during the first quarter of 1998, the Company opened one store in
the Phoenix, Tampa and Dallas markets, respectively. The Company operated 41 and
8 dealerships at December 31, 1997 and 1996, respectively, and 46 and 14
dealerships at March 31, 1998 and 1997, respectively.
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 the Gilbert Dealership
operations. For the Company's actual 1995 results, including the Gilbert
Dealership, see "Summary -- Ugly Duckling Corporation Summary Selected
Consolidated Financial Data" and "Consolidated Financial Statements."
In 1996, the Company completed an initial public offering and a secondary
offering in which it sold common stock for a total of $82.3 million. In February
1997, the Company completed a private placement of common stock for a total of
$88.7 million, net of expenses. The registration of the resale of the shares
sold in the private placement became effective in April 1997.
Restructuring of Third Party Dealer Operations. In 1994, the Company
acquired Champion Financial Services, Inc., an independent automobile finance
company. In April 1995, the Company initiated an aggressive plan to expand the
number of contracts purchased from its Third Party Dealer Branch Office network.
The Company operated 83 and 22 Branch Offices at December 31, 1997 and 1996,
respectively. In February 1998, the Company announced its intention to close its
Branch Office network, and exit this line of business. In conjunction therewith,
the Company recorded a pre-tax charge to discontinued operations totaling
approximately $9.1 million (approximately $5.4 million, net of income taxes)
during the first quarter of 1998. The restructuring was substantially complete
by the end of the first quarter of 1998 and included the termination of
approximately 400 employees, substantially all of whom were employed at the
Company's 76 Branch Offices that were in place on the date of the announcement.
The Company is continuing to negotiate terminations of leases for certain of its
closed Branch Office locations.
On April 28, 1998, the Company announced that its Board of Directors had
directed management to proceed with separating current operations into two
publicly held companies. The Company's continuing operations would focus
exclusively on the retail sale of used cars through its chain of dealerships, as
well as the collection and servicing of the resulting loans. The Company would
also retain its existing securitization program (the "Securitization Program")
and its interests in the bankruptcy remote subsidiaries that own residual
interests in all securitization transactions previously effected by the Company,
and its rent-a-car franchise business (which is generally inactive) (the
"Continuing Operations"). A new company would be formed to operate all
non-dealership operations. Non-dealership operations generally consist of the
Company's Cygnet Dealer Program pursuant to which the Company provides qualified
independent used car dealers with warehouse purchase facilities and operating
credit lines primarily secured by the dealers' retail installment contract
portfolio, as well as the bulk purchasing of loan portfolios and the servicing
of loan portfolios on behalf of unrelated third parties (other than the Kars
loan portfolio). As a result of these two events, the
56
<PAGE> 63
Company has reclassified to discontinued operations in the accompanying
consolidated balance sheets and consolidated statements of operations, the
results of operations of the Branch Office network and the operations that the
Company intends to Split-up. Unless otherwise noted, the following discussion
relates to Continuing Operations only.
STATEMENT OF FINANCIAL CONDITION
Total assets increased by 134.3% from $117.6 million at December 31, 1996
to $275.6 million at December 31, 1997. The increase was due in part to a
private placement the Company completed in February 1997 which resulted in an
increase in working capital of $89.4 million. The Company deployed this working
capital to acquire Finance Receivables, which increased by 328.4% from $14.2
million at December 31, 1996 to $60.8 million at December 31, 1997. In addition,
the Company increased Net Assets of Discontinued Operations by 109.2% from $48.9
million at December 31, 1996 to $102.4 million at December 31, 1997. This
increase was due to an increase in Finance Receivables acquired by the Company's
discontinued Branch Office network, as well as the acquisition of finance
receivables and origination of revolving facilities pursuant to the Company's
Cygnet Dealer Program. Additionally, the Company Dealership network increased
from 8 dealerships at December 31, 1996 to 41 at December 31, 1997. This
increase in the number of Company Dealerships resulted in an increase in
Inventory by 492.5% from $5.5 million at December 31, 1996 to $32.4 million at
December 31, 1997 and an increase in Property and Equipment of 96.5% from $20.0
million at December 31, 1996 to $39.2 million at December 31, 1997. Further,
Intangible Assets increased by 661.2% from $2.2 million at December 31, 1996 to
$16.4 million at December 31, 1997 due primarily to an increase in Goodwill
related to various acquisitions which were consummated in 1997, and Investments
Held in Trust increased by 268.0% from $3.2 million at December 31, 1996 to
$11.6 million at December 31, 1997 due primarily to an increase in the volume of
Finance Receivables securitized in 1997.
Growth in Finance Receivables. As a result of the Company's rapid
expansion, contract receivables serviced increased significantly. The Company
currently services loans originated or purchased by the Company, as well as
loans originated or purchased and subsequently securitized by the Company.
The following tables reflect the growth in period end balances measured in
terms of the principal amount and the number of contracts generated from or
acquired by Company Dealership operations.
TOTAL CONTRACTS OUTSTANDING:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996 MARCH 31, 1998
---------------------- ---------------------- ----------------------
PRINCIPAL NO. OF PRINCIPAL NO. OF PRINCIPAL NO. OF
AMOUNT CONTRACTS AMOUNT CONTRACTS AMOUNT CONTRACTS
--------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Total Contracts
Outstanding............... $183,321 35,762 $49,066 9,615 $218,505 39,734
Less Portfolios Securitized
and Sold.................. 127,356 27,769 41,998 8,570 185,240 35,237
-------- ------ ------- ----- -------- ------
Company Retained Total...... $ 55,965 7,993 $ 7,068 1,045 $ 33,265 4,497
======== ====== ======= ===== ======== ======
</TABLE>
In addition to the loan portfolio summarized above, the Company also
services loan portfolios totaling approximately $267.9 million ($127.3 million
for Kars and $140.6 million from Branch Office originations) as of December 31,
1997, $59.4 million (solely from Branch Office originations) as of December 31,
1996, and $243.6 million ($98.8 million for Kars and $144.8 million from Branch
Office originations) as of March 31, 1998, respectively.
The following tables reflect the growth in contract originations generated
from or acquired by Company Dealership operations measured in terms of the
principal amount and the number of contracts.
57
<PAGE> 64
TOTAL CONTRACTS ORIGINATED/PURCHASED:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS AND AVERAGE PRINCIPAL)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEARS ENDED DECEMBER 31, MARCH 31,
------------------------ ------------------
1997 1996 1998 1997
---------- --------- ------- -------
<S> <C> <C> <C> <C>
Principal Amount.......................... $172,230 $48,996 $69,708 $47,345
Number of Contracts....................... 29,251 6,929 9,339 9,063
Average Principal......................... $ 5,888 $ 7,071 $ 7,464 $ 5,223
</TABLE>
For the year ended December 31, 1997, Finance Receivable Principal Balances
originated/purchased increased by 251.5% to $172.2 million, including $55.4
million from the Seminole and EZ Plan acquisitions (approximately 13,250
contracts), from $49.0 million in the year ended December 31, 1996.
Finance Receivable Principal Balances originated/purchased during the three
months ended March 31, 1998 increased by 47.2% to $69.7 million from $47.3
million in the three month period ended March 31, 1997. During the three month
period ended March 31, 1997, finance receivable principal balances purchased
were affected by the purchase of approximately $31.1 million (6,953 contracts)
in finance receivables from Seminole.
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, 1997, 1996, AND 1995, AND THREE MONTHS ENDED MARCH
31, 1998 AND 1997
Sales of Used Cars increased by 130.3% to $123.8 million for the year ended
December 31, 1997 from $53.8 million for the year ended December 31, 1996 which
was a 40.1% increase from $38.4 million (pro forma) for the year ended December
31, 1995. This growth reflects increases in the number of used car dealerships
in operation and the average unit sales price. Units sold increased by 119.9% to
16,636 units in the year ended December 31, 1997 from 7,565 units in the year
ended December 31, 1996 compared to an increase of 8.8% from 1995 units sold of
6,956 (pro forma). Net same store unit sales declined by 11.6% in the year ended
December 31, 1997 compared to the year ended December 31, 1996. The Company
believes that this is due primarily to the increased emphasis on underwriting at
the Company Dealerships, particularly at one dealership where unit sales
decreased by 742 units, which represents 85.0% of the net decrease for the year
ended December 31, 1997. Net same store unit sales increased by 4.6% (pro forma)
in the year ended December 31, 1996 compared to the year ended December 31,
1995.
Sales of Used Cars increased by 300.7% to $73.0 million for the three month
period ended March 31, 1998 from $18.2 million for the three month period ended
March 31, 1997. This growth reflects a significant increase in the number of
used car dealerships in operation from 14 dealerships in operation during the
three month period ended March 31, 1997 compared to 46 dealerships in operation
during the three month period ended March 31, 1998. Units sold increased by
281.8% to 9,439 units in the three month period ended March 31, 1998 from 2,472
units in the three month period ended March 31, 1997. Same store sales increased
by 17.1% in the three month period ended March 31, 1998 compared to the three
month period ended March 31, 1997. This increase is primarily due to the timing
of store openings within the first quarter of 1997. Management expects same
store sales to remain relatively stable in future periods.
The average sales price per car increased by 4.7% to $7,443 for the year
ended December 31, 1997 from $7,107 for the year ended December 31, 1996
compared to a 17.2% increase in the year ended December 31, 1996 from $6,065
(pro forma) in 1995. The average sales price per car increased to $7,731 for the
three month period ended March 31, 1998 from $7,367 for the three month period
ended March 31, 1997.
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<PAGE> 65
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 127.0% to $72.4 million for the year ended December 31, 1997 from
$31.9 million for the year ended December 31, 1996, which was an increase of
41.8% from $22.5 million (pro forma) for the year ended December 31, 1995. On a
per unit basis, the Cost of Used Cars Sold increased by 3.2% to $4,349 for the
year ended December 31, 1997 from $4,214 for the year ended December 31, 1996,
which was an increase of 30.5% from $3,235 (pro forma) for the year ended
December 31, 1995. The gross margin on used car sales (Sales of Used Cars less
Cost of Used Cars Sold excluding Provision for Credit Losses) increased by
135.1% to $51.5 million for the year ended December 31, 1997 from $21.9 million
for the year ended December 31, 1996, which was an increase of 37.7% from $15.9
million (pro forma) for the year ended December 31, 1995. As a percentage of
sales, the gross margin was 41.6%, 40.7% , and 41.4% (pro forma) for the years
ended December 31, 1997, 1996, and 1995, respectively. On a per unit basis, the
gross margin per car sold was $1,316, $2,391, and $2,286 (pro forma) for the
years ended December 31, 1997, 1996, and 1995, respectively.
The Cost of Used Cars Sold increased by 306.1% to $40.4 million for the
three month period ended March 31, 1998 from $9.9 million for the three month
period ended March 31, 1997. On a per unit basis, the Cost of Used Cars Sold
increased by 6.3% to $4,276 for the three month period ended March 31, 1998 from
$4,021 for the three month period ended March 31, 1997. The gross margin on used
car sales (Sales of Used Cars less Cost of Used Cars Sold excluding Provision
for Credit Losses) increased by 294.2% to $32.6 million for the three month
period ended March 31, 1998 from $8.3 million for the three month period ended
March 31, 1997. As a percentage of sales, the gross margin was 44.7% and 45.4%
for the three month periods ended March 31, 1998 and 1997, respectively. On a
per unit basis, the gross margin per car sold was $3,455 and $2,988 for the
three month periods ended March 31, 1998 and 1997, respectively. The increase in
the average cost per unit and for the decline in gross margin percent and per
car sold is primarily the result of an increase in vehicle reconditioning costs
from the prior comparable period.
Provision for Credit Losses. The Provision for Credit Losses increased by
131.5% to $22.4 million in the year ended December 31, 1997 from $9.7 million
for the year ended December 31, 1996 compared to 24.4% from $7.8 million (pro
forma) in 1995. On a percentage basis, the Provision for Credit Losses per unit
originated at Company Dealerships increased by 6.3% to $1,505 per unit in the
year ended December 31, 1997 from $1,416 per unit in the year ended December 31,
1996 compared to an increase of 3.1% from $1,239 (pro forma) per unit in 1995.
This increase is primarily due to an increase in the average amount financed in
the years ended December 31, 1997, 1996, and 1995, respectively, to $7,301 per
unit in the year ended December 31, 1997 from $7,071 per unit in the year ended
December 31, 1996 and $5,966 per unit in the year ended December 31, 1995. As a
percentage of Company Dealership contract balances originated, the Provision for
Credit Losses averaged 19.1%, 19.7%, and 22.8% (pro forma), for the years ended
December 31, 1997, 1996, and 1995, respectively.
The Provision for Credit Losses increased by 361.0% to $15.0 million in the
three month period ended March 31, 1998 from $3.3 million for the three month
period ended March 31, 1997. This increase is primarily due to the 429.1%
increase in contract principal balances originated at the Company Dealerships
from the comparable period in 1997. The Provision for Credit Losses per unit
originated at Company Dealerships increased by 4.2% to $1,610 per unit in the
three month period ended March 31, 1998 from $1,545 per unit in the three month
period ended March 31, 1997. As a percentage of contract balances originated at
Company Dealerships, the Provision for Credit Losses averaged 21.6% and 20.1%,
for the three month periods ended March 31, 1998 and 1997, respectively.
Interest Income. Interest Income consists primarily of interest on finance
receivables from Company Dealership sales, and income from Residuals in Finance
Receivables Sold. Interest Income increased by 46.1% to $12.6 million for the
year ended December 31, 1997 from $8.6 million for the year ended December 31,
1996, which increased by 4.5% from $8.2 million in the year ended December 31,
1995. Interest Income during the years ended December 31, 1997 and 1996 was
adversely affected by the sale of finance receivables pursuant to the
Securitization Program, and will continue to be affected in future periods by
additional securitizations.
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<PAGE> 66
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 94.4% of sales
revenue and 96.2% of the used cars sold at Company Dealerships for the year
ended December 31, 1997 compared to 91.1% of sales revenue and 91.6% of the used
cars sold at Company Dealerships for the year ended December 31, 1996, and 89.7%
(pro forma) of sales revenue and 91.2% (pro forma) of the used cars sold for the
year ended December 31, 1995. The Company financed 95.5% of sales revenue and
98.9% of the used cars sold at Company Dealerships for the three month period
ended March 31, 1998, compared to 89.2% of sales revenue and 85.4% of the used
cars sold for the three month period ended March 31, 1997. The average amount
financed increased to $7,301 for the year ended December 31, 1997 from $7,071
for the year ended December 31, 1996, which had increased from $5,966 for the
year ended December 31, 1995. The average amount financed decreased to $7,464
for the three month period ended March 31, 1998 from $7,699 for the three month
period ended March 31, 1997. The decrease in the average amount financed,
despite an increase in the average sales price from the comparable period in the
prior year, is due to an increase in the average down payment collected on
financed sales. As a result of its expansion into markets with interest rate
limits, the Company's yield on its Company Dealership receivable contract
portfolio has trended downward. The average effective yield on finance
receivables from Company Dealerships was approximately 26.7%, 29.2%, and 28.0%
for the years ended December 31, 1997, 1996, and 1995, respectively. The
effective yield on Finance Receivables from Company Dealerships was 26.0% and
28.0%, for the three month periods ended March 31, 1998 and 1997, respectively.
The Company's policy is to charge 29.9% per annum on its Company Dealership
contracts. However, in those states that impose usury limits, the Company
charges the maximum interest rate permitted.
Interest Income increased by 156.5% to $3.9 million for the three month
period ended March 31, 1998 from $1.5 million for the three month period ended
March 31, 1997. Interest Income was reduced by the sale of finance receivables
with remaining principal balances of $185.2 million and $48.5 million as of
March 31, 1998 and 1997, respectively, pursuant to the Securitization Program,
and will continue to be affected in future periods by additional
securitizations.
Gain on Sale of Finance Receivables. Champion Receivables Corporation
("CRC") and Champion Receivables Corporation II ("CRC II") (collectively
referred to as the "Securitization Subsidiaries"), are the Company's wholly
owned special purpose "bankruptcy remote" entities. During the first quarter of
1996, the Company initiated a Securitization Program under which CRC sold
securities backed by contracts to SunAmerica Life Insurance Company
("SunAmerica"). Beginning with the third fiscal quarter of 1997, the Company
expanded the Securitization Program to include CRC II and sales of CRC II
securities through private placement of securities to investors other than
SunAmerica. Under the Securitization Program, the Securitization Subsidiaries
assign and transfer the contracts to separate trusts ("Trusts") pursuant to
Pooling and Servicing Agreements (the "Pooling Agreements"). Pursuant to the
Pooling Agreements, Class A Certificates and subordinated Class B Certificates
are issued to the Securitization Subsidiaries. The Securitization Subsidiaries
then sell the Class A Certificates to unrelated investors. The transferred
contracts are serviced by Champion Acceptance Corporation ("CAC"), another
subsidiary of the Company. For the Company's securitizations that took place
prior to July 1, 1997, the Company's Class A Certificates received ratings from
Standard & Poors ranging from "BBB" to "A". To obtain these ratings from
Standard & Poors, CRC was required to provide a credit enhancement by
establishing and maintaining a cash spread account for the benefit of the Class
A certificate holders. For the securitization transactions that were consummated
after July 1, 1997, the Company's Class A Certificates received a "AAA" rating
from Standard & Poors, and a "Aaa" rating from Moody's Investors Service. To
obtain these ratings, CRC II (1) obtained an insurance policy from MBIA
Insurance Corporation which unconditionally and irrevocably guaranteed full and
complete payment of the Class A guaranteed distribution (as defined), and (2)
provided a credit enhancement by establishing and maintaining a cash spread
account for the benefit of the Class A certificate holders. The Securitization
Subsidiaries make an initial cash deposit into the spread account, ranging from
3% to 4% of the initial underlying finance receivables principal balance and
pledge this cash to the Trusts. The Securitization Subsidiaries are also
required to then make additional deposits to the spread account from the
residual cash flow (through the trustees) as necessary to attain and maintain
the spread account at a specified percentage, ranging from 6.0% to 12.0%
(increasing up to 100% upon the occurrence of termination events or the failure
to
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<PAGE> 67
meet certain performance tests), of the underlying finance receivables principal
balance. Distributions are not made to the Securitization Subsidiaries on the
Class B Certificates unless the spread account has the required balance, the
required periodic payments to the Class A Certificate holders are current, and
the trustee, servicer and other administrative costs are current.
The Company recognizes a Gain on Sale of Loans equal to the difference
between the sales proceeds for the finance receivables sold and the Company's
recorded investment in the finance receivables sold. The Company's investment in
finance receivables consists of the principal balance of the finance
receivables, as well as the allowance for credit losses related thereto.
Therefore, once the Company securitizes a pool of loans, the Company reduces the
allowance for credit losses for the amount of allowance for credit losses
related to the loans securitized. 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.
To the extent that actual cash flows on a securitization are below original
estimates, and differ materially from the original securitization assumptions
and, in the opinion of management, those differences appear to be other than
temporary in nature, the Company would be required to revalue the Residuals in
Finance Receivables Sold held by the Securitization Subsidiaries and record a
charge to earnings based upon the reduction. For a discussion of how the Company
values the Residuals in Finance Receivables Sold, see "Residuals in Finance
Receivables Sold" below. During the year ended December 31, 1997, the Company
recorded a $5.7 million charge (approximately $3.4 million, net of income taxes)
to write down the Residuals in Finance Receivables Sold.
During the year ended December 31, 1997, the Securitization Subsidiaries
made initial spread account deposits totaling $6.1 million. Additional net
deposits into the spread accounts during the year ended December 31, 1997
totaled approximately $1.8 million. As of December 31, 1997, the Company
maintained a total spread account balance of $10.4 million. In addition to the
spread account balance of $10.4 million, the Company had deposited a total of
$1.2 million in trust accounts in conjunction with certain other agreements.
CRC II made an initial spread account deposit totaling $3.5 million during
the three months ended March 31, 1998 in conjunction with a single
securitization. Based upon securitizations in effect as of March 31, 1998, the
Company's continuing operations were required to maintain an aggregate balance
in its spread accounts of $18.6 million, a portion of which may be funded over
time. As of March 31, 1998, the Company maintained an aggregate spread account
balance of $13.9 million which satisfied the funding requirement for all of the
securitization transactions consummated prior to the three month period ended
March 31, 1998. Accordingly, an additional $4.7 million related to the
securitization consummated during the three month period ended March 31, 1998
will need to be funded from future cash flows. The additional funding
requirements will decline as the trustees deposit additional cash flows into the
spread account and as the principal balance of the underlying finance
receivables declines. In addition to the spread account balance of $13.9
million, the Company had deposited a total of $1.3 million in trust accounts in
conjunction with certain other agreements.
The Company also maintains spread accounts for the securitization
transactions that were consummated by the Company's discontinued operations. The
Company had met its targeted balance of $6.9 million in these spread accounts as
of March 31, 1998.
During the year ended December 31, 1997, the Company securitized an
aggregate of $151.7 million in contracts, issuing $121.4 million in Class A
securities, and $30.3 million in Class B securities (Residuals in Finance
Receivables Sold). In 1996, the Company securitized an aggregate of $58.2
million in contracts, issuing $44.7 million in Class A securities and $13.5
million in Class B securities. The Company recorded the carrying value of the
Residuals in Finance Receivables sold at $17.7 million and $10.1 million,
respectively, with a balance of $13.3 million and $8.5 million as of December
31, 1997 and 1996, respectively. The Company recorded Gain on Sale of Loans of
$6.7 million and $3.9 million, net of expenses (and a $5.7 million charge
recorded by the Company during 1997), related to securitization transactions
during the years ended December 31, 1997 and 1996, respectively.
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<PAGE> 68
During the quarter ended March 31, 1998, the Company securitized an
aggregate of $86.6 million in contracts, issuing $62.6 million in Class A
securities and $24.0 million in Class B securities. The Company recorded the
carrying value of the Residuals in Finance Receivables sold at $13.9 million for
a balance of $24.7 million at March 31, 1998. During the quarter ended March 31,
1997, the Company securitized an aggregate of $15.1 million in contracts issuing
$11.6 million in Class A securities and $3.5 million in Class B securities. The
Company recorded the carrying value of the Residuals in Finance Receivables sold
at $2.1 million. The Company recorded a Gain on Sale of Loans of $4.6 million
during the three month period ended March 31, 1998, compared to $1.1 million
during the three month period ended March 31, 1997. The Gain on Sale of Loans as
a percentage of principal balances securitized was 5.3% and 7.5% in the three
month periods ended March 31, 1998 and 1997, respectively. The decrease in the
gain on sale percentage is due to the contracts carrying a lower average
contract rate than those securitized in the comparable period last year, and the
utilization of a higher cumulative net loss assumption for the 1998
securitization. In addition, the contracts in the 1998 securitization were more
seasoned than the contracts in the 1997 securitization resulting in less future
interest income available for gain recognition.
During 1997, the Trusts issued certificates at a weighted average yield of
6.7%, with the yields ranging from 6.3% to 8.1%, resulting in net spreads, after
servicing and trustee fees, ranging from 13.7% to 17.8% and averaging 15.8%.
During 1996, the Trusts issued certificates at a weighted average yield of 8.4%,
with the yields ranging from 8.2% to 8.6%, resulting in net spreads, after
servicing and trustee fees, ranging from 16.8% to 17.4% and averaging 17.1%. The
decrease in net spreads from 1996 to 1997, despite lower certificate yields, is
primarily the result of the decrease in the average contract yield of the
finance receivable contracts securitized due to the Company's expansion into
markets with interest rate limits.
During the three month period ended March 31, 1998, the Trust issued
certificates at a yield of 6.11% resulting in net spread, before net credit
losses and after servicing, insurer, and trustee fees, of 17.0%.
Other Income. Other Income which consists primarily of servicing income,
earnings on investments from the Company's cash and cash equivalents, and
franchise fees from the Company's rent-a-car franchisees increased by 385.8% to
$12.3 million for the year ended December 31, 1997 from $2.5 million for the
year ended December 31, 1996, compared to an increase of 723.7% from $308,000 in
the year ended December 31, 1995. The Company services the securitized contracts
for monthly fees ranging from .25% to .33% of the beginning of month principal
balances (3.0% to 4.0% annualized). In addition, in conjunction with the Kars
acquisition in September 1997, the Company recognizes income from servicing the
Kars portfolio at a rate of approximately .33% (4.0% annualized) of beginning of
month principal balances. Servicing income for the year ended December 31, 1997
increased to $8.7 million from $1.9 million in the year ended December 31, 1996.
The significant increase is due to the increase in the principal balance of
contracts being serviced pursuant to the Securitization Program and the addition
of servicing of the Kars portfolio. The increase in Other Income is also due to
an increase in earnings on investments of $1.2 million compared to no investment
earnings in the years ended December 31, 1996 and 1995.
Other Income increased to $4.0 million for the three months ended March 31,
1998 from $1.4 million for the three months ended March 31, 1997. Servicing
income for the three months ended March 31, 1998 increased to $3.8 million from
$1.0 million in the three month period ended March 31, 1997. This increase is
due to the increase in the principal balance of contracts being serviced
pursuant to the Securitization Program and the addition of servicing of the
third party portfolio. 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 127.3% to $66.6 million for
the year ended December 31, 1997 from $29.3 million for the year ended December
31, 1996 compared to an increase of 46.1% in 1996 from $20.0 million in 1995.
Growth of Sales of Used Cars, Interest Income, Gain on Sale of Loans, and Other
Income were the primary contributors to the increase.
Income before Operating Expenses grew by 204.4% to $30.1 million for the
three month period ended March 31, 1998 from $9.9 million for the three month
period ended March 31, 1997. Growth of Sales of Used Cars, Interest Income on
the loan portfolios and Other Income were the primary contributors to the
increase.
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<PAGE> 69
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
The Company has three distinct business segments. These consist of retail
car sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), and corporate and other
operations.
A summary of Operating Expenses by business segment for the years ended
December 31, 1997, 1996, and 1995, and the three month periods ended March 31,
1998 and 1997, respectively, follows:
<TABLE>
<CAPTION>
COMPANY
COMPANY DEALERSHIP CORPORATE
DEALERSHIPS RECEIVABLES & OTHER TOTAL
----------- ----------- --------- -------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
Selling and Marketing.......................... $10,499 $ -- $ 39 $10,538
General and Administrative..................... 17,215 12,303 9,894 39,412
Depreciation and Amortization.................. 1,536 1,108 506 3,150
------- ------- ------- -------
$29,250 $13,411 $10,439 $53,100
======= ======= ======= =======
Year ended December 31, 1996:
Selling and Marketing.......................... $ 3,568 $ -- $ 17 $ 3,585
General and Administrative..................... 6,306 2,859 3,056 12,221
Depreciation and Amortization.................. 318 769 295 1,382
------- ------- ------- -------
$10,192 $ 3,628 $ 3,368 $17,188
======= ======= ======= =======
Year ended December 31, 1995:
Selling and Marketing.......................... $ 3,856 $ -- $ -- $ 3,856
General and Administrative..................... 6,441 2,563 2,673 11,677
Depreciation and Amortization.................. 279 479 467 1,225
------- ------- ------- -------
$10,576 $ 3,042 $ 3,140 $16,758
======= ======= ======= =======
Three Months ended March 31, 1998:
Selling and Marketing.......................... $ 5,290 $ -- $ 36 $ 5,326
General and Administrative..................... 9,537 4,255 2,877 16,669
Depreciation and Amortization.................. 613 338 201 1,152
------- ------- ------- -------
$15,440 $ 4,593 $ 3,114 $23,147
======= ======= ======= =======
Three Months ended March 31, 1997:
Selling and Marketing.......................... $ 1,525 $ -- $ 7 $ 1,532
General and Administrative..................... 2,469 1,488 1,647 5,604
Depreciation and Amortization.................. 200 206 123 529
------- ------- ------- -------
$ 4,194 $ 1,694 $ 1,777 $ 7,665
======= ======= ======= =======
</TABLE>
Selling and Marketing Expenses. For the years ended December 31, 1997,
1996, and 1995, Selling and Marketing Expenses are comprised almost entirely of
advertising costs and commissions relating to Company Dealership operations.
Selling and Marketing Expenses increased by 193.9% to $10.5 million for the year
ended December 31, 1997 from $3.6 million for the year ended December 31, 1996,
which was an increase of 12.6% from $3.2 million (pro forma) in 1995. As a
percentage of Sales of Used Cars, these expenses averaged 8.5%, 6.7%, and 8.3%
(pro forma) for the years ended December 31, 1997, 1996, and 1995, respectively.
On a per unit sold basis, Selling and Marketing expenses increased by 34.0% to
$633 per unit for the year ended December 31, 1997 from $474 per unit for the
year ended December 31, 1996, which was a decrease of 7.1%
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<PAGE> 70
from $510 (pro forma) per unit in 1995. The significant increase in per unit
marketing in 1997 is primarily due to the Company's expansion into several new
markets. The Company operated dealerships in ten markets during 1997, compared
to operating in two markets in 1996 and 1995. As a result of this expansion, the
Company incurred significant marketing costs in new markets in an effort to
establish brand name recognition.
Selling and Marketing Expenses increased by 247.7% to $5.3 million for the
three month period ended March 31, 1998 from $1.5 million for the three month
period ended March 31, 1997. As a percentage of Sales of Used Cars, these
expenses averaged 7.3% for the three month period ended March 31, 1998 and 8.4%
for the three month period ended March 31, 1997. On a per unit sold basis,
Selling and Marketing Expenses of Company Dealerships decreased to $564 per unit
for the three month period ended March 31, 1998 from $620 per unit for the three
month period ended March 31, 1997. This decrease is primarily due to a general
reduction in marketing expenses in the Tampa market compared to the same period
in the prior year. In the prior year, upon entering the Tampa market, the
Company incurred significant marketing costs in an effort to establish brand
recognition.
General and Administrative Expenses. General and Administrative Expenses
increased by 222.5% to $39.4 million for the year ended December 31, 1997 from
$12.2 million for the year ended December 31, 1996, which was an increase of
15.1% from $10.6 million (pro forma) for the year ended December 31, 1995. These
expenses represented 25.4%, 17.8%, and 20.4% of total revenues for the years
ended December 31, 1997, 1996, and 1995, respectively. The increase in General
and Administrative Expenses is primarily a result of the Company's increased
number of used car dealerships, as well as continued expansion of infrastructure
to administer growth.
General and Administrative Expenses increased by 197.4% to $16.7 million
for the three month period ended March 31, 1998 from $5.6 million for the three
month period ended March 31, 1997. These expenses represented 19.5% and 25.1% of
total revenues for three month periods ended March 31, 1998, and 1997,
respectively. The increase in General and Administrative Expenses is a result of
the Company's increased number of used car dealerships. However, the decrease in
General and Administrative Expenses as a percent of total revenues is primarily
due to the relatively greater increase in revenues over the incremental costs
required to manage the Company as it adds additional dealerships.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on the Company's property and equipment and
amortization of the Company's goodwill and trademarks. Depreciation and
amortization increased by 127.9% to $3.2 million for the year ended December 31,
1997 from $1.4 million for the year ended December 31, 1996, which was an
increase of 12.8% from $1.2 million for the year ended December 31, 1995.
Depreciation and amortization increased by 117.8% to $1.2 million for the three
month period ended March 31, 1998 from $529,000 for the three month period ended
March 31, 1997. The increases were due primarily to the increase in amortization
of goodwill associated with the Company's recent acquisitions, and increased
depreciation expense from the addition of used car dealerships.
Interest Expense. Interest Expense decreased by 70.9% to $706,000 in 1997
from $2.4 million in 1996 which was a decrease of 54.4% from $5.3 million in
1995. The decrease from 1995 to 1996 and then from 1996 to 1997 is primarily the
result of the private placement of Common Stock in February 1997, which
generated $89.2 million in cash, the two public offerings that were completed in
1996, which generated $79.4 million in cash, and the Company's Securitization
Program, which generated cash from the sale of Finance Receivables which the
Company utilized to pay down debt. A total of $4.6 million, $2.8 million and
$628,000 in interest expense was related to discontinued operations in the years
ended December 31, 1997, 1996 and 1995, respectively.
Interest expense increased by 265.6% to $647,000 in the three month period
ended March 31, 1998 from $177,000 in the three month period ended March 31,
1997. The increase in interest expense over the prior comparable period is due
primarily to increased borrowings to support the Company's increasing finance
receivable portfolio, property and equipment and inventory. A total of $2.0
million and $594,000 in interest expense was related to discontinued operations
for the three month periods ended March 31, 1998 and 1997, respectively.
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<PAGE> 71
Income Taxes. Income taxes from continuing operations increased to $2.8
million in 1997 which is an effective tax rate of approximately 40.9%, compared
to $694,000 in 1996, up from zero in 1995. In 1996, the Company utilized all of
the Valuation Allowance that existed against its deferred income tax assets as
of December 31, 1995. No income tax benefit was recognized in 1995 as a result
of an increase in the Valuation Allowance for deferred tax assets.
Income taxes from continuing operations totaled $2.5 million and $499,000
during the three month periods ended March 31, 1998 and 1997 respectively, an
effective rate of 40.1% and 39.7%, respectively.
Earnings (Loss) from Discontinued Operations. Discontinued operations
consist of the Company's Cygnet Dealer Program, the Branch Office network, the
Company's bulk purchasing and loan servicing operations, and transactions
related to FMAC.
Earnings (Loss) from discontinued operations, net of income taxes increased
to $5.4 million in the year ended December 31, 1997 from a loss of $1.1 million
in 1996, compared to a loss of $153,000 in 1995. The losses in 1995 and 1996
were related to the Company's Branch Office network. Earnings from discontinued
operations in 1997 were significantly impacted by the FMAC transaction which
generated a pre-tax gain on sale of loans of $8.1 million, as well as $3.8
million in interest income from the debtor in possession loan and the senior
bank group notes held by the Company, net of interest expense on the carrying
costs related to the FMAC transaction and an operating loss from the Branch
Office network.
Loss from discontinued operations was $5.6 million in the three month
period ended March 31, 1998 compared to earnings of $2.5 million in three month
period ended March 31, 1997. The loss in the three month period ended March 31,
1998 was due to a loss from disposal of discontinued operations of $4.8 million
from the closure of the Branch Office network and an operating loss of $785,000
from discontinued operations from the Branch Office network, compared to
earnings in the comparable quarter in 1997 due to a gain on sale of finance
receivables from the Branch office network.
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.
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<PAGE> 72
The following table reflects activity in the Allowance, as well as
information regarding charge off activity, for the years ended December 31, 1997
and 1996, in thousands.
<TABLE>
<CAPTION>
YEARS ENDED THREE MONTHS ENDED
DECEMBER 31, MARCH 31,
------------------- -------------------
1997 1996 1998 1997
-------- ------- -------- -------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Year.............. $ 1,625 $ 7,500 $ 10,356 $ 1,625
Provision for Credit Losses............. 22,354 9,657 15,034 3,261
Allowance on Acquired Loans............. 15,309 -- -- 9,034
Reduction Attributable to Loans Sold.... (21,408) (9,330) (17,090) (3,100)
Net Charge Offs......................... (7,524) (6,202) (2,147) (1,597)
-------- ------- -------- -------
Balance, End of Year.................... $ 10,356 $ 1,625 $ 6,153 $ 9,223
======== ======= ======== =======
Allowance as % of Year Ended Principal
Balance.............................. 18.5% 23.0% 18.5% 28.4%
======== ======= ======== =======
Charge off Activity:
Principal Balances...................... $ 10,285 $ 8,115 $ 3,197 $ 2,263
Accrued Interest........................ -- 487 -- --
Recoveries, Net......................... (2,761) (2,400) (1,050) (666)
-------- ------- -------- -------
Net Charge Offs......................... $ 7,524 $ 6,202 $ 2,147 $ 1,597
======== ======= ======== =======
Net Charge Offs as % of Average
Principal Outstanding................ 17.6% 23.0% 13.1% 18.2%
======== ======= ======== =======
</TABLE>
The Allowance on contracts was 18.5% of outstanding principal balances as
of March 31, 1998 and December 31, 1997, 23.0% at December 31, 1996, and 28.4%
at March 31, 1997. The Allowance at March 31, 1997 was significantly effected by
the Seminole portfolio acquisition in which the Company obtained $9.0 million of
Allowance on Acquired Loans on a total loan portfolio of $31.1 million,
resulting in a significant increase in the Allowance as a percentage of
outstanding principal balances.
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.
Recoveries as a percentage of principal balances charged off averaged 26.8%
for the year ended December 31, 1997 compared to 29.6% for the year ended
December 31, 1996, 32.8% for the three month period ended March 31, 1998, and
29.4%, for the three month period ended March 31, 1997. Loan recoveries in
Arizona are positively effected by the Company's ability to receive a sales tax
benefit for charged off loans that it does not receive in certain other markets.
As a result of the Company's expansion outside of the Arizona market in 1997,
recovery rates for the loan portfolio were negatively effected.
Static Pool Analysis. To monitor contract performance, beginning in June
1995, the Company implemented "static pool" analysis for contracts originated
since January 1, 1993. Static pool analysis is a monitoring methodology by which
each month's originations and subsequent charge offs are assigned to a unique
pool and the pool performance is monitored separately. Improving or
deteriorating performance is measured based on cumulative gross and net charge
offs as a percentage of original principal balances, based on the number of
complete payments made by the customer before charge off. The table below sets
forth the cumulative net charge offs as a percentage of original contract
cumulative balances, based on the quarter of origination and segmented by the
number of payments made prior to charge off. For periods denoted by "-", the
pools have not seasoned sufficiently to allow for computation of cumulative
losses. For periods denoted by "x", 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 is
presented on a quarterly basis.
Effective January 1, 1997, the Company modified its methodology to reflect
additional historical experience in computing "Monthly Payments Completed by
Customer Before Charge Off" as it relates to loan
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balances charged off after final insurance settlements and on loans modified
from their original terms. Resulting adjustments affect the timing of previously
reported interim cumulative losses, but do not impact ending cumulative losses.
For loan balances charged off after insurance settlement principal reductions,
the revised calculation method only gives credit for payments actually made by
the customer and excludes credit for reductions arising from insurance proceeds.
For modified loans, completed payments now reflect customer payments made both
before and after the loan was modified. The numbers presented below reflect the
adoption of the revised calculation method.
Currently reported cumulative losses may also vary from those previously
reported due to ongoing collection efforts on charged off accounts and the
difference between final proceeds on the liquidation of repossessed collateral
versus original accounting estimates. Management believes that such variation
will not be material.
The following table sets forth as of April 30, 1998, the cumulative net
charge offs as a percentage of original contract cumulative (pool) balances,
based on the quarter of origination and segmented by the number of monthly
payments completed by customer before charge off. Additionally, set forth is the
percent of principal reduction for each pool since inception and cumulative
total net losses incurred (TLI). Such data contains a revision of previously
reported data as a result of a recently detected computational error.
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
<TABLE>
<CAPTION>
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF
--------------------------------------------------------------
ORIG. 0 3 6 12 18 24 TLI REDUCED
------- --- ---- ---- ---- ---- ---- ---- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1993:
1st Quarter........... $ 2,326 6.9% 18.7% 26.5% 31.8% 33.9% 35.1% 35.4% 100.0%
2nd Quarter........... $ 2,942 7.2% 18.9% 25.1% 29.4% 31.7% 32.1% 32.4% 100.0%
3rd Quarter........... $ 3,455 8.6% 19.5% 23.7% 28.5% 30.7% 31.6% 31.9% 100.0%
4th Quarter........... $ 4,261 6.3% 16.1% 21.6% 27.0% 28.9% 29.5% 29.6% 100.0%
1994:
1st Quarter........... $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter........... $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter........... $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter........... $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter........... $ 8,191 1.1% 7.3% 12.2% 17.3% 19.8% 20.7% 20.8% 99.8%
2nd Quarter........... $ 9,845 1.7% 7.0% 11.8% 16.3% 19.1% 20.7% 21.0% 99.1%
3rd Quarter........... $10,106 1.9% 6.8% 10.8% 17.6% 21.4% 23.0% 23.4% 96.5%
4th Quarter........... $ 8,426 1.2% 5.6% 10.7% 17.5% 22.1% 23.7% 23.9% 94.5%
1996:
1st Quarter........... $13,635 1.3% 7.5% 13.2% 20.7% 24.7% x 26.1% 89.6%
2nd Quarter........... $13,462 2.2% 9.2% 13.9% 22.8% 26.7% -- 27.6% 83.6%
3rd Quarter........... $11,082 1.6% 7.1% 13.1% 21.8% x -- 26.2% 77.4%
4th Quarter........... $10,817 1.6% 8.9% 16.4% 24.8% -- -- 27.3% 71.7%
1997:
1st Quarter........... $16,279 2.2% 10.6% 17.6% x -- -- 24.7% 64.0%
2nd Quarter........... $25,875 1.5% 10.0% 16.1% -- -- -- 20.3% 50.9%
3rd Quarter........... $32,147 1.3% 8.5% x -- -- -- 14.4% 37.6%
4th Quarter........... $42,529 1.5% x -- -- -- -- 8.8% 26.8%
1998:
1st Quarter........... $69,708 x -- -- -- -- -- 2.2% 14.4%
2nd Quarter........... $67,202 x -- -- -- -- -- 0.1% 2.5%
</TABLE>
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The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
Company Dealership contract principal balances.
<TABLE>
<CAPTION>
RETAINED SECURITIZED MANAGED
-------- ----------- -------
<S> <C> <C> <C>
December 31,1997:
31 to 60 days............................................. 2.2% 4.5% 3.6%
61 to 90 days............................................. 0.6% 2.2% 1.5%
December 31,1996:
31 to 60 days............................................. 2.3% 5.4% 5.0%
61 to 90 days............................................. 0.6% 1.9% 1.7%
March 31, 1998:
31 to 60 days............................................. 1.2% 2.5% 2.2%
61 to 90 days............................................. 3.6% 0.9% 1.4%
</TABLE>
In accordance with the Company's charge off policy, there are no accounts
more than 90 days delinquent as of December 31, 1997 and 1996.
RESIDUALS IN FINANCE RECEIVABLES SOLD
Residuals in Finance Receivables Sold represent the Company's interests
through its Securitization Subsidiaries in the subordinated Class B certificates
in the securitization transactions. The Company utilizes a number of estimates
in arriving at the initial valuation of the Residuals in Finance Receivables
Sold, which represent the expected present value of net cash flows into the
Trust in excess of those required to pay principal and interest on the Class A
Certificates. The present value of expected cash flows is a function of a number
of items including, but not limited to, charge off rates, repossession recovery
rates, portfolio delinquency, prepayment rates, and Trust expenses. Subsequent
to the initial recording of the Residuals in Finance Receivables Sold, the
carrying value is adjusted for the actual cash flows into the respective Trusts
in order to maintain a carrying value which approximates the present value of
the expected net cash flows into the Trust in excess of those required to pay
all obligations of the respective Trust other than the obligations to the Class
B Certificates. To the extent that actual cash flows on a securitization are
below original estimates, and differ materially from the original securitization
assumptions, and in the opinion of management, those differences appear to be
other than temporary in nature, the Company would be required to revalue the
Residuals in Finance Receivables Sold, and record a charge to earnings based
upon the reduction. During the year ended December 31, 1997, the Company
recorded a $5.7 million charge (approximately $3.4 million, net of income taxes)
to write down the Residuals in Finance Receivables Sold. The Company determined
a write down in the Residuals in Finance Receivables Sold was necessary due to
an increase in net losses in the securitized loan portfolio.
With the exception of the Company's first two securitization transactions
which took place during the first six months of 1996, the estimated cash flows
into the Trusts were discounted with a rate of 16%. The two securitization
transactions that took place during the first six months of 1996 were discounted
with a rate of 25%. For securitization transactions between June 30, 1996 and
June 30, 1997, net losses were originally estimated using total expected
cumulative net losses at loan origination of approximately 26.0%, adjusted for
actual cumulative net losses prior to securitization. Prepayment rates were
estimated to be 1.5% per month of the beginning of month balance. The $5.7
million charge (approximately $3.4 million, net of income taxes) in the year
ended December 31, 1997 which resulted in a reduction in the carrying value of
the Company's Residuals in Finance Receivables Sold had the effect of increasing
the cumulative net loss assumption to approximately 27.5% for the securitization
transactions that took place prior to July 1, 1997. As a result of this charge,
the remaining allowance for credit losses inherent in the securitization
assumptions as a percentage of the remaining principal balances of securitized
contracts was approximately 17.9% as of December 31, 1997, compared to 16.2% as
of December 31, 1996. There can be no assurance that the charge taken by the
Company was sufficient and that the Company will not record additional charges
in the future in order to write down the Residuals in Finance Receivables Sold.
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<PAGE> 75
For the securitization transactions that took place during the two quarters
ended December 31, 1997, net losses were estimated using total expected
cumulative net losses at loan origination of approximately 27.5%, adjusted for
actual cumulative net losses prior to securitization. For the securitization
that was completed during the three month period ended March 31, 1998, net
losses were estimated using total cumulative net losses at loan organization of
approximately 29.5%, adjusted for actual cumulative net losses prior to
securitization. The estimated cash flows into the trust were discounted with a
rate of 16%.
The remaining allowance for credit losses inherent in the securitization
assumptions as a percentage of the remaining principal balances of securitized
contracts was approximately 22.2% as of March 31, 1998, compared to 17.9% as of
December 31, 1997 and 16.2% as of December 31, 1996. There can be no assurance
that the charge taken by the Company was sufficient and that the Company will
not record additional charges in the future in order to write down the Residuals
in Finance Receivables Sold.
The assumptions utilized in prior securitizations may not necessarily be
the same as those utilized in future securitizations. The Company classifies the
residuals as "held-to-maturity" securities in accordance with SFAS No. 115.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support increases in its contract
portfolio, expansion of Company Dealerships, the purchase of inventories, the
purchase of property and equipment, and for working capital and general
corporate purposes. The Company intends to continue to expand the Cygnet Dealer
Program until the Split-up is complete. The Company has funded its capital
requirements through equity offerings, operating cash flow, the sale of finance
receivables, and supplemental borrowings.
The Company's Net Cash Provided by (Used in) Operating Activities of
Continuing Operations decreased by 156.7% to ($13.7) million for 1997 from $24.1
million in 1996, compared to an increase of 272.1% from $6.4 million in 1995.
The decrease in 1997 was primarily due to increases in purchases of Finance
Receivables, Gain on Sale of Finance Receivables, and Increases in Inventory
offset by increases in Net Earnings, Provision for Credit Losses, proceeds from
sale of Finance Receivables and a decrease in collections of Finance
Receivables. The increase in 1996 was primarily due to increases in Net
Earnings, the Provision for Credit Losses, and collections of Finance
Receivables, offset by an increases in purchases of Finance Receivables, Other
Assets and the Gain on Sale of Loans.
The Company's Net Cash Provided by Operating Activities of Continuing
Operations increased by 5,219.8% or $18.2 million to $18.6 million for the three
month period ended March 31, 1998 from $349,000 in the three month period ended
March 31, 1997. The increase was primarily due to increases in proceeds from
sales of finance receivables, collections of finance receivables, the provision
for credit losses, decrease in inventory, offset by increases in the purchase of
finance receivables, and Gain on Sale of Finance Receivables.
Net Cash Used in Investing Activities of Continuing Operations increased by
498.3% to $62.9 million in the year ended December 31, 1997 from $10.5 million
in the year ended December 31, 1996. The increase was due primarily to the $5.3
million used for the net increase in Investments Held in Trust, $35.8 million
for the purchase of the assets of Seminole, EZ Plan, and Kars, and the $13.2
million increase used for the purchases of Property and Equipment. Net Cash Used
in Investing Activities of Continuing Operations decreased by 54.4% from $23.1
million in the year ended December 31, 1995 to $10.5 million in the year ended
December 31, 1996. The decrease was due primarily to a net increase in Finance
Receivables of $20.2 million and the $3.1 million used for the net increase in
the Investments Held in Trust, and the $2.6 million increase used for the
purchases of Property and Equipment.
The Net Cash Used in Investing Activities of Continuing Operations
increased by 4.6% or $383,000 to $8.7 million in the three months ended March
31, 1998 from $8.3 million in the three months ended March 31, 1997. The
increase was due to an increase in Investments Held in Trust and the purchase of
Property and Equipment. Further, the Company used $3.5 million for the purchase
of the assets of Seminole during the three month period ended March 31, 1997
compared to the three month period ended March 31, 1998 when no acquisition took
place.
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The Company's Net Cash Provided by Financing Activities of Continuing
Operations increased by 173.7% to $109.8 million in the year ended December 31,
1997 from $40.1 million in the year ended December 31, 1996. This increase was
the result of the $89.4 million in proceeds from the Company's private placement
of Common Stock, plus the addition of Notes Payable of $22.6 million. Net Cash
Provided by Financing Activities of Continuing Operations increased by 28.0% to
$40.1 million in the year ended December 31, 1996 from $31.3 million in the year
ended December 31, 1995. 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 of Continuing
Operations decreased by 82.3% or $61.3 million to $13.2 million in the three
month period ended March 31, 1998 from $74.5 million in the three month period
ended March 31, 1997. This decrease was primarily the result of the $88.7
million in proceeds from the Company's sale of common stock in the three month
period ended March 31, 1997, net of increases in notes payable and subordinated
notes payable.
The Company's Net Cash Used in Discontinued Operations increased by 31.1%
or $11.4 million to $48.1 million in the year ended December 31, 1997 from $36.7
million in the year ended December 31, 1996, compared to an increase of 171.5%
from $13.5 million in the year ended December 31, 1995. The increase in the
periods was primarily due to increases in finance receivables originated by the
discontinued operations.
The Company's Net Cash Used in Discontinued Operations increased by 122.4%
or $14.4 million to $26.1 million in the three month period ended March 31, 1998
from $11.7 million in the three month period ended March 31, 1997 due primarily
to an increase in finance receivables originated and retained by the
discontinued operations.
Revolving Facility. The Company maintains a revolving credit facility (the
"Revolving Facility") with General Electric Capital Corporation ("GE Capital")
that has a maximum commitment of up to $100.0 million. Under the Revolving
Facility, the Company may borrow up to 65.0% of the principal balance of
eligible contracts originated from the sale of used cars and up to 86.0% of the
principal balance of eligible contracts originated by the Branch Offices.
However, an amount up to $10 million of the borrowing capacity under the
Revolving Facility is not available at any time when the guarantee of the
Company to the Contract Purchaser (defined below under "Transactions Regarding
First Merchants Acceptance Corporation") is in effect. The Revolving Facility
expires in December 1998. The facility is secured by substantially all of the
Company's assets. As of March 31, 1998, the Company's borrowing capacity under
the Revolving Facility was $61.9 million, the aggregate principal amount
outstanding under the Revolving Facility was approximately $48.3 million, and
the amount available to be borrowed under the facility was $13.6 million. The
Revolving Facility bears interest at the 30-day LIBOR plus 3.15%, payable daily
(total rate of 8.8% as of March 31, 1998).
The Revolving Facility contains covenants that, among other things, limit
the Company's ability to, without GE Capital's consent: (i) incur additional
indebtedness; (ii) make unsecured loans or other advances of money to officers,
directors, employees, stockholders or affiliates in excess of $25,000 in total;
(iii) engage in securitization transactions (other than the Securitization
Program, for which GE Capital has consented); (iv) merge with, consolidate with,
acquire or otherwise combine with any other person or entity, transfer any
division or segment of its operations to another person or entity, or form new
subsidiaries; (v) make any change in its capital structure; (vi) declare or pay
dividends except in accordance with all applicable laws and not in excess of
fifteen percent (15%) of each year's net earnings available for distribution;
(vii) make certain investments and capital expenditures; and (viii) engage in
certain transactions with affiliates. These covenants also require the Company
to maintain specified financial ratios, including a debt ratio of 2.1 to 1 and a
net worth of at least $75,000,000, and to comply with all laws relating to the
Company's business. The Revolving Facility also provides that a transfer of
ownership of the Company that results in less than 15.0% of the Company's voting
stock being owned by Mr. Ernest C. Garcia II will result in an event of default
under the Revolving Facility.
Under the terms of the Revolving Facility, the Company is required to
maintain an interest coverage ratio which the Company failed to satisfy during
the first quarter of 1998. This was primarily as a result of the
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charges taken with respect to the closure of the Branch Office network, for
which the Company incurred a loss from discontinued operations of $5.4 million
(net of income tax benefit of $3.7 million.) GE Capital has waived the covenant
violation as of March 31, 1998.
The Company's Revolving Facility currently contains provision for
borrowings based upon eligible finance receivable contracts and does not provide
for borrowings based upon contracts or notes receivable acquired or issued
pursuant to the Cygnet Dealer Program. Further, the Revolving Facility does not
contain provision for borrowing against the Company's inventory. The Company
considers these assets to be sources of additional liquidity and, therefore, is
currently exploring alternatives regarding obtaining financing secured by the
assets generated by the Cygnet Dealer Program and the Company's inventory.
Subordinated Indebtedness and Preferred Stock. Prior to its public
offering in June 1996, the Company historically borrowed substantial amounts
from Verde Investments Inc. ("Verde"), an affiliate of the Company. The
Subordinated Notes Payable balances outstanding to Verde totaled $12.0 million
as of March 31, 1998 and December 31, 1997, respectively. Subsequent to March
31, 1998, the Company made a $2.0 million payment on the Subordinated Note
Payable. Prior to June 21, 1996, these borrowings accrued interest at an annual
rate of 18.0%. Effective June 21, 1996 the annual interest rate on these
borrowings was reduced to 10.0%. The Company is required to make monthly
payments of interest and annual payments of principal in the amount of $2.0
million. This debt is junior to all of the Company's other indebtedness and the
Company may suspend interest and principal payments in the event it is in
default on obligations to any other creditors. In July 1997, the Company's Board
of Directors approved the prepayment of the $12.0 million in subordinated debt
after the earlier of (1) the Company's completion of a debt offering; or (2) at
such time as (a) the FMAC transactions (described below under "Transactions with
First Merchants Acceptance Corporation") have been completed or the cash
requirements for completion of said transaction are known, and (b) the company
either has cash in excess of its current needs or has funds available under its
financing sources in excess of its current needs. No such prepayment has been
made as of the date of filing of this Proxy. Any such prepayment would require
the consent of the lenders in the Company's subordinated debt offering effected
in February 1998 as described below.
In February 1998, the Company issued $15.0 million in subordinated notes to
unrelated parties. The unsecured three year notes call for interest at 12% per
annum payable quarterly and are senior to the Verde subordinated note payable.
In connection with the issuance of the senior subordinated notes payable, the
Company issued warrants, which were valued using the Bloch-Scholes
option-pricing model at approximately $900,000, to the lenders to purchase up to
500,000 shares of the Company's common stock at an exercise price of $10.00 per
share exercisable at any time until the later of (1) February 2001, or (2) such
time as the notes have been paid in full.
Additional Financing. On January 28, 1998, the Company issued a $7.0
million note payable which accrued interest at 9.5% per annum. The Company paid
this note payable in full on April 1, 1998.
On February 19, 1998, the Company executed a $30.0 million short term
standby repurchase credit facility. Pursuant to the terms of this facility, the
lender agreed to purchase, subject to repurchase rights of the Company, certain
eligible sub-prime automobile finance receivables originated and or purchased by
the Company for a purchase price (and corresponding repurchase obligation) of no
more than $30.0 million. During the three month period ended March 31, 1998, the
lender purchased approximately $30.0 million in contracts pursuant to the
facility which accrued interest at a rate of 9.5% per annum. The Company
exercised its repurchase obligation on March 24, 1998.
Securitizations. The Company's Securitization Program is a primary source
of funding for the Company. Under this program, the Company sold approximately
$170.4 million in certificates secured by contracts to SunAmerica through
securitizations effected prior to June 30, 1997. Since June 30, 1997, the
Company has consummated additional securitizations under the Securitization
Program with private investors through Greenwich Capital Markets, Inc.
("Greenwich Capital"). In February 1998, the Company executed a commitment
letter with Greenwich Capital under which, among other things, Greenwich Capital
will become the exclusive securitization agent for the Company for up to $1.0
billion of AAA-rated surety wrapped securities as part of the Company's ongoing
Securitization Program.
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At the closing of each securitization, the Securitization Subsidiaries
receive payment for the certificates sold (net of Investments Held in Trust).
The Company also generates cash flow under this program from ongoing servicing
fees and excess cash flow distributions resulting primarily from the difference
between the payments received from customers on the contracts and the payments
paid on the Class A Certificates. In addition, securitization allows the Company
to fix its cost of funds for a given contract portfolio, and broadens the
Company's capital source alternatives. Failure to periodically engage in
securitization transactions will adversely affect the Company.
In connection with its securitization transactions, the Securitization
Subsidiaries are required to make an initial cash deposit into an account held
by the trustee (spread account) and to pledge this cash to the Trust to which
the finance receivables were sold. The Trust in turn invests the cash in high
quality liquid investment securities. In addition, the cash flows due to the B
Certificates first are deposited into the spread account as necessary to attain
and maintain the spread account at a specified percentage of the underlying
finance receivables principal balance. In the event that the cash flows
generated by the finance receivables sold to the Trust are insufficient to pay
obligations of the Trust, including principal or interest due to certificate
holders or expenses of the Trust, the trustee will draw funds from the spread
account as necessary to pay the obligations of the Trust. The spread account
must be maintained at a specified percentage of the principal balances of the
finance receivables held by the Trust, which can be increased in the event
delinquencies or losses exceed specified levels. If the spread account exceeds
the specified percentage, the trustee will release the excess cash to the
Securitization Subsidiaries from the pledged spread account.
Debt Shelf Registration. On July 18, 1997, the Company filed a Form S-3
registration statement for the purpose of registering up to $200 million of its
debt securities in one or more series at prices and on terms to be determined at
the time of sale. The registration statement has been declared effective by the
Securities and Exchange Commission and is available for future debt offerings.
Transactions Regarding First Merchants Acceptance Corporation. The Company
was actively involved in the bankruptcy proceedings of First Merchants
Acceptance Corporation ("FMAC"). FMAC was in the business of purchasing and
securitizing loans made primarily to sub-prime borrowers by various Third Party
Dealers. In various transactions relating to the FMAC bankruptcy proceedings,
the Company, among other things, (1) purchased the secured claims of certain
creditors of FMAC, sold the contracts securing such claims at a profit to a
third party purchaser, guaranteed the purchaser a specified return on the
contracts and obtained a related guarantee from FMAC secured by, among other
things, the stock of certain entities holding residual interests and certain
equity certificates in various securitized loan pools of FMAC, and entered into
servicing arrangements with respect to such contracts; (2) made
debtor-in-possession loans to FMAC, secured as described above, and received
interest income therefrom; (3) entered into various servicing agreements with
respect to receivables in the securitized pools of FMAC; (4) obtained rights to
receive certain payments with respect to distributions on residual interests in
such securitized pools and obtained certain interests in charged off receivables
in such pools; (5) obtained rights to certain fees; (6) obtained the FMAC
servicing platform; and (7) issued certain warrants to purchase Company Common
Stock consisting of (a) warrants issued to FMAC's bank group to purchase up to
389,800 shares of the Company's Common Stock at an exercise price of $20.00 per
share at any time through February 20, 2000, and subject to a call feature by
the Company if the closing market price of the Company's Common Stock equals or
exceeds $27.00 per share for a period of five consecutive trading days, and (b)
warrants issued to FMAC to purchase 325,000 shares of the Company's Common Stock
at any time through April 1, 2001 at a price of $20.00 per share, subject to a
call feature by the Company if the closing market price of the Company's Common
Stock equals or exceeds $28.50 per share for a period of 10 consecutive trading
days. The Company also contributed to FMAC all of its shares of FMAC common
stock in exchange for the assets constituting FMAC's servicing platform.
It is the Company's intent to transfer substantially all of the rights and
liabilities related to the FMAC transaction (except cash received by the Company
prior to the Effective Date) to Cygnet in conjunction with the Split-up.
However, the Company will remain liable as to certain liabilities in the FMAC
transaction. For additional information concerning the FMAC transaction, and the
liabilities that will be retained by the Company with respect thereto following
the Split-up, see "Risk Factors -- Risks Relating to the FMAC
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Transaction." The transactions described above were consummated primarily by the
Company's discontinued 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, certain of these companies have filed for bankruptcy protection.
These announcements have had a disruptive effect on the market for securities of
sub-prime automobile finance companies, have resulted in a tightening of credit
to the sub-prime markets, and could lead to enhanced regulatory oversight. A
reduction in access to the capital markets or to credit sources could have an
adverse affect on the Company.
Capital Expenditures and Commitments. The Company is pursuing an
aggressive growth strategy. In January 1997, the Company acquired selected
assets of a group of companies engaged in the business of selling and financing
used motor vehicles, including four dealerships located in the Tampa Bay/St.
Petersburg market (Seminole). In March 1997, the Company opened its first used
car dealership in the Las Vegas market. In April 1997, the Company acquired
selected assets of a company in the business of selling and financing used motor
vehicles, including seven dealerships located in the San Antonio market (EZ
Plan). In September 1997, the Company acquired selected assets of a company in
the business of selling used motor vehicles, including six dealerships in the
Los Angeles market, two in the Miami market, two in the Atlanta market and two
in the Dallas market (Kars).
In the first quarter of 1998, the Company opened three new dealerships.
Further, the Company currently has one dealership in San Antonio, two
dealerships in Los Angeles, three dealerships in Atlanta, four dealerships in
Dallas, two dealerships in Tampa, one dealership in Las Vegas, and one
dealership in Albuquerque currently under development. The Company believes that
it will expend approximately $1.5 to $1.7 million to construct (excluding
inventory) each Company Dealership.
On July 11, 1997, the Company entered into an agreement, as amended, to
provide "debtor in possession" financing to FMAC in an amount up to $21.5
million to be adjusted downward from time to time. As of July 1, 1998, the
maximum commitment was reduced to $12.4 million and the outstanding balance on
the DIP Facility totaled $9.8 million. The Company expects the maximum
commitment to be further reduced to $11.5 million in the next six months as FMAC
receives additional income tax refunds from various taxing jurisdictions.
The Company intends to finance these expenditures through operating cash
flows and supplemental borrowings, including amounts available under the
Revolving Facility and the Securitization Program, if any.
Sale-Leaseback of Real Property. In March 1998, the Company executed a
commitment letter with an investment company for the sale-leaseback of up to
$37.0 million in real property. Pursuant to the terms of the commitment letter,
which is subject to final negotiation, approval of the Company's Board of
Directors, and execution of definitive agreements, the Company would sell
certain real property to the investment company for its original cost and
leaseback the properties for an initial term of twenty years. The Company would
retain certain extension options, and pay monthly rents of approximately
one-twelfth of 10.75% of the purchase price plus all occupancy costs and taxes.
The commitment letter calls for annual increases in the monthly rents of not
less than 2%. On May 14, 1998, the Company completed the first closing of the
sales-leaseback transaction. In conjunction with this closing, the Company sold
property for approximately $21.8 million. Substantially all of the proceeds from
the sale were utilized to pay down the Revolving Facility.
Common Stock Repurchase Program. In October 1997, the Company's Board of
Directors authorized a stock repurchase program by which the Company may acquire
up to one million shares of its Common Stock from time to time on the open
market. Under the program, purchases may be made depending on market conditions,
share price, and other factors. The stock repurchase program will terminate on
December 31, 1998, unless extended by the Company's Board of Directors, and may
be discontinued at any time. As of the date of filing of this Proxy Statement,
the Company had repurchased 28,000 shares of its Common Stock.
Reliance Transaction. In February 1998, the Company entered into servicing
and transition servicing arrangements with Reliance Acceptance Group, Inc.
("Reliance"), which company also filed a voluntary
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petition for relief under Chapter 11 of the Bankruptcy Code that same month. It
is the Company's intent to transfer all contract rights and liabilities related
to, and assets (except cash received by the Company prior to the Effective Date)
obtained in, the Reliance transaction to the Company's discontinued operations
in conjunction with the Split-up. However, the Company will remain liable as to
certain obligations in the Reliance transaction. See "Risk Factors -- Risks
Relating to the Reliance Transaction." The following is a general description of
the Reliance transaction.
Pursuant to the servicing agreement entered into between the Company and
Reliance (the "Servicing Agreement"), as amended, following the Effective Date,
the Company will service certain receivables of Reliance in exchange for (i) a
monthly servicing fee of the greater of four percent (4%) per annum of the
aggregate outstanding principal balance of all non-defaulted receivables
computed monthly on the basis of the declining balance of the receivables
portfolio (consisting of Reliance's portfolio of (A) prime receivables and (B)
sub-prime receivables), or fifteen dollars ($15.00) per receivable per month
plus reimbursement of certain costs and expenses; (ii) $1.3 million in proceeds
realized from the sale of a pool of charged off receivables existing as of the
Reliance petition date ("Charged-Off Proceeds"); (iii) a total of (A) four
percent (4%) of the outstanding principal balance of each receivable (exclusive
of defaulted and certain other receivables) sold in any bulk sale to a person
other than the Company or an affiliate of the Company, and (B) $3.25 million in
net collections, recovery, and sale proceeds from the receivables portfolio and
certain other cash receipts of Reliance reduced by any amount previously paid
under clause (A) above, following payment of Reliance's primary bank debt and,
if applicable, repayment to Reliance of any proceeds of litigation, the Reliance
Warrants (as defined below), and equity proceeds used by Reliance to pay its
primary bank debt ("Post-Bank Debt Proceeds"); and (iv) following the Company's
receipt of the Post-Bank Debt Proceeds, fifteen percent (15%) of the net
collections, recovery, and sale proceeds from the receivables portfolio and
certain other cash receipts of Reliance (the "Incentive Fee"). Reliance, in
consideration for entering into the Servicing Agreement will receive privately
issued warrants ("Reliance Warrants") to purchase shares of Common Stock of the
Company as follows: fifty thousand (50,000) Reliance Warrants will be granted to
Reliance upon the Company's receipt of the Charged-Off Proceeds; up to one
hundred thousand (100,000) Reliance Warrants will be granted to Reliance based
upon the Company's receipt of up to $3.25 million of Post-Bank Debt Proceeds;
and Reliance will be granted an additional seventy-five thousand (75,000)
Reliance Warrants for every $1 million actually received by the Company through
the Incentive Fee. The Reliance Warrants will have a strike price of twelve
dollars and 50/100 ($12.50) for the first one hundred fifty thousand (150,000)
Reliance Warrants and a strike price for all other Reliance Warrants of the
greater of twelve dollars and 50/100 ($12.50) or one hundred twenty percent
(120%) of the market price of the Common Stock on the date of issuance of the
Reliance Warrants. The Reliance Warrants will be exercisable as follows: (i) the
first 50,000 Reliance Warrants will be exercisable for three years from the
Reliance Petition Date and (ii) all remaining Reliance Warrants will be
exercisable for three years from the date of issuance.
As of the close of business on the effective date of Reliance's plan of
reorganization (July 31, 1998), the Company will purchase Reliance's furniture,
fixtures, and equipment, including computer software and hardware and related
licenses for $250,000, payable in twelve equal monthly installments over a
period of one year beginning August 15, 1998, and will have a period of sixty
days to require Reliance to assume and assign to the Company any of the leases
or other contracts not previously rejected by Reliance.
Year 2000. The Company has commenced certain limited reviews and
assessments of its computer systems in order to evaluate its exposure to year
2000 issues. The Company has incurred costs and expenses of approximately
$25,000 to date in evaluating its year 2000 issues. The Company expects to make
modifications or changes to its computer information systems to enable proper
processing of transactions relating to the year 2000 and beyond. The Company
estimates total costs and expenses to be between $500,000 to $1,000,000 to
modify its existing systems and make it year 2000 compliant. The Company
considers year 2000 costs and expenses to be material to its operation and
financial position. The Company will evaluate appropriate courses of action,
including replacement of certain systems whose associated costs would be
recorded as assets and subsequently amortized, or modification of its existing
systems which costs would be expended as incurred. Resolution of all year 2000
issues is critical to the Company's business. There can be no assurance that the
Company will be able to completely resolve all year 2000 issues in a timely
fashion or that the ultimate cost to
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identify and implement solutions to all year 2000 problems will not exceed the
Company's estimated range for year 2000 costs provided above. Failure to resolve
year 2000 issues would have a material adverse effect on the Company's business,
financial condition, and results of operations.
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, and for bulk
purchases, by increasing the purchase discount at which the Company purchases
the contract portfolio. To date, inflation has not had a significant impact on
the Company's operations.
ACCOUNTING MATTERS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130) which became effective for the Company January 1, 1998. SFAS No. 130
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general-purpose financial statements. The Company
had no comprehensive income.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131) which became effective for
the Company January 1, 1998. SFAS No. 131 establishes standards for the way that
public enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim reports issued to stockholders.
Management does not believe that the adoption of SFAS No. 131 will have a
material effect on the Company's disclosures.
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BUSINESS OF THE COMPANY AFTER THE SPLIT-UP
Subsequent to the Split-up, the Company, together with its then
subsidiaries, will focus primarily on the sale and financing of used motor
vehicles to the sub-prime market. Substantially all of the third party financing
operations currently operated by the Company will be operated by Cygnet. The
following describes the Company giving effect to the disposition of Cygnet.
GENERAL
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. The Company began its used car sales and financing operations in
1992 and has pursued an aggressive growth strategy since that time. 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 Sub-Prime Borrowers. As of the date of this Proxy Statement, the Company is
operating 47 Company Dealerships located in nine metropolitan areas in seven
states.
During 1997, the Company originated 16,001 contracts through its Company
Dealerships with an aggregate principal balance of $116.8 million. The principal
balance of the Company's total contract portfolio serviced as of December 31,
1997, was $451.3 million, including $238.0 million in contracts serviced under
the Company's Securitization Program and $127.3 million on behalf of third
parties. During the three month period ended March 31, 1998, the Company
originated 9,339 contracts through its Company Dealerships with an aggregate
principal balance of $69.7 million. As of March 31, 1998, the Company's total
contract portfolio serviced was $462.1 million, including $276.2 million in
contracts serviced under the Securitization Program, $98.8 million on behalf of
third parties, and $53.9 million from the discontinued Branch Office portfolio.
The Company was formed in Arizona in 1992 for the purpose of purchasing
Duck Ventures, Inc. and other subsidiaries and was reincorporated in Delaware in
1996. Except as otherwise specified, all references in this Proxy Statement to
the "Company" refer to Ugly Duckling Corporation and its subsidiaries.
OVERVIEW OF USED CAR SALES AND FINANCE INDUSTRY
Used Car Sales. 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 ("Buy Here -- Pay Here
dealers") that sell and finance the sale of used cars to Sub-Prime Borrowers.
Buy Here -- Pay Here dealers typically offer their customers certain advantages
over more traditional financing sources, such as expanded credit opportunities,
flexible payment terms (including prorating customer payments due within one
month into several smaller payments and scheduling 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 Car Max, 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. The 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
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categorized according to the type of car sold (new versus used) and the credit
characteristics of the borrower. Sub-prime Borrowers are generally classified
according to the following 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. 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.
RECENT ACQUISITIONS
During 1997, the Company completed several acquisitions. In January 1997,
the Company acquired substantially all of the assets of Seminole, including four
dealerships in Tampa/St. Petersburg and a contract portfolio of approximately
$31.1 million in exchange for approximately $2.5 million in cash and assumption
of $29.9 million in debt. In April 1997, the Company purchased substantially all
of the assets of EZ Plan, including seven dealerships in San Antonio and a
contract portfolio of approximately $24.3 million in exchange for approximately
$26.3 million in cash. In September 1997, the Company acquired substantially all
of the dealership and loan servicing assets (but not the loan portfolio) of
Kars, including six dealerships in the Los Angeles market, two in the Miami
market, two in the Atlanta market and two in the Dallas market, in exchange for
approximately $5.5 million in cash. These acquisitions were recorded in
accordance with the "purchase method" of accounting, and, accordingly, the
purchase price was allocated to the assets purchased and the liabilities assumed
based upon the estimated fair values at the date of acquisition. The excess of
the purchase price over the fair values of the net assets acquired was
approximately $14.8 million and was recorded as goodwill, which is being
amortized over periods ranging from fifteen to twenty years. The results of
operations of the acquired operations have been included in the Company's
consolidated statements of operations from the respective acquisition dates.
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 $123.8
million, $53.8 million, and $47.8 million ($46.6 million excluding sales at the
Gilbert Dealership which was closed at the end of 1995) for the years ended
December 31, 1997, 1996, and 1995, respectively.
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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, regional centralized purchasing, value-added marketing programs, and
dedication to customer service. Company Dealerships are generally 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 50 to 200
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. 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
or reconditioning centers, where they are inspected and reconditioned for sale.
The average sales price per car at Company Dealerships was $7,443, $7,107, and
$6,065 for the years ended December 31, 1997, 1996, and 1995 (exclusive of sales
at the Company's Gilbert Dealership), respectively. 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 generally ranging from 21.0% to
29.9% over periods generally ranging from 12 to 48 months. Except for vehicles
sold in the Phoenix, Arizona market, where the Company offers a one month, 1,000
mile warranty, 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 may subsequently
occur.
Used Car Financing. The Company finances approximately 95.0% of the used
cars sold 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 before the Company
will agree to finance the purchase of a car. The Company created these
underwriting guidelines 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 then 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 typically 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 reviewed by the
Company's loan review department for compliance with the Company's underwriting
standards and reverification of certain information relating to the borrower. To
the extent such reviews reveal non-compliance, such non-compliance is discussed
with dealership management and, where appropriate, remedial action is taken
against the responsible manager.
Advertising and Marketing. The Company's advertising campaigns generally
emphasize its multiple locations, wide selection of quality used cars, and
ability to provide financing to most Sub-Prime Borrowers.
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The Company's advertising campaign revolves around a series of radio and
television commercials that feature the Company's animated duck mascot, as well
as complementary 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.
A primary focus of the Company's marketing strategy is its ability to
finance consumers with poor credit histories. Consequently, the Company has
initiated 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.
- Visa Card Program. Pursuant to this program, the Company arranges for
qualified applicants to obtain a Visa credit card backed by a partially
refundable payment of approximately $175 or $250 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.
Dealership Management -- Responsibilities 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. The Company trains its general managers and sales 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.
LOAN SERVICING -- MONITORING AND COLLECTIONS
One of the Company's goals is to minimize credit losses through close
monitoring of contracts its services. Relating to this, upon the origination of
a contract, where necessary, Company personnel enter all terms of the contract
into the Company's computer systems. The Company's monitoring and collections
staff then utilize the Company's collections software to monitor the performance
of the contracts. The Company currently services its loan portfolios on loan
servicing and collection data processing systems on various platforms. However,
the Company is in the process of converting substantially all of the loan
servicing and collections data processing systems of the Continuing Company
Businesses to a single loan servicing and collections data processing system.
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
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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 retain 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 its credit loss.
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 approximately 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.
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.
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 Car Max, which have entered the used car sales
business. 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. However, none of these companies have indicated an intention
to focus on the Buy Here-Pay Here segment of the market.
The Company's primary 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 on a regional basis, 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 a technology-based corporate infrastructure that
enables the Company to monitor and service large volumes of contracts.
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 significantly in excess
of traditional finance companies on the contracts originated at its Company
Dealerships. Historically, a significant portion of the Company's used car sales
activities were conducted in, and a significant portion 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
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limits, such as Florida and Texas. The Company attempts to mitigate these rate
restrictions by attempting to obtain higher sales prices on the cars it sells.
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 the Effective Date, it is expected that the Company will employ
approximately 1,900 persons in the Continuing Company Businesses. None of the
Company's employees are covered by a collective bargaining agreement.
SEASONALITY
Historically, the Company has experienced higher same store 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.
PROPERTIES
As of May 31, 1998, the Company leased substantially all of its facilities,
of which 54 were Branch Office locations that the Company closed in 1998. The
Company is continuing to negotiate lease settlements and terminations with
respect to its Branch Office network closure. The Company's corporate
headquarters is located in approximately 30,000 square feet of leased space in
Phoenix, Arizona. Following the Split-up, the Company expects to move to new
office space under a lease of similar terms and conditions, at or near the
current location.
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<PAGE> 88
MANAGEMENT OF THE COMPANY
BOARD OF DIRECTORS, BOARD COMMITTEES, AND MEETINGS
BOARD OF DIRECTORS. During the year ended December 31, 1997, the Board of
Directors of the Company met on 19 occasions. No Company officer or former
officer was a member of the Board of Directors, except for Mr. Garcia.
COMPENSATION COMMITTEE. The Compensation Committee of the Board of
Directors, which consists of Messrs. Jennings and Willey, met nine times during
1997. The Compensation Committee reviews executive salaries and administers any
bonus, incentive compensation, and stock option plans of the Company, including
the Incentive Plan. In addition, the Compensation Committee consults with
management of the Company regarding compensation policies and practices of the
Company. The Report of the Compensation Committee for 1997 is set forth below.
No Company officer or former officer was a member of the Compensation Committee.
Following the Effective Date of the Split-up, Mr. Garcia will also be a member
of the Compensation Committee.
AUDIT COMMITTEE. The Audit Committee, which prior to Mr. Moreno's
resignation effective June 30, 1998, consisted of Messrs. Abrahams and Moreno
and currently consists of Mr. Abrahams alone, met one time during 1997. The
Audit Committee reviews the professional services provided by the Company's
independent auditors, the annual financial statements of the Company, and the
Company's system of internal controls. No Company officer or former officer was
a member of the Audit Committee. Following the Annual Meeting, Mr. Abrahams will
continue to be the sole member of the Audit Committee until the Effective Date
of the Split-up, when Mr. Garcia will also be a member of the Audit Committee.
OTHER COMMITTEES. The Company does not maintain a nominating or similar
committee.
DIRECTOR ATTENDANCE. During 1997, the incumbent Company directors attended
75% or more of both the meetings of the Company board and board committees on
which they served, except for one director. Mr. Moreno attended 68% of the
meetings of the Board of Directors. Board and board committee meetings include
regular and special meetings and actions by unanimous written consent. In
addition to board and committee meetings, directors discharge their
responsibilities throughout the year by personal meetings and telephone contact
with Company executive officers and others regarding the business and affairs of
the Company and its subsidiaries.
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INFORMATION CONCERNING DIRECTORS AND EXECUTIVE OFFICERS
Information concerning the names, ages, terms, positions with the Company,
and business experience of the Company's current directors and executive
officers is set forth below as of July 1, 1998.
<TABLE>
<CAPTION>
TERM AS
DIRECTOR DIRECTOR
DIRECTOR/ OFFICER NAME AGE POSITION EXPIRES SINCE
- ---------------------- --- -------- -------- ------------
<S> <C> <C> <C> <C>
Ernest C. Garcia II(1)(2).............. 41 Chairman of the Board and Chief 1998 1992(3)
Executive Officer
Robert J. Abrahams(1).................. 71 Director 1998 June 1996(4)
Christopher D. Jennings(2)............. 44 Director 1998 June 1996(4)
John N. MacDonough..................... 54 Director 1998 June 1996(4)
Frank P. Willey(2)..................... 44 Director 1998 June 1996(4)
Gregory B. Sullivan(5)................. 40 President and Chief Operating
Officer
Steven P. Johnson...................... 38 Senior Vice President and
General Counsel
Russell J. Grisanti.................... 51 Executive Vice President --
Operations
Steven T. Darak........................ 50 Senior Vice President and Chief
Financial Officer
Steven A. Tesdahl...................... 39 Senior Vice President and Chief
Information Officer
Donald L. Addink....................... 48 Vice President -- Senior Analyst
Peter R. Fratt......................... 40 Vice President -- Real Estate
Eric J. Splaver........................ 35 Corporate Controller
</TABLE>
- ---------------
(1) Member of the Audit Committee. Mr. Abrahams will be the sole member of the
Audit Committee until Mr. Garcia joins the Audit Committee following the
Effective Date.
(2) Member of the Compensation Committee. Following the Effective Date, Mr.
Garcia will also be a member of the Compensation Committee.
(3) Elected upon the Company's founding in 1992.
(4) Elected on or around the date the Company made an initial public offering of
its Common Stock.
(5) Mr. Sullivan has been nominated as a director in place of Mr. Moreno, who
resigned from the Company's Board of Directors effective June 30, 1998
because of time constraints relating to family and other business interests.
Ernest C. Garcia II has served as the Chairman of the Board and Chief
Executive Officer of the Company since its founding in 1992, and served as
President from 1992 to 1996. Since 1991, Mr. Garcia has served as President of
Verde, a real estate investment corporation that is also an affiliate of the
Company. Mr. Garcia's sister is married to Mr. Johnson.
Robert J. Abrahams has served as a director of the Company since June 1996.
Mr. Abrahams has served since 1988 as a consultant to the financing industry,
including service as a consultant to the Company from 1994 to 1995. From 1960 to
1988, Mr. Abrahams was an executive officer of Heller Financial, Inc., a finance
company. Prior to joining Heller Financial, Inc., Mr. Abrahams co-founded
Financial Acceptance Company in 1948. Mr. Abrahams is also a director of Smart
Choice Automotive Group, Inc., a retail automotive and finance company, and HMI
Industries, Inc., a manufacturing and direct selling company. Mr. Abrahams
serves as a member of the Audit Committee of the Board of Directors.
Christopher D. Jennings has served as a director of the Company since June
1996. Mr. Jennings currently serves as Managing Director of Friedman, Billings,
Ramsey & Co., Inc., an investment banking firm. Mr. Jennings served as a
managing director of Cruttenden Roth Incorporated ("Cruttenden Roth"), an
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<PAGE> 90
investment banking firm, from 1995 to April 1998. From 1992 to 1994, Mr.
Jennings served as a Managing Director of investment banking at Sutro & Co., an
investment banking firm. From 1989 to 1992, Mr. Jennings served as a Senior
Managing Director at Maiden Lane Associates, Ltd., a private equity fund. Prior
to 1989, Mr. Jennings served in various positions with, among others, Dean
Witter Reynolds, Inc. and Warburg Paribas Becker, Inc., both of which are
investment banking firms. Mr. Jennings serves as a member of the Compensation
Committee of the Board of Directors. See "Management of the Company -- Certain
Relationships and Related Transactions" and "-- Security Ownership of Certain
Beneficial Owners and Management."
John N. MacDonough has served as a director of the Company since June 1996.
Mr. MacDonough has served as Chairman and Chief Executive Officer of Miller
Brewing Company, a brewer and marketer of beer, since 1993, having previously
served from 1992 to 1993 as President and Chief Operating Officer of that
company. Prior to 1992, Mr. MacDonough was employed in various positions at
Anheuser Busch, Inc., also a brewer and marketer of beer. Mr. MacDonough is also
a director of Marshall & Ilsley Bank. Mr. MacDonough is married to the sister of
Mr. Sullivan.
Frank P. Willey has served as a director of the Company since June 1996.
Mr. Willey has served as the President of Fidelity National Financial, Inc., one
of the nation's largest title insurance underwriters, since January 1995. From
1984 to 1995, Mr. Willey served as the Executive Vice President and General
Counsel of Fidelity National Title. Mr. Willey is also a director of Fidelity
National Financial, Inc., CKE Restaurants, Inc., an operator of various
quick-service restaurant chains, and Southern Pacific Funding Corporation, a
specialty finance company that originates, purchases, and sells high-yield,
non-conforming mortgage loans. Mr. Willey serves as a member of the Compensation
Committee of the Board of Directors.
Gregory B. Sullivan has served as President and Chief Operating Officer of
the Company since March 1996. Mr. Sullivan has also served as President of Ugly
Duckling Car Sales, Inc. since December 1996. From 1995 through February 1996,
Mr. Sullivan was a consultant to the Company. Mr. Sullivan formerly served as
President and principal stockholder of National Sports Games, Inc., an amusement
game manufacturing company that he co-founded in 1989 and sold in 1994. Prior to
1989, Mr. Sullivan was involved in the securities industry and practiced law
with a large Arizona firm. He is an inactive member of the State Bar of Arizona.
Mr. Sullivan's sister is married to Mr. MacDonough. Mr. Sullivan has been
nominated to the Board of Directors of the Company to replace Mr. Moreno.
Russell J. Grisanti has served as Executive Vice President of the Company
since June of 1997. From 1989 to 1991, Mr. Grisanti served as the President of
Brookland Financial; from 1991 to 1994, Mr. Grisanti served as the President of
Kars-Yes Financial, Inc.; and from 1995 to 1996, Mr. Grisanti served as
President of Central Auto Sales. From 1996 to June 1997, Mr. Grisanti provided
consulting services to various companies in the automobile sales and financing
industry. Mr. Grisanti has also held positions as Chief Financial Officer of
various savings and loan associations and real estate firms and was an Audit
Manager with Coopers & Lybrand LLP. Mr. Grisanti is a CPA and has an MBA.
Steven P. Johnson has served as Senior Vice President, Secretary, and
General Counsel of the Company since its founding in 1992. Since 1991, Mr.
Johnson has also served as the General Counsel of Verde, an affiliate of the
Company. Prior to 1991, Mr. Johnson practiced law in Tucson, Arizona. Mr.
Johnson is licensed to practice law in Arizona and Colorado and is married to
the sister of Mr. Garcia.
Steven T. Darak has served as the Senior Vice President and Chief Financial
Officer of the Company since February 1994, having joined the Company in 1994 as
Vice President and Chief Financial Officer. From 1989 to 1994, Mr. Darak owned
and operated Champion Financial Services, Inc., a used car finance company that
the Company acquired in early 1994. Prior to 1989, Mr. Darak served in various
positions in the banking industry and in public accounting.
Steven A. Tesdahl has served as Senior Vice President and Chief Information
Officer since September 1997. From 1993 to 1997, Mr. Tesdahl was a Partner with
Andersen Consulting, a leading global provider of business integration
consulting services. Prior to 1993, Mr. Tesdahl was an Associate Partner with
Andersen Consulting.
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<PAGE> 91
Donald L. Addink has served as the Vice President -- Senior Analyst of the
Company since 1995 and also serves as the Vice President of Verde. From 1988 to
1995, Mr. Addink served as Executive Vice President of Pima Capital Co., a life
insurance holding company. Prior to 1988, Mr. Addink served in various
capacities with a variety of insurance companies. Mr. Addink is a Fellow of the
Society of Actuaries and a Member of the American Academy of Actuaries.
Peter R. Fratt has served as Vice President -- Real Estate of the Company
since October 1993. From 1989 to 1993, Mr. Fratt was an associate of CB
Commercial Real Estate Services. Prior to that time, Mr. Fratt was involved in
commercial real estate brokerage and investment.
Eric J. Splaver has served as Corporate Controller of the Company since May
1994. From 1986 to 1994, Mr. Splaver worked as a certified public accountant
with KPMG Peat Marwick LLP.
Directors of the Company are elected for one year terms. Each director of
the Company serves until the following annual meeting of the Company, until his
successor is duly elected and qualified, or until retirement, resignation, or
removal. Executive officers of the Company serve at the discretion of the Board
of Directors.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
Prior to 1992, when he founded the Company, Mr. Garcia was involved in
various real estate, securities, and banking ventures. Arising out of two
transactions in 1987 between Lincoln Savings and Loan Association ("Lincoln")
and entities controlled by Mr. Garcia, the Resolution Trust Corporation (the
"RTC"), which ultimately took over Lincoln, asserted that Lincoln improperly
accounted for the transactions and that Mr. Garcia's participation in the
transactions facilitated the improper accounting. Facing severe financial
pressures, Mr. Garcia agreed to plead guilty to one count of bank fraud, but in
light of his cooperation with authorities both before and after he was charged,
was sentenced to only three years probation, which has expired, was fined $50
(the minimum fine the court could assess), and during the period of his
probation, which ended in 1996, was banned from becoming an officer, director or
employee of any federally-insured financial institution or a securities firm
without governmental approval. In separate actions arising out of this matter,
Mr. Garcia agreed not to violate the securities laws, and filed for bankruptcy
both personally and with respect to certain entities he controlled. The
bankruptcies were discharged by 1993.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since its inception, the Company has maintained business relationships and
engaged in certain transactions with the affiliated companies and parties
described below. The Company believes that these transactions are currently on
terms no less favorable to the Company than could be obtained in an arm's length
transaction. Any future transactions between the Company and its affiliated
entities, executive officers, directors, or significant stockholders will
require the approval of a majority of the independent directors of the Company
and will be on terms no less favorable to the Company than the Company could
obtain from non-affiliated parties.
Pursuant to an agreement (the "Modification Agreement") between the Company
and Verde, effective June 21, 1996, Verde agreed to sell to the Company at any
time prior to June 21, 1997, subject to financing, six car lots, a vehicle
reconditioning center, and two office buildings owned by Verde and leased to the
Company at the lower of $7.45 million or the appraised value of the properties
(as determined by an independent third party), and to lower the rents on such
properties to an aggregate of $745,000 per year subject to cost of living
adjustments if the sale did not take place. 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. Rents paid to Verde pursuant to these leases totaled $1.5 million in
1996. The Company believed that the reduced rental rates approximated the
financing costs that would be incurred in connection with the purchase of such
properties. In addition, Verde assigned to the Company its leasehold interest in
two properties it sub-leased to the Company. These transactions (the reduction
in rental rates and/or the purchase of property) would have resulted in savings
to the Company of approximately $626,000 for 1996. Also pursuant to the
Modification Agreement, Verde lowered the interest rate on $14.0 million of the
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<PAGE> 92
Company's subordinated debt payable to Verde from 18.0% to 10.0% per annum and
lowered from 12.0% to 10.0% the dividend rate on $10.0 million of the Company's
Preferred Stock held by Verde. For the years ended 1997 and 1996, the Company
paid Verde $2.0 million and $553,000 of principal, and approximately $1.2
million and $1.9 million of interest, respectively, in connection with the Verde
subordinated debt. In July 1997, the Company's Board of Directors approved the
prepayment of the subordinated debt payable to Verde which had a $10.0 million
balance as of May 31, 1998, subject to certain conditions. See "Management's
Discussion and Analysis of Results of Operations and Financial Condition of the
Continuing Company Businesses -- Subordinated Indebtedness and Preferred Stock."
If the Rights Offering proposed herein is approved and effected, on or prior to
the Closing Date thereof, the Company would, subject to certain consents, prepay
the Verde subordinated debt. See "Proposal No. 4 -- Approval of the Split-up of
the Company and its Subsidiaries into Two Publicly-Held Corporate Groups -- The
Split-up Proposal -- Repayment of Verde Subordinated Debt." On December 31,
1996, the Company purchased the properties listed above from Verde pursuant to
the Modification Agreement. Mr. Garcia is the President and sole stockholder of
Verde. In connection with the purchase, Verde returned security deposits which
totaled $364,000.
In January 1996, in connection with the sale of its Gilbert dealership, the
Company purchased the land for the Gilbert dealership from Verde for a total
price of $750,000, which the Company believes approximated fair market value.
Simultaneous with such purchase, the Company sold the land purchased from Verde
together with the dealership building and other improvements (which had been
constructed by the Company) to a third party for $512,500 in cash and a
promissory note in the principal amount of $1.2 million. The Company recognized
a loss on the sale of $120,000, for which an allowance was established as of
December 31, 1995.
Mr. Christopher D. Jennings, a director of the Company, was a managing
director of Cruttenden Roth until April 1998. Cruttenden Roth served as the sole
representative in the Company's initial public offering. In its capacity as
representative, Cruttenden Roth participated in the underwriting discount and
received a non-accountable expense allowance and warrants to purchase Common
Stock. See "Management of the Company -- Security Ownership of Certain
Beneficial Owners and Management."
In September 1997, the Company's Board of Directors approved the Ugly
Duckling Director and Officer Stock Purchase Program (the "Stock Purchase
Program"). The Stock Purchase Program includes the providing of loans of up to
$1.0 million in total to the directors and senior officers under the program to
assist directors' and officers' purchases of Company Common Stock on the open
market. The program provides for loans, which are unsecured by the related
Common Stock, at arms-length terms and conditions. During November 1997, senior
officers purchased 50,000 shares of Common Stock under the Stock Purchase
Program and the Company advanced $500,000 to the senior officers for these
purchases. In May 1998, senior officers purchased an additional 40,000 shares of
Common Stock under the Stock Purchase Program and the Company advanced
approximately $400,000 to the senior officers for these purchases.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of July 1, 1998, for: (1) each
director of the Company; (2) the chief executive officer of the Company and the
four other most highly compensated executive officers of the Company who were
serving as executive officers at December 31, 1997 (the "Named Executive
Officers"); (3) all directors and executive officers of the Company as a group;
and (4) each beneficial owner of more than 5% of the outstanding Common Stock of
the Company as of July 1, 1998, unless otherwise indicated. To the knowledge of
the Company, each person listed below have sole voting and investment power with
respect to their shares,
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except to the extent that (a) authority is shared by their respective spouses
under applicable law, or (b) as otherwise indicated below.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED(1)
-----------------------
NUMBER
-----------------------
NAME OF BENEFICIAL OWNER(2) COMMON STOCK OPTIONS TOTAL (#) PERCENT
- --------------------------- ------------ ------- --------- -------
<S> <C> <C> <C> <C>
Ernest C. Garcia II(3)(12)...................... 4,687,500 4,687,500 25.2%
Robert J. Abrahams(4)........................... 8,744 8,744 *
Christopher D. Jennings(4)(5)................... 26,277 26,277 *
John N. MacDonough(4)........................... 4,444 4,444 *
Frank P. Willey(4).............................. 9,444 9,444 *
Gregory B. Sullivan(6).......................... 30,000 76,400 106,400 *
Steven T. Darak(6).............................. 140,000 10,000 150,000 *
Walter T. Vonsh(6).............................. 14,000 15,000 29,000 *
Donald L. Addink(7)............................. 98,000 67,000 165,000 *
Steven P. Johnson(6)............................ 311,000 9,000 320,000 1.7%
Harris Associates L.P.(8)(12)................... 1,825,000 1,825,000 9.9%
Wellington Management Company, LLP(9)(12)....... 1,664,500 1,664,500 9.0%
Merrill Lynch & Co., Inc.(10)(12)............... 1,615,000 1,615,000 8.8%
FMR Corp.(11)(12)............................... 1,284,000 1,284,000 6.9%
All directors and executive officers as a group
(15 persons).................................. 5,664,358 30.5%
</TABLE>
- ---------------
* Represents less than one percent of the outstanding Common Stock.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired within 60 days from the date set forth from July 1, 1998 through
the exercise of any option, warrant, or right. Shares of Common Stock
subject to options, warrants, or rights which are currently exercisable or
exercisable within 60 days are deemed outstanding for computing the
percentage of the person holding such options, warrants, or rights, but are
not deemed outstanding for computing the percentage of any other person.
The amounts and percentages are based upon 18,597,013 shares of Common
Stock outstanding as of July 1, 1998.
(2) Unless otherwise noted, the address of each of the listed stockholders is
2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016.
(3) Includes 136,500 shares and 51,000 shares held by The Garcia Family
Foundation, Inc., an Arizona nonprofit corporation, and Verde, an affiliate
of the Company and Mr. Garcia, respectively. Also, includes 50,000 shares
of Common Stock that Mr. Garcia presently owns, but to which he has
provided an option to purchase to Donald L. Addink. The Option Agreement
was entered into on August 18, 1997 and allows Mr. Addink to exercise the
option at any time through May 31, 2000 at an exercise price of $15.00 per
share. As of July 1, 1998, Mr. Addink had not exercised his option right to
purchase any of these shares of Common Stock from Mr. Garcia. Until the
option is exercised by Mr. Addink, Mr. Garcia retains voting and investment
power with respect to the 50,000 shares of Common Stock.
(4) The total for each independent Board of Director member includes 4,444
shares of Common Stock of the Company granted under the Company's Director
Incentive Plan. Shares having a value of $30,000 on or about the date of
grant (i.e., 4,444 shares of Common Stock) were granted and issued to each
independent Board member upon his appointment or election to the Board of
Directors in June 1996. Pursuant to the Director Incentive Plan, these
shares generally vest over a three-year period at an annual rate of 33%,
beginning on the first anniversary date after the date of grant (June
1996).
(5) The total for Mr. Jennings includes 6,444 shares of Common Stock of the
Company. The total also includes 19,833 warrants to purchase Common Stock
held of record by Cruttenden Roth, an investment banking firm of which Mr.
Jennings was previously a managing director. The warrants are convertible
into Common Stock at an exercise price of $9.45 per share and are fully
vested.
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<PAGE> 94
(6) The options listed for Messrs. Sullivan, Darak, Vonsh, and Johnson include
their respective options granted under the Incentive Plan that are
exercisable pursuant to the plan on July 1, 1998 or within 60 days
thereafter. The options are exercisable at various prices, established in
accordance with the provisions of the Incentive Plan.
(7) The total for Mr. Addink includes options granted under the Incentive Plan.
Generally options issued pursuant to the Incentive Plan vest over a
five-year period, with 20% of the options becoming exercisable by a holder
on each successive anniversary date of the grant. During 1997, the
Compensation Committee of the Board of Directors of the Company and the
Board approved an accelerated vesting schedule for Mr. Addink's existing
options under the Incentive Plan. The total also includes an option to
acquire 50,000 shares of Common Stock directly from Mr. Garcia, pursuant to
their Option Agreement dated August 18, 1997. As of July 1, 1998, Mr.
Addink had not exercised any of his option rights under this agreement. The
Option Agreement provides Mr. Addink the right to exercise his option at
any time through May 31, 2000 at an exercise price of $15.00 per share.
Until the option is exercised by Mr. Addink, Mr. Garcia retains voting and
investment power with respect to these 50,000 shares of Common Stock.
(8) Based on two (2) Schedule 13G filings as of December 31, 1997, by Harris
Associates L.P. ("Harris") and an affiliate of Harris, Harris Associates
Investment Trust and related funds ("Harris Trust"), all located at Two
North LaSalle Street, Suite 500, Chicago, Illinois 60602. According to
these Schedule 13Gs, Harris has shared voting and dispositive power over
1,825,000 of the shares (including 1,750,000 share of Harris Trust) and
Harris Trust has shared voting and dispositive power over 1,750,000 of the
shares of the Company's Common Stock. The Company makes no representation
as to the accuracy or completeness of the information provided in this
footnote or the above beneficial ownership table related to the same, which
is based solely on the Harris and Harris Trust, Schedule 13G filings.
(9) Based on a Schedule 13G (Amendment No. 1) ("Amendment") filing as of
December 31, 1997, by Wellington Management Company, LLP, at 75 State
Street, Boston, Massachusetts 02109. According to the Amendment, Wellington
Management Company, LLP has shared voting power over 767,100 of the shares
and shared dispositive power over 1,664,500 of the shares of the Company's
Common Stock. The Company makes no representation as to the accuracy or
completeness of the information provided in this footnote or the above
beneficial ownership table related to the same, which is based solely on
Wellington Management Company, LLP's Amendment filing.
(10) Based on a Schedule 13G filing as of December 31, 1997, by Merrill Lynch &
Co., Inc. ("Merrill Parent") and four (4) of its subsidiaries and/or
affiliates, including Merrill Lynch Global Allocation Fund, Inc. ("Merrill
Global"). Merrill Parent and one of its subsidiary/affiliates that is
included within this Merrill Schedule 13G filing are located at 250 Vesey
Street, New York, New York 10281. Merrill Global and the other two (2)
subsidiaries/affiliates that are included within this Merrill Schedule 13G
filing are located at 800 Scudders Mill Rd., Plainsboro, New Jersey 08536.
According to the Schedule 13G, Merrill Global has shared voting and
dispositive power over 1,530,000 of the shares and Merrill Parent along
with each of its other three subsidiaries and/or affiliates have shared
voting and dispositive power over 1,615,000 of the shares of the Company's
Common Stock. The Company makes no representation as to the accuracy or
completeness of the information provided in this footnote or the above
beneficial ownership table related to the same, which is based solely on
Merrill's Schedule 13G filing.
(11) Based on a Schedule 13G filing as of December 31, 1997, by FMR Corp., along
with certain of its affiliates ("FMR"), at 82 Devonshire Street, Boston,
Massachusetts 02019. According to the Schedule 13G, FMR has no voting power
over shares and has sole dispositive power over 1,284,000 shares of the
Company's Common Stock. The Company makes no representation as to the
accuracy or completeness of the information provided in this footnote or
the above beneficial ownership table related to the same, which is based
solely on FMR's Schedule 13G filing.
(12) The Company knows of no other person who beneficially owned more than five
percent of Company's Common Stock as of July 1, 1998.
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<PAGE> 95
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Exchange Act requires the Company's executive
officers, directors, and persons who own more than 10% of a registered class of
the Company's equity securities to file reports of ownership and changes in
ownership with the Commission. Officers, directors, and greater than 10%
stockholders are required by Commission regulations to furnish the Company with
copies of all Section 16(a) forms they file. Based upon a review of the filings
of such forms or written representations that no forms were required, the
Company believes that all of the Company's executive officers, directors, and
greater than 10% stockholders complied during the fiscal year ended December 31,
1997 with the reporting requirements of Section 16(a), with the exception of one
Form 3 filing of Mr. Russell J. Grisanti, which was made after the applicable
deadline. The delay in filing the Form 3 (initial statement of beneficial
ownership of security) was the result of an administrative error on the
Company's part in recognizing Mr. Grisanti as an executive officer of the
Company when he was hired, and the Company's processing of the filing on behalf
of Mr. Grisanti.
COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS, BENEFITS,
AND RELATED MATTERS
COMPENSATION OF DIRECTORS AND THE DIRECTOR INCENTIVE PLAN
The Company's independent directors are compensated $1,000 for physical
attendance at meetings of the Board of Directors and at meetings of committees
of the Board of Directors of which they are members, and are reimbursed for
reasonable travel expenses incurred in connection with attendance at each Board
and committee meeting. Board and committee members are not compensated for their
telephonic attendance at meetings. If a Board and committee meeting are held on
the same day, a member who attends both meetings will received combined total
compensation of only $1,000. In addition, pursuant to the Company's Director
Incentive Plan, upon initial appointment or initial election to the Board of
Directors, each independent director of the Company receives Common Stock of the
Company valued at $30,000 ("Director Stock"), which is generally subject to
vesting in equal annual increments over a three-year period as provided for
under the plan. As stated above, Mr. Moreno resigned from the Company's Board of
Directors effective June 30, 1998 due to time constraints relating to family and
other business interests. In consideration for Mr. Moreno's invaluable services
as a director to the Company for over the past two years, the Company has
decided to accelerate the vesting of the final one-third of Mr. Moreno's
Director Stock. Directors who are also officers of the Company are not
compensated for their service as directors and are not entitled to participate
in the Director Incentive Plan.
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SUMMARY COMPENSATION TABLE FOR NAMED EXECUTIVE OFFICERS
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities to the Company during the
three fiscal years ended December 31, 1997 of the Named Executive Officers:
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
------------------------------
ANNUAL COMPENSATION SECURITIES
---------------------------- UNDERLYING ALL OTHER
SALARY BONUS OPTIONS -- COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) AWARDS (#)(1) ($)(2)
- --------------------------- ---- -------- -------- -------------- ------------
<S> <C> <C> <C> <C> <C>
Ernest C. Garcia II............... 1997 $131,677 -- -- $ 3,935(3)
Chairman of the Board and 1996 121,538 -- -- 3,873(3)
Chief Executive Officer 1995 100,000 -- -- 3,151(3)
Gregory B. Sullivan............... 1997 197,846 -- -- 554
President and Chief 1996 97,385 -- 125,000 --
Operating Officer 1995 --(4) -- 116,000(4) --
Steven T. Darak................... 1997 $148,654 $ 25,000 -- $ 1,750(5)
Senior Vice President, 1996 100,000 100,000 40,000 9,250(5)
Chief Financial Officer, 1995 100,000 100,000 -- 12,250(5)
and Treasurer
Walter T. Vonsh(7)................ 1997 150,000 -- -- 3,439(6)
Senior Vice President -- Credit 1996 126,923 30,000 50,000 5,277(6)
1995 97,692 -- -- 3,704(6)
Donald L. Addink.................. 1997 139,671 10,000 -- 950
Vice President -- Senior 1996 122,142 10,000 42,000 485
Analyst 1995 71,026 10,000 58,000 984
</TABLE>
- ---------------
(1) The amounts shown in this column represent stock options granted pursuant to
the Incentive Plan. Generally, options are subject to vesting over a
five-year period, with 20.0% of the options becoming exercisable on each
successive anniversary of date of grant. See "Compensation of Directors and
Executive Officers, Benefits, and Related Matter -- Long-Term Incentive
Plan" for a discussion of the Incentive Plan.
(2) The amounts shown in this column include the dollar value of 401(k) plan
contributions made by the Company for the benefit of the Named Executive
Officers.
(3) This amount includes a $2,985 car allowance during 1997, and a $2,950 car
allowance during both 1996 and 1995, respectively, for Mr. Garcia.
(4) Mr. Sullivan became an executive officer of the Company during March, 1996.
For all of 1995 and a portion of 1996, Mr. Sullivan was employed as an
independent contractor by the Company and was not an employee. Therefore,
the above table does not reflect the compensation paid to Mr. Sullivan while
he was an independent contractor for the Company in 1995 and 1996,
respectively. The table does, however, reflect stock options granted to Mr.
Sullivan under the Incentive Plan during both 1995 and 1996.
(5) This amount includes $7,500 and $10,500 paid by the Company for a Phoenix
apartment for Mr. Darak during 1996 and 1995, respectively, while his full
time residence was in Tucson, Arizona, and a $1,750 car allowance during
each of 1997, 1996, and 1995.
(6) This amount includes a $2,550, $5,000, and $2,850 car allowance for Mr.
Vonsh during 1997, 1996, and 1995, respectively.
(7) Effective as of March 16, 1998, Mr. Vonsh resigned his officer position of
Senior Vice President -- Credit for the Company. Mr. Vonsh continues to be
employed by the Company in another capacity.
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<PAGE> 97
OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted pursuant to the Company's Incentive
Plan or otherwise during the fiscal year ended December 31, 1997 to the Named
Executive Officers.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AS OF DECEMBER
31, 1997 OF NAMED EXECUTIVE OFFICERS
The table below sets forth information with respect to option exercises and
the number and value of options outstanding at December 31, 1997 held by the
Named Executive Officers. The Company has never issued any other forms of stock
based awards.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES FISCAL YEAR END(#)(1) FISCAL YEAR END($)(2)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia II... -- -- -- -- -- --
Gregory B. Sullivan... -- -- 71,400 169,000 $282,974 446,336
Steven T. Darak....... -- -- 8,000 32,000 3,500 14,000
Walter T. Vonsh....... -- -- 10,000 40,000 8,750 35,000
Donald L. Addink(3)... 63,000 $622,490(4) 17,000 20,000 -- 35,000
</TABLE>
- ---------------
(1) Generally, options are subject to vesting over a five-year period, with 20%
of the options becoming exercisable on each successive anniversary of the
date of grant.
(2) In-the-money options are options for which the option exercise price (the
fair market value on the date of grant) was lower than the market price of
the Company's Common Stock on December 31, 1997, which market price of $8.50
per share was based on the closing price of the Common Stock on that date as
reported by Nasdaq. The values in the last two columns have not been, and
may never be, received by the Named Executive Officers. Actual gains, if
any, on option exercises will depend on the value of the Common Stock on the
exercise dates. Accordingly, there can be no assurance that the values shown
in the last two columns will be realized. The closing price of the Company's
Common Stock on July 30, 1998 was $7.66 per share.
(3) Subsequent to December 31, 1997 and during January 1998, Mr. Addink
exercised 20,000 stock options at an exercise price of approximately $6.75
per share. As discussed herein, these options were subject to accelerated
vesting pursuant to Mr. Addink's restated employment agreement with the
Company.
(4) The value realized represents the value of stock options exercised by Mr.
Addink during the last fiscal year. During this period, he exercised options
to acquire 63,000 shares of the Company's Common Stock. The value realized
was calculated by subtracting the exercise price of Mr. Addink's options
from the fair market value of the Common Stock underlying the options as of
the exercise date. The fair market value of the Company's Common Stock was
based on the closing price of the stock on the date of exercise as reported
by Nasdaq. Pursuant to Incentive Plan documents, the exercise date was the
date Mr. Addink provided notice of his exercise to the Company and method of
payment.
LONG-TERM INCENTIVE PLAN
In June 1995, the Company's stockholders approved the Incentive Plan. Under
the Incentive Plan, the Company may grant ISOs, NQSOs, SARs, performance shares,
restricted stock, dividend equivalents, and performance-based awards to
employees, consultants, and advisors of the Company. The Company believes that
the Incentive Plan promotes the success and enhances the value of the Company by
linking the personal interests of participants to those of the Company's
stockholders and providing participants with an incentive for outstanding
performance. The total number of shares of Common Stock originally available for
awards under the Incentive Plan, as amended, was 1,800,000, subject to a
proportionate increase or decrease in the event of a stock split, reverse stock
split, stock dividend, or other adjustment to the Company's total number of
issued and outstanding shares of Common Stock. As of July 1, 1998, the Company
had granted options under
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<PAGE> 98
the Incentive Plan to purchase approximately 1,677,758 (net of cancelled and
lapsed grants) shares of Common Stock to various of its employees of which
1,451,158 were outstanding. Also as of July 1, 1998, there were approximately
122,242 shares that remained available for grant under the Incentive Plan. If
the Split-up Proposal (Proposal No. 4) is approved and successfully concluded,
approximately 230,000 options granted under the Incentive Plan to existing
Company employees who become employees of Cygnet will be replaced with Cygnet
options and will again become available for issuance under the Incentive Plan.
See "Proposal No. 2 Amendments to the Ugly Duckling Corporation Long-Term
Incentive Plan -- Limitation on Awards and Shares Available under the Incentive
Plan." During the first quarter of 1998, the Compensation Committee granted,
subject to certain conditions, approximately 775,000 options to purchase Common
Stock of the Company to several of its officers, 250,000 of which were granted
under the Incentive Plan (which grant is included in the preceding option and
grant information as of July 1, 1998 for the Incentive Plan) and the remaining
525,000 of which were granted under the 1998 Executive Incentive Plan subject to
shareholder approval at the Annual Meeting. See "Proposal No. 3 -- Adoption of
Ugly Duckling Corporation 1998 Executive Incentive Plan," and "1998 Executive
Incentive Plan" below. See also below, "Compensation of Directors and Executive
Officers, Benefits, and Related Matters -- Contracts with Directors and
Executive Officers."
The Incentive Plan is administered by the Compensation Committee of the
Board of Directors, which has the authority to administer the Incentive Plan,
including the power to determine eligibility, the type and number of awards to
be granted, and the terms and conditions of any award granted, including the
price and timing of awards, vesting, and acceleration of such awards (other than
performance-based awards). The Incentive Plan limits the awards that can be
granted to a single participant to no more than 250,000 shares of Common Stock
during any single calendar year. The exercise price of all options granted under
the Incentive Plan in the past has been equal to the fair market value of the
Common Stock on the date of grant. The Compensation Committee may terminate,
amend, or modify the Incentive Plan at any time but no such termination,
amendment, or modification may affect any stock options, SARs, or restricted
stock awards then outstanding under the Incentive Plan. Also, any such
termination, amendment, or modification is subject to any stockholder approval
required under applicable law or by any national securities exchange or
association on which the Common Stock is then listed or reported. Unless
terminated by action of the Compensation Committee, the Incentive Plan will
continue in effect until June 30, 2005, but awards granted prior to such date
will continue in effect until they expire in accordance with their terms. The
Compensation Committee may amend the term of any award or option theretofore
granted, retroactively or prospectively, but no such amendment shall adversely
affect any such award or option without the holder's consent. Generally, stock
options issued under the Incentive Plan have been subject to vesting over a
five-year period, with 20.0% of the options becoming exercisable by the holder
thereof on each successive anniversary date of the grant, and such options
generally expire 10 years after the grant date. However, during 1997, the
Compensation Committee exercised its discretion and accelerated the vesting of
certain stock option awards previously granted to Mr. Addink under the Incentive
Plan. See "Compensation of Directors and Executive Officers, Benefits, and
Related Matters -- Contracts with Directors and Executive Officers" below.
1998 EXECUTIVE INCENTIVE PLAN
Subject to stockholder approval, the 1998 Plan would be effective as of
January 15, 1998. Under the 1998 Plan, the Company may grant ISOs, NQSOs, SARs,
performance shares, restricted stock, and performance-based awards to employees,
consultants, and advisors of the Company. The Company believes that the 1998
Plan promotes the success and enhances the value of the Company by linking the
personal interests of participants to those of the Company's stockholders and
providing participants with an incentive for outstanding performance. The total
number of shares of Common Stock originally available for awards under the 1998
Plan was 800,000, subject to a proportionate increase or decrease in the event
of a stock split, reverse stock split, stock dividend, or other adjustment to
the Company's total number of issued and outstanding shares of Common Stock. As
of July 1, 1998, the Company had granted options under the 1998 Plan to purchase
approximately 525,000 shares of Common Stock to various of its officers all of
which are outstanding. Also as of July 1, 1998, there were 275,000 shares that
remained available for grant under the 1998 Plan. If the Split-up Proposal
(Proposal No. 4) is approved and successfully concluded, approximately
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<PAGE> 99
150,000 options granted under the 1998 Plan to existing Company employees who
become employees of Cygnet will be replaced with Cygnet options and will again
become available for issuance under the 1998 Plan. See "Proposal No. 3 Adoption
of the Ugly Duckling Corporation 1998 Executive Incentive Plan -- Grants Under
the 1998 Plan -- Existing Grants." During the first quarter of 1998, the
Compensation Committee granted, subject to certain conditions, approximately
775,000 options to purchase Common Stock of the Company to several of its
officers, 525,000 of which were granted under the 1998 Plan (which grant is
included in the preceding option and grant information as of July 1, 1998 for
the 1998 Plan) and the remaining 250,000 of which were granted under the
Incentive Plan. See also below, "Compensation of Directors and Executive
Officers, Benefits, and Related Matters -- Contracts with Directors and
Executive Officers."
The 1998 Plan is administered by the Board of Directors or a committee of
the Board who qualify as non-employee directors and outside directors, which has
the authority to administer the 1998 Plan, including the power to determine
eligibility, the type and number of awards to be granted, and the terms and
conditions of any award granted, including the price and timing of awards,
vesting, and acceleration of such awards (other than performance-based awards).
The 1998 Plan limits the awards that can be granted to a single participant to
no more than 400,000 shares of Common Stock during any single calendar year. The
exercise price of options granted under the 1998 Plan will generally equal the
fair market value of the Common Stock on the date of grant except that the
committee is permitted to grant options at below fair market value. The
committee may, with the Board's approval, terminate, amend, or modify the 1998
Plan at any time but no such termination, amendment, or modification may affect
any stock options, SARs, or restricted stock awards then outstanding under the
1998 Plan without the participant's consent. Also, any such termination,
amendment, or modification is subject to any stockholder approval required under
applicable law or by any national securities exchange or association on which
the Common Stock is then listed or reported. The committee may amend the term of
any award or option theretofore granted, retroactively or prospectively, but no
such amendment shall adversely affect any such award or option without the
holder's consent.
401(k) PLAN
Under the Company's 401(k) plan, adopted in October 1995, eligible
employees may direct that a portion of their compensation, up to a legally
established maximum, be withheld by the Company and contributed to their
account. All 401(k) plan contributions are placed in a trust fund to be invested
by the 401(k) plan's trustee, except that the 401(k) plan permits participants
to direct the investment of their account balances among mutual or investment
funds available under the plan. The 401(k) plan provides a matching contribution
of 10.0% of a participant's contributions and discretionary additional matchings
if authorized by the Company. Amounts contributed to participant accounts under
the 401(k) plan and any earnings or interest accrued on the participant accounts
are generally not subject to federal income tax until distributed to the
participant and may not be withdrawn until death, retirement, or termination of
employment.
CHANGE OF CONTROL ARRANGEMENTS
The Incentive Plan provides that the Board of Directors or the Compensation
Committee (whichever entity is administering the Incentive Plan at the time)
may, in its sole and absolute discretion, provide participants with certain
rights and benefits in the event of a "Change of Control" (as defined in the
Incentive Plan), including, without limitation (1) allowing all grants to become
exercisable and all restrictions on outstanding grants to lapse and allowing
each participant the right to exercise the grants prior to the occurrence of the
Change of Control event; or (2) providing that every grant outstanding under the
Incentive Plan terminates, provided that the surviving or resulting entity
tenders grants to participants that substantially preserve the rights and
benefits of any grant then outstanding under the Incentive Plan. A "Change of
Control" under the Incentive Plan may be any consolidation or merger of the
Company in which the Company is not the continuing or surviving entity, or
pursuant to which stock would be converted into cash, securities, or other
property; any sale, lease, exchange, or other transfer of more than 40% of the
assets or earning power of the Company; the approval by stockholders of any plan
or proposal for liquidation or dissolution of the Company; or any person, other
than a current stockholder of the Company, or affiliate thereof or any employee
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<PAGE> 100
benefit plan of the Company or any subsidiary of the Company, becoming the
beneficial owner of 20% or more of the Company's outstanding stock. See also,
"Compensation of Directors and Executive Officers, Benefits, and Related
Matters -- Contracts with Directors and Executive Officers." If the Split-up
proposed herein is approved and successfully concluded, the resulting transfer
of assets would not result in a Change of Control under the Incentive Plan
because the Board of Directors and the Compensation Committee have not exercised
their discretion to provide Change of Control rights and benefits under the
Incentive Plan as a result of the proposed Split-up.
Change of Control provisions for the new proposed plan, the 1998 Executive
Incentive Plan, are summarized under the caption "Proposal No. 3 -- Adoption of
Ugly Duckling Corporation 1998 Executive Incentive Plan."
CONTRACTS WITH DIRECTORS AND EXECUTIVE OFFICERS
During the first quarter of 1998, the Compensation Committee granted,
subject to certain conditions, approximately 775,000 options to purchase Common
Stock of the Company to several of its officers. All such options were issued
with an exercise price of $8.25, the market value of the Company's Common Stock
on the date of grant (January 15, 1998). Included in this grant is a stock
option award to acquire 500,000 shares of the Company's stock to Gregory B.
Sullivan, President and Chief Operating Officer of the Company. Two Hundred
Fifty Thousand of the options granted to Mr. Sullivan were granted under the
Company's Incentive Plan and vest in equal increments over a 5 year period. The
other 250,000 options granted to Mr. Sullivan and the remaining 225,000 options
granted to other officers were granted under the Company's 1998 Plan, subject to
approval of the stockholders at the Annual Meeting. These options contain time
and price vesting requirements as described under "Proposal No. 3 -- Adoption of
the Ugly Duckling Corporation 1998 Executive Incentive Plan -- Grants under the
1998 Plan -- Effective Date Grants." As of June 1, 1998, the price hurdles for
the first two (2) time vesting periods had already been satisfied. The Company
believes that these option grants are material in the aggregate. As such, they
will have the effect of diluting the ownership interest of existing stockholders
of the Company.
On January 1, 1996, the Company entered into a three-year employment
agreement with Mr. Ernest C. Garcia II, the Company's Chairman and Chief
Executive Officer. The agreement establishes Mr. Garcia's base salary for 1997
at $132,000 per year and provides a minimum 10.0% increase in the base salary
each year throughout the term of the agreement. In addition, the agreement
provides for the continuation of Mr. Garcia's base salary and certain benefits
for a period of one year in the event Mr. Garcia is terminated by the Company
without cause prior to the expiration of that agreement. The agreement also
contains confidentiality and non-compete covenants. On the Effective Date, Mr.
Garcia's employment agreement would be assigned to and assumed by Cygnet.
On April 1, 1995, the Company entered into a three-year employment
agreement with Mr. Walter T. Vonsh, the Company's former Senior Vice
President -- Credit, that was modified on or about April 1, 1996, August 6, 1997
and May 26, 1998. As stated above, Mr. Vonsh is no longer the Senior Vice
President -- Credit for the Company, but continues to be employed by the Company
in other capacities and positions. The modified agreement provides for a base
salary of $150,000 per year through June 30, 2001 and certain other compensation
and benefits, including a one-time cash bonus of $81,000 that was paid on May
26, 1998. The modified agreement also provides for the continuation of Mr.
Vonsh's base salary and certain benefits for the term of the agreement in the
event Mr. Vonsh is terminated by the Company without cause prior to that time.
The modified agreement contains confidentiality and non-compete covenants.
On June 1, 1995, the Company entered into a five-year employment agreement
with Mr. Donald L. Addink, the Company's Vice President -- Senior Analyst, that
was amended and restated effective August 1, 1997. The restated agreement
establishes Mr. Addink's base salary at $165,000 per year beginning on or around
the effective date of the restated employment agreement, a $10,000 bonus payment
upon execution of the restated employment agreement, certain benefits, and the
continuation of Mr. Addink's base salary and certain benefits for a period of
one year in the event Mr. Addink is terminated by the Company without cause
prior to expiration of the restated employment agreement. The restated
employment agreement also contains
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<PAGE> 101
confidentiality and non-compete covenants. Further, the restated employment
agreement accelerated the vesting of Mr. Addink's 100,000 stock options
previously granted under the Incentive Plan, as described below. Originally, the
100,000 stock options were granted: (1) pursuant to the Incentive Plan's general
five-year vesting schedule with 20% vesting each year, and (2) on the following
dates, in the following number, and for the following exercise prices:
<TABLE>
<CAPTION>
NUMBER EXERCISE PRICE
DATE OF SHARES PER SHARE
- ---- --------- --------------
<S> <C> <C>
June 1995............................................ 58,000 $ 1.72
June 1996............................................ 25,000 6.75
December 1996........................................ 17,000 17.69
</TABLE>
In connection with the modification of Mr. Addink's employment agreement,
the Board of Directors of the Company and the Board's Compensation Committee
approved the acceleration of the above options, such that they became fully
vested on the following dates: (1) the June 1995 and December 1996 options
vested on August 1, 1997 (the date of the restated employment agreement), and
(2) the June 1996 options vested on January 15, 1998. The accelerated vesting
does not affect any other options of Mr. Addink held or thereafter acquired by
him. On the Effective Date, Mr. Addink's employment agreement would be assigned
to and assumed by Cygnet.
On June 12, 1997, the Company entered into a two-year employment agreement
with Russell J. Grisanti, the Company's Executive Vice President -- Operations.
The agreement establishes Mr. Grisanti's base salary at $170,000 per year
beginning on or around the effective date of the agreement, reimbursement of
certain costs and other assistance in connection with Mr. Grisanti (at the
request of the Company) relocating his household from California to Arizona, an
initial stock option grant to acquire 100,000 shares of the Company's Common
Stock, and certain other benefits. The initial option grant consisted of a NQSO
under the Incentive Plan, with terms and conditions consistent with the plan's
general terms. The agreement also provides for the continuation of Mr.
Grisanti's base salary for a period of one year in the event Mr. Grisanti is
terminated by the Company without cause prior to the expiration of the
agreement.
On August 16, 1997, the Company entered into an employment agreement with
Steven A. Tesdahl, the Company's Senior Vice President and Chief Information
Officer, which was amended as of May 21, 1998. The agreement provides for no
minimum or maximum term of employment. It does, however, establish Mr. Tesdahl's
annual base salary at $175,000 per year beginning on or around the effective
date of the agreement (subject to a minimum 10% increase on each anniversary of
the hire date), an initial stock option grant to acquire 100,000 shares of the
Company's Common Stock, a grant of restricted stock of the Company valued at
$100,000 at the approximate effective date of Mr. Tesdahl's employment with the
Company, and certain other benefits. The initial option grant consisted of a
NQSO under the Incentive Plan, with terms and conditions consistent with the
plan's general terms. The restricted stock award consisted of Common Stock of
the Company, which vested on or around January 15, 1998. The agreement provides
for the continuation of Mr. Tesdahl's base salary for a maximum period of one
year in the event Mr. Tesdahl is terminated by the Company without cause prior
to his one year anniversary date with the Company (i.e., prior to September 1,
1998). The potential severance benefit decreases over the period of Mr.
Tesdahl's employment with the Company and goes to zero after September 1, 2000.
The agreement contains a "Change of Control" provision that provides that upon
such an event occurring and either (a) Mr. Tesdahl himself terminates his
employment with the Company within 12 months after the change of control; or (b)
the Company terminates Mr. Tesdahl without cause within 90 days prior to the
change of control or within 12 months after the change of control, then in
either event Mr. Tesdahl will receive a termination fee equal to 200% of his
then current salary. In addition, at the time of a change of control, Mr.
Tesdahl's initial NQSO award will automatically fully vest without any further
action or authority of the Board of Directors or the Compensation Committee. The
agreement adopts the Incentive Plan's definition of a "Change of Control" and
adds an additional change of control event if neither Ernest C. Garcia, II nor
Gregory B. Sullivan is Chief Executive Officer of the Company. See "Compensation
of Directors and Executive Officers, Benefits, and Related Matters -- Change of
Control Arrangements." The Split-up would not constitute a change of control for
purposes of Mr. Tesdahl's employment agreement.
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<PAGE> 102
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
There are no compensation committee interlocks and no Company officer or
former officer was a member of the Company's Compensation Committee. However,
Mr. Jennings was, during 1997, and continues to be a member of the Compensation
Committee of the Board of Directors. As discussed herein, Mr. Jennings was a
managing director of Cruttenden Roth until April 1998. Cruttenden Roth served as
the sole representative in the Company's initial public offering. In its
capacity as representative, Cruttenden Roth participated in the underwriting
discount and received a non-accountable expense allowance and warrants to
purchase Common Stock. See above, "Management of the Company -- Security
Ownership of Certain Beneficial Owners and Management."
COMPENSATION COMMITTEE REPORT ON EXECUTIVE COMPENSATION
RESPONSIBILITY AND COMPOSITION OF THE COMPENSATION COMMITTEE. The
Company's Compensation Committee is comprised entirely of independent, outside
members of the Company's Board of Directors. The Compensation Committee reviews
and approves each of the elements of the executive compensation program of the
Company and periodically assesses the effectiveness and competitiveness of the
program in total. The Compensation Committee also administers and maintains the
key provisions of the executive compensation program and reviews with the Board
of Directors all significant aspects of compensation for the Company's
executives. In addition, the Compensation Committee determines the compensation
of the Company's executive officers.
OVERVIEW OF COMPENSATION PHILOSOPHY AND OBJECTIVES. The Compensation
Committee believes that compensation for the Company's executive officers should
be determined according to a competitive framework that helps build value for
the Company's stockholders. With this in mind, the Compensation Committee's
philosophy is to pay base salaries to executives at levels that enable the
Company to attract, motivate and retain highly qualified executives. In
addition, the Compensation Committee may provide cash bonuses and stock option
grants as a component of competitive compensation and/or as a reward for
performance based upon (1) individual performance, (2) the Company's and/or the
business unit's operating and financial results, and (3) other performance
measures. Stock option grants are intended to result in no reward if the stock
price does not appreciate, but may provide substantial rewards to executives as
stockholders benefit from stock price appreciation. Within this overall
philosophy, the Compensation Committee's specific objectives are to:
- Align the financial interests of executive officers with those of
stockholders by providing significant Company equity-based long-term
incentives.
- Provide annual variable compensation awards that take into account
the Company's overall performance and individual contributions, teamwork
and business unit results that help create value for the Company's
stockholders.
- Offer a total compensation program that takes into account the
compensation practices and financial performance of companies in Ugly
Duckling's industry and other comparable companies.
- Emphasize performance-based and equity-based compensation as
executive officer level increases. In particular, as officer level
increases, the Compensation Committee (1) focuses more on Company
performance, teamwork, individual contributions and business unit results
and less on comparable marketplace compensation comparisons, (2) emphasizes
more variable, performance-based compensation versus fixed compensation,
and (3) provides a significantly greater proportion of total compensation
which is equity-based. As a result, executive officers have a greater
proportion of total compensation at risk, meaning that payment will vary
depending upon overall Company performance, teamwork and individual and
business unit contributions.
COMPENSATION COMPONENTS AND PROCESS. There are three major components of
the Company's executive officer compensation: (1) base salary, (2) cash bonus
awards and (3) long term incentive awards, generally in the form of stock option
grants. Executive officers also participate in various other benefit plans,
including medical and 401(k) plans, typically available to all eligible
employees of the Company.
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<PAGE> 103
The Compensation Committee uses subjective judgment in determining
executive officer compensation levels for all of these components and takes into
account both qualitative and quantitative factors. The Compensation Committee
does not assign specific weights to these factors. Among the factors considered
by the committee are the recommendations of the Chairman of the Board and Chief
Executive Officer, Mr. Garcia, with respect to the compensation of the Company's
other key executive officers. However, the Compensation Committee makes the
final compensation decisions concerning these officers.
In making compensation decisions, the Compensation Committee considers
compensation practices and financial performance of companies in Ugly Duckling's
industry and other comparable companies. This information provides guidance and
a framework to the Compensation Committee, but the committee does not target
total executive compensation or any component thereof to any particular point
within, or outside, the range of companies in Ugly Duckling's industry and other
comparable companies' results. Specific compensation for individual officers
will vary from these levels as the result of subjective factors considered by
the Compensation Committee unrelated to compensation practices of comparable
companies. (See "Overview of Compensation Philosophy and Objectives" above.) In
making compensation decisions, the Compensation Committee also from time to time
receives assessments and advice regarding the compensation practices of the
Company and others from independent compensation consultants.
POLICY ON DEDUCTIBILITY OF COMPENSATION. Section 162(m) of the Internal
Revenue Code limits the tax deductibility by a company of compensation in excess
of $1,000,000 paid to any of its five most highly compensated executive
officers. However, performance-based compensation that has been approved by
stockholders is excluded from the $1,000,000 limit if, among other requirements,
the compensation is payable only upon attainment of pre-established, objective
performance goals and the board committee that establishes such goals consists
only of "outside directors" (as defined for purposes of Section 162(m)). All of
the members of the Compensation Committee qualify as "outside directors."
In the Company's opinion, the full amount of compensation resulting from
the grant/exercise of options under the Company's Long-Term Incentive Plan
continue to be deductible. All other forms of awards under the Incentive Plan
must meet the general requirements described in the previous paragraph in order
to avoid the deduction limitations of Section 162(m). Any future employee
incentive plan being considered for adoption by the Company will be evaluated
prior to any such adoption to determine the plan's anticipated compliance with
the Section 162(m) limitation and this policy. In this regard, the 1998 Plan has
been evaluated and the Company believes upon stockholder approval of such plan
and its full adoption that the full amount of compensation resulting from the
grant/exercise of options under the Company's 1998 Plan will be deductible by
Ugly Duckling.
While the tax impact of any compensation arrangement is one factor to be
considered, the Compensation Committee evaluates such impact in light of its
overall compensation philosophy. The Compensation Committee intends to establish
executive officer compensation programs which will maximize the Company's
deduction if the Compensation Committee determines that such actions are
consistent with its philosophy and in the best interests of the Company and its
stockholders. However, from time to time the Compensation Committee may award
compensation which is not fully deductible if the Compensation Committee
determines that such award is consistent with its philosophy and in the best
interests of the Corporation and its stockholders. To the extent possible, the
Company will state its belief in its annual proxy statement as to the
deductibility of compensation paid to executive officers during the pertinent
reporting period(s).
BASE SALARY AND CASH BONUSES. Each Company executive receives a base
salary, which when aggregated with their bonus, is intended to be competitive
with similarly situated executives in Ugly Duckling's industry and executives at
other comparable companies. The Company targets base pay at the level required
to attract and retain highly qualified executives. In determining salaries, the
Compensation Committee also takes into account, among other factors, individual
experience and performance and specific needs particular to the Company.
In addition to base salary, executives are eligible to receive cash
bonuses. Less than $40,000 was paid to the Named Executive Officers during 1997
as cash bonuses. The bonuses are based upon executive performance and certain
other factors. The Company believes that bonuses paid in 1997 were reflective of
97
<PAGE> 104
such performance. The amount of bonus and the performance criteria vary with the
position and role of the executive within the Company, although bonuses are
significantly tied to the Company's financial performance.
Base salary and cash bonuses to Company executives for 1997 were determined
and paid in accordance with the compensation philosophy and specific objectives
discussed in this report. (See "Overview of Compensation Philosophy and
Objectives" above.)
On January 15, 1998 the Compensation Committee approved the following
annual base salaries for 1998 for the corresponding Named Executive Officer: Mr.
Garcia -- $145,200, Mr. Sullivan -- $200,000, Mr. Darak -- $175,000, Mr. Vonsh
$150,000, and Mr. Addink $165,000.
STOCK OPTIONS. The Company believes that it is important for executives to
have an equity stake in the Company and, toward this end, makes stock option
grants to key executives from time to time. In making option awards, the
Compensation Committee reviews the level of awards granted to executives at
companies in Ugly Duckling's industry and executives at other comparable
companies, the awards granted to other executives within the Company and the
individual officer's specific role and contribution at the Company. The Company
presently has one long-term incentive award plan, the Long-Term Incentive Plan.
(See "Proposal No. 2 -- Amendments to the Ugly Duckling Corporation Long-Term
Incentive Plan" for a detailed description of the Incentive Plan). Effective
January 15, 1998, the Board of Directors, upon the Compensation Committee's
recommendation, approved a second long-term incentive award plan for the
Company, the 1998 Executive Incentive Plan, subject to stockholder approval.
Also on January 15, 1998, the Compensation Committee granted, subject to certain
conditions, approximately 775,000 options to purchase Common Stock of the
Company to several of its officers, at an exercise price of $8.25 per share,
(the market value of the Company's Common Stock on the January 15th grant date)
("January 1998 Option Grants"). Included in this grant and subject to
stockholder approval, are 525,000 options pursuant to the 1998 Plan for initial
grants to certain officers (i.e., the "Existing Grants"). Also included in the
January 1998 Option Grants is a total award of 500,000 options to Gregory B.
Sullivan, President and Chief Executive Officer of the Company (250,000 options
under the Incentive Plan and 250,000 under the 1998 Plan). (See "Proposal No.
3 -- Adoption of the Ugly Duckling Corporation 1998 Executive Incentive Plan"
for a detailed description of the 1998 Plan and "Contracts with Directors and
Executive Officers," above for more information on the January 1998 Option
Grants.)
In 1997, the Company did not request and the Compensation Committee did not
approved stock option grants to any executive officer. During 1997, the
Compensation Committee approved stock option grants under the Incentive Plan to
several other officers of the Company that were not executive officers. These
options to non-executive officers were granted at fair market value with all of
the options granted in 1997 generally subject to vesting over a five-year
period, with 20% of the options becoming exercisable on each successive
anniversary of the date of grant, and expiring ten years after the grant date.
Stock option grants to Company officers for 1997 were awarded in accordance
with the compensation philosophy and specific objectives discussed in this
report. (See "Overview of Compensation Philosophy and Objectives" above.)
OTHER BENEFITS. Executive officers are eligible to participate in benefit
programs designed for all full time employees of the Company. These programs
include medical, disability and life insurance and a savings program qualified
under Section 401(k) of the Internal Revenue Code.
CHIEF EXECUTIVE OFFICER COMPENSATION. Mr. Garcia was the founder of the
Company and has served as its Chief Executive Officer since the Company's
inception in 1992. On an annual basis, the Compensation Committee reviews and
approves the compensation of Mr. Garcia. On January 1, 1996, the Company entered
into a three-year employment agreement with Mr. Garcia. The agreement
established Mr. Garcia's base salary for 1996 at $121,538 and provides for a
minimum 10.0% increase in the base salary each year throughout the term of the
agreement. For 1997 Mr. Garcia's base salary was approximately $132,000 and for
1998 is established at $145,200. Mr. Garcia did not receive a bonus in 1997, he
did not participate in the Company's Long-Term Incentive Plan in 1997, and thus
far, in 1998 he has not participated in either the
98
<PAGE> 105
Long-Term Incentive Plan or the 1998 Plan. Mr. Garcia does receive standard
benefits under the Company's 401(k) plan. The Compensation Committee believes
that Mr. Garcia's compensation (including his base salary, and lack of cash
bonuses and stock option awards) is below the compensation paid to Chief
Executive Officers of comparable, publicly-held automobile finance companies,
and other companies comparable to Ugly Duckling. In addition, Mr. Garcia is a
significant stockholder of the Company, and to the extent his performance as
Chief Executive Officer translates into an increase in the value of the
Company's stock, all stockholders, including him, share the benefits.
The Compensation Committee approved the compensation of Mr. Garcia and the
Company's executive officers for 1997, following the principles and procedures
outlined in this report.(1)
COMPENSATION COMMITTEE
Christopher D. Jennings Frank P. Willey
- ---------------
(1) Pursuant to Item 402(a)(9) of Regulation S-K promulgated by the Securities
and Exchange Commission, neither the "Compensation Committee Report on
Executive Compensation" nor the material under the caption "Stockholder
Return Performance Graph" shall be deemed to be filed with the Commission
for purposes of the Exchange Act, nor shall such report or such material be
deemed to be incorporated by reference in any past or future filing by the
Company under the Exchange Act or the Securities Act.
99
<PAGE> 106
STOCKHOLDER RETURN PERFORMANCE GRAPH
Set forth below is a line graph comparing the percentage change during the
relevant period in the cumulative total stockholder return on the Company's
Common Stock against the cumulative return on the Nasdaq Market Index as well as
the MG Group Index 744 -- Auto Dealerships ("Industry Group Index"). The Nasdaq
Retail Trade Index is also provided for comparative purposes as required by the
rules of the Securities and Exchange Commission. For its Industry Group Index,
the Company decided for this Proxy Statement to switch from the Nasdaq Retail
Trade Index to the MG Group Index 744 -- Auto Dealerships. This Industry Group
Index more closely reflects the Company peer group, since the index is composed
of companies engaged in the specialty retail of new and used automobiles and
other vehicles through the operation and/or franchising of dealerships. The
relevant performance period for the graph is from June 18, 1996 through December
31, 1996 (monthly) and from January 1, 1997 through December 31, 1997. The graph
assumes that $100 was invested on June 18, 1996 (the date the Company's Common
Stock began trading on Nasdaq following its initial public offering) in the
Company's Common Stock and in each of the indices, and that any dividends were
reinvested quarterly. The data source for the graph is Media General Financial
Services, Inc.
<TABLE>
<CAPTION>
UGLY
Measurement Period DUCKLING NASDAQ NASDAQ
(Fiscal Year Covered) CORP MG GROUP MARKET RETAIL
<S> <C> <C> <C> <C>
6/18/96 100.00 100.00 100.00 100.00
6/28/96 99.33 98.34 100.00 100.00
7/31/96 95.30 97.59 91.57 93.87
8/30/96 97.99 97.56 96.31 100.52
9/30/96 143.62 111.35 103.04 105.57
10/31/96 169.13 123.09 101.85 101.21
11/29/96 186.58 92.88 108.18 103.69
12/31/96 209.40 102.40 107.93 99.18
12/31/97 91.28 64.79 132.02 116.50
</TABLE>
100
<PAGE> 107
EXPERTS
The consolidated financial statements of the Company and Subsidiaries as of
December 31, 1997 and 1996, and for each of the years in the three-year period
ended December 31, 1997, have been included herein and in the Proxy Statement in
reliance upon the report of KPMG Peat Marwick, LLP, independent certified public
accountants, appearing elsewhere herein and upon the authority of said firm as
experts in accounting and auditing.
OTHER MATTERS
PROXY SOLICITATION
The Company will pay the cost of proxy solicitation with the solicitation
made by use of mail, personally, or by telephone or telegraph. In addition, the
Company has retained Corporate Investor Communications, Inc. to help solicit
proxies at an estimated cost of $4,000 plus out-of-pocket expenses. The Company
reimburses banks, brokers, and other nominees for their customary expenses
incurred in connection with the forwarding of such materials. The Company may
request that proxies be solicited, without additional compensation, by
directors, officers, and other regular employees of the Company and its
subsidiaries.
INDEPENDENT ACCOUNTANTS
The principal independent public accounting firm utilized by the Company
during the fiscal year ended December 31, 1997 was KPMG Peat Marwick, LLP
independent certified public accountants ("Auditors"). It is presently
contemplated that the Auditors will be retained as the principal accounting firm
to be utilized by the Company during the current fiscal year. A representative
of the Auditors will attend the Annual Meeting for the purpose of responding to
appropriate questions and will be afforded an opportunity to make a statement if
he or she so desires.
The Auditors were the Company's independent auditors for fiscal 1997 and
have been the Company's independent auditors for more than the past 5 years.
Audit services provided to the Company by the Auditors consist of the audit of
the consolidated financial statements of the Company and its subsidiaries and
the preparation of various reports based thereon; services relating to filings
with the Commission, audits of the Company's 401(k) plan, and other review, tax,
and consulting work. In addition, in January of 1998, the Auditors were retained
as independent compensation consultants to advise and report to the Compensation
Committee on the terms and conditions of the 1998 Plan and the option awards
granted under the 1998 Plan and the Incentive Plan in January of 1998.
STOCKHOLDER PROPOSALS
Stockholder proposals for the 1999 Annual Meeting must be received at the
principal executive offices of the Company by November 18, 1998 to be considered
for inclusion in the Company's proxy materials relating to such meeting.
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents or portions of documents filed by the Company with
the SEC are incorporated by reference herein:
1. Annual Report on Form 10-K for the fiscal year ended December 31,
1997.
2. Quarterly Report on Form 10-Q and Form 10-Q/A for the fiscal
quarter ended March 31, 1998.
3. The Company's Current Reports on Form 8-K dated December 15, 1997
and filed January 2, 1998, dated February 6, 1998 and filed February 9,
1998, dated January 28, 1998 and filed February 10, 1998, dated February
10, 1998 and filed February 20, 1998, dated June 11, 1998 and filed June
16, 1998, and dated June 19, 1998 and filed June 25, 1998.
101
<PAGE> 108
The Company will provide without charge to each person to whom a copy of
this Proxy Statement is delivered, on the written or oral request of any such
person, by first class mail or other equally prompt means within one business
day of receipt of such request, a copy of any or all of the foregoing documents
incorporated herein by reference (other than any exhibits to such documents
which are not specifically incorporated herein or into such documents by
reference). Requests should be directed to:
Ugly Duckling Corporation
2525 East Camelback, Suite 1150
Phoenix, Arizona 85016
Attn: Corporate Secretary
All documents filed by the Company with the Commission pursuant to Section
13(a), 13(c), 14 or 15(d) of the Exchange Act after the date hereof and prior to
the date of the Annual Meeting shall be deemed to be incorporated by reference
herein.
Any statements contained in a document incorporated by reference herein
shall be deemed to be modified or superseded for purposes hereof to the extent
that a statement contained herein (or in any other subsequently filed document
that also is incorporated by reference herein) modifies or supersedes such
statement. Any statement so modified or superseded shall not be deemed to
constitute a part hereof except as so modified or superseded.
OTHER ANNUAL MEETING MATTERS
By signing the enclosed proxy card, you are conferring the authority to
vote upon the persons indicated on the card. This authority includes
discretionary authority to vote your shares in accordance with the proxyholders'
judgment with respect to all matters which properly come before the meeting in
addition to the scheduled items of business. The Board of Directors intends to
instruct its proxyholders to vote in accordance with the recommendations of the
Board of Directors. As of the printing of this Notice of Annual Meeting of
Stockholders and Proxy Statement, the Board of Directors and the Company know of
no matters to be presented for action at the meeting other than items listed on
the proxy card.
YOUR VOTE IS IMPORTANT
It is important that your shares be represented and voted at the meeting.
Please vote as soon as possible whether or not you plan to attend the meeting.
Kindly mark, sign, date, and return the accompanying proxy card in the envelope
provided.
Ugly Duckling Corporation
Signature of Ernest C. Garica II
ERNEST C. GARCIA II
Chairman of the Board and
Chief Executive Officer
August 4, 1998
102
<PAGE> 109
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1997 and
1996................................................... F-3
Consolidated Statements of Operations for the years ended
December 31, 1997, 1996 and 1995....................... F-4
Consolidated Statements of Stockholders' Equity for the
years ended December 31, 1997, 1996 and 1995........... F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1997, 1996 and 1995....................... F-6
Notes to Consolidated Financial Statements.................. F-7
</TABLE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997.................................. F-30
Condensed Consolidated Statements of Operations for the
three months ended March 31, 1998 and 1997............. F-31
Condensed Consolidated Statements of Cash Flows for the
three months ended March 31, 1998 and 1997............. F-32
Notes to Condensed Consolidated Financial Statements........ F-33
</TABLE>
F-1
<PAGE> 110
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, 1997 and 1996, 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, 1997.
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, 1997 and 1996, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1997 in conformity with generally accepted
accounting principles.
/s/ KPMG PEAT MARWICK LLP
Phoenix, Arizona
February 10, 1998, except for Note 2 to the consolidated financial statements
which is as of April 27, 1998
F-2
<PAGE> 111
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1996
-------- --------
<S> <C> <C>
ASSETS
Cash and Cash Equivalents................................... $ 3,537 $ 18,455
Finance Receivables, Net.................................... 60,778 14,186
Investments Held in Trust................................... 11,637 3,162
Inventory................................................... 32,372 5,464
Property and Equipment, Net................................. 39,182 19,942
Intangible Assets, Net...................................... 16,366 2,150
Other Assets................................................ 9,350 5,328
Net Assets of Discontinued Operations....................... 102,411 48,942
-------- --------
$275,633 $117,629
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable.......................................... $ 2,867 $ 1,379
Accrued Expenses and Other Liabilities.................... 13,821 7,027
Notes Payable............................................. 65,171 12,904
Subordinated Note Payable................................. 12,000 14,000
-------- --------
Total Liabilities................................. 93,859 35,310
-------- --------
Stockholders' Equity
Preferred Stock; $.001 par value, 10,000,000 shares
authorized, none issued and outstanding................ -- --
Common Stock; $.001 par value, 100,000,000 shares
authorized, 18,521,000 and 13,327,000 issued and
outstanding............................................ 19 13
Additional Paid-in Capital................................ 172,603 82,599
Retained Earnings (Accumulated Deficit)................... 9,152 (293)
-------- --------
Total Stockholders' Equity........................ 181,774 82,319
Commitments, Contingencies and Subsequent Events
-------- --------
$275,633 $117,629
======== ========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-3
<PAGE> 112
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------
1997 1996 1995
-------- ------- -------
(IN THOUSANDS, EXCEPT EARNINGS
PER SHARE AMOUNTS)
<S> <C> <C> <C>
Sales of Used Cars.......................................... $123,814 $53,768 $47,824
Less:
Cost of Used Cars Sold.................................... 72,358 31,879 29,733
Provision for Credit Losses............................... 22,354 9,657 8,359
-------- ------- -------
29,102 12,232 9,732
-------- ------- -------
Other Income:
Interest Income........................................... 12,559 8,597 8,227
Gain on Sale of Loans..................................... 6,721 3,925 --
Servicing Income.......................................... 8,738 1,887 --
Other Income.............................................. 3,587 650 308
-------- ------- -------
31,605 15,059 8,535
-------- ------- -------
Income before Operating Expenses............................ 60,707 27,291 18,267
-------- ------- -------
Operating Expenses:
Selling and Marketing..................................... 10,538 3,585 3,856
General and Administrative................................ 39,412 12,221 11,677
Depreciation and Amortization............................. 3,150 1,382 1,225
-------- ------- -------
53,100 17,188 16,758
-------- ------- -------
Income before Interest Expense.............................. 7,607 10,103 1,509
Interest Expense............................................ 706 2,429 5,328
-------- ------- -------
Earnings (Loss) before Income Taxes......................... 6,901 7,674 (3,819)
Income Taxes................................................ 2,820 694 --
-------- ------- -------
Earnings (Loss) from Continuing Operations.................. 4,081 6,980 (3,819)
Discontinued Operations:
Earnings (Loss) from Operations of Discontinued
Operations, net of income taxes (benefit) of $3,759,
($594), and $0......................................... 5,364 (1,114) (153)
-------- ------- -------
Net Earnings (Loss)......................................... $ 9,445 $ 5,866 $(3,972)
======== ======= =======
Earnings (Loss) per Common Share from Continuing Operations:
Basic..................................................... $ 0.23 $ 0.77 $ (0.69)
======== ======= =======
Diluted................................................... $ 0.22 $ 0.73 $ (0.69)
======== ======= =======
Net Earnings (Loss) per Common Share:
Basic..................................................... $ 0.53 $ 0.63 $ (0.72)
======== ======= =======
Diluted................................................... $ 0.52 $ 0.60 $ (0.72)
======== ======= =======
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-4
<PAGE> 113
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED TOTAL
SHARES AMOUNT EARNINGS STOCKHOLDERS'
------------------- --------------------- (ACCUMULATED EQUITY
PREFERRED COMMON PREFERRED COMMON DEFICIT) (DEFICIT)
--------- ------ --------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 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 Director's........... -- 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
Issuance of Common Stock for
Cash.......................... -- 5,194 -- 89,398 -- 89,398
Issuance of Common Stock
Warrants...................... -- -- -- 612 -- 612
Net Earnings for the Year....... -- -- -- -- 9,445 9,445
------ ------ -------- -------- ------- --------
BALANCES AT DECEMBER 31, 1997... -- 18,521 $ -- $172,622 $ 9,152 $181,774
====== ====== ======== ======== ======= ========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-5
<PAGE> 114
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
--------- -------- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss)....................................... $ 9,445 $ 5,866 $(3,972)
Adjustments to Reconcile Net Earnings (Loss) to Net Cash
Provided by (Used in) Operating Activities from
Continuing Operations:
Loss (Earnings) from Discontinued Operations.............. (5,364) 1,114 153
Provision for Credit Losses............................... 22,354 9,657 8,359
Gain on Sale of Loans..................................... (6,721) (3,925) --
Decrease in Deferred Income Taxes......................... 510 498 500
Depreciation and Amortization............................. 3,150 1,382 1,225
Purchase of Finance Receivables for Sale.................. (116,830) (48,996) --
Proceeds from Sale of Finance Receivables................. 81,098 30,259 --
Collections of Finance Receivables........................ 15,554 26,552 --
Decrease (Increase) in Inventory.......................... (20,592) 778 (1,394)
Increase in Other Assets.................................. (1,252) (2,155) (507)
Increase in Accounts Payable, Accrued Expenses, and Other
Liabilities............................................. 6,345 2,571 2,937
Increase (Decrease) in Income Taxes Receivable/Payable.... (1,377) 535 (983)
Other, Net................................................ -- -- 169
--------- -------- -------
Net Cash Provided by (Used in) Operating Activities
of Continuing Operations.............................. (13,680) 24,136 6,487
--------- -------- -------
Cash Flows from Investing Activities:
Increase in Finance Receivables........................... -- -- (38,606)
Collections of Finance Receivables........................ -- -- 18,373
Increase in Investments Held in Trust..................... (8,475) (3,162) --
Net Decrease in Notes Receivable.......................... 151 137 --
Purchase of Property and Equipment........................ (18,764) (5,549) (2,882)
Payment for Acquisition of Assets......................... (35,841) -- --
Other, Net................................................ -- (1,944) 60
--------- -------- -------
Net Cash Used in Investing Activities of Continuing
Operations............................................. (62,929) (10,518) (23,055)
--------- -------- -------
Cash Flows from Financing Activities:
Additions to Notes Payable................................ 22,578 1,000 22,259
Repayments of Notes Payable............................... -- (28,610) --
Net Issuance (Repayment) of Subordinated Notes Payable.... (2,000) (553) 6,262
Redemption of Preferred Stock............................. -- (10,000) --
Proceeds from Issuance of Common Stock.................... 89,398 79,435 5
Other, Net................................................ (180) (1,158) 2,807
--------- -------- -------
Net Cash Provided by Financing Activities of Continuing
Operations............................................. 109,796 40,114 31,333
--------- -------- -------
Net Cash Used in Discontinued Operations.................... (48,105) (36,696) (13,514)
--------- -------- -------
Net Increase (Decrease) in Cash and Cash Equivalents........ (14,918) 17,036 1,251
Cash and Cash Equivalents at Beginning of Year.............. 18,455 1,419 168
--------- -------- -------
Cash and Cash Equivalents at End of Year.................... $ 3,537 $ 18,455 $ 1,419
========= ======== =======
Supplemental Statement of Cash Flows Information:
Interest Paid............................................. $ 5,382 $ 5,144 $ 5,890
========= ======== =======
Income Taxes Paid......................................... $ 6,570 $ 450 $ 535
========= ======== =======
Assumption of Debt in Connection with Acquisition of
Assets.................................................. $ 29,900 $ -- $ --
========= ======== =======
Conversion of Note Payable to Common Stock................ $ -- $ 3,000 $ --
========= ======== =======
Conversion of Subordinated Debt to Preferred Stock........ $ -- $ -- $10,000
========= ======== =======
Purchase of Property and Equipment with Notes Payable..... $ -- $ 8,313 $ --
========= ======== =======
Purchase of Property and Equipment with Capital Leases.... $ 357 $ 57 $ 792
========= ======== =======
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-6
<PAGE> 115
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) ORGANIZATION AND ACQUISITIONS
Ugly Duckling Corporation, a Delaware corporation (the Company), was
incorporated in April 1996 as the successor to Ugly Duckling Holdings, Inc.
(UDH), an Arizona corporation, formed in 1992. Contemporaneous with the
formation of the Company, UDH was merged into the Company with each share of
UDH's common stock exchanged for 1.16 shares of common stock in the Company and
each share of UDH's preferred stock exchanged for one share of preferred stock
in the Company under identical terms and conditions. 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 and the
Statements of Stockholders' Equity reflect 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 14.
During 1997, the Company completed several acquisitions. In January 1997,
the Company acquired substantially all of the assets of Seminole Finance
Corporation and related companies (Seminole) including four dealerships in
Tampa/St. Petersburg and a contract portfolio of approximately $31.1 million in
exchange for approximately $2.5 million in cash and assumption of $29.9 million
in debt. In April 1997, the Company purchased substantially all of the assets of
E-Z Plan, Inc. (EZ Plan), including seven dealerships in San Antonio and a
contract portfolio of approximately $24.3 million in exchange for approximately
$26.3 million in cash. In September 1997, the Company acquired substantially all
of the dealership and loan servicing assets (but not the loan portfolio) of
Kars-Yes Holdings Inc. and related companies (Kars), including six dealerships
in the Los Angeles market, two in the Miami market, two in the Atlanta market
and two in the Dallas market, in exchange for approximately $5.5 million in
cash. These acquisitions were recorded in accordance with the "purchase method"
of accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon the estimated fair
values at the date of acquisition. The excess of the purchase price over the
fair values of the net assets acquired was approximately $14.8 million and has
been recorded as goodwill, which is being amortized over periods ranging from
fifteen to twenty years. The results of operations of the acquired operations
have been included in the accompanying statements of operations from the
respective acquisition dates.
The following summary, prepared on a pro forma basis, combines the
consolidated results of operations (unaudited) as if the acquisitions had taken
place on January 1, 1996. Such pro forma amounts are not necessarily indicative
of what the actual results of operations might have been if the acquisitions had
been effective on January 1, 1996, (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------
1997 1996
-------- --------
<S> <C> <C>
Sales of Used Cars................................. $225,882 $244,074
======== ========
Interest Income.................................... $ 26,907 $ 32,467
======== ========
Other Income....................................... $ 16,595 $ 12,244
======== ========
Total Revenues..................................... $268,510 $285,785
======== ========
Earnings (Loss) From Continuing Operations......... $ 29,399 $ (6,682)
======== ========
Net Loss........................................... $(29,325) $ (7,508)
======== ========
Basic Loss Per Share From Continuing Operations.... $ (1.64) $ (0.74)
======== ========
Diluted Loss Per Share From Continuing
Operations....................................... $ (1.64) $ (0.74)
======== ========
Basic Loss Per Share............................... $ (1.95) $ (0.95)
======== ========
Diluted Loss Per Share............................. $ (1.95) $ (0.95)
======== ========
</TABLE>
F-7
<PAGE> 116
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(2) DISCONTINUED OPERATIONS
In February 1998, the Company announced its intention to close its branch
office network (the "Branch Offices") through which the Company purchased retail
installment contracts, and exit this line of business in the first quarter of
1998. The Company recorded a pre-tax charge to discontinued operations of $9.1
million (approximately $5.4 million, net of income taxes) in the quarter ended
March 31, 1998. The closure was substantially complete as of March 31, 1998 and
included the termination of approximately 400 employees, substantially all of
whom are employed at the Company's 76 branches that were in place on the date of
the announcement. Approximately $1.0 million of the discontinued operations
charge is for termination benefits, $2.5 million for write-off of pre-opening
and start-up costs, and the remainder for lease payments on idle facilities,
writedowns of leasehold improvements, data processing and other equipment. In
April 1998, the Company announced that its Board of Directors had directed
management to proceed with separating current operations into two publicly held
companies. The Company's continuing operations will focus exclusively on the
retail sale of used cars through its chain of dealerships, as well as the
collection and servicing of the resulting loans. It is anticipated that a new
company will be formed to operate all non-dealership operations. As a result of
these two announcements, the Company has restated the accompanying consolidated
balance sheets and consolidated statements of operations to reflect the
Company's discontinued operations, including the split-up businesses and the
Company's third party dealer Branch Office network in accordance with Accounting
Principles Board Opinion No. 30 "Reporting the Results of Operations --
Reporting the Effects of Disposal of a Segment of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions."
Included within the Company's discontinued operations is a collateralized
dealer financing program ("Cygnet Dealer Program"), pursuant to which the
Company provides qualified independent used car dealers ("Third Party Dealers")
with warehouse purchase facilities and operating credit lines primarily secured
by the dealers' retail installment contract portfolio. Discontinued operations
also include the bulk purchase and/or servicing of contracts originated by other
subprime lenders, which the Company believes is a more efficient method of
purchasing or obtaining servicing rights to sub-prime automobile contracts than
through the closed Branch Office network. The Company intends to split-up the
Cygnet Dealer Program and the operations that bulk purchase and/or service
contracts by other subprime lenders. Further, discontinued operations include
the Branch Office network, which the Company closed in February 1998 and which
will not be included in the anticipated split-up.
The components of Net Assets of Discontinued Operations as of December 31,
1997 and December 31, 1996 follow (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
Finance Receivables, net................................ $ 46,218 $44,978
Residuals in Finance Receivables Sold................... 16,099 1,377
Investments Held in Trust............................... 7,277 316
Notes Receivable........................................ 25,686 --
Property and Equipment.................................. 2,070 710
Capitalized Start-up Costs.............................. 2,453 --
Other Assets, net of Accounts Payable and Accrued
Liabilities........................................... 2,608 1,561
-------- -------
$102,411 $48,942
======== =======
</TABLE>
F-8
<PAGE> 117
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Following is a summary of the operating results of the Discontinued
Operations for the years ended December 31, 1997, 1996, and 1995 (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1997 1996 1995
-------- ------- -------
<S> <C> <C> <C>
Revenues............................................. $ 37,207 $ 7,768 $ 1,845
Expenses............................................. (28,084) (9,477) (1,998)
-------- ------- -------
Earnings (Loss) before Income Taxes (Benefit)........ 9,123 (1,708) (153)
Income Taxes (Benefit)............................... 3,759 (594) --
-------- ------- -------
Earnings (Loss) from Discontinued Operations......... $ 5,364 $(1,114) $ (153)
======== ======= =======
</TABLE>
(3) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Operations
The Company, through its subsidiaries, owns and operates used car sales
dealerships, a property and casualty insurance company, and is a franchisor of
rental car operations. Additionally, Champion Receivables Corporation and
Champion Receivables Corporation II, "bankruptcy remote entities" are the
Company's wholly-owned special purpose securitization subsidiaries. Their assets
include residuals in finance receivables sold and investments held in trust,
including amounts classified as discontinued operations, in the amounts of
$29,376,000 and $17,600,000 respectively, at December 31, 1997 and in the
amounts of $9,889,000 and $2,843,000, respectively at December 31, 1996, which
amounts would not be available to satisfy claims of creditors of the Company.
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.
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.
Concentration of Credit Risk
The Company provides sales finance services in connection with the sales of
used cars to individuals residing primarily in several metropolitan areas. The
Company operated a total of forty-one, eight, and eight used car dealerships
(company dealerships) in ten, two and two metropolitan markets in 1997, 1996 and
1995, respectively.
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.
F-9
<PAGE> 118
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. 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.
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.
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 actual cash flows on a securitization are below original
estimates and differ materially from the original securitization assumptions,
and in the opinion of management if those differences appear to be other than
temporary in nature, the Company's residual will be adjusted, 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.
Residuals in finance receivables sold are classified as "held-to-maturity"
securities in accordance with SFAS No. 115.
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 Company may be required to transfer the
servicing of the portfolio to another servicer.
Finance Receivables and Allowance for Credit Losses
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 acquired allowances.
F-10
<PAGE> 119
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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." Direct loan
origination costs represent the unamortized balance of costs incurred in the
origination of contracts at the Company's dealerships.
An allowance for credit losses (allowance) is established by charging the
provision for credit losses and the allocation of acquired allowances. The
evaluation of the allowance considers such factors as 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. In the
opinion of management, the Allowance for Credit Losses as of December 31, 1997
and 1996 is sufficient to absorb anticipated net credit losses. However, there
can be no assurance that the allowance will prove adequate.
Notes Receivable
Notes receivable are recorded at cost, less related allowance for impaired
notes receivable. Management, considering information and events regarding the
borrowers ability to repay their obligations, including an evaluation of the
estimated value of the related collateral, considers a note to be impaired when
it is probable that the Company will be unable to collect all amounts due
according to the contractual terms of the note agreement. When a loan is
considered to be impaired, the amount of impairment is measured based on the
present value of expected future cash flows discounted at the note's effective
interest rate. Impairment losses are included in the allowance for credit losses
through a charge to provision for credit losses. Cash receipts on impaired notes
receivable are applied to reduce the principal amount of such notes until the
principal has been received and are recognized as interest income, thereafter.
Inventory
Inventory consists of used vehicles held for sale which is valued at the
lower of cost or market, and repossessed vehicles which are valued at market
value. Vehicle reconditioning costs are capitalized as a component of inventory
cost. The cost of used vehicles sold is determined on a specific identification
basis.
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.
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 to twenty years.
F-11
<PAGE> 120
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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. Advertising costs capitalized as of December 31, 1997 were
immaterial. The Company had no advertising costs capitalized as of December 31,
1996.
Stock Option Plan
The Company accounts 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 is 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 the disclosure provisions of SFAS No. 123, Accounting for Stock-Based
Compensation, which permits entities to 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 as defined in SFAS No.
123 had been applied.
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.
F-12
<PAGE> 121
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Earnings Per Share
Basic earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed of
Long-Lived Assets and certain identifiable intangibles are 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 undiscounted 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.
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
The Company adopted the provisions of SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
(SFAS No. 125) on January 1, 1997. 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. Adoption of SFAS No. 125 did not have a material impact on the
Company.
Reclassifications
Certain reclassifications have been made to the prior years' consolidated
financial statement amounts to conform to the current year presentation.
(4) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
A summary of finance receivables as of December 31, 1997 and 1996 follows
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
Installment Sales Contract Principal Balances........... $ 55,965 $ 7,068
Add: Accrued Interest Receivable........................ 461 42
Loan Origination Costs, Net............................. 1,431 189
-------- -------
Principal Balances, Net................................. 57,857 7,299
Residuals in Finance Receivables Sold................... 13,277 8,512
-------- -------
71,134 15,811
Allowance for Credit Losses............................. (10,356) (1,625)
-------- -------
Finance Receivables, net................................ $ 60,778 $14,186
======== =======
</TABLE>
F-13
<PAGE> 122
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The finance receivables are classified as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
------- ------
<S> <C> <C>
Finance Receivables Held for Sale......................... $52,000 $6,400
Finance Receivables Held for Investment................... 5,857 899
------- ------
$57,857 $7,299
======= ======
</TABLE>
A summary of allowance for credit losses on finance receivables for the
years ended December 31, 1997, 1996 and 1995 follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1997 1996 1995
-------- ------ ------
<S> <C> <C> <C>
Balances, Beginning of Year.................... $ 1,625 $7,500 $6,050
Provision for Credit Losses.................... 22,354 9,657 8,359
Allowance on Acquired Loans.................... 15,309 -- --
Net Charge Offs................................ (7,524) (6,202) (6,909)
Sale of Finance Receivables.................... (21,408) (9,330) --
-------- ------ ------
Balances, End of Year.......................... $ 10,356 $1,625 $7,500
======== ====== ======
</TABLE>
The valuation of the Residual in Finance Receivables Sold as of December
31, 1997 totaled $13,277,000 which represents the present value of the Company's
interest in the anticipated future cash flows of the underlying portfolio. With
the exception of the Company's first two securitization transactions which took
place during the first six months of 1996, the estimated cash flows into the
Trusts were discounted with a rate of 16%. The two securitization transactions
that took place during the first six months of 1996 were discounted with a rate
of 25%. For securitization between June 30, 1996 and June 30, 1997, net losses
were originally estimated using total expected cumulative net losses at loan
origination of approximately 26.0%, adjusted for actual cumulative net losses
prior to securitization. Prepayment rates were estimated to be 1.5% per month of
the beginning of month balances.
During the year ended December 31, 1997, the Company recorded a $5.7
million charge to write-down the residuals in finance receivables sold. The
charge had the effect of increasing the cumulative net loss assumption to
approximately 27.5%, for the securitization transactions that took place prior
to June 30, 1997. For the securitization transactions that took place subsequent
to June 30, 1997, net losses were estimated using total expected cumulative net
losses at loan origination of approximately 27.5%, adjusted for actual
cumulative net losses prior to securitization. Prepayment rates were estimated
to be 1.5% per month of the beginning of month balance.
F-14
<PAGE> 123
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1997 and 1996, the Residuals in Finance Receivables Sold
were comprised of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1996
-------- -------
<S> <C> <C>
Retained interest in subordinated securities (B
certificates)......................................... $ 25,483 $ 9,747
Net interest spreads, less present value discount....... 10,622 5,590
Reduction for estimated credit losses................... (22,828) (6,825)
-------- -------
Residuals in finance receivables sold................... $ 13,277 $ 8,512
======== =======
Securitized principal balances outstanding.............. $127,356 $41,998
======== =======
Estimated credit losses and allowances as a % of
securitized principal balances outstanding............ 17.9% 16.2%
======== =======
</TABLE>
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the years ended December 31, 1997 and 1996,
respectively (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Balance, Beginning of Year............................... $ 8,512 $ --
Additions................................................ 17,734 10,119
Amortization............................................. (7,242) (1,607)
Write-down of Residual in Finance Receivables Sold....... (5,727) --
------- -------
Balance, End of Year..................................... $13,277 $ 8,512
======= =======
</TABLE>
(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 from 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 1997, the Company made initial spread account deposits totaling
$6,068,000. Additional net deposits through the trustee during 1997 totaled
$1,763,000. The total balance in the spread accounts was $10,357,000 as of
December 31, 1997. In connection therewith, the specified spread account balance
based upon the aforementioned specified percentages of the balances of the
underlying portfolios as of December 31, 1997 was $10,458,000, resulting in
additional funding requirements from future cash flows as of December 31,
F-15
<PAGE> 124
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
1997 of $101,000. 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.
During 1996, the Company made initial spread account deposits totaling
$2,330,000. Additional net deposits through the trustee during 1996 totaled
$196,000 resulting in a total balance in the spread accounts of $2,526,000 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 $3,361,000.
In connection with certain other agreements, the Company has deposited a
total of $1,280,000, and $636,000 in an interest bearing trust account as of
December 31, 1997 and 1996, respectively.
(6) PROPERTY AND EQUIPMENT
A summary of Property and Equipment as of December 31, 1997 and 1996
follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Land..................................................... $13,813 $ 7,811
Buildings and Leasehold Improvements..................... 16,234 5,690
Furniture and Equipment.................................. 10,932 5,268
Vehicles................................................. 224 156
Construction in Process.................................. 2,817 3,536
------- -------
44,020 22,461
Less Accumulated Depreciation and Amortization........... (4,838) (2,519)
------- -------
Property and Equipment, Net.............................. $39,182 $19,942
======= =======
</TABLE>
Interest Expense capitalized in 1997, 1996 and 1995 totaled $229,000, zero,
and $54,000, respectively.
(7) INTANGIBLE ASSETS
A summary of intangible assets as of December 31, 1997 and 1996 follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
------- ------
<S> <C> <C>
Original Cost:
Goodwill.................................................. $16,741 $1,944
Trademarks................................................ 581 581
Covenants not to Compete.................................. 250 --
------- ------
17,572 2,525
Accumulated Amortization.................................. (1,206) (375)
------- ------
Intangibles, Net.......................................... $16,366 $2,150
======= ======
</TABLE>
Amortization expense relating to intangible assets totaled $831,000,
$63,000, and $63,000 for the years ended December 31 1997, 1996, and 1995,
respectively.
F-16
<PAGE> 125
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) OTHER ASSETS
A summary of Other Assets as of December 31, 1997 and 1996 follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1996
------ ------
<S> <C> <C>
Note Receivable............................................ $ 912 $1,063
Prepaid Expenses........................................... 1,957 790
Income Taxes Receivable.................................... 1,693 316
Servicing Receivables...................................... 1,389 --
Deposits................................................... 829 687
Employee Advances.......................................... 821 --
Escrow Deposits............................................ -- 900
Deferred Income Taxes...................................... -- 376
Other Assets............................................... 1,749 1,196
------ ------
$9,350 $5,328
====== ======
</TABLE>
(9) ACCRUED EXPENSES AND OTHER LIABILITIES
A summary of Accrued Expenses and Other Liabilities as of December 31, 1997
and 1996 follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
------- ------
<S> <C> <C>
Sales Taxes............................................... $ 3,909 $2,904
Accrued Payroll, Benefits & Taxes......................... 2,366 486
Servicing Liability....................................... 1,503 695
Deferred Revenue.......................................... 840 601
Accrued Advertising....................................... 850 50
Obligations under Capital Leases.......................... 775 742
Accrued Post Sale Support................................. 771 250
Deferred Income Taxes..................................... 133 --
Others.................................................... 2,674 1,299
------- ------
$13,821 $7,027
======= ======
</TABLE>
In connection with the retail sale of vehicles, the Company is required to
pay sales taxes to certain government jurisdictions. In certain of these
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.
F-17
<PAGE> 126
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) NOTES PAYABLE
A summary of Notes Payable at December 31, 1997 and 1996 follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
$100,000,000 revolving loan with a finance company, interest
payable daily at 30 day LIBOR (5.70% at December 31, 1997)
plus 3.15% through December 1998, secured by substantially
all assets of the Company................................. $56,950 $ 4,602
Two notes payable to a finance company totaling $7,450,000,
monthly interest payable at the prime rate (8.50% at
December 31, 1997) 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............. 7,450 7,450
Others bearing interest at rates ranging from 9% to 11% due
through April 2007, secured by certain real property and
certain property and equipment............................ 771 852
------- -------
Total............................................. $65,171 $12,904
======= =======
</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,
1997 and 1996.
A summary of future minimum principal payments required under the
aforementioned notes payable after December 31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, AMOUNT
- ------------ -------
<S> <C>
1998..................................................... $58,021
1999..................................................... 1,169
2000..................................................... 1,179
2001..................................................... 1,191
2002..................................................... 3,296
Thereafter............................................... 315
-------
$65,171
=======
</TABLE>
(11) SUBORDINATED NOTE PAYABLE
During 1996, the Company amended its previous subordinated notes payable
with Verde and executed a single $14,000,000 unsecured note payable with Verde.
The 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 $12,000,000 and $14,000,000 outstanding under this
note payable at December 31, 1997 and 1996, respectively.
Interest expense related to the subordinated note payable with Verde
totaled $1,232,000, $1,933,000, and $3,492,000 during the years ended December
31, 1997, 1996 and 1995, respectively.
F-18
<PAGE> 127
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(12) INCOME TAXES
Income taxes amounted to $2,820,000, $694,000, and zero for the years ended
December 31, 1997, 1996 and 1995, respectively (an effective tax rate of 40.9%,
9.0% and 0.0%, respectively). A reconciliation between taxes computed at the
federal statutory rate of 35% in 1997 and 34% in 1996 and 1995 (the "Expected"
income taxes (benefit)) and the Company's effective taxes follows (in
thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------
1997 1996 1995
------ ------- -------
<S> <C> <C> <C>
Computed "Expected" Income Taxes (Benefit)..... $2,415 $ 2,609 $(1,298)
State Income Taxes, Net of Federal Effect...... 425 143 --
Change in Valuation Allowance.................. -- (2,251) 1,354
Other, Net..................................... (20) 193 (56)
------ ------- -------
$2,820 $ 694 $ --
====== ======= =======
</TABLE>
Components of income taxes (benefit) for the years ended December 31, 1997,
1996 and 1995 follow (in thousands):
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------- -------- ------
<S> <C> <C> <C>
1997:
Federal........................................ $1,751 $ 424 $2,175
State.......................................... 560 85 645
------ ------ ------
2,311 509 2,820
Discontinued operations........................ 2,589 1,170 3,759
------ ------ ------
$4,900 $1,679 $6,579
====== ====== ======
1996:
Federal........................................ $ 152 $ 326 $ 478
State.......................................... 44 172 216
------ ------ ------
196 498 694
Discontinued operations........................ (345) (249) (594)
------ ------ ------
$ (149) $ 249 $ 100
====== ====== ======
1995:
Federal........................................ $ (500) $ 500 $ --
State.......................................... -- -- --
------ ------ ------
(500) 500 --
Discontinued operations........................ 51 (51) --
------ ------ ------
$ (449) $ 449 $ --
====== ====== ======
</TABLE>
F-19
<PAGE> 128
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1997 and 1996 are presented below (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
------- -------
<S> <C> <C>
Deferred Tax Assets:
Finance Receivables, Principally Due to the Allowance for
Credit Losses.......................................... $ 192 $ 233
Inventory................................................. 246 73
Federal and State Income Tax Net Operating Loss
Carryforwards.......................................... 28 --
Residual in Finance Receivables........................... -- 154
Accrued Post Sale Support................................. 357 138
Other..................................................... 25 45
------- -------
Total Gross Deferred Tax Assets........................... 848 643
Less: Valuation Allowance................................. -- --
------- -------
Net Deferred Tax Assets........................... 848 643
------- -------
Deferred Tax Liabilities:
Software Development Costs................................ (158) (192)
Loan Origination Fees..................................... (586) (75)
Other..................................................... (237) --
------- -------
Total Gross Deferred Tax Liabilities................... (981) (267)
------- -------
Net Deferred Tax Asset (Liability)................ $ (133) $ 376
======= =======
</TABLE>
The valuation allowance for deferred tax assets as of December 31, 1997 and
1996 was zero. There was no change in the Valuation Allowance for the year ended
December 31, 1997. The net change in the total Valuation Allowance for the year
ended December 31, 1996 was a decrease of $2,251,000. 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 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.
At December 31, 1997, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $91,000, which, subject to annual
limitations, are available to offset future taxable income, if any, through
2110.
(13) SERVICING
Pursuant to the Company's securitization program which began in 1996, the
Company securitizes loan portfolios with servicing retained. The Company
services the securitized portfolios for a monthly fee ranging from .25% to .33%
(3.0% to 4.0% per annum) of the beginning of month principal balance of the
serviced portfolios. During 1997, the Company began servicing a loan portfolio
for an unaffiliated party and recognizes servicing fee income of approximately
.33% (4.0% annualized) of beginning of month balances, generally subject to a
minimum fee of $15 per contract per month. The Company recognized servicing
income of $8,738,000 and $1,887,000 in the years ended December 31, 1997 and
1996, respectively.
F-20
<PAGE> 129
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of portfolios serviced by the Company as of December 31, 1997 and
1996 follows:
<TABLE>
<CAPTION>
1997 1996
-------- --------
<S> <C> <C>
Finance receivables from continuing operations.............. $ 55,965 $ 7,068
Securitized with servicing retained......................... 127,356 41,998
-------- --------
Amounts originated by the Company........................... 183,321 49,066
Finance receivables from Discontinued operations:
Finance Receivables....................................... 29,965 49,772
Securitized with servicing retained....................... 110,669 9,664
Servicing on behalf of other................................ 127,322 --
-------- --------
Total serviced portfolios......................... $451,277 $108,502
======== ========
</TABLE>
Pursuant to the terms of the various servicing agreements, the serviced
portfolios are subject to certain performance criteria. In the event the
serviced portfolios do not satisfy such criteria the servicing agreements
contain various remedies up to and including the removal of servicing rights
from the Company.
(14) LEASE COMMITMENTS
The Company leases used car sales facilities, offices, and certain office
equipment from unrelated entities under various operating leases which expire
through March 2007. The leases require monthly rental payments aggregating
approximately $580,000 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.
Rent expense for the year ended December 31, 1997 totaled $5,345,000.
During 1996, 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. Rent expense for the year ended December 31, 1996
totaled $2,394,000 which included rents paid to Verde totaling $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.
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, 1997 follows (in thousands):
<TABLE>
<CAPTION>
CONTINUING DISCONTINUED
DECEMBER 31, OPERATIONS OPERATIONS AMOUNT
- ------------ ---------- ------------ -------
<S> <C> <C> <C>
1998....................................... $ 6,203 $1,432 $ 7,635
1999....................................... 5,668 1,227 6,895
2000....................................... 4,396 488 4,884
2001....................................... 2,728 82 2,810
2002....................................... 1,314 28 1,342
Thereafter................................. 1,233 -- 1,233
------- ------ -------
Total............................ $21,542 $3,257 $24,799
======= ====== =======
</TABLE>
F-21
<PAGE> 130
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) 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.
During 1997, the Company completed a private placement of 5,075,500 shares
of common stock for a total of approximately $89,156,000 cash, net of stock
issuance costs. The registration of the shares sold in the private placement was
effective in April 1997. 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.
During 1997, the Company issued warrants for the right to purchase 389,800
shares of the Company's common stock for $20.00 per share. The warrants were
valued at approximately $612,000. These warrants remained outstanding at
December 31, 1997. In addition, 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, 1997.
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.
F-22
<PAGE> 131
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(16) EARNINGS (LOSS) PER SHARE
A summary of the reconciliation from basic earnings (loss) per share to
diluted earnings (loss) per share for the years ended December 31, 1997, 1996,
and 1995 follows (in thousands, except for per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
------- ------ -------
<S> <C> <C> <C>
Net Earnings (Loss)....................................... $ 9,445 $5,866 $(3,972)
Less: Preferred Stock Dividends........................... -- (916) --
------- ------ -------
Earnings (Loss) available to Common Stockholders.......... $ 9,445 $4,950 $(3,972)
======= ====== =======
Earnings (Loss) From Continuing Operations................ $ 4,081 $6,980 $(3,819)
Less: Preferred Stock Dividends........................... -- (916) --
------- ------ -------
Earnings (Loss) available to Common Stockholders.......... $ 4,081 $6,064 $(3,819)
======= ====== =======
Basic EPS-Weighted Average Shares Outstanding............. 17,832 7,887 5,522
======= ====== =======
Basic Earnings (Loss) Per Share From Continuing
Operations.............................................. $ 0.23 $ 0.77 $ (0.69)
======= ====== =======
Basic Earnings (Loss) Per Share........................... $ 0.53 $ 0.63 $ (0.72)
======= ====== =======
Basic EPS-Weighted Average Shares Outstanding............. 17,832 7,887 5,522
Effect of Diluted Securities:
Warrants................................................ 98 71 --
Stock Options........................................... 304 340 --
------- ------ -------
Dilutive EPS-Weighted Average Shares Outstanding.......... 18,234 8,298 5,522
======= ====== =======
Diluted Earnings (Loss) Per Share From Continuing
Operations.............................................. $ 0.22 $ 0.73 $ (0.69)
======= ====== =======
Diluted Earnings (Loss) Per Share......................... $ 0.52 $ 0.60 $ (0.72)
======= ====== =======
Warrants Not Included in Diluted EPS Since Antidilutive... 390 -- --
======= ====== =======
Stock Options Not Included in Diluted EPS Since
Antidilutive............................................ 828 -- --
======= ====== =======
</TABLE>
(17) 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 1,800,000 shares of common
stock to be granted to employees at a price of 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 six
years after the date of grant. The options generally vest over a period of five
years.
At December 31, 1997, there were 344,000 additional shares available for
grant under the Plan. The per share weighted-average fair value of stock options
granted during 1997 and 1996 was $6.54 and $8.39, respectively on the date of
grant using the Black-Scholes option-pricing model with the following weighted-
average assumptions: 1997 -- expected dividend yield 0%, risk-free interest rate
of 5.53%, expected volatility of 40.0%, and an expected life of 5 years;
1996 -- expected dividend yield 0%, risk-free interest rate of 6.4%, 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
F-23
<PAGE> 132
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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,
------------------------
1997 1996
---------- ----------
<S> <C> <C>
Net Earnings from Continuing Operations Available to Common
Stockholders.............................................. $4,081,000 $6,064,000
Pro Forma Net Earnings from Continuing Operations Available
to Common Stockholders.................................... $3,342,000 $5,185,000
Net Earnings Available to Common Stockholders............... $9,445,000 $4,950,000
Pro forma Net Earnings Available to Common Stockholders..... $8,567,000 $3,916,000
Earnings per Share -- Basic
Continuing Operations..................................... $ 0.23 $ 0.77
Continuing Operations Pro Forma........................... $ 0.19 $ 0.66
Net Earnings.............................................. $ 0.53 $ 0.63
Pro Forma Net Earnings.................................... $ 0.48 $ 0.50
Earnings per Share -- Diluted
Continuing Operations..................................... $ 0.22 $ 0.73
Continuing Operations Pro Forma........................... $ 0.18 $ 0.62
Net Earnings.............................................. $ 0.52 $ 0.60
Net Earnings Pro Forma.................................... $ 0.47 $ 0.47
</TABLE>
The full impact of calculating compensation cost for stock options under
SFAS No. 123 is not reflected in the pro forma net earnings amounts presented
above because compensation cost is reflected over the options' vesting period of
five years.
A summary of the aforementioned stock plan activity follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
PRICE PER
NUMBER SHARE
--------- ----------
<S> <C> <C>
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
--------- ------
Granted................................................... 582,000 15.07
Forfeited................................................. (78,000) 14.00
Exercised................................................. (118,000) 2.04
--------- ------
Balance, December 31, 1997.................................. 1,298,000 $11.76
========= ======
</TABLE>
F-24
<PAGE> 133
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of stock options granted at December 31, 1997 follows:
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------ ----------------------------
NUMBER WEIGHTED-AVG. WEIGHTED-AVG. NUMBER WEIGHTED-AVG.
RANGE OF OUTSTANDING REMAINING EXERCISE EXERCISABLE EXERCISE
EXERCISE PRICES AT 12/31/97 CONTRACTUAL LIFE PRICE AT 12/31/97 PRICE
- --------------- ----------- ---------------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C>
$ .50 to $1.00....... 97,000 6.4 years $ 0.86 -- $ --
$1.50 to $2.60....... 169,000 3.7 years 2.36 58,000 2.45
$3.45 to $9.40....... 162,000 4.4 years 6.80 24,000 6.86
$11.88 to $20.75..... 870,000 5.3 years 15.73 75,000 17.28
--------- ------ ------- ------
1,298,000 $11.76 157,000 $10.21
========= ====== ======= ======
</TABLE>
(18) COMMITMENTS AND CONTINGENCIES
During 1997, the Company acquired certain notes receivable collateralized
by a loan portfolio. Thereafter, the Company exchanged the notes receivable for
the underlying collateral (the acquired collateral) and received a guarantee
from the borrower of an 11.0% return on the acquired collateral. An unrelated
third party purchased the collateral and the Company guaranteed the purchaser, a
return of 10.35%, not to exceed $10,000,000. No accruals have been made by the
Company related to this guarantee.
The Company has commenced a study of its computer systems in order to
assess its exposure to year 2000 issues. The Company expects to make the
necessary modifications or changes to its computer information systems to enable
proper processing of transactions relating to the year 2000 and beyond. The
Company will evaluate appropriate courses of action, including replacement of
certain systems whose associated costs would be recorded as assets and
subsequently amortized or modification of its existing systems which costs would
be expensed as incurred.
In October 1997 the Company's Board of Directors authorized a stock
repurchase program by which the Company may acquire up to one million shares of
its common stock from time to time on the open market. Under the program,
purchases may be made depending on market conditions, share price and other
factors. The stock repurchase program will terminate on December 31, 1998,
unless extended by the Company's Board of Directors, and may be discontinued at
any time. The Company had not repurchased any shares of common stock related to
this program as of December 31, 1997.
On July 18, 1997, the Company filed a Form S-3 registration statement for
the purpose of registering up to $200 million of its debt securities in one or
more series at prices and on terms to be determined at the time of sale. The
registration statement has been declared effective by the Securities and
Exchange Commission and is available for future debt offerings.
During 1997, the Company acquired approximately 2.5% of the outstanding
common stock of FMAC with a cost of approximately $1,450,000. In connection with
FMAC's proposed plan of reorganization, and subject to bankruptcy court
approval, the Company and FMAC have agreed to exchange the Company's common
stock in FMAC for the property and equipment that constitute FMAC's loan
servicing platform. The Company anticipates receiving bankruptcy court approval
for the plan of reorganization during the first fiscal quarter of 1998.
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
material adverse effect on the Company. No provision has been made in the
accompanying consolidated financial statements for losses, if any, that might
result from the ultimate disposition of these matters.
F-25
<PAGE> 134
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Subsequent to year end, the Company executed a commitment letter with a
finance company for the Company to obtain a short term $30.0 million standby
repurchase credit facility and a $150.0 million surety-enhanced revolving credit
facility. The commitment letter also provides for the finance company to be the
exclusive securitization agent of the Company for $1.0 billion of AAA-rated
surety wrapped securities as part of the Company's ongoing securitization
program.
(19) 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,
as amended, covers substantially all employees having no less than three months
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 $49,000, $23,000 and $5,000 during the
years ended December 31, 1997, 1996, and 1995, respectively.
(20) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107, "Disclosures about
Fair Value of Financial Instruments," requires that the Company disclose
estimated fair values for its financial instruments. The following summary
presents a description of the methodologies and assumptions used to determine
such amounts.
Limitations
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve uncertainties, matters of judgment and,
therefore, cannot be determined with precision. These estimates do not reflect
any premium or discount that could result from offering for sale at one time the
Company's entire holdings of a particular instrument. Changes in assumptions
could significantly affect these estimates.
Since the fair value is estimated as of December 31, 1997 and 1996, 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 estimated to be the fair value because of the
liquidity of these instruments.
Finance Receivables, Residuals in Finance Receivables Sold, and Notes
Receivable
The carrying amount is estimated 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.
F-26
<PAGE> 135
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
(21) BUSINESS SEGMENTS
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended December 31, 1997, 1996,
and 1995, respectively. The Company has three distinct business segments. These
consist of retail car sales operations (Company dealerships), the income
generated from the finance receivables generated at the Company dealerships, 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
COMPANY DEALERSHIP CORPORATE
DEALERSHIPS RECEIVABLES AND OTHER TOTAL
----------- ----------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
December 31, 1997:
Sales of Used Cars............................. $123,814 $ -- $ -- $123,814
Less: Cost of Cars Sold........................ 72,358 -- -- 72,358
Provision for Credit Losses.................... 22,354 -- -- 22,354
-------- ------- -------- --------
29,102 -- -- 29,102
Interest Income................................ -- 12,559 -- 12,559
Gain on Sale of Loans.......................... -- 6,721 -- 6,721
Other Income................................... 1,498 8,814 2,013 12,325
-------- ------- -------- --------
Income before Operating Expenses............... 30,600 28,094 2,013 60,707
-------- ------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 10,499 -- 39 10,538
General and Administrative..................... 17,215 12,303 9,894 39,412
Depreciation and Amortization.................. 1,536 1,108 506 3,150
-------- ------- -------- --------
29,250 13,411 10,439 53,100
-------- ------- -------- --------
Income (Loss) before Interest Expense.......... $ 1,350 $14,683 $ (8,426) $ 7,607
======== ======= ======== ========
Capital Expenditures........................... $ 13,571 $ 3,791 $ 1,402 $ 18,764
======== ======= ======== ========
Identifiable Assets............................ $ 74,287 $78,514 $122,832 $275,633
======== ======= ======== ========
</TABLE>
F-27
<PAGE> 136
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
COMPANY
COMPANY DEALERSHIP CORPORATE
DEALERSHIPS RECEIVABLES AND OTHER TOTAL
----------- ----------- --------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
December 31, 1996:
Sales of Used Cars............................. $ 53,768 $ -- $ -- $ 53,768
Less: Cost of Cars Sold........................ 31,879 -- -- 31,879
Provision for Credit Losses.................... 9,657 -- -- 9,657
-------- ------- -------- --------
12,232 -- -- 12,232
Interest Income................................ -- 8,426 171 8,597
Gain on Sale of Loans.......................... -- 3,925 -- 3,925
Other Income................................... 195 1,887 455 2,537
-------- ------- -------- --------
Income before Operating Expenses............... 12,427 14,238 626 27,291
-------- ------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 3,568 -- 17 3,585
General and Administrative..................... 6,306 2,859 3,056 12,221
Depreciation and Amortization.................. 318 769 295 1,382
-------- ------- -------- --------
10,192 3,628 3,368 17,188
-------- ------- -------- --------
Income (loss) before Interest Expense.......... $ 2,235 $10,610 $ (2,742) $ 10,103
======== ======= ======== ========
Capital Expenditures........................... $ 4,530 $ 455 $ 564 $ 5,549
======== ======= ======== ========
Identifiable Assets............................ $ 20,698 $12,775 $ 84,156 $117,629
======== ======= ======== ========
December 31, 1995:
Sales of Used Cars............................. $ 47,824 $ -- $ -- $ 47,824
Less: Cost of Cars Sold........................ 29,733 -- -- 29,733
Provision for Credit Losses.................... 8,359 -- -- 8,359
-------- ------- -------- --------
9,732 -- -- 9,732
Interest Income................................ -- 8,227 -- 8,227
Other Income................................... -- -- 308 308
-------- ------- -------- --------
Income before Operating Expenses............... 9,732 8,227 308 18,267
-------- ------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 3,856 -- -- 3,856
General and Administrative..................... 6,441 2,563 2,673 11,677
Depreciation and Amortization.................. 279 479 467 1,225
-------- ------- -------- --------
10,576 3,042 3,140 16,758
-------- ------- -------- --------
Income (loss) before Interest Expense.......... $ (844) $ 5,185 $ (2,832) $ 1,509
======== ======= ======== ========
Capital Expenditures........................... $ 1,195 $ 1,561 $ 126 $ 2,882
======== ======= ======== ========
Identifiable Assets............................ $ 11,452 $32,187 $ 17,151 $ 60,790
======== ======= ======== ========
</TABLE>
F-28
<PAGE> 137
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(22) QUARTERLY FINANCIAL DATA -- UNAUDITED
A summary of the quarterly data for the years ended December 31, 1997 and
1996 follows:
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1997:
Total Revenue......................... $22,296 $36,147 $44,821 $52,155 $155,419
======= ======= ======= ======= ========
Income before Operating Expenses...... 9,096 15,348 18,725 17,538 60,707
======= ======= ======= ======= ========
Operating Expenses.................... 7,665 11,447 14,100 19,888 53,100
======= ======= ======= ======= ========
Income (Loss) before Interest
Expense............................ 1,431 3,901 4,625 (2,350) 7,607
======= ======= ======= ======= ========
Earnings (Loss) from Continuing
Operations......................... $ 755 $ 2,150 $ 2,559 $(1,383) $ 4,081
======= ======= ======= ======= ========
Earnings (Loss) from Discontinued
Operations......................... 2,507 2,161 (4,387) 5,083 5,364
======= ======= ======= ======= ========
Net Earnings (Loss)................... $ 3,262 $ 4,311 $(1,828) $ 3,700 $ 9,445
======= ======= ======= ======= ========
Basic Earnings (Loss) Per Share from
Continuing Operations.............. $ 0.05 $ 0.12 $ 0.14 $ (0.07) $ 0.23
======= ======= ======= ======= ========
Diluted Earnings (Loss) Per Share from
Continuing Operations.............. $ 0.05 $ 0.11 $ 0.14 $ (0.07) $ 0.22
======= ======= ======= ======= ========
Basic Earnings (Loss) Per Share....... $ 0.21 $ 0.23 $ (0.10) $ 0.20 $ 0.53
======= ======= ======= ======= ========
Diluted Earnings (Loss) Per Share..... $ 0.20 $ 0.23 $ (0.10) $ 0.20 $ 0.52
======= ======= ======= ======= ========
1996:
Total Revenues........................ $18,327 $18,628 $16,204 $15,668 $ 68,827
======= ======= ======= ======= ========
Income before Operating Expenses...... 6,893 7,126 6,126 7,146 27,291
======= ======= ======= ======= ========
Operating Expenses.................... 4,309 4,824 3,366 4,689 17,188
======= ======= ======= ======= ========
Income before Interest Expense........ 2,584 2,302 2,760 2,457 10,103
======= ======= ======= ======= ========
Earnings from Continuing Operations... $ 1,334 $ 1,210 $ 2,353 $ 2,083 $ 6,980
======= ======= ======= ======= ========
Earnings (Loss) from Discontinued
Operations......................... (269) (127) 386 (1,104) (1,114)
======= ======= ======= ======= ========
Net Earnings.......................... $ 1,065 $ 1,083 $ 1,967 $ 1,751 $ 5,866
======= ======= ======= ======= ========
Basic Earnings Per Share from
Continuing Operations.............. $ 0.18 $ 0.16 $ 0.24 $ 0.17 $ 0.77
======= ======= ======= ======= ========
Diluted Earnings Per Share from
Continuing Operations.............. $ 0.18 $ 0.15 $ 0.23 $ 0.16 $ 0.73
======= ======= ======= ======= ========
Basic Earnings Per Share.............. $ 0.13 $ 0.14 $ 0.20 $ 0.15 $ 0.63
======= ======= ======= ======= ========
Diluted Earnings Per Share............ $ 0.13 $ 0.13 $ 0.19 $ 0.14 $ 0.60
======= ======= ======= ======= ========
</TABLE>
F-29
<PAGE> 138
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
ASSETS
Cash and Cash Equivalents................................... $ 514 $ 3,537
Finance Receivables, net.................................... 53,009 60,778
Investments Held in Trust................................... 15,181 11,637
Inventory................................................... 25,458 32,372
Property and Equipment, net................................. 43,505 39,182
Goodwill and Trademarks, net................................ 14,657 16,366
Other Assets................................................ 12,164 9,350
Net Assets of Discontinued Operations....................... 124,375 102,411
-------- --------
$288,863 $275,633
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable.......................................... $ 1,784 $ 2,867
Accrued Expenses and Other Liabilities.................... 15,765 13,821
Notes Payable............................................. 63,304 65,171
Subordinated Notes Payable................................ 27,000 12,000
-------- --------
Total Liabilities...................................... 107,853 93,859
-------- --------
Stockholders' Equity:
Preferred Stock; $.001 par value, 10,000,000 authorized,
none issued and outstanding............................ -- --
Common Stock; $.001 par value, 100,000,000 shares
authorized, 18,585,000 and 18,521,000 issued and
outstanding............................................ 19 19
Additional Paid-in Capital................................ 173,705 172,603
Retained Earnings......................................... 7,286 9,152
-------- --------
Total Stockholders' Equity............................. 181,010 181,774
-------- --------
$288,863 $275,633
======== ========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
F-30
<PAGE> 139
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1998 1997
------- -------
<S> <C> <C>
Sales of Used Cars.......................................... $72,972 $18,211
Less:
Cost of Used Cars Sold.................................... 40,363 9,939
Provision for Credit Losses............................... 15,034 3,261
------- -------
17,575 5,011
------- -------
Other Income:
Interest Income........................................... 3,879 1,512
Gain on Sale of Finance Receivables....................... 4,614 1,131
Servicing Income.......................................... 3,837 1,014
Other Income.............................................. 146 428
------- -------
12,476 4,085
------- -------
Income before Operating Expenses............................ 30,051 9,096
------- -------
Operating Expenses:
Selling and Marketing..................................... 5,326 1,532
General and Administrative................................ 16,669 5,604
Depreciation and Amortization............................. 1,152 529
------- -------
23,147 7,665
------- -------
Income before Interest Expense.............................. 6,904 1,431
Interest Expense............................................ 647 177
------- -------
Earnings before Income Taxes................................ 6,257 1,254
Income Taxes................................................ 2,511 499
------- -------
Earnings from Continuing Operations......................... 3,746 755
Discontinued Operations:
Earnings (Loss) from Operations of Discontinued Operations,
net of income taxes (benefit) of ($492) and $1,653
respectively.............................................. (785) 2,507
Loss on Disposal of Discontinued Operations net of income
taxes (benefit) of ($3,024) and $0, respectively.......... (4,827) --
------- -------
Net Earnings (Loss)......................................... $(1,866) $ 3,262
======= =======
Earnings per Common Share from Continuing Operations:
Basic..................................................... $ 0.20 $ 0.05
======= =======
Diluted................................................... $ 0.20 $ 0.05
======= =======
Net Earnings (Loss) per Common Share:
Basic..................................................... $ (0.10) $ 0.21
======= =======
Diluted................................................... $ (0.10) $ 0.20
======= =======
Shares Used in Computation-Continuing Operations:
Basic..................................................... 18,557 15,904
======= =======
Diluted................................................... 19,093 16,580
======= =======
Shares Used in Computation-Net Earnings (Loss):
Basic..................................................... 18,557 15,904
======= =======
Diluted................................................... 19,093 16,580
======= =======
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
F-31
<PAGE> 140
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss)....................................... $ (1,866) $ 3,262
Adjustments to Reconcile Net Earnings (Loss) to Net
Cash Provided by Operating Activities from Continuing
Operations:
Loss (Earnings) from Discontinued Operations........... 5,612 (2,507)
Provision for Credit Losses............................ 15,034 3,261
Gain on Sale of Finance Receivables.................... (4,614) (1,131)
Purchase of Finance Receivables........................ (69,708) (12,838)
Proceeds from Sale of Finance Receivables.............. 62,556 10,662
Collections of Finance Receivables..................... 5,935 730
Decrease (Increase) in Deferred Income Taxes........... (2,205) 573
Depreciation and Amortization.......................... 1,152 529
Decrease (Increase) in Inventory....................... 6,915 (528)
Increase in Other Assets............................... (2,157) (3,804)
Increase in Accounts Payable, Accrued Expenses, and
Other Liabilities..................................... 1,120 576
Increase in Income Taxes Receivable/Payable............ 792 1,564
-------- --------
Net Cash Provided by Operating Activities of
Continuing Operations:.............................. 18,566 349
-------- --------
Cash Flows Used In Investing Activities:
Increase in Investments Held in Trust..................... (3,543) (984)
Net Decrease in Notes Receivable.......................... 38 38
Purchase of Property and Equipment........................ (5,202) (3,929)
Payment for Acquisition of Assets......................... -- (3,449)
-------- --------
Net Cash Used in Investing Activities of Continuing
Operations:......................................... (8,707) (8,324)
-------- --------
Cash Flows from Financing Activities:
Issuance of Notes Payable................................. 30,000 --
Repayment of Notes Payable................................ (31,867) (12,107)
Issuance (Repayment) of Subordinated Notes Payable........ 15,000 (2,000)
Proceeds from Issuance of Common Stock.................... 202 88,662
Other, Net................................................ (126) (69)
-------- --------
Net Cash Provided by Financing Activities of
Continuing Operations:.............................. 13,209 74,486
-------- --------
Net Cash Used in Discontinued Operations.................... (26,091) (11,729)
-------- --------
Net Increase (Decrease) in Cash and Cash Equivalents........ (3,023) 54,782
Cash and Cash Equivalents at Beginning of Period............ 3,537 18,455
-------- --------
Cash and Cash Equivalents at End of Period.................. $ 514 $ 73,237
======== ========
Supplemental Statement of Cash Flows Information:
Interest Paid............................................. $ 2,222 $ 843
======== ========
Income Taxes Paid......................................... $ 408 $ 15
======== ========
Assumption of Debt in Connection with Acquisition of
Assets................................................. $ -- $ 29,900
======== ========
Purchase of Property and Equipment with Capital Leases.... $ -- $ 211
======== ========
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
F-32
<PAGE> 141
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of
Ugly Duckling Corporation (Company) have been prepared in accordance with
generally accepted accounting principles for interim financial information and
pursuant to rules and regulations of the Securities and Exchange Commission.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for a complete financial statement
presentation. In the opinion of management, such unaudited interim information
reflects all adjustments, consisting only of normal recurring adjustments,
necessary to present the Company's financial position and results of operations
for the periods presented. The results of operations for interim periods are not
necessarily indicative of the results to be expected for a full fiscal year. The
Condensed Consolidated Balance Sheet as of December 31, 1997 was derived from
audited consolidated financial statements as of that date but does not include
all the information and footnotes required by generally accepted accounting
principles. It is suggested that these condensed consolidated financial
statements be read in conjunction with the Company's audited consolidated
financial statements included in the Company's Annual Report on Form 10-K, for
the year ended December 31, 1997.
NOTE 2. DISCONTINUED OPERATIONS
In February 1998, the Company announced its intention to close its branch
office network (the "Branch Offices") through which the Company purchased retail
installment contracts, and exit this line of business in the first quarter of
1998. The closure was substantially complete as of March 31, 1998. The Company
is continuing to negotiate lease settlements and terminations with respect to
its Branch Office network closure. Further, in April 1998, the Company announced
that its Board of Directors had directed management to proceed with separating
current operations into two publicly held companies. The Company's continuing
operations will focus exclusively on the retail sale of used cars through its
chain of dealerships, as well as the collection and servicing of the resulting
loans. The Company would also retain its existing securitization program (the
"Securitization Program") and the residual interests in all securitization
transactions previously effected by the Company, its existing insurance
operations relating to its dealership activities, and its rent-a-car franchise
business (which is generally inactive) (the "Continuing Operations"). It is
anticipated that a new company will be formed to operate all non-dealership
operations. As a result of these two announcements, the Company has restated the
accompanying condensed consolidated balance sheets and condensed consolidated
statements of operations to reflect the Company's discontinued operations,
including the split-up businesses and the Company's third party dealer branch
office network in accordance with Accounting Principles Board Opinion No. 30
"Reporting the Results of Operations -- Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions."
Included within the Company's discontinued operations is a collateralized
dealer financing program ("Cygnet Dealer Program"), pursuant to which the
Company provides qualified independent used car dealers ("Third Party Dealers")
with warehouse purchase facilities and operating credit lines primarily secured
by the dealers' retail installment contract portfolio. Discontinued operations
also include the bulk purchase and/or servicing of contracts originated by other
subprime lenders, which the Company believes is a more efficient method of
purchasing or obtaining servicing rights to sub-prime automobile contracts than
through the closed Branch Office network. The Company intends to split-up the
Cygnet Dealer Program and the operations that bulk purchase and/or service
contracts by other subprime lenders. Further, discontinued operations include
the Branch Office network which the Company closed in February 1998 and which
will not be included in the anticipated split-up.
F-33
<PAGE> 142
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of Net Assets of Discontinued Operations as of March 31,
1998 and December 31, 1997 follow (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Finance Receivables, net.................................... $ 71,089 $ 46,218
Residuals in Finance Receivables Sold....................... 13,511 16,099
Investments Held in Trust................................... 6,868 7,277
Notes Receivable............................................ 29,900 25,686
Furniture and Equipment..................................... 3,490 2,070
Capitalized Start-up Costs.................................. -- 2,453
Other Assets, net of Accounts Payable and Accrued
Liabilities............................................... (483) 2,608
-------- --------
$124,375 $102,411
======== ========
</TABLE>
Following is a summary of the operating results of the Discontinued
Operations for the three month periods ended March 31, 1998 and 1997 (in
thousands):
<TABLE>
<CAPTION>
MARCH 31,
-------------------
1998 1997
-------- -------
<S> <C> <C>
Revenues.................................................... $ 6,520 $ 8,854
Expenses.................................................... (15,648) (4,694)
-------- -------
Earnings (Loss) before Income Tax Benefit................... (9,128) 4,160
Income Taxes (Benefit)...................................... (3,516) 1,653
-------- -------
Earnings (Loss) from Discontinued Operations................ $ (5,612) $ 2,507
======== =======
</TABLE>
NOTE 3. SUMMARY OF FINANCE RECEIVABLES, NET
Following is a summary of Finance Receivables, net, as of March 31, 1998
and December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Installment Sales Contract Principal Balances............... $33,265 $ 55,965
Add: Accrued Interest....................................... 331 461
Loan Origination Costs................................ 825 1,431
------- --------
Principal Balances, net..................................... 34,421 57,857
Residuals in Finance Receivables Sold....................... 24,741 13,277
------- --------
59,162 71,134
Less Allowance for Credit Losses............................ (6,153) (10,356)
------- --------
Finance Receivables, net.................................... $53,009 $ 60,778
======= ========
The finance receivables are classified as follows:
Finance Receivables Held for Sale........................... $31,000 $ 52,000
Finance Receivables Held for Investment..................... 3,421 5,857
------- --------
$34,421 $ 57,857
======= ========
</TABLE>
F-34
<PAGE> 143
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of March 31, 1998 and December 31, 1997, the Residuals in Finance
Receivables Sold were comprised of the following (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Retained interest in subordinated securities (B
Certificates)............................................. $ 43,729 $ 25,483
Net interest spreads, less present value discount........... 22,150 10,622
Reduction for estimated credit losses....................... (41,138) (22,828)
-------- --------
Residuals in finance receivables sold....................... $ 24,741 $ 13,277
======== ========
Securitized principal balances outstanding.................. $185,240 $127,356
======== ========
Estimated credit losses as a % of securitized principal
balances outstanding...................................... 22.2% 17.9%
======== ========
</TABLE>
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the three month periods ended March 31, 1998 and
1997, respectively (in thousands).
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Balance, Beginning of Period................................ $13,277 $ 8,512
Additions................................................... 13,858 2,339
Amortization................................................ (2,394) (769)
------- -------
Balance, End of Period...................................... $24,741 $10,082
======= =======
</TABLE>
NOTE 4. NOTES PAYABLE
Following is a summary of Notes Payable as of March 31, 1998 and December
31, 1997 (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Revolving Facility with GE Capital.......................... $48,264 $56,950
Mortgage loan with finance company.......................... 7,273 7,450
Note Payable to a finance company........................... 7,000 --
Others...................................................... 767 771
------- -------
$63,304 $65,171
======= =======
</TABLE>
F-35
<PAGE> 144
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NOTE 5. EARNINGS (LOSS) PER SHARE
Net Earnings (Loss) per common share amounts are based on the weighted
average number of common shares and common stock equivalents outstanding for the
three month periods ended March 31, 1998, and 1997 as follows (in thousands,
except for per share amounts):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1997
------- -------
<S> <C> <C>
Earnings from Continuing Operations......................... $ 3,746 $ 755
======= =======
Net Earnings (Loss)......................................... $(1,866) $ 3,262
======= =======
Basic EPS-Weighted Average Shares Outstanding............... 18,557 15,904
======= =======
Basic Earnings (Loss) Per Share from:
Continuing Operations..................................... $ 0.20 $ 0.05
======= =======
Net Earnings (Loss)....................................... $ (0.10) $ 0.21
======= =======
Basic EPS-Weighted Average Shares Outstanding............... 18,557 15,904
Effect of Diluted Securities:
Warrants.................................................. 87 176
Stock Options............................................. 449 500
------- -------
Dilutive EPS-Weighted Average Shares Outstanding............ 19,093 16,580
======= =======
Diluted Earnings (Loss) Per Share from:
Continuing Operations..................................... $ 0.20 $ 0.05
======= =======
Net Earnings (Loss)....................................... $ (0.10) $ 0.20
======= =======
Warrants Not Included in Diluted EPS Since Antidilutive..... 715 --
======= =======
Stock Options Not Included in Diluted EPS Since
Antidilutive.............................................. 603 128
======= =======
</TABLE>
NOTE 6. BUSINESS SEGMENTS
The Company has three distinct business segments. These consist of retail
car sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), and corporate and other
operations. These segments exclude the activities of the discontinued
operations.
A summary of Operating Expenses by business segment for the three month
periods ended March 31, 1998 and 1997, respectively, follows:
<TABLE>
<CAPTION>
COMPANY
COMPANY DEALERSHIP CORPORATE
DEALERSHIPS RECEIVABLES AND OTHER TOTAL
----------- ----------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1998:
Sales of Used Cars.............................. $72,972 $ -- $ -- $72,972
Less: Cost of Cars Sold......................... 40,363 -- -- 40,363
Provision for Credit Losses................... 15,034 -- -- 15,034
------- ------- ------- -------
17,575 -- -- 17,575
</TABLE>
F-36
<PAGE> 145
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
COMPANY
COMPANY DEALERSHIP CORPORATE
DEALERSHIPS RECEIVABLES AND OTHER TOTAL
----------- ----------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest Income................................. $ -- $ 3,815 $ 64 $ 3,879
Gain on Sale of Loans........................... -- 4,614 -- 4,614
Servicing Income................................ -- 3,837 -- 3,837
Other Income.................................... 101 -- 45 146
------- ------- ------- -------
Income before Operating Expenses................ 17,676 12,266 109 30,051
------- ------- ------- -------
Operating Expenses:
Selling and Marketing......................... 5,290 -- 36 5,326
General and Administrative.................... 9,537 4,255 2,877 16,669
Depreciation and Amortization................. 613 338 201 1,152
------- ------- ------- -------
15,440 4,593 3,114 23,147
------- ------- ------- -------
Income (Loss) before Interest Expense........... $ 2,236 $ 7,673 $(3,005) $ 6,904
======= ======= ======= =======
1997:
Sales of Used Cars.............................. $18,211 $ -- $ -- $18,211
Less: Cost of Cars Sold......................... 9,939 -- -- 9,939
Provision for Credit Losses .................. 3,261 -- -- 3,261
------- ------- ------- -------
5,011 -- -- 5,011
Interest Income................................. -- 1,083 429 1,512
Gain on Sale of Loans........................... -- 1,131 -- 1,131
Servicing Income................................ -- 1,014 -- 1,014
Other Income.................................... 204 -- 224 428
------- ------- ------- -------
Income before Operating Expenses................ 5,215 3,228 653 9,096
------- ------- ------- -------
Operating Expenses:
Selling and Marketing......................... 1,525 -- 7 1,532
General and Administrative.................... 2,469 1,488 1,647 5,604
Depreciation and Amortization ................ 200 206 123 529
------- ------- ------- -------
4,194 1,694 1,777 7,665
------- ------- ------- -------
Income (Loss) before Interest Expense........... $ 1,021 $ 1,534 $(1,124) $ 1,431
======= ======= ======= =======
</TABLE>
NOTE 7. ACQUISITION
On January 15, 1997, the Company acquired substantially all of the assets
of Seminole Finance Corporation and related companies ("Seminole"), including
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million (6,953 contracts) in exchange for approximately $2.5
million in cash and the assumption of $29.9 million in debt. The following
summary, prepared on a pro forma basis, combines the consolidated results of
operations (unaudited) for the three months ended March 31, 1997 as if the
acquisition had been consummated as of January 1, 1997. These proforma results
are not necessarily indicative of the future results of operations of the
Company or the results that would have been obtained had the acquisition taken
place on January 1, 1997 (in thousands, except per share data).
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UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1997
------------------
<S> <C>
Sales of Used Cars.......................................... $22,642
=======
Interest Income............................................. $ 1,512
=======
Other Income................................................ $ 2,593
=======
Total Revenues.............................................. $26,747
=======
Earnings before Discontinued Operations..................... $ 686
=======
Net Earnings................................................ $ 3,192
=======
Earnings per share from Continuing Operations:
Basic..................................................... $ 0.04
=======
Diluted................................................... $ 0.04
=======
Net Earnings per share:
Basic..................................................... $ 0.20
=======
Diluted................................................... $ 0.19
=======
</TABLE>
NOTE 8. USE OF ESTIMATES
The preparation of financial statements requires management to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statement and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. These
include the provision for loss on discontinued operations that was recorded in
the accompanying condensed consolidated financial statements for the three month
period ended March 31, 1998, which provision is based upon management's best
estimate of the amounts expected to be realized from the closure of the Branch
Office network as well as from the split-up of certain operations. The amounts
the Company will ultimately realize could differ materially from the amounts
assumed in arriving at the loss anticipated on disposal of the discontinued
operations.
NOTE 9. BANKRUPTCY REMOTE ENTITIES
Champion Receivables Corporation ("CRC") and Champion Receivables
Corporation II ("CRC II") (collectively referred to as "Securitization
Subsidiaries"), are the Company's wholly-owned special purpose "bankruptcy
remote entities." Their assets, including assets included in Discontinued
Operations, include Residuals in Finance Receivables Sold and Investments Held
In Trust, in the amounts of approximately $38.3 million and $20.8 million,
respectively, at March 31, 1998, which amounts would not be available to satisfy
claims of creditors of the Company on a consolidated basis.
NOTE 10. RECLASSIFICATIONS
Certain reclassifications have been made to conform to the current
presentation.
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<PAGE> 147
APPENDIX A
RESTATED
(AS OF JANUARY 15, 1998)
UGLY DUCKLING CORPORATION
LONG-TERM INCENTIVE PLAN
ARTICLE 1 PURPOSE
1.1. General. The purpose of the Ugly Duckling Corporation Long-Term
Incentive Plan (the "Plan") is to promote the success, and enhance the value, of
Ugly Duckling Corporation and its subsidiaries (collectively, the "Company") by
linking the personal interests of its employees, consultants and advisors to
those of Company shareholders and by providing its employees, consultants and
advisors with an incentive for outstanding performance. The Plan is further
intended to provide flexibility to the Company in its ability to motivate,
attract, and retain the services of employees, consultants and advisors upon
whose judgment, interest, and special effort the successful conduct of the
Company's operation is largely dependent. Accordingly, the Plan permits the
grant of incentive awards from time to time to selected employees, consultants
and advisors of the Company and any Subsidiary.
ARTICLE 2 EFFECTIVE DATE
2.1. Effective Date. The Plan is effective as of June 30, 1995 (the
"Effective Date"). Within one year after the Effective Date, the Plan shall be
submitted to the shareholders of the Company for their approval. The Plan will
be deemed to be approved by the shareholders if it receives the affirmative vote
of the holders of a majority of the shares of stock of the Company present, or
represented, and entitled to vote at a meeting duly held (or by the written
consent of the holders of a majority of the shares of stock of the Company
entitled to vote) in accordance with the applicable provisions of the Arizona
General Corporation Law and the Company's Bylaws and Articles of Incorporation.
Any Awards granted under the Plan prior to shareholder approval are effective
when made (unless the Committee specifies otherwise at the time of grant), but
no Award may be exercised or settled and no restrictions relating to any Award
may lapse before shareholder approval. If the shareholders fail to approve the
Plan, any Award previously made shall be automatically canceled without any
further act.
ARTICLE 3 DEFINITIONS AND CONSTRUCTION.
3.1. Definitions. When a word or phrase appears in this Plan with the
initial letter capitalized, and the word or phrase does not commence a sentence,
the word or phrase shall generally be given the meaning ascribed to it in this
Section or in Sections 1.1 or 2.1 unless a clearly different meaning is required
by the context. The following words and phrases shall have the following
meanings:
(a) "Award" means any option, Stock Appreciation Right, Restricted
Stock Award, Performance Share Award, Dividend Equivalent Award, or
Performance-Based Award, or any other right or interest relating to Stock
or cash, granted to a Participant under the Plan.
(b) "Award Agreement" means any written agreement, contract, or other
instrument or document evidencing an Award.
(c) "Board" means the Board of Directors of the Company or a Committee
thereof formed under Section 4, as the case may be.
(d) "Cause" means (except as otherwise provided in an Award Agreement)
if the Board, in its reasonable and good faith discretion, determines that
the employee, consultant or advisor (i) has developed or pursued interests
substantially adverse to the Company, (ii) materially breached any
employment, engagement or confidentiality agreement or otherwise failed to
satisfactorily discharge his or her duties, (iii) has not devoted all or
substantially all of his or her business time, effort and attention to the
affairs of the Company (or such lesser amount as has been agreed to in
writing by the Company),
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(iv) is convicted of a felony involving moral turpitude, or (v) has engaged
in activities or omissions that are detrimental to the well-being of the
Company.
(e) "Change of Control" means and includes each of the following
(except as otherwise provided in an Award Agreement):
(1) there shall be consummated any consolidation or merger of the
Company in which the Company is not the continuing or surviving entity,
or pursuant to which Stock would be converted into cash, securities or
other property, other than a merger of the Company in which the holders
of the Company's Stock immediately prior to the merger have the same
proportionate ownership of beneficial interest of common stock or other
voting securities of the surviving entity immediately after the merger;
(2) there shall be consummated any sale, lease, exchange or other
transfer (in one transaction or a series of related transactions) of
assets or earning power aggregating more than 40% of the assets or
earning power of the Company and its subsidiaries (taken as a whole),
other than pursuant to a sale-leaseback, structured finance or other
form of financing transaction; (3) the shareholders of the Company shall
approve any plan or proposal for liquidation or dissolution of the
Company;
(4) any person (as such term is used in Section 13(d) and 14(d)(2)
of the Exchange Act), other than any current shareholder of the Company
or affiliate thereof or any employee benefit plan of the Company or any
subsidiary of the Company or any entity holding shares of capital stock
of the Company for or pursuant to the terms of any such employee benefit
plan in its role as an agent or trustee for such plan, shall become the
beneficial owner (within the meaning of Rule 13d-3 under the Exchange
Act) of 20% or more of the Company's outstanding Stock; or
(5) during any period of two consecutive years, individuals who at
the beginning of such period shall fail to constitute a majority
thereof, unless the election, or the nomination for election by the
Company's shareholders, of each new director was approved by a vote of
at least two-thirds of the directors then still in office who were
directors at the beginning of the period.
(f) "Code" means the Internal Revenue Code of 1986, as amended from
time to time.
(g) "Committee" means the committee of the Board described in Article
4.
(h) "Covered Employee" means an Employee who is a "covered employee"
within the meaning of Section 162(m) of the Code.
(i) "Disability" shall mean any illness or other physical or mental
condition of a Participant which renders the Participant incapable of
performing his customary and usual duties for the Company, or any medically
determinable illness or other physical or mental condition resulting from a
bodily injury, disease or mental disorder which in the judgment of the
Committee is permanent and continuous in nature. The Committee may require
such medical or other evidence as it deems necessary to judge the nature
and permanency of the Participant's condition.
(j) "Dividend Equivalent" means a right granted to a Participant under
Article 11.
(k) "Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended from time to time.
(l) "Fair Market Value" means with respect to Stock or any other
property, the fair market value of such Stock or other property as
determined by the Board in its discretion, under one of the following
methods: (i) the closing price for the Stock as reported on any national
securities exchange on which the Stock is then listed (which shall include
the Nasdaq National Market) for that date or, if no price is so reported
for that date, such price on the next preceding date for which the closing
price was reported; or (ii) the price as determined by such methods or
procedures as may be established from time to time by the Board.
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(m) "Incentive Stock Option" means an Option that is intended to meet
the requirements of Section 422 of the Code or any successor provision
thereto.
(n) "Non-Employee Director" means a member of the Board who qualifies
as a "Non-Employee Director" as defined in Rule 16b-3(b)(3) of the Exchange
Act, or any successor definition adopted by the Board.
(o) "Non-Qualified Stock Option" means an Option that is not intended
to be an Incentive Stock Option.
(p) "Option" means a right granted to a Participant under Article 7 of
the Plan to purchase Stock at a specified price during specified time
periods. An Option may be either an Incentive Stock Option or a
Non-Qualified Stock Option.
(q) "Participant" means a person who, as an employee of or consultant
or advisor to the Company or any Subsidiary, has been granted an Award
under the Plan. A "Participant" shall not include any Director of the
Company or any Subsidiary who is not also an employee of or consultant to
the Company or any Subsidiary.
(r) "Performance-Based Awards" means the Performance Share Awards and
Restricted Stock Awards granted to selected Covered Employees pursuant to
Articles 9 and 10, but which are subject to the terms and conditions set
forth in Article 12. All Performance-Based Awards are intended to qualify
as "performance-based compensation" under Section 162(m) of the Code.
(s) "Performance Criteria" means the criteria that the Committee
selects for purposes of establishing the Performance Goal or Performance
Goals for a Participant for a Performance Period. The Performance Criteria
that will be used to establish Performance Goals are limited to the
following: pre- or after-tax net earnings, sales growth, operating
earnings, operating cash flow, return on net assets, return on
stockholders' equity, return on assets, return on capital, Stock price
growth, stockholder returns, gross or net profit margin, earnings per
share, price per share of Stock, and market share, any of which may be
measured either in absolute terms or as compared to any incremental
increase or as compared to results of a peer group. The Committee shall,
within the time prescribed by Section 162(m) of the Code, define in an
objective fashion the manner of calculating the Performance Criteria it
selects to use for such Performance Period for such Participant.
(t) "Performance Goals" means, for a Performance Period, the goals
established in writing by the Committee for the Performance Period based
upon the Performance Criteria. Depending on the Performance Criteria used
to establish such Performance Goals, the Performance Goals may be expressed
in terms of overall Company performance or the performance of a division,
business unit or an individual. The Committee, in its discretion, may,
within the time prescribed by Section 162(m) of the Code, adjust or modify
the calculation of Performance Goals for such Performance Period in order
to prevent the dilution or enlargement of the rights of Participants, (i)
in the event of, or in anticipation of, any unusual or extraordinary
corporate item, transaction, event, or development; or (ii) in recognition
of, or in anticipation of, any other unusual or nonrecurring events
affecting the Company, or the financial statements of the Company, or in
response to, or in anticipation of, changes in applicable laws,
regulations, accounting principles, or business conditions.
(u) "Performance Period" means the one or more periods of time, which
may be of varying and overlapping durations, as the Committee may select,
over which the attainment of one or more Performance Goals will be measured
for the purpose of determining a Participant's right to, and the payment
of, a Performance-Based Award.
(v) "Performance Share" means a right granted to a Participant under
Article 9, to receive cash, Stock, or other Awards, the payment of which is
contingent upon achieving certain performance goals established by the
Committee.
(w) "Plan" means the Ugly Duckling Corporation Long-Term Incentive
Plan, as amended from time to time.
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(x) "Restricted Stock Award" means Stock granted to a Participant
under Article 10 that is subject to certain restrictions and to risk of
forfeiture.
(y) "Stock" means the common stock of the Company and such other
securities of the Company that may be substituted for Stock pursuant to
Article 13.
(z) "Stock Appreciation Right" or "SAR" means a right granted to a
Participant under Article 8 to receive a payment equal to the difference
between the Fair Market Value of a share of Stock as of the date of
exercise of the SAR over the grant price of the SAR, all as determined
pursuant to Article 8.
(aa) "Subsidiary" means any corporation, domestic or foreign, of which
a majority of the outstanding voting stock or voting power is beneficially
owned directly or indirectly by the Company.
ARTICLE 4 ADMINISTRATION
4.1. Board/Committee. The Plan shall be administered by the Board of
Directors or a Committee that is appointed by, and serves at the discretion of,
the Board. Any Committee shall consist of at least two individuals, each of whom
qualifies as (i) a Non-Employee Director, and (ii) an "outside director" under
Code Section 162(m) and the regulations issued thereunder. For purposes of this
Plan, the "Board" shall mean the Board of Directors or the Committee, as the
case may be.
4.2. Action By The Board. A majority of the Board shall constitute a
quorum. The acts of a majority of the members present at any meeting at which a
quorum is present and acts approved in writing by a majority of the Board in
lieu of a meeting shall be deemed the acts of the Board. Each member of the
Board is entitled to, in good faith, rely or act upon any report or other
information furnished to that member by any officer or other employee of the
Company or any Subsidiary, the Company's independent certified public
accountants, or any executive compensation consultant or other professional
retained by the Company to assist in the administration of the Plan.
4.3. Authority Of Board. The Board shall have the full and, except as
otherwise provided below, exclusive power to interpret the Plan and to adopt
such rules, regulations, and guidelines for carrying out the Plan as may be
necessary or proper, all of which power shall be executed in the best interests
of the Company and in keeping with the objectives of the Plan. This power
includes, but is not limited to, the following:
(a) Designate Participants;
(b) Determine the type or types of Awards to be granted to each
Participant;
(c) Determine the number of Awards to be granted and the number of
shares of Stock to which an Award will relate;
(d) Determine the terms and conditions of any Award granted under the
Plan including but not limited to, the exercise price, grant price, or
purchase price, any restrictions or limitations on the Award, any schedule
for lapse of forfeiture restrictions or restrictions on the exercisability
of an Award, and accelerations or waivers thereof, based in each case on
such considerations as the Board in its sole discretion determines ;
provided, however, that the Committee shall not have the authority to
accelerate the vesting, or waive the forfeiture, of any Performance-Based
Awards;
(e) Determine whether, to what extent, and under what circumstances an
Award may be settled in, or the exercise price of an Award may be paid in,
cash, Stock, other Awards, or other property, or an Award may be canceled,
forfeited, or surrendered;
(f) Prescribe the form of each Award Agreement, which need not be
identical for each Participant;
(g) Decide all other matters that must be determined in connection
with an Award;
(h) Establish, adopt or revise any rules and regulations as it may
deem necessary or advisable to administer the Plan; and
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(i) Make all other decisions and determinations that may be required
under the Plan or as the Board deems necessary or advisable to administer
the Plan.
Notwithstanding the above or anything else in the Plan to the contrary, the
Chief Executive officer and the President of the Company, acting together, also
have the authority, subject to the terms, conditions, and parameters set forth
by the Board from time to time, to select Award recipients and establish the
terms and conditions of Awards, provided, however, that any such Award recipient
must not be a person who, at the time the Award is granted, is subject to the
restrictions imposed by Section 16 of the Exchange Act or a person who is a
Covered Employee.
4.4. Decisions Binding. The Board's interpretation of the Plan, any
Awards granted under the Plan, any Award Agreement and all decisions and
determinations by the Board with respect to the Plan are final, binding, and
conclusive on all parties.
ARTICLE 5 SHARES SUBJECT TO THE PLAN
5.1. Number of Shares. Subject to adjustment provided in Section 14.1,
the aggregate number of shares of Stock reserved and available for Awards or
which may be used to provide a basis of measurement for or to determine the
value of an Award (such as with a Stock Appreciation Right or Performance Share
Award) shall be 1,800,000.
5.2. Lapsed Awards. To the extent that an Award terminates, expires or
lapses for any reason, any shares of Stock subject to the Award will again be
available for the grant of an Award under the Plan and shares subject to SARs or
other Awards settled in cash will be available for the grant of an Award under
the Plan.
5.3. Stock Distributed. Any Stock distributed pursuant to an Award may
consist, in whole or in part, of authorized and unissued Stock, treasury Stock
or Stock purchased on the open market.
5.4. Limitations On Awards To Any Single Participant. No single
Participant may receive Awards covering in the aggregate more than 250,000
shares of Stock during any single calendar year.
ARTICLE 6 ELIGIBILITY
6.1. General. Awards may be granted only to individuals who are employees
(including employees who also are directors or officers) of the Company or a
Subsidiary or to consultants or advisors thereto, as determined by the Board.
ARTICLE 7 STOCK OPTIONS
7.1. General. The Board is authorized to grant Options to Participants on
the following terms and conditions:
(a) Exercise Price. The exercise price per share of Stock under an
Option shall be determined by the Committee and set forth in the Award
Agreement. It is the intention under the Plan that the exercise price for
any Option shall not be less than the Fair Market Value as of the date of
grant; provided, however that the Committee may, in its discretion, grant
Options (other than Options that are intended to be Incentive Stock Options
or Options that are intended to qualify as "performance-based compensation"
under Code Section 162(m)) with an exercise price of less than Fair Market
Value on the date of grant.
(b) Time And Conditions Of Exercise. The Board shall determine the
time or times at which an Option may be exercised in whole or in part. The
Board also shall determine the performance or other conditions, if any,
that must be satisfied before all or part of an Option may be exercised.
(c) Payment. The Board shall determine the methods by which the
exercise price of an Option may be paid, the form of payment, including,
without limitation, cash, shares of Stock, or other property
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(including broker-assisted "cashless exercise" arrangements), and the
methods by which shares of Stock shall be delivered or deemed to be
delivered to Participants.
(d) Evidence Of Grant. All Options shall be evidenced by a written
Award Agreement between the Company and the Participant. The Award
Agreement shall include such provisions as may be specified by the Board.
7.2 Incentive Stock Options. The terms of any Incentive Stock Options
granted under the Plan must comply with the following additional rules:
(a) Exercise Price. The exercise price per share of Stock shall be
set by the Board, provided that the exercise price for any Incentive Stock
Option may not be less than the Fair Market Value as of the date of the
grant.
(b) Exercise. In no event, may any Incentive Stock Option be
exercisable for more than ten years from the date of its grant.
(c) Lapse Of Option. An Incentive Stock Option shall lapse under the
following circumstances:
(1) The Incentive Stock Option shall lapse ten (10) years after it
is granted, unless an earlier time is set in the Award Agreement.
(2) The Incentive Stock Option shall lapse upon termination of
employment for Cause or for any other reason, other than the
Participant's death or Disability, unless the Committee determines in
its discretion to extend the exercise period for no more than ninety
(90) days after the Participant's termination of employment.
(3) In the case of the Participant's termination of employment due
to Disability or death, the Incentive Stock Option shall lapse upon
termination of employment, unless the Committee determines in its
discretion to extend the exercise period of the Incentive Stock Option
for no more than twelve (12) months after the date the Participant
terminates employment. Upon the Participant's death, any vested and
otherwise exercisable Incentive Stock Options may be exercised by the
Participant's legal representative or representatives, by the person or
persons entitled to do so under the Participant's last will and
testament, or, if the Participant shall fail to make testamentary
disposition of such Incentive Stock Option or shall die intestate, by
the person or persons entitled to receive said Incentive Stock Option
under the applicable laws of descent and distribution.
(d) Individual Dollar Limitation. The aggregate Fair Market Value
(determined as of the time an Award is made) of all shares of Stock with
respect to which Incentive Stock Options are first exercisable by a
Participant in any calendar year may not exceed one Hundred Thousand
Dollars ($100,000.00).
(e) Ten Percent Owners. An Incentive Stock Option shall be granted to
any individual who, at the date of grant, owns stock possessing more than
ten percent (10%) of the total combined voting power of all classes of
Stock of the Company only if, at the time such Option is granted, the
Option price is at least one hundred ten percent (110%) of the Fair Market
Value of the Stock and such Option by its terms is not exercisable after
the expiration of five (5) years from the date the Option is granted.
(f) Expiration Of Incentive Stock Options. No Award of an Incentive
Stock Option may be made pursuant to this Plan after the tenth anniversary
of the Effective Date.
(g) Right To Exercise. During a Participant's lifetime, an Incentive
Stock Option may be exercised only by the Participant.
(h) Employees Only. Incentive Stock Options may be granted only to
Participants who are employees of the Company or any Subsidiary.
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ARTICLE 8 STOCK APPRECIATION RIGHTS
8.1. Grant Of SARs. The Board is authorized to grant SARs to Participants
on the following terms and conditions:
(a) Right To Payment. Upon the exercise of a Stock Appreciation
Right, the Participant to whom it is granted has the right to receive the
excess, if any, of:
(1) The Fair Market Value of one share of Stock on the date of
exercise; over
(2) The grant price of the Stock Appreciation Right as determined
by the Board, which shall not be less than the Fair Market Value of one
share of Stock on the date of grant in the case of any SAR related to
any Incentive Stock Option.
(b) Other Terms. All awards of Stock Appreciation Rights shall be
evidenced by an Award Agreement. The terms, methods of exercise, methods of
settlement, form of consideration payable in settlement, and any other
terms and conditions of any Stock Appreciation Right shall be determined by
the Board at the time of the grant of the Award and shall be reflected in
the Award Agreement.
ARTICLE 9 PERFORMANCE SHARES
9.1. Grant Of Performance Shares. The Board is authorized to grant
Performance Shares to Participants on such terms and conditions as may be
selected by the Board. The Board shall have the complete discretion to determine
the number of Performance Shares granted to each Participant. All Awards of
Performance Shares shall be evidenced by an Award Agreement.
9.2. Right To Payment. A grant of Performance Shares gives the
Participant rights, valued as determined by the Board, and payable to, or
exercisable by, the Participant to whom the Performance Shares are granted, in
whole or in part, as the Board shall establish at grant or thereafter. The Board
shall set performance goals and other terms or conditions to payment of the
Performance Shares in its discretion which, depending on the extent to which
they are met, will determine the number and value of Performance Shares that
will be paid to the Participant.
9.3. Other Terms. Performance Shares may be payable in cash, Stock, or
other property, and have such other terms and conditions as determined by the
Board and reflected in the Award Agreement.
ARTICLE 10 RESTRICTED STOCK AWARDS
10.1. Grant Of Restricted Stock. The Board is authorized to make Awards
of Restricted Stock to Participants in such amounts and subject to such terms
and conditions as may be selected by the Board. All Awards of Restricted Stock
shall be evidenced by an Award Agreement.
10.2. Issuance And Restrictions. Restricted Stock shall be subject to
such restrictions on transferability and other restrictions as the Board may
impose (including, without limitation, limitations on the right to vote
Restricted Stock or the right to receive dividends on the Restricted Stock).
These restrictions may lapse separately or in combination at such times, under
such circumstances, in such installments, or otherwise, as the Board determines
at the time of the grant of the Award or thereafter.
10.3. Forfeiture. Except as otherwise determined by the Board at the time
of the grant of the Award or thereafter, upon termination of employment during
the applicable restriction period, Restricted Stock that is at that time subject
to restrictions shall be forfeited and reacquired by the Company, provided,
however, that the Board may provide in any Award Agreement that restrictions or
forfeiture conditions relating to Restricted Stock will be waived in whole or in
part in the event of terminations resulting from specified causes, and the Board
may in other cases waive in whole or in part restrictions or forfeiture
conditions relating to Restricted Stock.
10.4. Certificates For Restricted Stock. Restricted Stock granted under
the Plan may be evidenced in such manner as the Board shall determine. If
certificates representing shares of Restricted Stock are registered in the name
of the Participant, certificates must bear an appropriate legend referring to
the terms, conditions,
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and restrictions applicable to such Restricted Stock, and the Company may, at
its sole and absolute discretion, retain physical possession of the certificate
until such time as all applicable restrictions lapse.
ARTICLE 11 DIVIDEND EQUIVALENTS
11.1. Grant Of Dividend Equivalents. The Board is authorized to grant
Dividend Equivalents to Participants subject to such terms and conditions as may
be selected by the Board. Dividend Equivalents shall entitle the Participant to
receive payments equal to dividends with respect to all or a portion of the
number of shares of Stock subject to an Option Award or SAR Award, as determined
by the Board. The Board may provide that Dividend Equivalents be paid or
distributed when accrued or be deemed to have been reinvested in additional
shares of Stock, or otherwise reinvested.
ARTICLE 12 PERFORMANCE-BASED AWARDS
12.1. Purpose. The purpose of this Article 12 is to provide the Committee
the ability to qualify the Restricted Stock Awards under Article 10 and the
Performance Share Awards under Article 9 as "performance-based compensation"
under Section 162(m) of the Code. If the Committee, in its discretion, decides
to grant a Performance-Based Award to a Covered Employee, the provisions of this
Article 12 shall control over any contrary provision contained in Articles 9 or
10.
12.2. Applicability. This Article 12 shall apply only to those Covered
Employees selected by the Committee to receive Performance-Based Awards. The
Committee may, in its discretion, grant Restricted Stock Awards or Performance
Share Awards to Covered Employees that do not satisfy the requirements of this
Article 12. The designation of a Covered Employee as a Participant for a
Performance Period shall not in any manner entitle the Participant to receive an
Award for the period. Moreover, designation of a Covered Employee as a
Participant for a particular Performance Period shall not require designation of
such Covered Employee as a Participant in any subsequent Performance Period and
designation of one Covered Employee as a Participant shall not require
designation of any other Covered Employees as a Participant in such period or in
any other period.
12.3. Discretion Of Committee With Respect To Performance Awards. With
regard to a particular Performance Period, the Committee shall have full
discretion to select the length of such Performance Period, the type of
Performance-Based Awards to be issued, the kind and/or level of the Performance
Goal, and whether the Performance Goal is to apply to the Company, a Subsidiary
or any division or business unit thereof or the individual.
12.4. Payment of Performance Awards. Unless otherwise provided in the
relevant Award Agreement, a Participant must be employed by the Company or a
Subsidiary on the last day of the Performance Period to be eligible for a
Performance Award for such Performance Period. Furthermore, a Participant shall
be eligible to receive payment under a Performance-Based Award for a Performance
Period only if the Performance Goals for such period are achieved.
In determining the actual size of an individual Performance-Based Award,
the Committee may reduce or eliminate the amount of the Performance-Based Award
earned for the Performance Period, if in its sole and absolute discretion, such
reduction or elimination is appropriate.
12.5. Maximum Award Payable. Notwithstanding any provision contained in
the Plan to the contrary, the maximum Performance-Based Award payable to any one
Participant under the Plan for a Performance Period is 250,000 shares of Stock,
or in the event the Performance-Based Award is paid in cash, such maximum
Performance-Based Award shall be determined by multiplying 250,000 by the Fair
Market Value of one share of Stock as of the date of grant of the
Performance-Based Award.
ARTICLE 13 PROVISIONS APPLICABLE TO AWARDS
13.1. Stand-Alone, Tandem, and Substitute Awards. Awards granted under
the Plan may, in the discretion of the Board, be granted either alone or in
addition to, in tandem with, or in substitution for, any other Award granted
under the Plan. If an Award is granted in substitution for another Award, the
Board may
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require the surrender of such other Award in consideration of the grant of the
new Award. Awards granted in addition to or in tandem with other Awards may be
granted either at the same time as or at a different time from the grant of such
other Awards.
13.2. Exchange Provisions. The Board may at any time offer to exchange or
buy out any previously granted Award for a payment in cash, Stock, or another
Award (subject to Section 13.1), based on the terms and conditions the Board
determines and communicates to the Participant at the time the offer is made.
13.3. Term of Award. The term of each Award shall be for the period as
determined by the Board, provided that in no event shall the term of any
Incentive Stock Option or a Stock Appreciation Right granted in tandem with the
Incentive Stock Option exceed a period of ten years from the date of its grant.
13.4. Form of Payment for Awards. Subject to the terms of the Plan and
any applicable law or Award Agreement, payments or transfers to be made by the
Company or a Subsidiary on the grant or exercise of an Award may be made in such
forms as the Board determines at or after the time of grant, including without
limitation, cash, Stock, other Awards, or other property, or any combination,
and may be made in a single payment or transfer, in installments, or on a
deferred basis, in each case determined in accordance with rules adopted by, and
at the discretion of, the Board. The Board may also authorize payment in the
exercise of an Option by net issuance or other cashless exercise methods.
13.5. Limits on Transfer. No right or interest of a Participant in any
Award may be pledged, encumbered, or hypothecated to or in favor of any party
other than the Company or a Subsidiary, or shall be subject to any lien,
obligation, or liability of such Participant to any other party other than the
Company or a Subsidiary. Except as otherwise provided by the Board or the
Committee, no Award shall be assignable or transferable by a Participant other
than by will or the laws of descent and distribution.
13.6 Beneficiaries. Notwithstanding Section 13.5, a Participant may, in
the manner determined by the Board, designate a beneficiary to exercise the
rights of the Participant and to receive any distribution with respect to any
Award upon the Participant's death. A beneficiary, legal guardian, legal
representative, or other person claiming any rights under the Plan is subject to
all terms and conditions of the Plan and any Award Agreement applicable to the
Participant, except to the extent the Plan and Award Agreement otherwise
provide, and to any additional restrictions deemed necessary or appropriate by
the Board. If the Participant is married and resides in a jurisdiction in which
community property laws apply, a designation of a person other than the
Participant's spouse as his beneficiary with respect to more than 50 percent of
the Participant's interest in the Award shall not be effective without the
written consent of the Participant's spouse. If no beneficiary has been
designated or survives the Participant, payment shall be made to the person
entitled thereto under the Participant's will or the laws of descent and
distribution. Subject to the foregoing, a beneficiary designation may be changed
or revoked by a Participant at any time provided the change or revocation is
filed with the Board.
13.7. Stock Certificates. All Stock certificates delivered under the Plan
are subject to any stop-transfer orders and other restrictions as the Board
deems necessary or advisable to comply with federal or state securities laws,
rules and regulations and the rules of any national securities exchange or
automated quotation system on which the Stock is listed, quoted, or traded. The
Board may place legends on any Stock certificate to reference restrictions
applicable to the Stock.
13.8. Tender Offers. In the event of a public tender for all or any
portion of the Stock, or in the event that a proposal to merge, consolidate, or
otherwise combine with another company is submitted for shareholder approval,
the Board may in its sole discretion declare previously granted Options to be
immediately exercisable. To the extent that this provision causes Incentive
Stock Options to exceed the dollar limitation set forth in Section 7.2(d), the
excess Options shall be deemed to be Non-Qualified Stock Options.
13.9. Change of Control. A Change of Control shall, in the sole
discretion of the Board:
(a) Cause every Award outstanding hereunder to become fully
exercisable and all restrictions on outstanding Awards to lapse and allow
each Participant the right to exercise Awards prior to the occurrence of
the event otherwise terminating the Awards over such period as the Board,
in its sole and
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absolute discretion, shall determine. To the extent that this provision
causes Incentive Stock Options to exceed the dollar limitation set forth in
Section 7.2(d), the excess Options shall be deemed to be Non-Qualified
Stock Options; or
(b) Cause every Award outstanding hereunder to terminate, provided
that the surviving or resulting corporation shall tender an option or
options to purchase its shares or exercise such rights on terms and
conditions, as to the number of shares, rights or otherwise, which shall
substantially preserve the rights and benefits of any Award then
outstanding hereunder.
ARTICLE 14 CHANGES IN CAPITAL STRUCTURE
14.1. General. In the event a stock dividend is declared upon the Stock,
the shares of Stock then subject to each Award (and the number of shares subject
thereto) shall be increased proportionately without any change in the aggregate
purchase price therefor. Subject to Section 13.9, in the event the Stock shall
be changed into or exchanged for a different number or class of shares of Stock
or of shares of another corporation, whether through reorganization,
recapitalization, stock split-up or combination of shares, there shall be
substituted for each such share of Stock then subject to each Award (and for
each share of Stock then subject thereto) the number and class of shares of
Stock into which each outstanding share of Stock shall be so exchanged, all
without any change in the aggregate purchase price for the shares then subject
to each Award.
ARTICLE 15 AMENDMENT, MODIFICATION AND TERMINATION
15.1. Amendment Modification and Termination. The Board may terminate,
amend or modify the Plan at any time and from time to time. However, the Board
may not amend, modify or terminate the Plan without shareholder approval if
shareholder approval is required under applicable law or by any national
securities exchange or system on which the Stock is then listed or reported.
15.2. Awards Previously Granted. No termination, amendment, or
modification of the Plan shall adversely affect in any material way any Award
previously granted under the Plan, without the written consent of the
Participant.
ARTICLE 16 GENERAL PROVISIONS
16.1. No Rights to Awards. No Participant or employee or consultant shall
have any claim to be granted any Award under the Plan, and neither the Company
nor the Board is obligated to treat Participants and employees or consultants
uniformly.
16.2. No Stockholders Rights. No Award gives the Participant any of the
rights of a shareholder of the Company unless and until shares of Stock are in
fact issued to such person in connection with such Award.
16.3. Withholding. The Company or any Subsidiary shall have the authority
and the right to deduct or withhold, or require a Participant to remit to the
Company, an amount sufficient to satisfy United States Federal, state, and local
taxes (including the Participant's FICA obligation and any withholding
obligation imposed by any country other than the United States in which the
Participant resides) required by law to be withheld with respect to any taxable
event arising as a result of this Plan. With respect to withholding required
upon any taxable event under the Plan, Participants may elect, subject to the
Board's approval, to satisfy the withholding requirement, in whole or in part,
by having the Company or any Subsidiary withhold shares of Stock having a Fair
Market Value on the date of withholding equal to the amount to be withheld for
tax purposes in accordance with such procedures as the Board establishes. The
Board may, at the time any Award is granted, require that any and all applicable
tax withholding requirements be satisfied by the withholding of shares of Stock
as set forth above.
16.4. No Right to Employment. Nothing in the Plan or any Award Agreement
shall interfere with or limit in any way the right of the Company or any
Subsidiary to terminate any Participant's employment at any time, nor confer
upon any Participant any right to continue in the employ of the Company or any
Subsidiary.
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16.5. Unfunded Status of Awards. The Plan is intended to be an "unfunded"
plan for incentive and deferred compensation. With respect to any payments not
yet made to a Participant pursuant to an Award, nothing contained in the Plan or
any Award Agreement shall give the Participant any rights that are greater than
those of a general creditor of the Company or any Subsidiary.
16.6. Indemnification. To the extent allowable under applicable law, each
member of the Committee or of the Board shall be indemnified and held harmless
by the Company from any loss, cost, liability, or expense that may be imposed
upon or reasonably incurred by such member in connection with or resulting from
any claim, action, suit, or proceeding to which he or she may be a party or in
which he or she may be involved by reason of any action or failure to act under
the Plan and against and from any and all amounts paid by him or her in
satisfaction of judgment in such action, suit, or proceeding against him or her
provided he or she gives the Company an opportunity, at its own expense, to
handle and defend the same before he or she undertakes to handle and defend it
on his or her own behalf. The foregoing right of indemnification shall not be
exclusive of any other rights of indemnification to which such persons may be
entitled under the Company's Articles of Incorporation or By-Laws, as a matter
of law, or otherwise, or any power that the Company may have to indemnify them
or hold them harmless.
16.7. Relationship to Other Benefits. No payment under the Plan shall be
taken into account in determining any benefits under any pension, retirement,
savings, profit sharing, group insurance, welfare or other benefit plan of the
Company or any Subsidiary.
16.8. Expenses. The expenses of administering the Plan shall be borne by
the Company and its Subsidiaries.
16.9. Titles and Headings. The titles and headings of the Sections in the
Plan are for convenience of reference only, and in the event of any conflict,
the text of the Plan, rather than such titles or headings, shall control.
16.10. Fractional Shares. No fractional shares of stock shall be issued
and the Board shall determine, in its discretion, whether cash shall be given in
lieu of fractional shares or whether such fractional shares shall be eliminated
by rounding up.
16.11. Securities Law Compliance. With respect to any person who is, on
the relevant date, obligated to file reports under Section 16 of the Exchange
Act, transactions under this Plan are intended to comply with all applicable
conditions of Rule 16b-3 or its successors under the Exchange Act. To the extent
any provision of the Plan or action by the Board fails to so comply, it shall be
void to the extent permitted by law and voidable as deemed advisable by the
Board, and such provision or action shall be deemed to be modified so as to
comply with Rule 16b-3.
16.12. Government and Other Regulations. The obligation of the Company to
make payment of awards in Stock or otherwise shall be subject to all applicable
laws, rules, and regulations, and to such approvals by government agencies as
may be required. The Company shall be under no obligation to register under the
Securities Act of 1933, as amended, any of the shares of Stock paid under the
Plan. If the shares paid under the Plan may in certain circumstances be exempt
from registration under such act, the Company may restrict the transfer of such
shares in such manner as it deems advisable to ensure the availability of any
such exemption.
16.13. Governing Law. The Plan and all Award Agreements shall be
construed in accordance with and governed by the laws of the State of Arizona.
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APPENDIX B
UGLY DUCKLING CORPORATION
1998 EXECUTIVE INCENTIVE PLAN
ARTICLE 1 PURPOSE
1.1 General. The purpose of the Ugly Duckling Corporation 1998 Executive
Incentive Plan (the "Plan") is to promote the success, and enhance the value, of
Ugly Duckling Corporation (the "Company") by linking the personal interests of
its employees, officers, and executives of, and consultants and advisors to, the
Company to those of Company stockholders and by providing such individuals with
an incentive for outstanding performance in order to generate superior returns
to shareholders of the Company. The Plan is further intended to provide
flexibility to the Company in its ability to motivate, attract, and retain the
services of employees, officers, and executives of, and consultants and advisors
to, the Company upon whose judgment, interest, and special effort the successful
conduct of the Company's operation is largely dependent.
ARTICLE 2 EFFECTIVE DATE
2.1 Effective Date. The Plan is effective as of January 15, 1998, the
date the Plan is approved by the Company's shareholders (the "Effective Date").
ARTICLE 3 DEFINITIONS AND CONSTRUCTION
3.1 Definitions. When a word or phrase appears in this Plan with the
initial letter capitalized, and the word or phrase does not commence a sentence,
the word or phrase shall generally be given the meaning ascribed to it in this
Section or in Sections 1.1 or 2.1 unless a clearly different meaning is required
by the context. The following words and phrases shall have the following
meanings:
(a) "Award" means any Option, Stock Appreciation Right, Restricted
Stock Award, Performance Share Award, or Performance-Based Award granted to
a Participant under the Plan.
(b) "Award Agreement" means any written agreement, contract, or other
instrument or document evidencing an Award.
(c) "Board" means the Board of Directors of the Company.
(d) "Cause" means (except as otherwise provided in an Award Agreement)
if the Committee, in its reasonable and good faith discretion, determines
that the employee, consultant or advisor (i) has developed or pursued
interests substantially adverse to the Company, (ii) materially breached
any employment, engagement or confidentiality agreement or otherwise failed
to satisfactorily discharge his or her duties, (iii) has not devoted all or
substantially all of his or her business time, effort and attention to the
affairs of the Company (or such lesser amount as has been agreed to in
writing by the Company), (iv) is convicted of a felony involving moral
turpitude, or (v) has engaged in activities or omissions that are
detrimental to the well-being of the Company.
(e) "Change of Control" means any of the following:
(1) any merger of the Company in which the Company is not the
continuing or surviving entity, or pursuant to which Stock would be
converted into cash, securities or other property, other than a merger
of the Company in which the holders of the Company's Stock immediately
prior to the merger have the same proportionate ownership of beneficial
interest of common stock or other voting securities of the surviving
entity immediately after the merger;
(2) any sale, lease, exchange or other transfer (in one transaction
or a series of related transactions) of assets or earning power
aggregating more than 40% of the assets or earning power of the Company
and its subsidiaries (taken as a whole), other than pursuant to a
sale-leaseback, structured finance or other form of financing
transaction or pursuant to any separating of the
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Company's assets into two or more publicly held companies as announced
in the Company's press release dated April 28, 1998;
(3) the shareholders of the Company shall approve any plan or
proposal for liquidation or dissolution of the Company;
(4) any person (as such term is used in Section 13(d) and 14(d)(2)
of the Exchange Act), other than any current shareholder of the Company
or affiliate thereof or any employee benefit plan of the Company or any
subsidiary of the Company or any entity holding shares of capital stock
of the Company for or pursuant to the terms of any such employee benefit
plan in its role as an agent or trustee for such plan, shall become the
beneficial owner (within the meaning of Rule 13d-3 under the Exchange
Act) of 20% or more of the Company's outstanding Stock; or
(5) during any period of two consecutive years, individuals who at
the beginning of such period shall fail to constitute a majority
thereof, unless the election, or the nomination for election by the
Company's shareholders, of each new director was approved by a vote of
at least two-thirds of the directors then still in office who were
directors at the beginning of the period.
(f) "Code" means the Internal Revenue Code of 1986, as amended.
(g) "Committee" means the committee of the Board described in Article
4.
(h) "Covered Employee" means an Employee who is a "covered employee"
within the meaning of Section 162(m) of the Code.
(i) "Disability" shall mean any illness or other physical or mental
condition of a Participant which renders the Participant incapable of
performing his customary and usual duties for the Company, or any medically
determinable illness or other physical or mental condition resulting from a
bodily injury, disease or mental disorder which in the judgment of the
Committee is permanent and continuous in nature. The Committee may require
such medical or other evidence as it deems necessary to judge the nature
and permanency of the Participant's condition.
(j) "Effective Date Grant" means the Options granted to selected
covered Participants pursuant to Article 12. Each Effective Date Grant is
intended to qualify as "performance-based compensation" under Code Section
162(m).
(k) "Exchange Act" means the Securities Exchange Act of 1934, as
amended from time to time.
(l) "Fair Market Value" means, as of any given date, the fair market
value of Stock or other property on a particular date determined by such
methods or procedures as may be established from time to time by the
Committee. Unless otherwise determined by the Committee, the Fair Market
Value of Stock as of any date shall be the closing price for the Stock as
reported on the NASDAQ National Market System (or on any national
securities exchange on which the Stock is then listed) for that date or, if
no closing price is so reported for that date, the closing price on the
next preceding date for which a closing price was reported.
(m) "Incentive Stock Option" means an Option that is intended to meet
the requirements of Section 422 of the Code or any successor provision
thereto.
(n) "Non-Employee Director" means a member of the Board who qualifies
as a "Non-Employee Director" as defined in Rule 16b-3(b)(3) of the Exchange
Act, or any successor definition adopted by the Board.
(o) "Non-Qualified Stock Option" means an Option that is not intended
to be an Incentive Stock Option.
(p) "Option" means a right granted to a Participant under Article 7 or
Article 12 of the Plan to purchase Stock at a specified price during
specified time periods. An Option may be either an Incentive Stock Option
or a Non-Qualified Stock Option.
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(q) "Participant" means a person who, as an executive of, or other
individual providing important services to, the Company or any Subsidiary,
has been granted an Award under the Plan.
(r) "Performance-Based Awards" means the Performance Share Awards and
Restricted Stock Awards granted to selected Covered Employees pursuant to
Articles 9 and 10, but which are subject to the terms and conditions set
forth in Article 11. All Performance-Based Awards are intended to qualify
as "performance-based compensation" under Section 162(m) of the Code.
(s) "Performance Criteria" means the criteria that the Committee
selects for purposes of establishing the Performance Goal or Performance
Goals for a Participant for a Performance Period. The Performance Criteria
that will be used to establish Performance Goals are limited to the
following: pre-or after-tax net earnings, sales growth, operating earnings,
operating cash flow, return on net assets, return on stockholders' equity,
return on assets, return on capital, Stock price growth, stockholder
returns, gross or net profit margin, earnings per share, price per share of
Stock, and market share, any of which may be measured either in absolute
terms or as compared to any incremental increase or as compared to results
of a peer group. The Committee shall, within the time prescribed by Section
162(m) of the Code, define in an objective fashion the manner of
calculating the Performance Criteria it selects to use for such Performance
Period for such Participant.
(t) "Performance Goals" means, for a Performance Period, the goals
established in writing by the Committee for the Performance Period based
upon the Performance Criteria. Depending on the Performance Criteria used
to establish such Performance Goals, the Performance Goals may be expressed
in terms of overall Company performance or the performance of a division,
business unit or an individual. The Committee, in its discretion, may,
within the time prescribed by Section 162(m) of the Code, adjust or modify
the calculation of Performance Goals for such Performance Period in order
to prevent the dilution or enlargement of the rights of Participants (i) in
the event of, or in anticipation of, any unusual or extraordinary corporate
item, transaction, event, or development, or (ii) in recognition of, or in
anticipation of, any other unusual or nonrecurring events affecting the
Company, or the financial statements of the Company, or in response to, or
in anticipation of, changes in applicable laws, regulations, accounting
principles, or business conditions.
(u) "Performance Period" means the one or more periods of time, which
may be of varying and overlapping durations, as the Committee may select,
over which the attainment of one or more Performance Goals will be measured
for the purpose of determining a Participant's right to, and the payment
of, a Performance-Based Award.
(v) "Performance Share" means a right granted to a Participant under
Article 9, to receive cash, Stock, or other Awards, the payment of which is
contingent upon achieving certain performance goals established by the
Committee.
(w) "Plan" means the Ugly Duckling Corporation 1998 Executive
Incentive Plan, as amended from time to time.
(x) "Restricted Stock Award" means Stock granted to a Participant
under Article 10 that is subject to certain restrictions and to risk of
forfeiture.
(y) "Stock" means the common stock of the Company and such other
securities of the Company that may be substituted for Stock pursuant to
Article 12.
(z) "Stock Appreciation Right" or "SAR" means a right granted to a
Participant under Article 8 to receive a payment equal to the difference
between the Fair Market Value of a share of Stock as of the date of
exercise of the SAR over the grant price of the SAR, all as determined
pursuant to Article 8.
(aa) "Subsidiary" means any corporation of which a majority of the
outstanding voting stock or voting power is beneficially owned directly or
indirectly by the Company.
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ARTICLE 4 ADMINISTRATION
4.1 Committee. The Plan shall be administered by the Board or a Committee
appointed by, and which serves at the discretion of, the Board. If the Board
appoints a Committee, the Committee shall consist of at least two individuals,
each of whom qualifies as (i) a Non-Employee Director, and (ii) an "outside
director" under Code Section 162(m) and the regulations issued thereunder.
Reference to the Committee shall refer to the Board if the Board does not
appoint a Committee.
4.2 Action by the Committee. A majority of the Committee shall constitute
a quorum. The acts of a majority of the members present at any meeting at which
a quorum is present and acts approved in writing by a majority of the Committee
in lieu of a meeting shall be deemed the acts of the Committee. Each member of
the Committee is entitled to, in good faith, rely or act upon any report or
other information furnished to that member by any officer or other employee of
the Company or any Subsidiary, the Company's independent certified public
accountants, or any executive compensation consultant or other professional
retained by the Company to assist in the administration of the Plan.
4.3 Authority of Committee. The Committee has the exclusive power,
authority and discretion to:
(a) Designate Participants to receive Awards;
(b) Determine the type or types of Awards to be granted to each
Participant;
(c) Determine the number of Awards to be granted and the number of
shares of Stock to which an Award will relate;
(d) Determine the terms and conditions of any Award granted under the
Plan including but not limited to, the exercise price, grant price, or
purchase price, any restrictions or limitations on the Award, any schedule
for lapse of forfeiture restrictions or restrictions on the exercisability
of an Award, and accelerations or waivers thereof, based in each case on
such considerations as the Committee in its sole discretion determines;
provided, however, that the Committee shall not have the authority to
accelerate the vesting, or waive the forfeiture, of any Performance-Based
Awards;
(e) Amend, modify, or terminate any outstanding Award, with the
Participant's consent unless the Committee has the authority to amend,
modify or terminate an Award without the Participant's consent under any
other provision of the Plan.
(f) Determine whether, to what extent, and under what circumstances an
Award may be settled in, or the exercise price of an Award may be paid in,
cash, Stock, other Awards, or other property, or an Award may be canceled,
forfeited, or surrendered;
(g) Prescribe the form of each Award Agreement, which need not be
identical for each Participant;
(h) Decide all other matters that must be determined in connection
with an Award;
(i) Establish, adopt or revise any rules and regulations as it may
deem necessary or advisable to administer the Plan; and
(j) Make all other decisions and determinations that may be required
under the Plan or as the Committee deems necessary or advisable to
administer the Plan.
4.4 Decisions Binding. The Committee's interpretation of the Plan, any
Awards granted under the Plan, any Award Agreement and all decisions and
determinations by the Committee with respect to the Plan are final, binding, and
conclusive on all parties.
ARTICLE 5 SHARES SUBJECT TO THE PLAN
5.1 Number of Shares. Subject to adjustment provided in Section 13.1, the
aggregate number of shares of Stock reserved and available for grant under the
Plan shall be 800,000.
5.2 Lapsed Awards. To the extent that an Award terminates, expires or
lapses for any reason, any shares of Stock subject to the Award will again be
available for the grant of an Award under the Plan and
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shares subject to SARs or other Awards settled in cash will be available for the
grant of an Award under the Plan.
5.3 Stock Distributed. Any Stock distributed pursuant to an Award may
consist, in whole or in part, of authorized and unissued Stock, treasury Stock
or Stock purchased on the open market.
5.4 Limitation on Number of Shares Subject to Awards. Notwithstanding any
provision in the Plan to the contrary, and subject to the adjustment in Section
13.1, the maximum number of shares of Stock with respect to one or more Awards
that may be granted to any one Participant during the Company's fiscal year
shall be 400,000.
ARTICLE 6 ELIGIBILITY AND PARTICIPATION
6.1 Eligibility.
(a) General. Persons eligible to participate in this Plan include all
employees, officers, and executives of, and consultants and advisors to,
the Company or a Subsidiary, as determined by the Committee, including such
individuals who are also members of the Board.
(b) Foreign Participants. In order to assure the viability of Awards
granted to Participants employed in foreign countries, the Committee may
provide for such special terms as it may consider necessary or appropriate
to accommodate differences in local law, tax policy, or custom. Moreover,
the Committee may approve such supplements to, or amendments, restatements,
or alternative versions of the Plan as it may consider necessary or
appropriate for such purposes without thereby affecting the terms of the
Plan as in effect for any other purpose; provided, however, that no such
supplements, amendments, restatements, or alternative versions shall
increase the share limitations contained in Section 5.1 of the Plan.
6.2 Actual Participation. Subject to the provisions of the Plan, the
Committee may, from time to time, select from among all eligible individuals,
those to whom Awards shall be granted and shall determine the nature and amount
of each Award. No individual shall have any right to be granted an Award under
this Plan.
ARTICLE 7 STOCK OPTIONS
7.1 General. The Committee is authorized to grant Options to Participants
on the following terms and conditions:
(a) Exercise Price. The exercise price per share of Stock under an
Option shall be determined by the Committee and set forth in the Award
Agreement. It is the intention under the Plan that the exercise price for
any Option shall not be less than the Fair Market Value as of the date of
grant; provided, however that the Committee may, in its discretion, grant
Options (other than Options that are intended to be Incentive Stock Options
or Options that are intended to qualify as performance-based compensation
under Code Section 162(m)) with an exercise price of less than Fair Market
Value on the date of grant.
(b) Time and Conditions of Exercise. The Committee shall determine
the time or times at which an Option may be exercised in whole or in part.
The Committee shall also determine the performance or other conditions, if
any, that must be satisfied before all or part of an Option may be
exercised.
(c) Payment. The Committee shall determine the methods by which the
exercise price of an Option may be paid, the form of payment, including,
without limitation, cash, shares of Stock (through actual tender or by
attestation), or other property (including broker-assisted "cashless
exercise" arrangements), and the methods by which shares of Stock shall be
delivered or deemed to be delivered to Participants.
(d) Evidence of Grant. All Options shall be evidenced by a written
Award Agreement between the Company and the Participant. The Award
Agreement shall include such additional provisions as may be specified by
the Committee.
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7.2 Incentive Stock Options. Incentive Stock Options shall be granted
only to employees and the terms of any Incentive Stock Options granted under the
Plan must comply with the following additional rules:
(a) Exercise Price. The exercise price per share of Stock shall be
set by the Committee, provided that the exercise price for any Incentive
Stock Option may not be less than the Fair Market Value as of the date of
the grant.
(b) Exercise. In no event, may any Incentive Stock Option be
exercisable for more than ten years from the date of its grant.
(c) Lapse of Option. An Incentive Stock Option shall lapse under the
following circumstances:
(1) The Incentive Stock Option shall lapse ten years from the date
it is granted, unless an earlier time is set in the Award Agreement.
(2) The Incentive Stock Option shall lapse upon termination of
employment for Cause or for any other reason, other than the
Participant's death or Disability, unless the Committee determines in
its discretion to extend the exercise period for no more than ninety
(90) days after the Participant's termination of employment.
(3) If the Participant terminates employment on account of
Disability or death before the Option lapses pursuant to paragraph (1)
or (2) above, the Incentive Stock Option shall lapse, unless it is
previously exercised, on the earlier of (i) the date on which the Option
would have lapsed had the Participant not become Disabled or lived and
had his employment status (i.e., whether the Participant was employed by
the Company on the date of his Disability or death or had previously
terminated employment) remained unchanged; or (ii) 12 months after the
date of the Participant's termination of employment on account of
Disability or death. Upon the Participant's Disability or death, any
Incentive Stock Options exercisable at the Participant's Disability or
death may be exercised by the Participant's legal representative or
representatives, by the person or persons entitled to do so under the
Participant's last will and testament, or, if the Participant shall fail
to make testamentary disposition of such Incentive Stock Option or shall
die intestate, by the person or persons entitled to receive said
Incentive Stock Option under the applicable laws of descent and
distribution.
(d) Individual Dollar Limitation. The aggregate Fair Market Value
(determined as of the time an Award is made) of all shares of Stock with
respect to which Incentive Stock Options are first exercisable by a
Participant in any calendar year may not exceed $100,000.00 or such other
limitation as imposed by Section 422(d) of the Code, or any successor
provision. To the extent that Incentive Stock Options are first exercisable
by a Participant in excess of such limitation, the excess shall be
considered Non-Qualified Stock Options.
(e) Ten Percent Owners. An Incentive Stock Option shall be granted to
any individual who, at the date of grant, owns stock possessing more than
ten percent of the total combined voting power of all classes of Stock of
the Company only if such Option is granted at a price that is not less than
110% of Fair Market Value on the date of grant and the Option is
exercisable for no more than five years from the date of grant.
(f) Expiration of Incentive Stock Options. No Award of an Incentive
Stock Option may be made pursuant to this Plan after the tenth anniversary
of the Effective Date.
(g) Right to Exercise. During a Participant's lifetime, an Incentive
Stock Option may be exercised only by the Participant.
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ARTICLE 8 STOCK APPRECIATION RIGHTS
8.1 Grant of SARs. The Committee is authorized to grant SARs to
Participants on the following terms and conditions:
(a) Right to Payment. Upon the exercise of a Stock Appreciation
Right, the Participant to whom it is granted has the right to receive the
excess, if any, of:
(1) The Fair Market Value of a share of Stock on the date of
exercise; over
(2) The grant price of the Stock Appreciation Right as determined
by the Committee, which shall not be less than the Fair Market Value of
a share of Stock on the date of grant in the case of any SAR related to
any Incentive Stock Option.
(b) Other Terms. All awards of Stock Appreciation Rights shall be
evidenced by an Award Agreement. The terms, methods of exercise, methods of
settlement, form of consideration payable in settlement, and any other
terms and conditions of any Stock Appreciation Right shall be determined by
the Committee at the time of the grant of the Award and shall be reflected
in the Award Agreement.
ARTICLE 9 PERFORMANCE SHARES
9.1 Grant of Performance Shares. The Committee is authorized to grant
Performance Shares to Participants on such terms and conditions as may be
selected by the Committee. The Committee shall have the complete discretion to
determine the number of Performance Shares granted to each Participant. All
Awards of Performance Shares shall be evidenced by an Award Agreement.
9.2 Right to Payment. A grant of Performance Shares gives the Participant
rights, valued as determined by the Committee, and payable to, or exercisable
by, the Participant to whom the Performance Shares are granted, in whole or in
part, as the Committee shall establish at grant or thereafter. The Committee
shall set performance goals and other terms or conditions to payment of the
Performance Shares in its discretion which, depending on the extent to which
they are met, will determine the number and value of Performance Shares that
will be paid to the Participant.
9.3 Other Terms. Performance Shares may be payable in cash, Stock, or
other property, and have such other terms and conditions as determined by the
Committee and reflected in the Award Agreement.
ARTICLE 10 RESTRICTED STOCK AWARDS
10.1 Grant of Restricted Stock. The Committee is authorized to make
Awards of Restricted Stock to Participants in such amounts and subject to such
terms and conditions as may be selected by the Committee. All Awards of
Restricted Stock shall be evidenced by a Restricted Stock Award Agreement.
10.2 Issuance and Restrictions. Restricted Stock shall be subject to such
restrictions on transferability and other restrictions as the Committee may
impose (including, without limitation, limitations on the right to vote
Restricted Stock or the right to receive dividends on the Restricted Stock).
These restrictions may lapse separately or in combination at such times, under
such circumstances, in such installments, or otherwise, as the Committee
determines at the time of the grant of the Award or thereafter.
10.3 Forfeiture. Except as otherwise determined by the Committee at the
time of the grant of the Award or thereafter, upon termination of employment
during the applicable restriction period, Restricted Stock that is at that time
subject to restrictions shall be forfeited, provided, however, that the
Committee may provide in any Restricted Stock Award Agreement that restrictions
or forfeiture conditions relating to Restricted Stock will be waived in whole or
in part in the event of terminations resulting from specified causes, and the
Committee may in other cases waive in whole or in part restrictions or
forfeiture conditions relating to Restricted Stock.
10.4 Certificates for Restricted Stock. Restricted Stock granted under
the Plan may be evidenced in such manner as the Committee shall determine. If
certificates representing shares of Restricted Stock are registered in the name
of the Participant, certificates must bear an appropriate legend referring to
the terms,
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conditions, and restrictions applicable to such Restricted Stock, and the
Company may, at its discretion, retain physical possession of the certificate
until such time as all applicable restrictions lapse.
ARTICLE 11 PERFORMANCE-BASED AWARDS
11.1 Purpose. The purpose of this Article 11 is to provide the Committee
the ability to qualify the Performance Share Awards under Article 9 and the
Restricted Stock Awards under Article 10 as "performance-based compensation"
under Section 162(m) of the Code. If the Committee, in its discretion, decides
to grant a Performance-Based Award to a Covered Employee, the provisions of this
Article 11 shall control over any contrary provision contained in Articles 9 or
10.
11.2 Applicability. This Article 11 shall apply only to those Covered
Employees selected by the Committee to receive Performance-Based Awards. The
Committee may, in its discretion, grant Restricted Stock Awards or Performance
Share Awards to Covered Employees that do not satisfy the requirements of this
Article 11. The designation of a Covered Employee as a Participant for a
Performance Period shall not in any manner entitle the Participant to receive an
Award for the period. Moreover, designation of a Covered Employee as a
Participant for a particular Performance Period shall not require designation of
such Covered Employee as a Participant in any subsequent Performance Period and
designation of one Covered Employee as a Participant shall not require
designation of any other Covered Employees as a Participant in such period or in
any other period.
11.3 Discretion of Committee with Respect to Performance Awards. With
regard to a particular Performance Period, the Committee shall have full
discretion to select the length of such Performance Period, the type of
Performance-Based Awards to be issued, the kind and/or level of the Performance
Goal, and whether the Performance Goal is to apply to the Company, a Subsidiary
or any division or business unit thereof.
11.4 Payment of Performance Awards. Unless otherwise provided in the
relevant Award Agreement, a Participant must be employed by the Company or a
Subsidiary on the last day of the Performance Period to be eligible for a
Performance Award for such Performance Period. Furthermore, a Participant shall
be eligible to receive payment under a Performance-Based Award for a Performance
Period only if the Performance Goals for such period are achieved.
In determining the actual size of an individual Performance-Based Award,
the Committee may reduce or eliminate the amount of the Performance-Based Award
earned for the Performance Period, if in its sole and absolute discretion, such
reduction or elimination is appropriate.
11.5 Maximum Award Payable. The maximum Performance-Based Award payable
to any one Participant under the Plan for a Performance Period is 400,000 shares
of Stock, or in the event the Performance-Based Award is paid in cash, such
maximum Performance-Based Award shall be determined by multiplying 400,000 by
the Fair Market Value of one share of Stock as of the date of grant of the
Performance-Based Award.
ARTICLE 12 EFFECTIVE DATE GRANTS
12.1 Effective Date Grants. The Effective Date Grants awarded to
Participants selected by the Committee shall be subject to the following terms
and conditions:
(a) Exercise Price. The exercise price per share of Stock under the
Effective Date Grants shall be the Fair Market Value as of the Effective
Date.
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(b) Time and Conditions of Exercise. The Effective Date Grants shall
become exercisable on the last to occur of:
(1) the date the Effective Date Grants vests in accordance with the
schedule below; and
(2) the date the stock price hurdles with respect to each Effective
Date Grant for 10 consecutive trading days is met in accordance with the
schedule below, before, on, or after the date such Grant vests.
<TABLE>
<CAPTION>
PERCENTAGE OF EFFECTIVE DATE EFFECTIVE DATE STOCK PRICE HURDLE
DATE GRANT THAT VESTS GRANT VESTS AFTER VESTING DATE
- ----------------------- ---------------------- ----------------------
<S> <C> <C>
First 20%............. First anniversary of Fair Market Value on
the Effective Date the Effective Date
plus 20%
Second 20%............ Second anniversary of Fair Market Value on
the Effective Date the Effective Date
plus 40%
Third 20%............. Third anniversary of Fair Market Value on
the Effective Date the Effective Date
plus 60%
Fourth 20%............ Fourth anniversary of Fair Market Value on
the Effective Date the Effective Date
plus 80%
Fifth 20%............. Fifth anniversary of Fair Market Value on
the Effective Date the Effective Date
plus 100%
</TABLE>
Notwithstanding the above schedule, the Effective Date Grants shall
become fully vested and exercisable on January 15, 2005, unless sooner
exercised or forfeited.
The following example illustrates how the vesting schedule is intended
to operate:
Example: If at any time during the first year after the Effective
Date Grant, the traded price of Company's stock appreciates 40% from the
stock's Fair Market Value on the Effective Date (and such price exceeds
the stock price hurdle for at least 10 consecutive trading days), the
first two stock price hurdles will be met, so that the Option will be
20% vested after the first anniversary and 40% vested after the second
anniversary notwithstanding the Fair Market Value of the stock at either
anniversary date.
(c) Payment. The Committee shall determine the methods by which the
exercise price of the Effective Date Grants may be paid, the form of
payment, including, without limitation, cash, shares of Stock (through
actual tender or by attestation), or other property (including
broker-assisted "cashless exercise" arrangements), and the methods by which
shares of Stock shall be delivered or deemed to be delivered to
Participants.
(d) Evidence of Grant. All Effective Date Grants shall be evidenced
by a written Award Agreement between the Company and the Participant. The
Award Agreement shall include such other provisions as may be specified by
the Committee.
ARTICLE 13 PROVISIONS APPLICABLE TO AWARDS
13.1 Stand-Alone, Tandem, and Substitute Awards. Awards granted under the
Plan may, in the discretion of the Committee, be granted either alone or in
addition to, in tandem with, or in substitution for, any other Award granted
under the Plan. If an Award is granted in substitution for another Award, the
Committee may require the surrender of such other Award in consideration of the
grant of the new Award. Awards granted in addition to or in tandem with other
Awards may be granted either at the same time as or at a different time from the
grant of such other Awards.
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13.2 Exchange Provisions. The Committee may at any time offer to exchange
or buy out any previously granted Award for a payment in cash, Stock, or another
Award (subject to Section 13.1), based on the terms and conditions the Committee
determines and communicates to the Participant at the time the offer is made.
13.3 Term of Award. The term of each Award shall be for the period as
determined by the Committee, provided that in no event shall the term of any
Incentive Stock Option or a Stock Appreciation Right granted in tandem with the
Incentive Stock Option exceed a period of ten years from the date of its grant.
13.4 Form of Payment for Awards. Subject to the terms of the Plan and any
applicable law or Award Agreement, payments or transfers to be made by the
Company or a Subsidiary on the grant or exercise of an Award may be made in such
forms as the Committee determines at or after the time of grant, including
without limitation, cash, Stock, other Awards, or other property, or any
combination, and may be made in a single payment or transfer, in installments,
or on a deferred basis, in each case determined in accordance with rules adopted
by, and at the discretion of, the Committee.
13.5 Limits on Transfer. No right or interest of a Participant in any
Award may be pledged, encumbered, or hypothecated to or in favor of any party
other than the Company or a Subsidiary, or shall be subject to any lien,
obligation, or liability of such Participant to any other party other than the
Company or a Subsidiary. Except as otherwise provided by the Committee, no Award
shall be assignable or transferable by a Participant other than by will or the
laws of descent and distribution.
13.6 Beneficiaries. Notwithstanding Section 13.5, a Participant may, in
the manner determined by the Committee, designate a beneficiary to exercise the
rights of the Participant and to receive any distribution with respect to any
Award upon the Participant's death. A beneficiary, legal guardian, legal
representative, or other person claiming any rights under the Plan is subject to
all terms and conditions of the Plan and any Award Agreement applicable to the
Participant, except to the extent the Plan and Award Agreement otherwise
provide, and to any additional restrictions deemed necessary or appropriate by
the Committee. If the Participant is married, a designation of a person other
than the Participant's spouse as his beneficiary with respect to more than 50
percent of the Participant's interest in the Award shall not be effective
without the written consent of the Participant's spouse. If no beneficiary has
been designated or survives the Participant, payment shall be made to the person
entitled thereto under the Participant's will or the laws of descent and
distribution. Subject to the foregoing, a beneficiary designation may be changed
or revoked by a Participant at any time provided the change or revocation is
filed with the Committee.
13.7 Stock Certificates. All Stock certificates delivered under the Plan
are subject to any stop-transfer orders and other restrictions as the Committee
deems necessary or advisable to comply with Federal or state securities laws,
rules and regulations and the rules of any national securities exchange or
automated quotation system on with the Stock is listed, quoted, or traded. The
Committee may place legends on any Stock certificate to reference restrictions
applicable to the Stock.
13.8 Acceleration Upon a Change of Control. If a Change of Control
occurs, all outstanding Options, Stock Appreciation Rights, and other Awards
shall become fully exercisable and all restrictions on outstanding Awards shall
lapse, except in the event that the surviving or resulting entity agrees to
assume the Awards on terms and conditions that substantially preserve the
Participant's rights and benefits of the Award then outstanding. To the extent
that this provision causes Incentive Stock Options to exceed the dollar
limitation set forth in Section 7.2(d), the excess Options shall be deemed to be
Non-Qualified Stock Options. Upon, or in anticipation of, such an event, the
Committee may cause every Award outstanding hereunder to terminate at a specific
time in the future and shall give each Participant the right to exercise Awards
during a period of time as the Committee, in its sole and absolute discretion,
shall determine, except in the event that the surviving or resulting entity
agrees to assume the Awards on terms and conditions that substantially preserve
the Participant's rights and benefits of the Award then outstanding.
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ARTICLE 14 CHANGES IN CAPITAL STRUCTURE
14.1 General. In the event a stock dividend is declared upon the Stock,
the shares of Stock then subject to each Award (and the number of shares subject
thereto) shall be increased proportionately without any change in the aggregate
purchase price therefor. In the event the Stock shall be changed into or
exchanged for a different number or class of shares of Stock or of another
corporation, whether through reorganization, recapitalization, stock split-up,
combination of shares, merger or consolidation, there shall be substituted for
each such share of Stock then subject to each Award the number and class of
shares of Stock into which each outstanding share of Stock shall be so
exchanged, all without any change in the aggregate purchase price for the shares
then subject to each Award.
ARTICLE 15 AMENDMENT, MODIFICATION AND TERMINATION
15.1 Amendment, Modification and Termination. With the approval of the
Board, at any time and from time to time, the Committee may terminate, amend or
modify the Plan; provided, however, that to the extent necessary and desirable
to comply with any applicable law, regulation, or stock exchange rule, the
Company shall obtain shareholder approval of any Plan amendment in such a manner
and to such a degree as required.
15.2 Awards Previously Granted. No termination, amendment, or
modification of the Plan shall adversely affect in any material way any Award
previously granted under the Plan, without the written consent of the
Participant.
ARTICLE 16 GENERAL PROVISIONS
16.1 No Rights to Awards. No Participant , employee, or other person
shall have any claim to be granted any Award under the Plan, and neither the
Company nor the Committee is obligated to treat Participants, employees, and
other persons uniformly.
16.2 No Stockholders Rights. No Award gives the Participant any of the
rights of a stockholder of the Company unless and until shares of Stock are in
fact issued to such person in connection with such Award.
16.3 Withholding. The Company or any Subsidiary shall have the authority
and the right to deduct or withhold, or require a Participant to remit to the
Company, an amount sufficient to satisfy Federal, state, and local taxes
(including the Participant's FICA obligation) required by law to be withheld
with respect to any taxable event arising as a result of this Plan.
16.4 No Right to Employment. Nothing in the Plan or any Award Agreement
shall interfere with or limit in any way the right of the Company or any
Subsidiary to terminate any Participant's employment at any time, nor confer
upon any Participant any right to continue in the employ of the Company or any
Subsidiary.
16.5 Unfunded Status of Awards. The Plan is intended to be an "unfunded"
plan for incentive compensation. With respect to any payments not yet made to a
Participant pursuant to an Award, nothing contained in the Plan or any Award
Agreement shall give the Participant any rights that are greater than those of a
general creditor of the Company or any Subsidiary.
16.6 Indemnification. To the extent allowable under applicable law, each
member of the Committee or of the Board shall be indemnified and held harmless
by the Company from any loss, cost, liability, or expense that may be imposed
upon or reasonably incurred by such member in connection with or resulting from
any claim, action, suit, or proceeding to which he or she may be a party or in
which he or she may be involved by reason of any action or failure to act under
the Plan and against and from any and all amounts paid by him or her in
satisfaction of judgment in such action, suit, or proceeding against him or her
provided he or she gives the Company an opportunity, at its own expense, to
handle and defend the same before he or she undertakes to handle and defend it
on his or her own behalf. The foregoing right of indemnification shall not be
exclusive of any other rights of indemnification to which such persons may be
entitled under the Company's Articles of Incorporation or By-Laws, as a matter
of law, or otherwise, or any power that the Company may have to indemnify them
or hold them harmless.
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16.7 Relationship to Other Benefits. No payment under the Plan shall be
taken into account in determining any benefits under any pension, retirement,
savings, profit sharing, group insurance, welfare or other benefit plan of the
Company or any Subsidiary.
16.8 Expenses. The expenses of administering the Plan shall be borne by
the Company and its Subsidiaries.
16.9 Titles and Headings. The titles and headings of the Sections in the
Plan are for convenience of reference only, and in the event of any conflict,
the text of the Plan, rather than such titles or headings, shall control.
16.10 Fractional Shares. No fractional shares of stock shall be issued
and the Committee shall determine, in its discretion, whether cash shall be
given in lieu of fractional shares or whether such fractional shares shall be
eliminated by rounding up or down as appropriate.
16.11 Securities Law Compliance. With respect to any person who is, on
the relevant date, obligated to file reports under Section 16 of the Exchange
Act, transactions under this Plan are intended to comply with all applicable
conditions of Rule 16b-3 or its successors under the Exchange Act. To the extent
any provision of the Plan or action by the Committee fails to so comply, it
shall be void to the extent permitted by law and voidable as deemed advisable by
the Committee.
16.12 Government and Other Regulations. The obligation of the Company to
make payment of awards in Stock or otherwise shall be subject to all applicable
laws, rules, and regulations, and to such approvals by government agencies as
may be required. The Company shall be under no obligation to register under the
Securities Act of 1933, as amended (the "1933 Act"), any of the shares of Stock
paid under the Plan. If the shares paid under the Plan may in certain
circumstances be exempt from registration under the 1933 Act, the Company may
restrict the transfer of such shares in such manner as it deems advisable to
ensure the availability of any such exemption.
16.13 Governing Law. The Plan and all Award Agreements shall be construed
in accordance with and governed by the laws of the State of Arizona.
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APPENDIX C
July 20, 1998
PERSONAL AND CONFIDENTIAL
The Board of Directors
Ugly Duckling Corporation
2525 East Camelback Road
Suite 1150
Phoenix, Arizona 85016
Gentlemen:
You have asked CIBC Oppenheimer Corp. ("CIBC Oppenheimer") to render a
written opinion ("Fairness Opinion") to the Board of Directors as to the
fairness to the shareholders of Ugly Ducking Corporation ("UDC" or the
"Company"), from a financial point of view, of the Transaction (as defined
below) between UDC and Cygnet Financial Corporation ("Cygnet"). UDC's
stockholders are being asked to approve the split up of the Company and its
subsidiaries into two publicly-held corporate groups (the "Split Up"), and the
sale of certain of the Company's assets and operations to Cygnet in exchange for
the Consideration (as defined below) to be received from Cygnet, and are being
offered the rights (the "Rights") to purchase one share of Cygnet common stock
at $7.00 per share (the "Subscription Price") for each four shares of UDC owned
(collectively, the "Transaction").
It is our understanding that the principal terms and conditions of the
Transaction provide that UDC will receive (1) a cash payment equal to the
difference between (i) the greater of the appraised value or the net book value
of the assets, third party dealer finance operations and assets and the bulk
purchase and servicing operations and assets to be transferred to Cygnet (net of
liabilities assumed), and (ii) $40 million; and (2) 40,000 shares of Cygnet's
Cumulative Convertible Preferred Stock, Series A, with an aggregate liquidation
preference of $40 million (collectively, the "Consideration"). The Preferred
Stock will initially pay cash dividends at the rate of 7% per annum, increasing
by an additional 1% per annum on each anniversary of the issuance thereof up to
a maximum of 11%, and will be convertible after the third anniversary of such
issuance or prior thereto under certain limited circumstances into shares of
Cygnet's common stock at specified prices. The stockholders of UDC will receive
Rights to purchase Cygnet common shares at the Subscription Price applying the
ratio of one (1) right to purchase one (1) Cygnet common share for every four
(4) UDC common shares owned. Furthermore, Ernest C. Garcia II, Chairman and
Chief Executive Officer of UDC, agrees to act as standby purchaser and purchase
the number of shares of Cygnet common stock necessary to meet the 75%
subscription requirements at the Subscription Price and in return shall be
granted 500,000 warrants in Cygnet that provide him the right to purchase
500,000 Cygnet shares at an exercise price equal to 120% of the Subscription
Price at any time through the fifth anniversary of the effective date. Mr.
Garcia shall also have the right to purchase up to an additional $5.0 million of
Cygnet common stock and officers and directors of Cygnet shall have the right to
purchase up to $1.5 million of Cygnet common stock at the Subscription Price at
the time of the Split-up.
In arriving at our Fairness Opinion we:
(a) reviewed the draft Capitalization Agreement dated 7/7/98;
(b) reviewed UDC's audited financial statements for the fiscal years
ended December 31, 1994, 1995, 1996 and 1997; and for the three months
ended March 31, 1997 and 1998;
(c) reviewed Cygnet's audited financial statements for the fiscal year
ended December 31, 1997 and unaudited financial statements for the three
months ended March 31, 1997 and 1998;
(d) reviewed financial projections of Cygnet prepared by Cygnet's and
UDC's managements;
(e) reviewed the terms and conditions related to the convertible
Preferred Stock to be issued by Cygnet to UDC;
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Board of Directors Page 2
July 20, 1998
(f) held discussions with senior management of Cygnet and UDC with
respect to the business and prospects for future growth of both Cygnet and
UDC;
(g) reviewed and analyzed certain publicly available financial data
for certain companies we deemed comparable to UDC and Cygnet;
(h) performed discounted cash flow analyses of Cygnet using certain
assumptions of future performance provided to us by the management of
Cygnet and UDC;
(i) reviewed and analyzed certain publicly available financial
information for mergers and acquisitions transactions that we deemed
comparable and relevant to the Transaction;
(j) reviewed and analyzed certain publicly available financial
information regarding publicly traded companies that we deemed comparable
and relevant to the Transaction;
(k) reviewed and analyzed certain available financial information for
preferred convertible securities, preferred securities, and subordinated
debt securities that we deemed comparable to the convertible Preferred
Stock to be issued as part of the Consideration;
(l) reviewed the draft Proxy Statement in connection with the
Transaction as filed with the Securities and Exchange Commission on June
22, 1998.
(m) reviewed public information concerning Cygnet and UDC; and
(n) performed such other analyses and reviewed such other information
as we deemed appropriate.
In rendering our Fairness Opinion we relied upon and assumed, without
independent verification or investigation, the accuracy and completeness of all
of the financial and other information provided to us by the Company and Cygnet
and their respective employees, representatives and affiliates. With respect to
forecasts of future financial condition and operating results of Cygnet provided
to us, we assumed at the direction of UDC's and Cygnet's managements, without
independent verification or investigation, that such forecasts were reasonably
prepared on bases reflecting the best available information, estimates and
judgment of Cygnet's and UDC's respective management. We have not made any
independent evaluation or appraisal of the assets or the liabilities to be
transferred by UDC to Cygnet or the assets or liabilities of UDC, Cygnet or
other affiliated entities. We have read and reviewed an independent
evaluation/appraisal furnished by UDC of certain of the assets and liabilities
to be transferred by UDC to Cygnet, and have considered the appraised values
contained therein in the context of all the other information furnished or
otherwise considered by us; however, we have not relied upon that appraisal to
the exclusion of other information in formulating our opinion. We also
considered the views of management of UDC as to the strategic and operational
benefits they anticipate from the Split-Up. We are not expressing any opinion as
to the underlying valuation or future performance of UDC or Cygnet following the
Transaction, or the prices at which UDC's or Cygnet's common stock will trade
subsequent to the Transaction, nor are we expressing any opinion with respect to
the underlying business decision to implement the Split-Up. Our opinion is
necessarily based on the information available to us and general economic,
financial and stock market conditions and circumstances as they exist and can be
evaluated by us on the date thereof. It should be understood that although
subsequent developments may affect this opinion, we do not have any obligation
to update, revise or reaffirm the opinion.
As part of our investment banking business, we are regularly engaged in
valuations of businesses and securities in connection with acquisitions and
mergers, underwritings, secondary distributions of securities, private
placements and valuations for other purposes.
We acted as financial advisor to UDC in connection with the Transaction and
to the Board of Directors of UDC in rendering this opinion and will receive a
fee for our services. In the ordinary course of its business, CIBC Oppenheimer
and its affiliates may actively trade securities of UDC, and potentially Cygnet,
for their
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Board of Directors Page 3
July 20, 1998
own account and for the accounts of customers and, accordingly, may at any time
hold a long or short position in such securities.
This Fairness Opinion is for the use of the Board of Directors of UDC in
connection with the Transaction, and does not constitute a recommendation to any
shareholder of UDC as to how such shareholder should vote with respect to the
Split-Up. Neither this Fairness Opinion nor the services provided by CIBC
Oppenheimer in connection herewith may be publicly disclosed or referred to in
any manner by UDC without the prior approval by CIBC Oppenheimer; provided,
however, that the text of this fairness Opinion and a summary description of the
Fairness Opinion in a form approved by CIBC Oppenheimer may be included in the
Company's Proxy Statement in connection with the Transaction.
Based upon and subject to the foregoing, and such other factors as we deem
relevant, it is our opinion that, as of the date hereof, the Transaction, is
fair to the shareholders of UDC from a financial point of view.
Very truly yours,
CIBC Oppenheimer
C-3
<PAGE> 173
PROXY PROXY
UGLY DUCKLING CORPORATION
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING OF STOCKHOLDERS--AUGUST 31, 1998
I appoint Ernest C. Garcia II, Gregory B. Sullivan and Steven P. Johnson,
individually and together, proxies with full power of substitution, to vote all
of my Common Stock of Ugly Duckling Corporation which I have the power to vote,
at the Annual Meeting of Stockholders to be held at The Phoenician, 6000 East
Camelback Road, Phoenix, Arizona 85251 on August 31, 1998, at 4:00 p.m. (Arizona
Time) and at any adjournments or postponements of the meeting. In the absence of
specific voting directions from me, my proxies will vote in accordance with the
Directors' recommendations on the reverse side of this card. My proxies may vote
according to their discretion on any other matter which may properly come before
the meeting. I revoke any proxy previously given and acknowledge that I may
revoke this proxy prior to its exercise.
Unless otherwise Marked, this proxy will be voted FOR the election of
director nominees and FOR Proposal Nos. 2, 3, and 4.
YOUR VOTE IS IMPORTANT: PLEASE SIGN AND DATE THE OTHER SIDE OF THIS PROXY
CARD AND RETURN IT PROMPTLY USING THE ENCLOSED ENVELOPE.
- -------------------------------------------------------------------------------
- FOLD AND DETACH HERE -
<PAGE> 174
UGLY DUCKLING CORPORATION
PLEASE MARK VOTE IN BOXES IN THE FOLLOWING MANNER USING DARK INK ONLY. [X]
The Board of Directors recommends a vote FOR Proposals 1, 2, 3 and 4.
For Withheld For All
1. ELECTION OF DIRECTORS: Except
Nominees: Robert J. Abrahams, Ernest C. Garcia II, [ ] [ ] [ ]
Christopher D. Jennings, John N. MacDonough,
Gregory B. Sullivan, Frank P. Willey
- ------------------------------------------------------
Except nominee(s) written above
For Withheld Abstain
2. To approve technical amendments to the [ ] [ ] [ ]
Company's Long-Term Incentive Plan
3. To approve the Company's 1998 Executive [ ] [ ] [ ]
Incentive Plan
4. To approve the Split-up Proposal [ ] [ ] [ ]
Please sign exactly as name(s) appear on your
Common Stock certificates. If acting as an
executor, administrator, trustee, custodian,
guardian, etc., you should so indicate in
signing. If the stockholder is a corporation,
please sign the full corporate name, by a duly
authorized officer. If shares are held jointly,
each stockholder named should sign.
Dated:____________________________________, 1998
________________________________________________
Signature
________________________________________________
Signature
This proxy, when properly executed will be voted as you specify above. If no
specific voting directions are given by you, this proxy will be voted FOR the
listed proposals and, with respect to such other business as may properly come
before the meeting, in accordance with the discretion of the appointed proxy.
PLEASE SIGN, DATE AND RETURN THIS PROXY PROMPTLY.
- --------------------------------------------------------------------------------
-- FOLD AND DETACH HERE --
<PAGE> 1
Filed pursuant to rule
424(b)(3) Reg No.333-57323
[CYGNET FINANCE LOGO]
CYGNET FINANCIAL CORPORATION
5,678,572 SHARES OF COMMON STOCK
AND
4,750,000 COMMON STOCK PURCHASE RIGHTS
This Prospectus relates to a rights offering (the "Rights Offering"), which
includes (a) a distribution of transferable rights ("Rights") to subscribe for
shares of Common Stock, $.001 par value (the "Common Stock") of Cygnet Financial
Corporation ("Cygnet") to holders of Common Stock, par value $.001 per share
("UDC Common Stock") of Ugly Duckling Corporation ("UDC"), (b) the sale of
shares of Common Stock upon exercise of the Rights (the "Offered Shares"), (c)
the sale of shares of Common Stock pursuant to the Over-Subscription Privilege
(as defined herein), (d) the sale of shares of Common Stock to the Standby
Purchaser (as defined herein) pursuant to the terms of the Standby Purchase
Agreement (as defined herein), and (e) the sale of shares of Common Stock
pursuant to the Additional Purchase Right (as defined herein) and the D&O
Purchase Right (as defined herein). The holders of UDC Common Stock receiving
Rights (and their transferees) are referred to herein as "Rights Offering
Participants."
The Rights Offering is being effected as part of a plan to separate UDC and
its existing subsidiaries into two publicly-held companies (the "Split-up").
Pursuant to the Split-up, Cygnet, a newly-formed Delaware corporation and
wholly-owned subsidiary of UDC, and its subsidiaries will acquire UDC's bulk
purchasing and certain servicing operations, its third party dealer financing
operations (excluding the branch office network operations that UDC closed in
the first quarter of 1998), and substantially all of the assets and certain
liabilities acquired pursuant to the transactions between UDC and First
Merchants Acceptance Corporation and Reliance Acceptance Group, Inc. Cygnet may
also effect certain additional transactions prior to the Split-up as generally
described herein. See "Business -- Recent Developments." In exchange for these
assets, Cygnet will issue $40 million of its Preferred Stock (as defined herein)
and make a cash or equivalent payment as described herein, which Cygnet
estimates will range from $10 million to $20 million. The sum of the Preferred
Stock and the cash payment will be equivalent to the greater of the appraised
value or book value of the assets transferred (in each case net of assumed
liabilities) determined as of the closing of the transaction. The proceeds of
the Rights Offering will be used primarily to provide funds to Cygnet for
capital expenditures and working capital and to fund the cash portion of the
consideration as described herein.
After consummation of the Split-up, Cygnet and UDC will be owned, operated,
and managed as separate public companies with separate management. Cygnet will
operate substantially all of the third party dealer finance operations currently
conducted by UDC, including its bulk purchasing and certain servicing operations
and its collateralized dealer finance program. UDC will retain and continue to
operate its "buy here-pay here" dealerships and to service the finance
receivables generated by those dealerships.
Pursuant to the Rights Offering, each holder of record of UDC Common Stock
on August 17, 1998 (the "Record Date") will receive one (1) Right for every four
(4) shares of UDC Common Stock held on the Record Date. Each Right represents
the right to subscribe for one share of Common Stock (the "Primary
Subscription") at an exercise price of $7.00 (the "Subscription Price"). The
Rights will be exercisable for a limited period (the "Rights Offering Period")
beginning on the date of such distribution (the "Commencement Date") and ending
at 5:00 p.m. (Minnesota time) on the date that is 20 days following the
Commencement Date or such other later date to which the Rights Offering is
extended (the "Expiration Date"). The Rights will trade only during the Rights
Offering Period. Holders of Rights who exercise all of their Rights may
subscribe at the Subscription Price for additional shares of Common Stock out of
the pool of shares underlying unexercised Rights on the Expiration Date, if any,
equal to the number of shares of Common Stock purchased through Rights exercised
during the Rights Offering Period (the "Over-Subscription Privilege"), subject
to allocation as described herein. See "The Rights Offering."
The issuance of Common Stock following the Rights Offering and the transfer
of assets from UDC to Cygnet are contingent upon, among other things, the
approval of the Split-up by the stockholders of UDC and the purchase of at least
75% of the Offered Shares (the "Required Purchase Amount"). Ernest C. Garcia,
II, Cygnet's Chairman of the Board, Chief Executive Officer, and President, and
the holder of approximately 25.2% of the outstanding shares of UDC Common Stock,
has agreed to purchase his full pro rata share of the Offered Shares. In
addition, as Standby Purchaser (as described herein), Mr. Garcia has agreed,
subject to certain conditions, to purchase, through the exercise of his
Over-Subscription Privilege and his Standby Purchase Obligation (as defined
herein), the number of shares of Common Stock required to meet the Required
Purchase Amount. If the Rights Offering is not consummated, all funds tendered
for shares of Common Stock will be returned promptly, without interest,
following the termination of the Rights Offering.
To provide additional capital, Mr. Garcia may, at his election, purchase up
to an additional 714,286 shares of Common Stock at the Subscription Price, for
an aggregate price of approximately $5 million, over and above the Required
Purchase Amount, and directors and officers of Cygnet (other than Mr. Garcia)
will have the opportunity to purchase up to 214,286 shares of Common Stock at
the Subscription Price, for an aggregate price of approximately $1.5 million,
over and above any shares of Common Stock that such directors and officers have
the right to acquire through the Rights Offering.
Prior to this Rights Offering, there has been no public market for the
Rights or the Common Stock. The Rights and the Common Stock have been approved
for listing on the Nasdaq National Market under the symbols "CGNTR" and "CGNT,"
respectively, subject to notice of issuance.
The Information Agent for the Rights Offering is Corporate Investor
Communications, Inc. ("CIC"). Questions concerning the Rights Offering may be
addressed to CIC at 1-888-673-4478.
SEE "RISK FACTORS" AT PAGE 13 OF THIS PROSPECTUS FOR A DISCUSSION OF
CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE
SECURITIES OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
PURCHASE PRICE COMMISSION PROCEEDS(1)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share...................... $7.00 none $7.00
- ---------------------------------------------------------------------------------------------------------------------------------
Total................... $39,750,004(2) none $39,750,004(2)
- ---------------------------------------------------------------------------------------------------------------------------------
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Before deducting expenses payable by Cygnet estimated at $1,275,000
relating to the Rights Offering.
(2) Assumes full exercise of all Rights, the Additional Purchase Right, and
the D&O Purchase Right, and the corresponding sale of all 5,678,572
shares of Common Stock offered hereby at the Subscription Price.
------------------------
THE DATE OF THIS PROSPECTUS IS AUGUST 4, 1998
<PAGE> 2
THERE MAY BE CERTAIN TAX CONSEQUENCES TO YOU IF THE RIGHTS OFFERING DESCRIBED
HEREIN IS EFFECTED. TO AVOID THE POSSIBILITY OF THE RECOGNITION OF ORDINARY
INCOME AND THE CREATION OF A POTENTIALLY DEFERRED OR NONDEDUCTIBLE CAPITAL LOSS,
IT WILL, IN MANY INSTANCES, BE IN THE INTERESTS OF RIGHTS OFFERING PARTICIPANTS
TO EITHER EXERCISE OR SELL THE RIGHTS, RATHER THAN TO ALLOW THE RIGHTS TO LAPSE.
PLEASE READ THE ENCLOSED MATERIALS CONCERNING THE RIGHTS OFFERING CAREFULLY.
<PAGE> 3
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information and combined financial statements, including the notes thereto,
appearing elsewhere in this Prospectus. Investors should carefully consider the
information set forth under the heading "Risk Factors." Unless the context
otherwise requires, the term "Company" as used herein means Cygnet Financial
Corporation and all of its subsidiaries, including the assets and operations of
those entities both before and after the separation of such assets and
operations from UDC.
THE COMPANY
General. Assuming successful completion of the Rights Offering and
consummation of the Split-up, the Company will engage in the business of
providing various financial services primarily to the sub-prime segment of the
automobile financing industry, which focuses on selling and financing the sale
of new and used cars to persons who have limited credit histories, low incomes,
or past credit problems ("Sub-Prime Borrowers"). The Company will (i) engage in
the bulk purchase and servicing of pools of finance receivables generated from
the sale of new and used automobiles by independent third party dealers ("Third
Party Dealers"), including pools of charged-off receivables, deficient loans, or
other receivables; (ii) service pools of various types of finance receivables;
(iii) operate a collateralized dealer financing program (the "Cygnet Dealer
Program"), pursuant to which it will provide qualified Third Party Dealers with
warehouse purchase facilities and revolving lines of credit primarily secured by
the dealers' finance receivable portfolios; and (iv) pursue other opportunities
in the financial services market.
On the effective date of the Split-up (the "Effective Date"), the Company
will acquire the bulk purchasing and certain servicing operations and related
assets from UDC and substantially all of UDC's servicing and other rights and
certain obligations pursuant to transactions with First Merchants Acceptance
Corporation ("FMAC") and Reliance Acceptance Group, Inc. ("Reliance"). The
Company intends to consider the bulk purchase and servicing of other portfolios
of finance receivables, including instances in which the holders of the
portfolios are experiencing financial difficulties. For a description of the
Company's bulk purchase and servicing operations and the Company's rights and
obligations with respect to the FMAC and Reliance transactions, see
"Business -- Bulk Purchasing and Servicing Operations." The Company also may
enter into other transactions and acquire other assets prior to the Effective
Date similar to those described above.
The Company also will acquire the operations and related assets associated
with the Cygnet Dealer Program, which provides qualified Third Party Dealers
with warehouse purchase facilities and revolving lines of credit primarily
secured by the dealers' finance receivable portfolios. Unlike other typical
financing programs available to dealers, the Cygnet Dealer Program permits
participating dealers to retain servicing rights with respect to their finance
receivable portfolios, which enables dealers to generate servicing income and
maintain relationships with their customers, which dealers believe is a key
factor in generating referrals for additional sales and improving the chances of
repeat business. For a description of the Cygnet Dealer Program, see
"Business -- Cygnet Dealer Program."
In late 1997, UDC, which operates a chain of "buy here-pay here" used car
dealerships in the United States, began a strategic evaluation of its
operations, ultimately determining to separate its dealership operations from
its non-dealership operations pursuant to the Split-up. Cygnet is a Delaware
corporation formed in June 1998 to acquire and operate the non-dealership
operations of UDC and will, upon successful completion of the Rights Offering
and consummation of the Split-up, be a separately-traded public company. The
Company's principal executive offices will be located at 2525 East Camelback
Road, Suite 1150, Phoenix, Arizona 85016 and its telephone number will be (602)
852-6600.
Recent Developments. The Company and UDC have recently concluded or
currently are in the process of evaluating a number of transactions (and may
identify and pursue other transactions in the ordinary course
3
<PAGE> 4
of business) that, if concluded prior to the Split-up, would be assigned to, or
concluded directly by, the Company ("Interim Transactions"). Interim
Transactions under consideration include (i) the acquisition of and/or a
management arrangement with an operating insurance agency, which offers
insurance-related products and services designed to reduce the risk of loss to
holders of portfolios of automobile and residential mortgage loans, for a price
estimated by the Company of approximately $4.0 million, (ii) the acquisition of
a pool of charged-off automobile financial receivables for a price estimated by
the Company of approximately $400,000, (iii) the purchase of a bank's interest
in a credit facility secured by a pool of receivables and by a residual interest
in a securitized pool of receivables for approximately $7.8 million, and (iv) a
loan from the Company of $2 million to a company in exchange for servicing
rights, warrants, and certain additional investment rights. Interim Transactions
recently concluded include (i) a servicing arrangement relating to a $50 million
portfolio of automobile finance receivables, and (ii) the assumption of special
servicing arrangements relating to six pools of automobile finance receivables,
and the purchase of five pools of charged off receivables for approximately
$600,000. For a more detailed description of transactions currently under
consideration or recently concluded by the Company, see "Business -- Recent
Developments." The Company does not believe any of the Interim Transactions
recently concluded or currently under consideration are material to its
financial condition or results of operations, individually or in the aggregate,
or that any of such transactions would constitute the acquisition of a business
for which separate financial statements would be required to be publicly
disclosed by the Company. In addition, none of the Interim Transactions
described above require approval by the shareholders of the Company or UDC, nor
are any of such transactions with an affiliate of the Company or UDC. Interim
Transactions under consideration are subject to a number of contingencies, which
may include the negotiation and preparation of definitive agreements, the
completion of due diligence, and the receipt of required consents from any third
parties. As a result, there can be no assurance that these transactions will be
consummated or that if consummated will be profitable.
In addition to the transactions described above, the Company may purchase
or enter into servicing agreements with respect to portfolios of loan
receivables, may purchase debt secured by portfolios of receivables, may
purchase servicing or other assets, and may enter into other similar
transactions prior to the Effective Date. To effect any Interim Transactions,
the Company may borrow money from a third party lender ("Third Party Loans") or
from UDC ("Interim Company Loans"). Third Party Loans made to the Company prior
to the Effective Date may be guaranteed by UDC. UDC will seek to have any such
guarantee released as of the Effective Date with the Company likely providing a
replacement guarantee. Interim Company Loans may become due and payable on the
Effective Date. With respect to any Interim Transactions effected or operations
conducted prior to the Effective Date, on the business day immediately preceding
the Effective Date, the Company will distribute to UDC all earnings accrued to
such date. In addition, the Company will pay to UDC the excess, if any, of the
aggregate appraised value of the assets and rights and related liabilities
acquired by the Company in Interim Transactions (the "Interim Assets") as of the
Effective Date over the aggregate book value of the Interim Assets (the "Interim
Consideration"). UDC and the Company may agree to other terms with respect to
how Interim Transactions will be structured or treated. The purpose for the
payment by the Company of the Interim Consideration is to place both parties in
substantially the same economic situation each would be in if the Interim
Transactions were effected by UDC rather than the Company prior to the Effective
Date and the resulting assets and liabilities were transferred to the Company on
the Effective Date.
THE RIGHTS OFFERING
General. The Rights Offering is being made as part of a plan pursuant to
which UDC and its existing subsidiaries will be separated into two publicly-held
companies (the "Split-up"). Pursuant to the Split-up, Cygnet, a newly-formed
Delaware corporation and wholly-owned subsidiary of UDC, and its subsidiaries,
will acquire UDC's bulk purchasing and certain servicing operations, its
third-party dealer financing operations (excluding the branch office network
operations that UDC closed in the first quarter of 1998), and substantially all
of UDC's assets and certain liabilities acquired pursuant to the FMAC and
Reliance transactions. In exchange for such assets, Cygnet will issue $40
million of its Preferred Stock (as defined below) and make a cash payment or
equivalent as described herein. The sum of the Preferred Stock and the
4
<PAGE> 5
cash or equivalent payment will be equal to the greater of the appraised value
or book value of the assets transferred (in each case net of assumed
liabilities) determined as of the Effective Date. The Company does not
anticipate that the appraised value of the assets transferred will be materially
different than their book value.
Description of Rights. In connection with the Split-up, Cygnet will issue
transferable rights ("Rights") to subscribe for shares of its Common Stock, par
value $.001 per share (the "Common Stock"), to UDC's stockholders of record as
of the Record Date pro rata in accordance with the ownership of UDC Common Stock
as of the Record Date. Each holder of record of UDC Common Stock on the Record
Date will receive one (1) Right for every four (4) shares of UDC Common Stock.
Each Right entitles the holder to purchase one (1) share of Common Stock (the
"Primary Subscription") at an exercise price of $7.00 (the "Subscription
Price"). The Rights are exercisable and transferable for a limited period (the
"Rights Offering Period") beginning on the date of such distribution (the
"Commencement Date") and ending at 5:00 p.m., Minnesota time, on the date that
is 20 days following the Commencement Date or such other later date to which the
Rights Offering is extended in the Company's sole discretion (the "Expiration
Date"). The Company may determine to extend the Rights Offering Period if the
Company believes a longer offering period is advisable in order to allow a more
diversified pool of holders to exercise the Rights or for any other reason. The
Company determined the Subscription Price based primarily upon two factors; (i)
the amount of cash the Company believes is necessary to satisfy its short-term
business plan and (ii) the number of shares of Common Stock that the Company
wanted to issue. The Company established a goal to issue between five and six
million shares of Common Stock, which resulted in the ratio of one Right for
every four shares of UDC Common Stock. In determining the amount of capital
required, the Company considered the potential for additional bulk purchasing
opportunities, the expected growth of the Cygnet Dealer Program, and the
development of corporate infrastructure to position the Company for acquisition
opportunities as well as the Company's ability to leverage the capital raised to
address these opportunities. The proceeds of the Rights Offering will be used
primarily to provide funds to the Company for capital expenditures and working
capital and to fund the cash portion of the consideration described herein.
Required Purchase Amount. The issuance of Common Stock following the
Rights Offering is contingent upon, among other things, approval of the Split-up
by the stockholders of UDC and the purchase of at least 75% of the Offered
Shares (the "Required Purchase Amount"). Mr. Garcia, Cygnet's Chairman of the
Board, Chief Executive Officer, and President, and the holder of approximately
25.2% of the outstanding shares of UDC Common Stock, has agreed to purchase his
full pro rata share of the Common Stock offered pursuant to the Rights Offering.
In addition, Mr. Garcia has agreed to purchase, subject to certain conditions,
through the exercise of his Over-Subscription Privilege (as described below),
and his Standby Purchase Obligation (as described below), the number of shares
of Common Stock required to meet the Required Purchase Amount.
Assets to be Transferred. If the Rights Offering is successfully
completed, on the Effective Date of the Split-up, UDC and its subsidiaries will
transfer to the Company certain assets and liabilities. In general, the Company
will acquire substantially all of UDC's assets and related liabilities required
to operate UDC's non-dealership operations, other than those assets and
liabilities related to UDC's branch office network, which UDC closed in the
first quarter of 1998. The transfer will include (i) UDC's bulk purchase and
certain servicing operations with respect to finance receivables originated by
Third Party Dealers, (ii) the assets and related liabilities of Cygnet Dealer
Finance, Inc., currently a wholly-owned subsidiary of UDC, through which the
Company will provide qualified Third Party Dealers with warehouse purchase
facilities and revolving lines of credit primarily secured by the dealers'
finance receivable portfolios under the Cygnet Dealer Program; (iii)
substantially all of UDC's rights and certain obligations pursuant to certain
transactions with FMAC, including the servicing platform and certain other
rights and residual interests, and the assumption by the Company of certain
funding obligations and guarantees of UDC in connection with the FMAC
transaction, but excluding certain rights and liabilities retained by UDC as
described under "Business -- Bulk Purchasing and Servicing
Operations -- Transactions Regarding First Merchants Acceptance Corporation;"
and (iv) substantially all of UDC's rights and certain obligations pursuant to
certain transactions with Reliance, including the servicing platform and certain
servicing and transition servicing arrangements, as described
5
<PAGE> 6
under "Business -- Bulk Purchasing and Servicing Operations -- Transactions
Regarding Reliance Acceptance Group." The Transferred Assets will not include
cash received by UDC prior to the Effective Date. UDC also may enter into other
transactions and acquire other assets prior to the Effective Date similar to
those described above and may transfer to the Company the assets and related
liabilities so acquired. All transferred assets and related liabilities are
collectively referred to herein as the "Split-up Businesses" or the "Transferred
Assets." As of June 30, 1998, the Transferred Assets had a net book value of
approximately $54.7 million and a net appraised value of approximately $54.9
million. The Company will record the Transferred Assets at their historical
basis, as if they had been acquired in a transaction accounted for as a "pooling
of interests." The Company anticipates that the net book value of the
Transferred Assets will increase prior to the transfer contemplated herein as
additional finance receivables are acquired under warehouse purchase facilities
or additional advances are made under revolving lines of credit through the
Cygnet Dealer Program.
Consideration for Transferred Assets. As consideration for the Transferred
Assets, Cygnet will issue to UDC 40,000 shares of Cumulative Convertible
Preferred Stock, Series A, $.001 par value per share (the "Preferred Stock"),
with an aggregate liquidation preference of $40 million, and make a cash or
equivalent payment equal to the difference between the greater of the appraised
value or book value of the Transferred Assets (in each case net of assumed
liabilities) determined as of the Effective Date and the $40 million of
Preferred Stock (the "Cash Payment"), which the Company currently estimates will
range from $10 million to $20 million. The Company also may be required to repay
to UDC any Interim Company Loans, would pay to UDC any Interim Consideration,
and would distribute to UDC any earnings accrued prior to the Effective Date.
UDC also may require the release of any guarantee of Third Party Loans to the
Company. Alternatively, UDC and the Company may agree as to other treatment of
the Interim Transactions.
Holders of the Preferred Stock, in preference to the Common Stock, will be
entitled to receive cumulative cash dividends, from the Effective Date through
the first anniversary of such date, at the initial annual rate of 7% of the Base
Liquidation Amount (as defined below), and escalating 1% per annum on each
anniversary thereafter to a maximum rate of 11% per annum on the aggregate Base
Liquidation Amount, in each case payable quarterly in arrears on the first day
of March, June, September, and December of each year, beginning December 1,
1998, when and as declared by the Board of Directors of Cygnet out of funds
legally available for such payment. Holders of the Preferred Stock, in
preference to the holders of Common Stock, will be entitled to receive, in the
event of dissolution or liquidation of Cygnet, $1,000 per share (the "Base
Liquidation Amount") plus accrued and unpaid dividends thereon (the "Liquidation
Preference Amount").
The Preferred Stock will be redeemable at Cygnet's option at any time in
whole or in part at a redemption price equal to the Liquidation Preference
Amount as of the redemption date; provided, however, that no such redemption
will be authorized unless, in the reasonable judgment of the Company and UDC,
the redemption proceeds would be treated for federal income tax purposes as
proceeds from a sale of such stock and not as dividends paid with respect to
such stock. As a consequence, redemption of the Preferred Stock may be limited
and may be confined to a single redemption of all outstanding Preferred Stock.
The Company will be authorized to redeem shares of Common Stock held by holders
of the Preferred Stock to the extent necessary to assure that the proceeds from
a redemption of Preferred Stock will be treated as proceeds from a sale of such
stock and not as dividends paid with respect to such stock. The Preferred Stock
will be convertible at the option of UDC in whole or in part at any time after
the third anniversary following the date of issuance or prior thereto if an
amount equal to six quarterly dividend payments on the Preferred Stock has
accrued and is unpaid until payment in full thereof as described herein. In such
case, the Preferred Stock may be converted into that number of shares of Common
Stock determined by dividing the Liquidation Preference Amount of the shares of
Preferred Stock to be converted by the lower of (a) the Subscription Price or
(b) 80% of the average Market Price (as defined below) of the Common Stock for
the ten consecutive trading days ending two business days prior to the date
notice of conversion is given. For purposes of the conversion of the Preferred
Stock, "Market Price" means (i) if the Common Stock is quoted on the Nasdaq
National Market or the Nasdaq SmallCap Market or on a national securities
exchange, the daily per share closing price of the Common Stock as quoted on the
Nasdaq National Market or the Nasdaq SmallCap Market or on the principal stock
exchange on which it is listed on the trading day in question, as the case may
be, whichever is the higher, or (ii) if the Common Stock is traded in the
over-the-counter market and not quoted on the
6
<PAGE> 7
Nasdaq National Market or the Nasdaq SmallCap Market or on any national
securities exchange, the closing bid price of the Common Stock on the trading
day in question, as reported by Nasdaq or an equivalent generally accepted
reporting service.
The Preferred Stock and the Common Stock into which it is convertible are
not registered under the Securities Act of 1933, as amended (the "Securities
Act"), and may not be sold by UDC unless such securities are registered or
unless an exemption from registration is available. Upon request by UDC, Cygnet
will register the resale of the Common Stock issued upon conversion of the
Preferred Stock under the Securities Act at the expense of Cygnet. The Preferred
Stock will not have any pre-emptive or other subscription rights.
Over-Subscription Privilege. Any Rights Offering Participant who exercises
all of his Rights may subscribe at the Subscription Price for additional shares
of Common Stock out of the pool of shares underlying unexercised Rights on the
Expiration Date, if any (the "Unexercised Pool"), equal to the number of shares
of Common Stock such Rights Offering Participant purchased during the Rights
Offering Period (the "Over-Subscription Privilege"), subject to allocation as
described herein. Mr. Garcia, as the Standby Purchaser, may exercise his
Over-Subscription Privilege in partial satisfaction of his obligations under the
Standby Purchase Agreement as described below.
Subscription Price. The exercise price of the Rights ("Subscription
Price") is $7.00 per share. Upon exercise of a Right and the payment of the
Subscription Price, the holder thereof will be entitled to receive one share of
Common Stock following the Split-up. The Subscription Price will not necessarily
bear any relationship to the trading price of the Common Stock after completion
of the Rights Offering.
Fractional Shares. Only Rights to purchase whole shares of Common Stock
will be issued in the Rights Offering. If the number of shares of UDC Common
Stock held by a Rights Offering Participant on the Record Date is not divisible
by four, the number of Rights to be issued to such stockholder will be rounded
upward to the nearest whole Right. For further information, see "The Rights
Offering -- No Fractional Shares."
Directors and Executive Officers. If the Split-up is successfully
concluded, Mr. Garcia will remain Chairman of the Board, Chief Executive
Officer, and President of Cygnet. Mr. Garcia currently is Chairman of the Board
and Chief Executive Officer of UDC and will remain as Chairman of the Board of
UDC following the Split-up. In addition, certain existing UDC directors,
officers, and employees have or will become directors and officers of the
Company. See "Management."
Standby Purchaser Obligation. The Standby Purchaser is Ernest C. Garcia,
II, Cygnet's Chairman of the Board, Chief Executive Officer, and President, and
the holder of approximately 25.2% of the outstanding shares of UDC Common Stock.
In accordance with the Rights Exercise and Standby Purchase Agreement between
the Company and Mr. Garcia (the "Standby Purchase Agreement"), subject to
certain conditions, Mr. Garcia, as the Standby Purchaser, will purchase
additional shares of Common Stock at the Subscription Price up to the Required
Purchase Amount (the "Standby Purchase Obligation"). In consideration for the
obligations incurred by Mr. Garcia under the Standby Purchase Agreement, on the
Effective Date, Cygnet will grant to Mr. Garcia warrants (the "Standby
Warrants") entitling Mr. Garcia to purchase up to 500,000 additional shares of
Common Stock at an exercise price equal to 120% of the Subscription Price, or
$8.40 per share (the "Warrant Exercise Price") at any time within five years
following the Effective Date. Neither the Standby Warrants nor the underlying
Common Stock into which they are exercisable are registered under the Securities
Act and such securities may not be sold by Mr. Garcia unless such securities are
registered or unless an exemption from registration is available. The Company
has agreed to register at its expense the resale of the Common Stock issued upon
exercise of the Standby Warrants at the request of Mr. Garcia at any time after
one year following the Effective Date. Mr. Garcia's rights and obligations in
connection with the Rights Offering may be exercised through his affiliates.
Additional Purchase Right. In addition to his Rights, the
Over-Subscription Privilege, and his Standby Purchase Obligation, Mr. Garcia
also will have the right (the "Additional Purchase Right"), at his election, to
purchase up to an additional 714,286 shares of Common Stock at the Subscription
Price, or an aggregate of approximately $5 million, over and above the Required
Purchase Amount. Such Additional Purchase Right will be contingent on a
successful Rights Offering and must be exercised on or prior to the Effective
Date.
7
<PAGE> 8
D&O Purchase Right. In addition, directors and officers of the Company
(excluding Mr. Garcia) will have the right (the "D&O Purchase Right"), at their
election, to purchase in the aggregate up to 214,286 additional shares of Common
Stock at the Subscription Price over and above the number of shares of Common
Stock they could acquire pursuant to any Rights they may have. Such D&O Purchase
Right will be contingent on a successful Rights Offering and must be exercised
on or prior to the Effective Date.
Additional Capital. The Company has secured a subordinated loan of $5
million from a third-party lender for a three year term. The loan bears interest
at 12% per annum and is payable quarterly with the principal to be paid in full
on the third anniversary of the Effective Date. In consideration for providing
such financing, Cygnet will issue warrants to purchase up to 115,000 shares of
Common Stock with an exercise price of $8.40 per share, subject to a call
feature by the Company if the closing price of the Common Stock equals or
exceeds $13.44 per share for a period of 20 consecutive trading days. The loan
is guaranteed by UDC. On the Effective Date, UDC's guarantee will be released
and replaced with a guarantee of the Company.
Trading Market. The Rights and the Common Stock have been approved for
listing on the Nasdaq National Market under the symbols "CGNTR" and "CGNT,"
respectively, subject to notice of issuance. There is no assurance, however,
that a trading market in the Rights or the Common Stock will develop or, if
developed, can be maintained. Upon the Expiration Date, subject to certain
guaranteed delivery procedures, any unexercised Rights will lapse, and become
null and void.
Tax Consequences to Rights Offering Participants. In the opinion of Snell
& Wilmer L.L.P., Rights Offering Participants who receive Rights in the original
distribution will generally recognize dividend income (taxable as ordinary
income) in an amount equal to the fair market value, if any, of the Rights as of
the date of their distribution. In the opinion of Willamette Management
Associates, an independent appraisal firm engaged by UDC in connection with the
Rights Offering and the Split-up (the "Appraiser") dated July 21, 1998, the fair
market value of the Rights as of the date of their distribution should be zero.
However, the Appraiser's opinion is not binding on the Internal Revenue Service.
For example, the Internal Revenue Service may assert that the price at which the
Rights trade during the 20-day trading period of the Rights is indicative of the
fair market value of the Rights on the date of their distribution. Accordingly,
there can be no assurance as to the precise amount of dividend income, if any, a
Rights Offering Participant will recognize upon the receipt of the Rights. If
the Rights are trading for value on the date of their distribution, UDC may, in
its discretion, report to Rights Offering Participants who receive Rights in the
original distribution the receipt of dividend income in an amount equal to the
average of the high and low trading prices of the Rights on such date.
To avoid the possibility of the recognition of ordinary income and the
creation of a potentially deferred or nondeductible capital loss, it will, in
many instances, be in the interests of Rights Offering Participants who receive
Rights in the original distribution to either exercise or sell the Rights,
rather than to allow the Rights to lapse. See "Federal Income Tax Consequences."
Exercise. The Rights are exercisable from the Commencement Date until 5:00
p.m., Minnesota time, on the Expiration Date.
Information Agent. The Information Agent for the Rights Offering is
Corporate Investor Communications, Inc. ("CIC"). Questions concerning the Rights
Offering may be addressed to CIC at 1-888-673-4478.
USE OF PROCEEDS FROM THE RIGHTS OFFERING
The Company intends to use a portion of the proceeds of the Rights Offering
to make the Cash Payment to UDC as part of the consideration for the Transferred
Assets. The remaining proceeds of the Rights Offering will be used by the
Company for capital expenditures and as working capital.
EFFECT OF RIGHTS OFFERING
Cygnet currently is a wholly-owned subsidiary of UDC. Following the
transactions described in this Prospectus, Cygnet and UDC will be owned,
operated, and managed as separate public companies. Assuming
8
<PAGE> 9
all holders of the Rights elect to purchase shares of Common Stock pursuant to
the Rights Offering, and the Cygnet directors and officers exercise their D&O
Purchase Right in full, Mr. Garcia will own approximately 23.6% of the
outstanding shares of Common Stock (or 33.2% if he fully exercises the
Additional Purchase Right) and UDC will own 100% of the outstanding Preferred
Stock of Cygnet. If the Preferred Stock were converted to Common Stock at the
Subscription Price of $7.00 per share, UDC would obtain 5,714,286 shares, or
approximately 61.6% of the then outstanding shares of Common Stock, assuming the
sale by Cygnet pursuant to the Rights Offering of 3,562,500 shares of Common
Stock (the Required Purchase Amount) and that no additional shares of Common
Stock are issued either on the Effective Date of the Split-up or thereafter. If
the Preferred Stock were converted to Common Stock at the Subscription Price,
and assuming the sale by Cygnet of 4,750,000 shares of Common Stock pursuant to
the Rights Offering and the sale of 714,286 additional shares to Ernest C.
Garcia, II pursuant to the Additional Purchase Right and 214,286 shares
available for purchase by officers and directors of Cygnet (other than Mr.
Garcia) pursuant to the D&O Purchase Right, and that no additional shares of
Common Stock are then outstanding, UDC would obtain approximately 50.2% of the
then outstanding shares of Cygnet.
INTERESTED TRANSACTIONS
As described above, officers and directors of the Company have certain
significant interests in the Split-up, including (i) Mr. Garcia's rights and
obligations as Standby Purchaser, which may enable Mr. Garcia to purchase
significant amounts of Common Stock at the Subscription Price to the extent such
stock is not purchased upon exercise of the Rights or pursuant to the
Over-Subscription Privilege by holders of the Rights, (ii) Mr. Garcia's right to
purchase up to 714,286 additional shares of Common Stock at the Subscription
Price, (iii) the right of officers and directors of UDC who will be officers and
directors of the Company on the Effective Date to purchase up to 214,286
additional shares of Common Stock at the Subscription Price, (iv) the issuance
of the Standby Warrants to Mr. Garcia to purchase 500,000 shares of Common Stock
at $8.40 per share for a period of 5 years following the Effective Date in
consideration for his obligations as Standby Purchaser, and (v) the use of a
portion of the Cash Payment by UDC to repay certain indebtedness to a
corporation wholly-owned by Mr. Garcia. The Company will also assume the
employment agreements of and will replace UDC options with Company options for
certain executive officers of UDC who will become executive officers of the
Company. In addition, Messrs. Johnson, Splaver and Ciccolini, each of whom is an
executive officer of the Company, will receive a total of 36,429 shares of
Common Stock pursuant to restricted stock grants (with an estimated aggregate
value of $255,000 on the Effective Date) and new options to purchase a total of
50,000 shares of Common Stock at the Subscription Price.
RISK FACTORS AND FORWARD LOOKING STATEMENTS
Prospective purchasers of Common Stock pursuant to the Rights Offering
should carefully consider all of the information contained in this Prospectus,
particularly each of the factors set forth under "Risk Factors" beginning on
page 13. Factors that may affect the Company's business, results of operations
and financial condition, and the price and market for its securities, include,
among others, the following:
- The Company's ability to maintain profitability is related to its ability
to successfully complete bulk purchases of finance receivable contracts
or enter into servicing arrangements with respect to such contracts. For
example, the Company believes that in the near future, a significant
portion of its revenues will be attributable to the FMAC transaction (as
described herein), unless other significant bulk purchase or servicing
transactions are consummated. There can be no assurance that the Company
will be able to successfully negotiate additional bulk purchase or
servicing arrangements, or, if it were able to do so, that such
transactions would be profitable. In addition, the Company's results of
operations may fluctuate dramatically based upon transactions entered
into in any given period.
- The operations of the Company are significantly dependent on its
personnel, in particular Mr. Garcia. Without Mr. Garcia's expertise in
attracting and obtaining bulk purchase and servicing opportunities, the
Company's operations could be materially adversely affected.
9
<PAGE> 10
- The profitable realization of bulk purchase and servicing opportunities
requires management of significant transition activities, accomplished
within a very short time period. These transition activities include,
among others, converting the servicing platform and related computer
systems utilized by the existing holder/servicer to the loan servicing
platform and related computer systems utilized by the Company, rapidly
changing servicing capacity, arranging for transition of employees, and
arranging for facilities to facilitate servicing. There is no assurance
that the Company can successfully manage the transition of subsequent
transactions.
- The Company operates primarily in the sub-prime finance market, which is
characterized by borrowers that are generally unable to obtain financing
from traditional sources of credit and the companies that provide
financing to such borrowers. Accordingly, the Company's operations will
be subject to a high risk of credit losses due to dealer defaults or
fraudulent activities, specifically related to the collection, depositing
and reporting of customer payments, which could have a material adverse
effect on the Company and the Company's ability to meet its own financing
obligations.
- The Company is dependent upon its information systems to properly account
for and monitor its finance receivable portfolio, its loan servicing
operations, and the Cygnet Dealer Program loan portfolio. The Company is
in the process of converting its existing servicing platforms to systems
licensed from Affiliated Computer Services, Inc. ("ACS"). There can be no
assurance that the conversions will be completed in a timely manner or
that such conversions will be successful. The Company's failure to
successfully migrate and convert its existing systems to ACS systems on a
timely basis could have a material adverse effect on the Company. In
addition, only a portion of the ACS systems are fully year 2000 ("Year
2000") compliant in processing transactions of the Company without major
system failure or miscalculations. The Company bears risks related to the
Year 2000 issue and could be materially adversely affected if other
entities (e.g., vendors or customers) not affiliated with the Company do
not appropriately address their own Year 2000 compliance issues. Further,
certain of the Company's own applications are not Year 2000 compliant at
this time. The Company believes that resolution of all Year 2000 issues
will be significant to the Company's business, and there can be no
assurance that the Company will be able to completely resolve all Year
2000 issues in a timely fashion or that the ultimate impact of the Year
2000 issues will not be material to the Company. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Year 2000."
- Mr. Garcia, the Company's Chairman of the Board, Chief Executive Officer
and President, and who could acquire a controlling interest in the
Company in certain circumstances, has been the subject of certain legal
proceedings involving his participation in a real estate transaction
involving Lincoln Savings and Loan Association, a federally insured
savings and loan institution that later went into receivership
("Lincoln"). In connection with these proceedings, Mr. Garcia agreed to
plead guilty to one count of bank fraud, for which he was sentenced to
three years probation (which has expired), was fined $50, and, during the
period of his probation, which ended in 1996, was banned from becoming an
officer, director or employee of any federally insured financial
institution or a securities firm without government approval. In separate
actions arising out of this matter, Mr. Garcia filed for bankruptcy both
personally and with respect to certain affiliated entities, each of which
had been discharged by 1993. Following the takeover of Lincoln by the RTC
in 1989, Mr. Raymond C. Fidel, the President of Cygnet Dealer Finance,
Inc. and formerly President of Lincoln, was charged with fraud arising
out of the sale of bonds at Lincoln of its parent company, American
Continental Corporation. Without admitting or denying any of the
allegations against him, Mr. Fidel consented to the entry of a permanent
injunction against further violations of the securities laws. In 1991,
Mr. Fidel pled guilty to two counts of federal securities fraud and to
six counts in California State court arising out of this matter, for
which Mr. Fidel was sentenced to three years probation, which has
expired. See "Risk Factors -- Risks Relating to the Business -- Prior
Legal Actions Involving Certain Executive Officers."
- There currently exists no public market for the Rights or shares of
Common Stock being offered pursuant to this Prospectus. While the Rights
and the Common Stock have been approved for listing
10
<PAGE> 11
on the Nasdaq National Market, subject to notice of issuance, there is no
assurance that a trading market in the Rights or the shares of Common
Stock will develop, or, if developed, can be sustained. Even if a trading
market does develop, there can be no assurance that the market price or
shares of Common Stock will remain at or above the Subscription Price.
This Prospectus 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
statements may include, but not be limited to, projections of revenues, income,
loss, capital expenditures, plans for future operations, financing needs or
plans, and plans relating to products or services of the Company, as well as
assumptions relating to the foregoing. The words "believe," "expect,"
"anticipate," "estimate," "project," and similar expressions identify forward
looking statements. Forward looking statements are inherently subject to risks
and uncertainties, some of which cannot be predicted or quantified. Future
events and actual results could differ materially from those set forth in,
contemplated by, or underlying the forward looking statements. Statements in
this Prospectus, including those contained in the section entitled "Risk
Factors," in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and in the Notes to the
Company's Combined Financial Statements, describe factors, among others, that
could contribute to or cause such differences. The Company undertakes no
obligation to update any forward looking statements.
GLOSSARY
Certain terms used in this Prospectus regarding the Company's business are
defined below.
Bulk purchase -- The purchase of an existing pool of individual installment
contract receivables.
Buy-here, pay-here dealer -- A used car dealer that retains ownership of
the installment contract receivables generated from the sale of vehicles to
Sub-Prime Borrowers and continues to collect the loan payments and perform all
related loan servicing functions.
Charge-offs -- Loans that are written off due to delinquency, inability to
locate a delinquent borrower and/or the vehicle, bankruptcy, or casualty damage
to the vehicle which is not covered by insurance.
Kelley Blue Book wholesale value -- A monthly sampling average of wholesale
prices for various vehicles based upon mileage, age, condition, and options.
Loan servicing -- All functions related to collecting and reporting on
installment contract receivables, including payment processing, contacting
borrowers regarding delinquent payments, engaging third parties to foreclose
upon the collateral and monitoring the status of insurance policies insuring the
collateral.
Payoffs -- Loans that have been paid in full including principal and earned
interest.
Repo -- A vehicle that has been repossessed from the borrower due to
default.
Repurchases -- Under the Cygnet Dealer Program, dealers are required to
repurchase installment contracts from the Company that are 45 days delinquent or
are in default for other reasons.
Sub-Prime Borrower -- A borrower who has little or no credit history or a
credit history characterized by consistent late payments and sporadic
employment. In addition to having an unfavorable employment history, the
borrower also may have experienced debt charge-offs, foreclosures, or personal
bankruptcy.
Warehouse purchase facilities -- Contractual relationship between a dealer
and a finance company whereby the finance company agrees to purchase installment
contract receivables that meet certain guidelines and requirements.
11
<PAGE> 12
SUMMARY COMBINED FINANCIAL INFORMATION
The summary combined financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the combined financial statements of the Company
and the notes thereto included in this Prospectus.
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31, 1997
----------------- -----------------
1998 1997
------- ------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues......................................... $12,550 $ 137 $15,959
Interest Income..................................... 6,382 137 7,472
Servicing Fees...................................... 4,937 -- --
Net Gain on Sale of Repossessed Collateral.......... 1,108 -- --
Gain on Sale of Notes Receivable.................... -- -- 8,132
Other Income........................................ 123 -- 355
Operating Expenses:
Provision for Credit Losses......................... 965 -- 691
Selling and Marketing Expense....................... 36 9 18
General and Administrative.......................... 9,001 1,008 3,766
Depreciation and Amortization....................... 230 62 153
------- ------ -------
Total Operating Expenses............................... 10,232 1,079 4,628
------- ------ -------
Earnings (Loss) Before Interest Expense................ 2,318 (942) 11,331
Interest Expense....................................... 1,714 37 2,067
------- ------ -------
Earnings (Loss) before Income Taxes.................... 604 (979) 9,264
Income Taxes (Benefit)................................. 244 (394) 3,728
------- ------ -------
Net Earnings (Loss).................................... $ 360 $ (585) $ 5,536
======= ====== =======
Basic Earnings (Loss) per Share........................ $ 360 $ (585) $ 5,536
======= ====== =======
Shares used in Computation............................. 1 1 1
======= ====== =======
Proforma Basic/Diluted Earnings (Loss) per Share(2).... $ (0.18) $(0.35) $ 0.48
======= ====== =======
Proforma Shares used in Computation(2)................. 5,679 5,679 5,683
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998 YEAR ENDED
--------------------------------------- DECEMBER 31, 1997
PRO FORMA -----------------
ACTUAL PRO FORMA(1) AS ADJUSTED(1) ACTUAL
------- ------------ -------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents................ $ 232 $16,167 $22,667 $ 1,225
Finance Receivables, Net................. 26,333 26,333 26,333 19,274
Notes Receivable, Net.................... 23,027 23,027 23,027 21,861
Total Assets............................. 58,580 74,515 81,015 50,034
Advances from Affiliate.................. 15,818 -- -- 9,106
Total Note Payable....................... 298 298 298 380
Total Stockholders' Equity............... 40,000 71,753 78,253 40,000
</TABLE>
- ---------------
(1) The table above sets forth (i) the combined capitalization of the Company as
of June 30, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,750,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company, a purchase price for the
Transferred Assets equivalent to UDC's June 30, 1998 net book value, and
payment in full of the Advances from Affiliate, which totaled $15,818,000 at
June 30, 1998; and (iii) the pro forma as adjusted capitalization of the
Company to give effect to the sale of 4,750,000 shares of Common Stock
offered hereby and the sale of 714,286 shares of Common Stock pursuant to
the Additional Purchase Right and 214,286 shares of Common Stock pursuant to
the D&O Purchase Right, assuming these rights are exercised in full, in each
case at the Subscription Price of $7.00 per share, after deducting estimated
offering expenses allocable to and payable by the Company, a purchase price
for the Transferred Assets equivalent to UDC's June 30, 1998 net book value,
and payment in full of the Advances from Affiliate, which totaled
$15,818,000 at June 30, 1998. The Advances from Affiliate represents the
$14.9 million Cash Payment plus other working capital advances from UDC.
(2) For purposes of computing the proforma earnings per share for the periods
presented, the Company has assumed the maximum potential issuance of shares
of Common Stock totaling 5,678,572 shares pursuant to the planned Rights
Offering, the Additional Purchase Right, the D&O Purchase Right and for
dilutive stock options that will be granted on the Effective Date. See note
14 to the Company's audited financial statements included herein.
12
<PAGE> 13
RISK FACTORS
An investment in the Rights and the shares of Common Stock offered hereby
involves certain risks. In addition to the other information included elsewhere
in this Prospectus, prospective investors should give careful consideration to
the following factors before purchasing Rights or the shares of Common Stock
offered hereby upon exercise of the Rights.
RISKS RELATING TO THE BUSINESS
NO ASSURANCE OF PROFITABILITY
The Company's net earnings for the year ended December 31, 1997 were $5.5
million. For the six months ended June 30, 1998, the Company's net earnings were
$360,000. The Company has experienced, and in the future is expected to continue
to experience, substantial variations in its results of operations as a result
of a number of factors, many of which are outside the Company's control.
Substantially all of the net earnings of the Company for the year ended
December 31, 1997 were attributable to the FMAC transaction. For a description
of the FMAC transaction and the profits generated therefrom, see
"Business -- Bulk Purchasing and Servicing Operations -- Transactions Regarding
First Merchants Acceptance Corporation." The profitability and cash flows of the
Company in the future, at least in the near term, will be highly dependent on
its ability to successfully conclude additional large bulk purchase and
servicing transactions similar to the FMAC and Reliance transactions. For a
description of the Reliance transaction, see "Business -- Bulk Purchasing and
Servicing Operations -- Transactions Regarding Reliance Acceptance Group." UDC's
ability to effect both the FMAC and Reliance transactions on favorable terms was
enhanced by recent industry conditions and by the fact that these companies were
in bankruptcy proceedings. See "Risk Factors -- Risks Relating to the
Business -- Industry Considerations and Legal Contingencies." In recent months,
UDC has experienced increased competition from other companies in its
consideration of transactions similar to FMAC and Reliance. There can be no
assurance that the Company will be able to effect similar transactions in the
future on terms as favorable to the Company as the FMAC and Reliance
transactions. Any inability of the Company to locate and conclude other
profitable bulk purchase or servicing opportunities in the future could have a
material adverse impact on the Company. See "Risk Factors -- Risks Relating to
the Business -- Avoidance of Excess Servicing Capacity."
In addition, the Company believes that a significant portion of its net
earnings in future periods may be attributable to the FMAC and Reliance
transactions. However, the ability of the Company to generate earnings from
these two transactions is subject to significant contingencies. See "Risk
Factors -- Risks Relating to the Business -- Risks Related to the FMAC
Transaction" and "Risk Factors -- Risks Relating to the Business -- Risks
Related to the Reliance Transaction."
The Company's ability to sustain profitability also will depend upon its
ability to meet its general objectives including: (i) expanding its revenue
generating operations while not proportionately increasing its administrative
overhead; (ii) purchasing portfolios of finance receivables with an acceptable
level of credit risk; (iii) effectively collecting payments due on the finance
receivables in its portfolios and in third party portfolios; (iv) locating
sufficient financing, with acceptable terms, to fund the expansion of the Cygnet
Dealer Program and the bulk purchase of additional finance receivables; and (v)
adapting to the increasingly competitive markets in which it operates. Outside
factors, such as the economic, regulatory, and judicial environments in which
the Company operates, also will have an effect on the Company's business.
Any of these factors could result in the periodic inefficient or
underutilization of the Company's resources and could cause the Company's
operating results to fluctuate significantly from period to period, including on
a quarterly basis. There can be no assurance that the Cygnet Dealer Program or
the FMAC or Reliance transactions or similar transactions effected in the future
will be profitable, or if they are, that such profitability can be sustained.
The Company's inability to achieve or maintain any or all of its objectives
could have a material adverse effect on the Company's business, financial
condition, or results of operations.
13
<PAGE> 14
DEPENDENCE ON UNIQUE TRANSACTIONS; QUARTERLY FLUCTUATIONS
As noted above, the Company's profitability will depend significantly on
its ability to effect large bulk purchase and servicing transactions, including,
among others, transactions similar to the FMAC and Reliance transactions.
Because each potential opportunity typically presents a unique set of risks and
circumstances, each transaction must be separately structured, evaluated, and
negotiated. This process typically consumes substantial amounts of executive
management time and attention with no assurance of a successful conclusion.
Accordingly, there can be no assurance that future opportunities of this type
can be identified and concluded on terms favorable to the Company. The failure
to identify and conclude such transactions on a continual basis could have a
material adverse effect on the Company. See "Risk Factors -- Risks Relating to
the Business -- No Assurance of Profitability" "-- Dependence on Key Personnel"
and "-- Avoidance of Excess Servicing Capacity." In addition, the timing of
effectuation of future transactions may result in wide variation in financial
results on a quarterly basis. Moreover, the Company may evaluate opportunities
for favorable transactions in industries other than the sub-prime automobile
financing market. To the extent the Company purchases portfolios of loan
receivables in other industries, such transactions are likely to present a
different set of risks and challenges for which the Company may be less prepared
as a result of its relative lack of experience in that industry.
The Company currently is considering a number of potential transactions in
the ordinary course of its business, none of which the Company believes is
material to its financial condition or results of operations, individually or in
the aggregate. For a description of these potential transactions, see
"Business -- Recent Developments." The consummation of these transactions is
subject to a number of contingencies, which may include the negotiation and
preparation of definitive agreements, completion of due diligence, and the
receipt of required consents from third parties. As a result, there can be no
assurance that any of these potential transactions will be completed by the
Company. If the Company is unable to conclude these transactions, the Company
will be required to pursue other opportunities to acquire servicing rights,
receivables portfolios and other assets as described above.
DEPENDENCE UPON KEY PERSONNEL
The Company's success will depend upon the continued services of the
Company's senior management, particularly its Chief Executive Officer, Mr.
Ernest C. Garcia, II, as well as the Company's ability to attract additional
members to its management team with experience in the bulk purchasing and
servicing industry and the used car dealer 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 does not currently plan to maintain
any key person life insurance on any of its executive officers.
The continued services of Mr. Garcia are critical to the future success of
the Company. In particular, in the bulk purchasing and servicing line of
business, the Company's success depends significantly on Mr. Garcia's ability to
(i) purchase portfolios of finance receivables at discounts sufficient to
generate profits and (ii) secure servicing of finance receivable portfolios with
sufficient volume and fees to generate profits. In particular, it is expected
that the Company will rely heavily on Mr. Garcia's expertise in identifying
opportunities to purchase or service large portfolios of finance receivables.
Losing the services of Mr. Garcia could adversely impact the Company's ability
to attract profitable bulk purchasing and servicing opportunities and in turn
could have a material adverse effect on the Company.
PRIOR LEGAL ACTIONS INVOLVING CERTAIN EXECUTIVE OFFICERS
Prior to 1992, when he founded UDC, Mr. Garcia was involved in various real
estate, securities, and banking ventures. Arising out of two transactions in
1987 between Lincoln Savings & Loan Association ("Lincoln") and entities
controlled by Mr. Garcia, the Resolution Trust Corporation (the "RTC"), which
ultimately took over Lincoln, asserted that Lincoln improperly accounted for the
transactions and that Mr. Garcia's participation in the transactions facilitated
the improper accounting. Facing severe financial pressures, Mr. Garcia agreed to
plead guilty to one count of bank fraud, but, in light of his cooperation with
authorities both before and after he was charged, was sentenced to only three
years probation (which has
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expired), was fined $50 (the minimum fine the court could assess), and, during
the period of his probation, which ended in 1996, was banned from becoming an
officer, director or employee of any federally-insured financial institution or
a securities firm without governmental approval. Because Cygnet is not a
federally-insured financial institution and Mr. Garcia's probationary period has
expired, the ban does not apply to Mr. Garcia's activities on behalf of Cygnet.
In separate actions arising out of this matter, Mr. Garcia agreed not to violate
the securities laws, and filed for bankruptcy both personally and with respect
to certain entities he has controlled. The bankruptcies were discharged by 1993.
In certain circumstances, Mr. Garcia could acquire a controlling interest in the
Company. See "-- Risks Relating to the Rights Offering -- Ownership of Common
Stock by Mr. Garcia." As a result of his position as Chairman of the Board,
Chief Executive Officer, and President of Cygnet and by virtue of his ability to
acquire a significant percentage of the Common Stock after the Rights Offering,
Mr. Garcia will have significant influence over the Company's activities.
Mr. Raymond C. Fidel is the President of Cygnet Dealer Finance, Inc., a
wholly owned subsidiary of Cygnet. From February 1982 to April 1989, Lincoln
employed Mr. Fidel, between 1988 and 1989, as its President. Following the
takeover of Lincoln by the RTC in 1989, Mr. Fidel and others were charged with
fraud (the "Complaint") arising out of the sale of bonds at Lincoln of its
parent company, American Continental Corporation ("ACC"). With the filing of the
Complaint, Mr. Fidel, without admitting or denying any of the allegations in the
Complaint, consented to the entry of a permanent injunction against further
violations of the securities laws. Mr. Fidel pled guilty in 1991 to two counts
of federal securities fraud, and to six counts in California State court (five
relating to fraud and one relating to the sale of securities without
qualification) arising out of this matter. In light of Mr. Fidel's cooperation
with authorities in their prosecution of executives of ACC, including Charles H.
Keating, Jr., and Mr. Fidel's efforts in stopping bond sales at Lincoln, Mr.
Fidel was given three years of probation, which has expired.
CONVERSION TO NEW SERVICING PLATFORMS
The Company is dependent upon its information systems to properly account
for and monitor its finance receivables portfolio, its loan servicing operations
and the Cygnet Dealer Program loan portfolio. The Cygnet Dealer Program
portfolio is currently tracked on an internally developed custom software
system. However, the Company recently signed a service bureau agreement (the
"ACS Agreement") with ACS to process the loan portfolios owned or serviced by
the Company. Due to the unique characteristics of the Cygnet Dealer Program, ACS
will be required to make a number of custom software enhancements to enable the
Cygnet Dealer Program to run on the ACS system. The Company anticipates that
implementation of the custom software changes and conversion from the Company's
in-house system to the ACS system will be completed by December 31, 1998. In
addition to the ACS system, the Company is developing a custom loan underwriting
and funding software module to interface between the Third Party Dealers'
systems and the ACS system. During 1999, the Company intends to migrate the
dealers from their separate stand alone loan systems to the ACS system for
purposes of loan servicing and collections. An extended delay in the conversion
to the ACS system, in the development of the custom loan underwriting and
funding software module, or in migrating the dealers to the ACS system for loan
servicing and collections, could have a negative impact on the Company's ability
to efficiently collect, account for and monitor the Cygnet Dealer Program loan
portfolio. Only a portion of the ACS systems is fully Year 2000 compliant.
Further, the Company bears certain risks related to Year 2000 in connection with
applications and systems of other vendors, the Company's equipment, and the
Company's customers. See "Risk Factors -- Risks Relating to the Business -- Data
Processing and Technology and Year 2000" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Year 2000."
The FMAC loan portfolio, aggregating approximately $378 million as of May
31, 1998, is currently being serviced on a loan servicing platform provided
under contract with Alltel Financial Information Services, Inc. ("Alltel"),
which is scheduled to expire in December 1998. If the Company continues to use
the Alltel platform after December 1998, the contract provides for a substantial
premium to be paid by the Company in exchange for the extension. The Company is
in the process of converting from the Alltel system to a system licensed from
ACS. This conversion is expected to be completed by the end of the third quarter
of 1998. There can be no assurance, however, that the conversion will be
completed in a timely manner. If the conversion is
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not completed in a timely manner, the Company may be required to extend the
contract with Alltel beyond December 1998 and pay the required premium.
Accordingly, failure to successfully migrate and convert to the ACS system could
have a material adverse effect on the Company.
Pursuant to Reliance's confirmed plan of reorganization, on August 1, 1998,
UDC will begin to service the Reliance finance receivables portfolio, which
totaled approximately $157 million as of April 30, 1998. See "Business -- Bulk
Purchasing and Servicing Operations -- Transactions Regarding Reliance
Acceptance Group." UDC will purchase all of Reliance's furniture, fixtures, and
equipment, including the servicing platform utilized by Reliance. The servicing
operations and servicing platform will be transferred to the Company on the
Effective Date of the Split-up. The Company intends to use this servicing
platform (along with certain real property leases), at least through December
1998, to service the Reliance receivables. Thereafter, servicing of the Reliance
receivables will be converted to the ACS system. There can be no assurance that
UDC will be able to perform all necessary actions to effectively service the
Reliance finance receivables portfolio in the limited time available. Further,
disruption of servicing of the Reliance portfolio could result in UDC or the
Company being removed as the servicer and could have other serious adverse
consequences to the Company. See "Risk Factors -- Risks Relating to the
Business -- Risks Related to the Reliance Transaction."
The conversion of both the Cygnet Dealer Program and the FMAC servicing
functions to ACS and the assimilation of the Reliance portfolio and subsequent
conversion to the ACS platform may result in various implementation and
integration issues that could temporarily interrupt the Company's ability to
effectively collect, monitor and account for the Cygnet Dealer Program and to
service the FMAC and Reliance portfolios without serious disruption. Any such
issues or interruptions could result in an increase in contract delinquencies
and charge-offs in the FMAC and/or Reliance portfolios and in the Cygnet Dealer
Program, which, depending on the severity of the matter, could result in the
Company being removed as the servicer for the FMAC and Reliance transactions and
have other material adverse consequences to the Company. See "Risk
Factors -- Risks Relating to the Business -- Risks Relating to the FMAC
Transaction" and "Risk Factors -- Risks Relating to the Business -- Risks
Relating to the Reliance Transaction."
DATA PROCESSING AND TECHNOLOGY AND YEAR 2000
The success of any participant that engages in the financing and servicing
of loan receivables, particularly those with a focus on the sub-prime industry,
including the Company, depends in large part on its ability to continue to adapt
its technology, on a timely and cost-effective basis, to meet changing customer
and industry standards and requirements.
As noted above, it is anticipated that the existing Cygnet Dealer Program
and FMAC and Reliance loan servicing functions will be converted to the ACS
system in the latter half of 1998. Pursuant to the ACS Agreement, the ACS
systems must be fully Year 2000 compliant by January 1, 1999. However, the
Company's sole remedy if ACS does not comply with this requirement is to
terminate the ACS Agreement and convert to another system, which would be costly
and disruptive and could have a material adverse effect on the Company's
business.
In addition to the ACS Year 2000 issues, the Company also continues to bear
risks related to the Year 2000 issue and could be materially adversely affected
if other entities (e.g., vendors or customers) not affiliated with the Company
do not appropriately address their own Year 2000 compliance issues. Further,
certain of the Company's own applications are not Year 2000 compliant at this
time. The Company anticipates that resolution of all Year 2000 issues will be
significant to the Company's business and operations. There can be no assurance
that the Company will be able to completely resolve all Year 2000 issues in a
timely fashion or that the ultimate impact of the Year 2000 issues will not be
material to the Company. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000."
Pursuant to the ACS Agreement, ACS has agreed to provide enhancements and
modifications to the base system that is licensed to ACS. Some of the
enhancements and modifications will remain proprietary to ACS and will not be
licensed to the Company. If ACS or the Company breaches the ACS Agreement, and
ACS no longer provides processing services, the Company may incur significant
costs in securing a
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replacement processing company that will be able to process the loans in the
same manner as ACS. Further, the Company's remaining computer applications would
not be sufficient to effectively manage the Cygnet Dealer Program or the loan
servicing of finance receivables portfolios.
The Company will be dependent on its loan servicing and collection
facilities as well as long-distance and local telecommunications access in order
to transmit and process information among its various facilities. The Company
maintains a standard program whereby it prepares and stores off site back ups of
its main system applications and data files on a routine basis. Following the
Split-up, the Company believes that it will be necessary to adopt a disaster
response plan. There can be no assurance that a failure will not occur in the
interim or that any plan adopted will prevent or enable timely resolution of any
systems failure. Further, a natural disaster, calamity, or other significant
event that causes long-term damage to any of these facilities or that interrupts
its telecommunications networks could have a material adverse effect on the
Company. With respect to the Company's servicing operations following conversion
to the ACS system, the Company will be required to rely on the disaster response
plan developed and utilized by ACS. ACS believes that its disaster response plan
is proprietary information and has not allowed the Company to fully evaluate
such plan. Therefore, if the disaster response plan of ACS is inadequate, the
occurrence of a disaster could have a material adverse effect on the Company's
business.
AVOIDANCE OF EXCESS SERVICING CAPACITY
On the Effective Date of the Split-up, the Company third party servicing
operations will be limited to the FMAC and Reliance portfolios and any Interim
Transactions effected prior to the Effective Date. Moreover, because of the
relatively short lives of automobile finance receivables, these portfolios are
expected to be reduced in the near future to a point at which, if not replaced
with additional finance receivables, the Company's servicing platform and
operations will have excess capacity. For the Company's servicing operations to
remain profitable, the Company must continually service a sufficient number of
finance receivables to generate servicing income in excess of fixed overhead
costs. For example, a significant portion of servicing overhead is based on
certain fixed costs for personnel salaries and other expenses as well as lease
or other facilities costs. If portfolios being serviced are not continually
replaced with new finance receivables, the Company will be required to reduce
the number of employees in its servicing operations, and then rehire such
employees as additional portfolios are obtained. Such practices can lead to low
employee morale and to disruptions and loss of efficiency in servicing functions
and can also result in substantial severance and facilities closure costs.
Therefore, in order to maintain the profitability of the Company's servicing
operations, it will be necessary for the Company to continue to identify and
secure servicing rights to significant portfolios of finance receivables. To an
extent, each bulk purchase and servicing transaction is a unique opportunity.
There can be no assurance that the Company will be able to identify and
successfully conclude sufficient bulk purchasing and servicing transactions to
maintain the profitability of these operations. See "Risk Factors -- Risks
Relating to the Business -- No Assurance of Profitability."
Although the Company is evaluating the possibility of expanding its
servicing operations to include receivables other than auto receivables, such as
mortgages or credit card receivables, in order to mitigate its excess capacity
issues, the Company has no experience in servicing such types of receivables and
may encounter other unanticipated problems. Moreover, there can be no assurance
that such receivables could be serviced on the existing and anticipated
servicing systems of the Company without substantial modification.
MANAGEMENT OF TRANSITION ACTIVITIES
The profitable realization of bulk purchase and servicing opportunities
requires effective management of significant transition activities, which must
be accomplished within a very short time period. These transition activities
include, among others, converting acquired or serviced loan portfolios from the
seller's or owner's servicing systems to the loan servicing systems utilized by
the Company, managing rapidly changing servicing capacity, arranging for
transition of employees, and arranging for facilities to allow servicing. These
issues are magnified as larger portfolios of the type the Company will seek to
purchase or service are transitioned into the Company's systems, and the
concurrent risks are greater if a transition is not smoothly implemented. There
can
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be no assurance that the Company can successfully manage the transition of its
current or subsequent transactions. See "Risk Factors -- Risks Relating to the
Business -- Conversion to New Servicing Platforms."
RISKS RELATED TO THE FMAC TRANSACTION
Although UDC's involvement in the FMAC bankruptcy proceedings has been
profitable, there can be no assurance that this transaction will continue to be
profitable in the future. Unless otherwise defined in this section, capitalized
terms utilized in this description of the risks inherent in the FMAC transaction
will have the meanings given in the detailed description of the FMAC transaction
under the heading "Business -- Bulk Purchasing and Servicing
Operations -- Transactions Regarding First Merchants Acceptance Corporation."
On the Effective Date of the Split-up, UDC will transfer to the Company
substantially all of its rights and certain liabilities accruing on or after the
Effective Date in connection with the FMAC transaction (except cash received by
UDC prior to the Effective Date). The Company will assume UDC's guarantee to the
Contract Purchaser of a stated return, based in part on a 10.35% per annum
interest rate, on certain Owned Contracts acquired from FMAC and sold to the
Contract Purchaser, subject to a maximum guarantee of $10.0 million. Although
FMAC has provided a similar guarantee to UDC, which will be transferred to the
Company, payable out of certain distributions from residual interests held by
FMAC in securitization transactions, the guarantee in some circumstances may be
less than the guarantee given by UDC to the Contract Purchaser. There can be no
assurance that there will be sufficient distributions from the residual
interests to support the guarantee. In addition, the Company will assume the
funding obligations of UDC with respect to the DIP Facility. The DIP Facility
and certain fees payable to UDC that will be assigned to the Company are also
payable out of certain expected tax refunds of FMAC and/or distributions from
the same residual interests in FMAC's securitization transactions. Although the
Company anticipates collecting such items, there can be no assurance that these
loans or fees will be paid. Payments pursuant to the residual interests may not
be made until the senior certificates in the securitization transactions are
paid in full. The liabilities to be assumed by the Company relating to the FMAC
transaction are not conditioned on the profit ultimately achieved by the Company
from that transaction and such liabilities may exceed payments made to the
Company.
In addition, although it is contemplated that all of UDC's servicing rights
with respect to the FMAC transaction will be transferred to the Company in
conjunction with the Split-up, the ability of the Company to take over such
servicing rights is subject to the consents of certain parties that have not yet
been obtained. Moreover, if consent is not obtained or the Company does not
satisfy the conditions to be an "Authorized Servicer," the Company would lose
the right to significant benefits expected in the FMAC transaction, including
ongoing servicing fees and its right to certain distributions from residual
interests in FMAC's securitized pools, which could have a material adverse
effect on the Company. The Company believes, however, that it will satisfy the
required conditions to qualify as an "Authorized Servicer."
Moreover, the Company will be required to meet certain performance criteria
with respect to servicing of the FMAC and Owned Contract portfolios. The failure
to meet the required performance criteria could result from a number of factors,
including, among others, general economic conditions that cause increased
payment delinquencies by the obligors on the contracts in the pools being
serviced, and servicing interruptions and inefficiencies caused by the Company's
anticipated servicing platform conversions or any Year 2000 issues. See "Risk
Factors -- Risks Relating to the Business -- Conversion to New Servicing
Platforms" and "Risk Factors -- Risks Relating to the Business -- Data
Processing and Technology and Year 2000." The failure to meet such performance
criteria could result in "termination events" under the various servicing
agreements governing the FMAC and Owned Contract portfolios, and in such case
the Company could lose the right to service the receivables in such portfolios
and the related servicing fees. If for any reason the Company cannot continue to
service the FMAC portfolios, the Company would lose significant benefits
expected in the FMAC transaction, including ongoing servicing fees and its right
to certain distributions from residual interests in FMAC's securitized pools,
which could have a material adverse effect on the Company.
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RISKS RELATED TO THE RELIANCE TRANSACTION
On the Effective Date of the Split-up, UDC will transfer to the Company all
of its rights and substantially all of its obligations in connection with the
Reliance transaction (except cash received by UDC prior to the Effective Date).
For a detailed description of the Reliance transaction, see "Business -- Bulk
Purchasing and Servicing Operations -- Transactions Regarding Reliance
Acceptance Group." There can be no assurance that the servicing rights and
interests to be obtained by the Company in the Reliance transaction will prove
valuable or profitable. In addition, the Company's ability to assume the
servicing rights in the Reliance transaction on or after the Effective Date is
subject to consents of certain parties, including Reliance, that have not yet
been obtained. Substantially all of the benefits expected in the Reliance
transaction are contingent on the Company's acquiring and retaining servicing
rights to the Reliance portfolio.
Further, the Company's ability to profitably service the Reliance portfolio
is largely dependent on its ability to effectively manage the transition
activities associated with the assumption of such servicing. See "Risk
Factors -- Risks Relating to the Business -- Management of Transition
Activities" and "Risk Factors -- Risks Relating to the Business -- Conversion to
New Servicing Platforms."
Moreover, the Company will be required to meet certain performance criteria
with respect to servicing of the Reliance portfolio. A failure to meet the
required performance criteria could result from a number of factors, including,
among others, general economic conditions that cause increased payment
delinquencies by the obligors on the contracts in the pools being serviced, and
servicing interruptions and inefficiencies caused by the Company's anticipated
servicing platform conversions or any Year 2000 issues. See "Risk Factors --
Risks Relating to the Business -- Conversion to New Servicing Platforms" and
"Risk Factors -- Risks Relating to the Business -- Data Processing and
Technology and Year 2000." The failure to meet such performance criteria could
result in a "termination event" under the servicing agreement entered into by
the Company with Reliance and, in such case, the Company could lose the right to
service the Reliance portfolio.
CYGNET DEALER PROGRAM
The Cygnet Dealer Program provides qualified Third Party Dealers with
financing options and revolving lines of credit primarily secured by such
dealers' finance receivable portfolios. While the Company will require dealers
to meet certain minimum net worth and operating history criteria to be
considered for inclusion in the Cygnet Dealer Program, it will, nevertheless, be
extending credit to dealers who may not otherwise be able to obtain debt
financing from traditional lending institutions such as banks, credit unions,
and major finance companies. Under the Cygnet Dealer Program, the dealer remains
responsible for collection of the contract payments and retains control of the
customer relationship. All cash collections, including regular monthly payments,
payoffs, and repurchases are deposited by the dealers into a bank account
maintained by the Company. Consequently, the Company will be subject to a high
risk of credit losses due to dealer defaults or fraudulent activities,
specifically related to the collection, depositing, and reporting of customer
payments, which could have a material adverse effect on the Company and on the
Company's ability to meet its own financing obligations.
SENSITIVITY TO INTEREST RATES
The Company anticipates that a substantial portion of its borrowing
facilities will be on a floating rate basis. Conversely, the contracts that the
Company purchases under its Dealer Collection Program (as defined herein) and
the contracts that it purchases in bulk typically bear interest at fixed rates.
Therefore, increases in interest rates would effectively reduce the interest
rate spread the Company earns on the retail installment contracts in its
portfolios. The Company can attempt to mitigate any such reduction by reducing
the advance rate under its Dealer Collection Program, increasing the discount
rate on bulk purchases, or securitizing its portfolios in order to lock in a
fixed cost of funds. However, the Company may not be able to increase the
interest rate spread on future purchases of contracts due to market competition
or restrictions placed on interest rates by various states. Further, there can
be no assurance that the Company would be successful in the implementation of a
securitization program. See "Risk Factors -- Risks Relating to the Business --
Securitizations."
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DEPENDENCE ON EXTERNAL FINANCING
Because of the significant equity being invested in the Company, the
Company's capital structure will support substantial additional leverage, and
could become highly leveraged in the future. The Company has borrowed, and will
continue to borrow, substantial amounts required to fund its operations. In this
regard, the Company's operations are highly capital intensive. Although the
Company has had discussions with various lenders regarding a credit facility,
there can be no assurance that the Company will be able to secure financing when
and as needed in the future, or on terms acceptable to the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
SECURITIZATIONS
To date, the Company has not entered into any securitization transactions.
However, the Company may finance its operations in part through securitization
transactions. The Company's ability to successfully complete securitizations 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 Company has yet to determine the accounting treatment for future
securitization transactions, if any. Should the Company structure a
securitization transaction in such a manner as to treat the securitization as a
sale, the securitized assets would be removed from the Company's balance sheet,
the Company would record a residual interest in the securitization, and gain on
sale would be recognized. However, the Company could structure a securitization
as a financing whereby the securitized assets would remain on the Company's
balance sheet and the Company would record a liability related to the issuance
of debt securities pursuant to the securitization. In this case, the Company
would continue to recognize revenue on the securitized assets as if they had not
been securitized, and would recognize interest expense on the related debt.
To the extent the Company were to record a gain on sale in connection with
securitizations, the gain would be based upon certain estimates and assumptions,
which may not subsequently be realized. The valuation of the residual interest
in securitization transactions is very subjective, and requires the use of many
assumptions about future events. To the extent that actual cash flows on a
securitization differ materially from the original securitization assumptions,
and in the opinion of management those differences appear to be other than
temporary in nature, the Company would be required to revalue its residual
interests in the finance receivable contracts that it has sold in the
securitization ("Residuals in Finance Receivables Sold"), and record a charge to
earnings based upon the reduction, which could be material and have a
significant effect on the Company. In addition, the Company would record ongoing
income based upon the cash flows on Residuals in Finance Receivables Sold. The
income recorded on the Residuals in Finance Receivables Sold would vary from
quarter to quarter based upon cash flows received in a given period. To the
extent that cash flows were deficient, charge-offs of finance receivables exceed
estimates, or assumptions applied to the underlying portfolio were not realized,
and in the opinion of management those differences were to appear to be other
than temporary in nature, the Company would be required to revalue the Residuals
in Finance Receivables Sold, and record a charge to earnings.
RISKS OF INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's expected borrowings would decrease the
profitability of the Company's existing portfolio. The Company has sought to
limit this risk by (i) maintaining a portion of its investment portfolio in a
floating rate program and (ii) limiting the maturity of finance receivable
contracts. If the Company's borrowing rates increase, then the Company will seek
to further limit the negative impact on earnings by increasing the purchase
discount at which the Company purchases finance receivables and/or require
higher stated annual percentage rates on finances receivables which are
purchased. To date, inflation has not had a significant impact on the Company's
operations.
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COMPETITION
The markets in which the Company competes are highly competitive. With
respect to its Cygnet Dealer Program and bulk purchasing and servicing
operations, the Company competes with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater resources, including access to lower priced capital. In
addition, there are numerous financial services companies serving, or capable of
serving, these markets. While traditional financial institutions, such as
commercial banks, savings and loans, credit unions, and captive finance
companies of major automobile manufacturers, have not consistently served the
sub-prime markets, the relatively high yields that can be earned by companies
involved in sub-prime financing have encouraged certain of these traditional
institutions to enter, or contemplate entering, these markets. Increased
competition may adversely affect the Company under the Dealer Collection Program
(as described herein) by reducing the discount at which the Company purchases
contracts, may result in a decrease in the discounts at which the Company
purchases portfolios in bulk, or may result in downward pressure on the rates
charged for loan servicing, all of which could have an adverse effect on the
Company. Further, increased competition for the bulk purchase and servicing
transactions that the Company must effect to remain profitable could have a
material adverse effect on the Company's business.
NO ASSURANCE OF SUCCESSFUL ACQUISITIONS
The Company intends to consider additional acquisitions, alliances, and
transactions involving other companies that could complement the Company's
existing business. There can be no assurance that suitable acquisition parties,
joint venture candidates, or transaction counter parties can be identified, or
that, if identified, any such transactions will be consummated on terms
favorable to the Company, or at all. Furthermore, there can be no assurance that
the Company will be able to integrate successfully such acquired businesses into
its existing operations, which could increase the Company's operating expenses
in the short-term and materially adversely affect the Company. Moreover, these
types of transactions by the Company may result in potentially dilutive
issuances of equity securities, the incurrence of additional debt, and
amortization of expenses related to goodwill and intangible assets, all of which
could adversely affect the Company's profitability. These transactions involve
numerous risks, such as the diversion of the attention of the Company's
management from other business concerns, the entrance of the Company into
markets in which it has had no or only limited experience, and the potential
loss of key employees of the acquired company, all of which could have a
material adverse effect on the Company.
GENERAL ECONOMIC CONDITIONS; RISKS ASSOCIATED WITH SUB-PRIME MARKET
The Company's business is directly related to the ability of the obligors
on the finance receivables that the Company services, expects to purchase in
bulk, and that secure its Cygnet Dealer Program to continue to make the required
payments on such contracts, which is affected by employment rates, prevailing
interest rates, and other general economic conditions. While the Company
believes that current economic conditions favor continued growth in the markets
it serves and those in which it seeks to expand, a future economic slowdown or
recession could lead to increased delinquencies, repossessions, and credit
losses on the finance receivables that the Company services, expects to purchase
in bulk, or that secure the Cygnet Dealer Program. Moreover, substantially all
of the finance receivables that the Company services, expects to purchase in
bulk, or that secure the Cygnet Dealer Program are with Sub-Prime Borrowers, who
due to their poor credit histories and/or low incomes 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. Because of the Company's primary focus on the sub-prime segment
of the automobile financing industry, the actual rate of delinquencies,
repossessions, and credit losses on the finance receivables that the Company
services, expects to purchase in bulk, or that secure the Cygnet Dealer Program
could be higher under adverse conditions than those experienced in the used car
sales and finance industry in general. Moreover, adverse economic conditions
that result in decreased sales of used cars could adversely affect the dealers
that participate in the Cygnet Dealer Program, which could have a material
adverse effect on such program.
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INDUSTRY CONSIDERATIONS AND LEGAL CONTINGENCIES
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation, and other events. In addition, certain of these
companies have filed for bankruptcy protection. These announcements have had a
disruptive effect on the market for securities of sub-prime automobile finance
companies, have resulted in a tightening of credit to the sub-prime markets, and
could lead to enhanced regulatory oversight. Furthermore, companies in the used
vehicle financing market have been named as defendants in an increasing number
of class action lawsuits brought by customers alleging violations of various
federal and state consumer credit and similar laws and regulations. Although the
Company is not currently a named defendant in any such lawsuits, no assurance
can be given that such claims will not be asserted against the Company in the
future or that the Company's operations will not be subject to enhanced
regulatory oversight.
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RISKS RELATING TO THE RIGHTS OFFERING
NO PUBLIC MARKET; MARKET PERCEPTION ISSUES
There currently exists no public market for the Rights or shares of Common
Stock being offered pursuant to this Prospectus. While the Rights and the Common
Stock have been approved for listing on the Nasdaq National Market, subject to
notice of issuance, there is no assurance that a trading market in the Rights or
the shares of Common Stock will develop, or, if developed, can be sustained. In
addition, trading in the Rights will be limited by the relatively short 20 day
Rights Offering Period. Trading transactions must be effected early in such
period to ensure ample time for the purchaser to exercise his Rights.
Even if a trading market does develop, there can be no assurance that the
market price for shares of Common Stock will remain at or above the Subscription
Price. Prices at which the Common Stock may trade, either prior to the Split-up,
on a "when-issued" basis, or subsequent thereto, cannot be predicted. Until the
Common Stock is fully distributed and an orderly market develops, the prices at
which trading in such stock occurs may fluctuate significantly. In addition,
continued listing on the Nasdaq National Market is subject to compliance with
certain initial listing and maintenance criteria, including the presence of at
least 400 holders of the Common Stock. Failure to maintain compliance with such
listing and maintenance requirements could subject the Common Stock to possible
delisting from the Nasdaq National Market, which could have a material adverse
effect on trading of the Common Stock and consequently, its market price.
Further, the prices of common stock of many participants in the sub-prime
automobile financing industry have fluctuated significantly in recent periods.
The prices at which the Common Stock will trade will be determined by the
marketplace and may be influenced by many factors, including, among others, the
value of the Company's assets, its ability to generate cash flow, its
profitability or lack thereof or other measures of value, the depth and
liquidity of the market for such shares, investors' perceptions of the Company
and the industries in which its businesses participate, and general economic and
market conditions.
Rights distributed to UDC's stockholders in the Rights Offering and shares
of Common Stock distributed to holders who exercise the Rights will be freely
transferable, except for securities received by persons who may be deemed to be
"affiliates" of UDC or of the Company within the meaning of Rule 145 promulgated
under the Securities Act. Sales by persons who are affiliates of UDC or the
Company within the meaning of Rule 145 at the time of the Rights Offering may be
subject to certain restrictions.
Although one purpose of the Split-up is to allow investors, lenders, and
others to more easily evaluate the performance and investment characteristics of
the business of the Company as opposed to the business to be retained by UDC and
to enhance the likelihood that each business group will achieve appropriate
market recognition of its performance, there will, at least for a significant
period of time, continue to be material ties between the two companies that may
prove confusing to the market. There can be no assurance that the market will
regard the Split-up as a positive development. If the market perceives more
disadvantages than advantages resulting from the Split-up, the price of the
Common Stock is likely to suffer a decline.
OWNERSHIP OF COMMON STOCK BY MR. GARCIA
Ernest C. Garcia, II, will be Cygnet's Chairman of the Board, Chief
Executive Officer, and President. Mr. Garcia is also the holder of approximately
25.2% of UDC's outstanding Common Stock. Mr. Garcia will agree to exercise his
entire 25.2% pro rata share of the Rights. In addition, Mr. Garcia will agree
through his Over-Subscription Privilege and Standby Purchase Obligation to
purchase additional shares of Common Stock pursuant to the Rights Offering in an
amount sufficient to satisfy the Required Purchase Amount. See "The Rights
Offering" for a complete description of the Over-Subscription Privilege, the
Standby Purchase Obligation, and the Required Purchase Amount. Mr. Garcia also
has the right to purchase up to 714,286 additional shares of Common Stock at the
Subscription Price over and above the Required Purchase Amount and will be
issued warrants to purchase an additional 500,000 shares of Common Stock. These
transactions taken together will result in Mr. Garcia's ownership of a
significant percentage of the outstanding Common Stock following the Split-up.
In certain circumstances, Mr. Garcia could acquire a majority of the Company's
Common Stock, in which case Mr. Garcia would be in a position to control the
voting with respect to virtually
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<PAGE> 24
all matters that affect the Company. As a result, Mr. Garcia will have
significant influence over the Company's activities, as well as on all matters
requiring approval of the Company's stockholders, including electing or removing
members of its Board of Directors, causing the Company to engage in transactions
with affiliated entities, causing or restricting the sale or merger of the
Company with other entities, and changing its dividend or other policies.
POTENTIAL FEDERAL INCOME TAX CONSEQUENCES OF THE RIGHTS OFFERING
In the opinion of Snell & Wilmer L.L.P., holders of UDC Common Stock who
receive Rights will generally recognize dividend income (taxable as ordinary
income) in an amount equal to the fair market value, if any, of the Rights as of
the date of their distribution. In the opinion of the Appraiser dated July 21,
1998, the fair market value of the Rights on the date of their distribution
should be zero. However, the opinion of the Appraiser is not binding on the
Internal Revenue Service. For example, the Internal Revenue Service may assert
that the price at which the Rights trade during the 20-day period of the Rights
will be indicative of the fair market value of the Rights on the date of their
distribution. Accordingly, there can be no assurance as to the exact amount of
dividend income, if any, a holder of UDC Common Stock who receives Rights will
recognize upon the receipt of Rights. If the Rights are trading for value on the
date of their distribution, UDC may, in its discretion, report to holders of UDC
Common Stock the receipt of dividend income in an amount equal to the average of
the high and low trading prices of the Rights on such date.
To avoid the possibility of the recognition of ordinary income and the
creation of a potentially deferred or nondeductible capital loss, it will, in
many instances, be in the interests of holders of UDC Common Stock receiving
Rights to either exercise or sell the Rights, rather than to allow the Rights to
lapse.
RISKS RELATING TO THE PREFERRED STOCK
The dividend rate for the Preferred Stock to be issued to UDC on the
Effective Date of the Split-up will be 7% per annum of the Base Liquidation
Amount for the period from the Effective Date to the first anniversary thereof.
Thereafter, the annual dividend rate will increase 1% per annum to a maximum
rate of 11% per annum of the Base Liquidation Amount. Although dividends on the
Preferred Stock are payable only out of funds legally available therefor when
and as declared by the Board of Directors, if dividends are not paid when due
for a period of two quarters, UDC will have the right to elect two members to
the Company's Board of Directors (in addition to the then existing number of
directors) at the next meeting of stockholders and thereafter until all accrued
dividends are paid in full. In addition, if dividends are not paid when due for
a period of six quarters, the Preferred Stock is convertible at UDC's option
into Common Stock as described herein. Moreover, accrued but unpaid dividends on
the Preferred Stock may adversely affect the market price for the Common Stock.
During the first three years following the Effective Date of the Split-up, the
Preferred Stock will not be convertible, except in certain circumstances
described above. Thereafter, the Preferred Stock will be convertible into Common
Stock at the lower of the Subscription Price or a discount to market of
approximately 20%. Thus, the Company will be motivated to redeem the Preferred
Stock during the first three years following the Effective Date. Redemptions of
Preferred Stock will not be authorized, however, unless, in the reasonable
judgment of the Company and UDC, the proceeds of such redemption will be treated
for federal income tax purposes as proceeds from a sale of such stock and not as
dividends paid with respect to such stock. As a consequence, redemptions of
Preferred Stock may be limited and may be confined to a single redemption of all
the outstanding shares of Preferred Stock. Further, it may be necessary to
contemporaneously redeem shares of Common Stock acquired by a holder of
Preferred Stock upon a prior conversion of Preferred Stock in order to assure
treatment of the proceeds of a redemption of Preferred Stock as proceeds from a
sale of such stock and not as dividends paid with respect to such stock. If the
Company is unable to redeem the Preferred Stock during such three year period,
whether because of financial circumstances, contractual restrictions, or
limitations inherent under the terms governing such stock, a conversion of the
Preferred Stock into Common Stock could have the effect of significantly
diluting the Company's Common Stock.
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<PAGE> 25
POTENTIAL ANTI-TAKEOVER EFFECT OF PREFERRED STOCK, CHANGE OF CONTROL
ARRANGEMENTS AND DELAWARE LAW
Certain provisions of the Company's Certificate of Incorporation and 1998
Stock Incentive Plan (as described herein) may have the effect of making it more
difficult for a third party to acquire, or of discouraging a third party from
attempting to acquire, control of the Company. Such provisions could limit the
price that certain investors may be willing to pay in the future for shares of
the Company's Common Stock. The Company's Certificate of Incorporation
authorizes the Company to issue "blank check" preferred stock in addition to the
Preferred Stock to be issued to UDC in connection with the Split-up, 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 will have the authority, without stockholder approval, to
issue additional shares of 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 additional shares of preferred stock could be utilized, under certain
circumstances, to discourage, delay, or prevent a merger, tender offer, or
change in control of the Company that a stockholder might consider to be in its
best interests. Although the Company has no present intention of issuing any
additional shares of its authorized preferred stock, there can be no assurance
that the Company will not do so in the future. See "Description of Capital
Stock -- Preferred Stock." The Company's 1998 Stock Incentive Plan contains
certain provisions that provide that, in the event of a "Change of Control" of
the Company, (i) all options and other share-based awards granted under the 1998
Stock Incentive Plan will become immediately exercisable; (ii) any restriction
periods and restrictions imposed on restricted stock granted under the 1998
Stock Incentive Plan will lapse; and (iii) the target value attainable under all
performance units and other performance-based awards granted under the 1998
Stock Incentive Plan shall be deemed to have been fully earned, unless, in each
case, the surviving entity agrees to assume the awards in a manner that
substantially preserves the participants' rights and benefits. These provisions
may make it more difficult for stockholders to take certain corporate actions
and could have the effect of delaying or preventing a change in control of the
Company. In addition, certain provisions of Delaware law applicable to the
Company also could delay or make more difficult a merger, tender offer or proxy
contest involving the Company. See "Management" and "Description of Capital
Stock."
NO INTEREST ON SUBSCRIPTION FUNDS IN ESCROW
In order to exercise the Rights and the related Over-Subscription
Privilege, holders of Rights must pay the Subscription Price no later than the
Expiration Date, or if certain notice of guaranteed delivery procedures are
utilized, three business days thereafter. All subscription funds will be
deposited into an escrow account with an independent escrow agent. If the
Effective Date has not occurred by thirty days following the Expiration Date,
the escrow will be terminated and subscription monies will be returned to
subscribers without interest. While the Company believes that the Effective Date
will occur shortly following the Expiration Date, no interest will be paid to
subscribers for monies held in the escrow account even if the Effective Date
does not occur.
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<PAGE> 26
THE RIGHTS OFFERING
PURPOSE OF THE RIGHTS OFFERING
The Company has agreed to make a Rights Offering to holders of UDC Common
Stock in connection with the Split-up. This Rights Offering represents the
Company's initial public offering of its securities, although unlike a
traditional public offering, the securities will be offered first to UDC's
stockholders before they are available to the general public. The Company
believes that the Rights Offering will provide an advantage over a traditional
initial public offering because this type of offering provides the Company with
the opportunity to offer its Common Stock to investors who, as UDC stockholders,
already have some knowledge of the Split-up Businesses, which have been operated
by UDC.
The Information Agent for the Rights Offering is Corporate Investor
Communications, Inc. ("CIC"). Questions concerning the Rights Offering may be
addressed to CIC at 1-888-673-4478.
DISTRIBUTION OF RIGHTS
In the event that UDC's stockholders approve the Split-up and all other
conditions thereto are satisfied, subject to UDC's Board of Directors exercising
its right, in its sole discretion without stockholder approval, to abandon,
defer (to a date certain or indefinitely), or modify the Rights Offering, the
Rights Offering will be made to UDC's stockholders of record as of August 17,
1998 (the "Record Date"). On the Commencement Date (as defined below) of the
Rights Offering, the Company will distribute the Rights to UDC's stockholders as
of the Record Date pro rata in accordance with the ownership of UDC Common Stock
on the Record Date. Each holder of record of UDC Common Stock as of the Record
Date will receive one (1) Right for every four (4) shares of UDC Common Stock.
Each Right will entitle the holder to acquire one (1) share of the Company's
Common Stock (the "Primary Subscription") at $7.00 per share (the "Subscription
Price"). The Subscription Price must be delivered to Norwest Bank Minnesota,
National Association, as distribution agent for the Company (the "Distribution
Agent"), and will be deposited by the Distribution Agent into an escrow account
(the "Escrow Account") established by the Company with Norwest Bank Minnesota,
National Association, as escrow agent (the "Escrow Agent"). Except as provided
in the next sentence below, in order to exercise the Rights, the full
Subscription Price for all exercised Rights must be paid on or prior to the
Expiration Date (defined below) or a notice of guaranteed delivery must be
received by the Distribution Agent by that date as described below under "The
Rights Offering Period" and "Method for Exercising Rights." Notwithstanding the
above, Mr. Garcia and his affiliates may exercise their Rights by payment of the
Subscription Price on or prior to the Effective Date. No interest will be paid
on subscription funds in the Escrow Account.
NO FRACTIONAL SHARES
If the number of shares of UDC Common Stock owned by a holder of record of
UDC Common Stock is not evenly divisible by four, the Company will round up to
the nearest whole number in calculating the number of Rights that such record
holder is entitled to receive. For example, if a record holder holds ten (10)
shares of UDC Common Stock, such holder will receive three (3) Rights. Holders
of record of UDC Common Stock as of the Rights Record Date will be instructed to
allocate the Rights received by them among any beneficial owners of UDC Common
Stock to which such Rights relate by rounding upward or downward to the nearest
whole Right. A record holder may request additional Rights from the Distribution
Agent if necessary to effect such an allocation among beneficial owners.
THE RIGHTS OFFERING PERIOD
Rights may be exercised at any time during the period beginning on the
commencement date of the Rights Offering (the "Commencement Date"), which is
expected to be on or about September 1, 1998, and ending at 5:00 p.m., Minnesota
time, on the date that is 20 days following the Commencement Date or such other
date to which the Rights Offering is extended (the "Expiration Date"). The
Company may determine to extend the Rights Offering Period in the event that the
Company believes a longer offering period is advisable
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<PAGE> 27
in order to allow a more diversified pool of holders to exercise the Rights or
for any other reason. After that date, except pursuant to certain procedures for
guaranteed delivery described below, Rights Offering Participants will not be
able to exercise or transfer their Rights and such Rights will be worthless. The
Company does not intend to honor any Rights received for exercise by the
Distribution Agent after the Expiration Date, except pursuant to such procedures
for guaranteed delivery, regardless of when such Rights were sent to the
Distribution Agent for exercise. Holders may also exercise their Rights by
contacting a bank, trust company, New York Stock Exchange member firm, or other
financial institution that is a member of an approved stock exchange medallion
program which can deliver to the Distribution Agent, on behalf of the holder, on
or prior to the Expiration Date, a Notice of Guaranteed Delivery guaranteeing
delivery of a properly completed subscription certificate (a "Subscription
Certificate") and payment of required subscription funds on or before the third
business day following the Expiration Date.
TRANSFERRING RIGHTS
Rights Offering Participants may sell the Rights in the market. Rights will
be admitted for trading on the Nasdaq National Market, under the symbol "CGNTR,"
and may be purchased or sold through normal brokerage channels through the last
business day prior to the Expiration Date. Rights Offering Participants should
consult with their regular investment and tax advisors and carefully consider
their alternatives. See "Federal Income Tax Consequences."
Each Rights Offering Participant may transfer all or a portion of such
Participant's Rights by endorsing and delivering to the Distribution Agent (at
the addresses set forth below) his or her Subscription Certificate. The Rights
Offering Participant must properly endorse the certificate for transfer, his or
her signature must be guaranteed by a bank or securities broker, and his or her
certificate must be accompanied by instructions to reissue the Rights to be
transferred in the name of the person purchasing the Rights. The Distribution
Agent will reissue certificates for the transferred Rights to the purchaser, and
will reissue a certificate for the balance, if any, to the transferor if it is
able to do so before the Expiration Date. The transferor will be responsible for
the payment of any commissions, fees, and other expenses (including brokerage
commissions and any transfer taxes) incurred in connection with the purchase or
sale of the transferor's Rights. Any questions regarding the transfer of Rights
should be directed to the Information Agent at its telephone number or address
listed below:
Corporate Investor Communications, Inc.
111 Commerce Road
Carlstadt, New Jersey 07072-2586
Telephone: (888) 673-4478
Because of the short Rights Offering Period, Rights Offering Participants
desiring to sell or transfer their Rights should do so early in the Rights
Offering Period to allow sufficient time for the transfer to be effected and the
transferee to exercise the Rights.
METHOD FOR EXERCISING RIGHTS
Rights may be exercised by completing and signing the purchase form that
appears on the back of each Subscription Certificate. To exercise Rights, a
Rights Offering Participant must send the completed and signed form, along with
payment in full of the Subscription Price for all shares of Common Stock to be
purchased, to the Distribution Agent. The Distribution Agent must receive these
documents and the payment not later than 5:00 p.m., Minnesota time, on the
Expiration Date. Rights may also be exercised by following the procedures for
guaranteed delivery described above under "The Rights Offering Period," in which
case the Notice of Guaranteed Delivery must be received by the Distribution
Agent by 5:00 p.m., Minnesota time, on the Expiration Date, and the properly
completed Subscription Certificate and payment of required subscription funds
must be received by the Distribution Agent by 5:00 p.m., Minnesota time, no
later than three business days following the Expiration Date. A Notice of
Guaranteed Delivery may be delivered by facsimile to the Distribution Agent at
612-450-4163, with delivery confirmed by telephone at 612-552-6995. Further
instructions for exercise of Rights and additional documentation that may be
required in certain cases will be contained in or included with the Subscription
Certificates.
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<PAGE> 28
Rights Offering Participants whose Rights are held by a nominee, such as a
bank, broker or trustee, must contact that nominee to exercise their Rights. In
such case, the nominee will complete the Subscription Certificate on behalf of
the Rights Offering Participant and arrange for proper payment. Nominees who
receive Rights for the account of others should notify the beneficial owners of
such Rights as soon as possible to ascertain such beneficial owners' intentions
and to obtain instructions with respect to the Rights. If the beneficial owner
so instructs, the nominee should complete the Subscription Certificate and
submit it to the Distribution Agent with the proper payment therefor. The
Company does not intend to honor any exercise of Rights received by the
Distribution Agent after the Expiration Date, or three business days thereafter
if a Notice of Guaranteed Delivery is delivered by the Expiration Date, except
that Mr. Garcia and his affiliates may exercise their Rights by delivery of
subscription documents and payment of the Subscription Price directly to Cygnet
on or prior to the Effective Date.
The Company suggests, for the protection of the Rights Offering
Participants, that Rights be delivered to the Distribution Agent by overnight or
express mail courier. If Rights are mailed, the Company suggests that Rights
Offering Participants use registered mail. In any event, mail or delivery of
Rights and payment for the Subscription Price must be made to the Distribution
Agent as follows:
<TABLE>
<S> <C> <C>
BY MAIL: BY HAND: BY OVERNIGHT/EXPRESS MAIL
COURIER:
Norwest Bank Minnesota, N.A. Norwest Bank Minnesota, N.A. Norwest Bank Minnesota, N.A.
Shareowner Services Shareowner Services Shareowner Services
Reorganization Department Reorganization Department Reorganization Department
P.O. Box 64858 161 North Concord Exchange 161 North Concord Exchange
St. Paul, MN 55164-0858 South St. Paul, MN 55075 South St. Paul, MN 55075
</TABLE>
The Subscription Price must be paid in U.S. dollars by certified check or
money order payable to "Norwest Bank Minnesota, National Association, as Escrow
Agent for Cygnet Financial Corporation," and will be deposited into escrow. The
Distribution Agent may also accept checks payable to "Norwest Bank Minnesota,
National Association," "Cygnet Financial Corporation," or similar designations,
although it will not be required to do so. No interest will be paid on
subscription funds in the Escrow Account.
The Escrow Agent will not deliver any funds to the Company until the
Split-up has been successfully completed and the shares of Common Stock have
been issued to the Rights Offering Participants. If for any reason the Rights
Offering is not successfully completed or the Split-up has not been effected
within 30 days following the Expiration Date, the Escrow Agent will return all
funds held in escrow as promptly as practicable to the Rights Offering
Participants, without interest.
The Company will decide all questions as to the validity, form and
eligibility (including times of receipt, beneficial ownership and compliance
with other procedural matters). The acceptance of subscription forms and the
Subscription Price also will be determined by the Company. Alternative,
conditional or contingent subscriptions will not be accepted. The Company
reserves the absolute right to reject any subscriptions not properly submitted.
In addition, the Company may reject any subscription if the acceptance of the
subscription would be unlawful. The Company in its sole discretion may waive any
defect or irregularity, or permit a defect or irregularity to be corrected
within such time as it may determine. Subscriptions will not be deemed to have
been received or accepted until all irregularities have been waived or cured
within such time as the Company determines in its sole discretion. Neither the
Company nor the Distribution Agent will be under any duty to give notification
of any defect or irregularity in connection with the submission of Subscription
Certificates or incur any liability for failure to give such notification. If an
exercise is rejected, the related payment of the Subscription Price will be
promptly returned by the Escrow Agent.
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<PAGE> 29
Any questions or requests for assistance concerning the method of
subscribing for shares of Common Stock or for additional copies of this
Prospectus or Subscription Certificates or Notices of Guaranteed Delivery may be
directed to the Information Agent at its telephone number and address listed
below:
Corporate Investor Communications, Inc.
111 Commerce Road
Carlstadt, New Jersey 07072-2586
Telephone: (888) 673-4478
Shareholders may also contact their brokers or nominees for information
with respect to the Rights.
THE OVER-SUBSCRIPTION PRIVILEGE
Each Rights Offering Participant who elects to exercise all of his or her
Rights may also subscribe for additional shares of Common Stock out of the pool
of shares underlying unexercised Rights on the Expiration Date, if any (the
"Unexercised Pool"), up to the number of shares purchased upon exercise of such
Participant's Rights (the "Over-Subscription Privilege"), subject to allocation
as described below. Shares purchased through the Over-Subscription Privilege
must be purchased at the Subscription Price. For example, if a Rights Offering
Participant holds and validly exercises 1,000 Rights, such Participant also may
subscribe for an additional 1,000 shares of Common Stock out of the Unexercised
Pool at the Subscription Price of $7.00 per share. If there are more shares
subscribed for pursuant to the Over-Subscription Privilege than are available in
the Unexercised Pool, each holder who elects to exercise his Over-Subscription
Election shall be authorized to purchase a pro rata portion of the Unexercised
Pool determined by calculating the product of (a) a fraction, the numerator of
which is equal to the number of shares of Common Stock as to which the
Over-Subscription Privilege of a holder is exercised and the denominator of
which is the total number of shares of Common Stock as to which the
Over-Subscription Privilege is exercised by all holders, and (b) the number of
shares available in the Unexercised Pool. The Escrow Agent will refund to
holders of Rights, without interest, all amounts paid for shares of Common Stock
subscribed for pursuant to the Over-Subscription Privilege and not issued or
sold to such holders due to the allocation described above. Except as described
in the next sentence below, the full amount of the Subscription Price for all
exercised Rights and shares subscribed for pursuant to the Over-Subscription
Privilege must be paid on or prior to the Expiration Date or a notice of
guaranteed delivery must be received by the Distribution Agent by that date in
order to validly exercise the Over-Subscription Privilege. Notwithstanding the
above, because of his obligations as Standby Purchaser, Mr. Garcia and his
affiliates may pay monies necessary to exercise the Over-Subscription Privilege
with respect to their Rights at the same time that they pay monies to fulfill
Mr. Garcia's Standby Purchase Obligation (described below). Such payments will
be made directly to the Company.
THE STANDBY PURCHASE OBLIGATION
Ernest C. Garcia, II, the Company's Chairman of the Board, Chief Executive
Officer, and President, and the holder of approximately 25.2% of the outstanding
shares of UDC Common Stock, will act as standby purchaser for the Rights
Offering (the "Standby Purchaser"). The successful conclusion of the Rights
Offering is contingent on the purchase of at least 75% of the Offered Shares
(the "Required Purchase Amount"). Mr. Garcia has agreed to purchase his full
25.2% pro rata share of the Offered Shares pursuant to the Rights Offering. In
addition, pursuant to that certain Rights Exercise and Standby Purchase
Agreement to be entered into between the Company and Mr. Garcia (the "Standby
Purchase Agreement"), through the Over-Subscription Privilege associated with
his Rights or pursuant to his Standby Purchase Obligation, Mr. Garcia will
purchase additional shares of Common Stock from the Unexercised Pool to the
extent necessary to satisfy the Required Purchase Amount. If, following the
Expiration Date, validly exercised Rights and the Over-Subscription Privilege do
not result in proper and valid subscriptions for the Required Purchase Amount,
then Mr. Garcia will be required to purchase additional shares of Common Stock
pursuant to the Standby Purchase Obligation in an amount necessary to achieve
the Required Purchase Amount. Mr. Garcia will pay any additional subscription
funds required pursuant to the Standby Purchase Obligation directly to the
Company on or prior to the Effective Date. In addition, Mr. Garcia's Standby
Purchase Obligation may be satisfied by any company or entity wholly-owned by
Mr. Garcia or any of his affiliates. As a result, Mr. Garcia
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<PAGE> 30
(or his affiliates) is expected to acquire at least 25.2% of Cygnet's Common
Stock through the Rights Offering and may acquire a substantially greater
percentage in certain circumstances as described herein. UDC intends to utilize
a portion of the Cash Payment to repay in full its $10 million subordinated note
to Verde Investments, Inc. ("Verde"), an affiliate of UDC, wholly-owned by Mr.
Garcia (the "Verde Note"), subject to the receipt of certain required consents.
Alternatively, Verde may deposit the Verde Note or any part thereof with the
Company in payment of all or any portion of the Subscription Price for exercise
of Rights acquired by Verde from Mr. Garcia or otherwise, the related
Over-Subscription Privilege, and the Standby Purchase Obligation. In such case,
the Company would transfer the Verde Note to UDC for cancellation in lieu of the
payment of a portion of the Cash Payment.
FAILURE BY THE STANDBY PURCHASER TO MEET HIS OBLIGATIONS
If the Standby Purchaser fails to meet his obligations under the Standby
Purchase Agreement, the Rights Offering may be canceled. If the Rights Offering
is canceled, the Escrow Agent will promptly return to all Rights Offering
Participants who elected to exercise Rights, without interest, any payment
received in respect of the Subscription Price and no shares of Common Stock will
be distributed.
THE STANDBY WARRANTS
In consideration for the obligations incurred by Mr. Garcia under the
Standby Purchase Agreement, on the Effective Date, Cygnet will grant to Mr.
Garcia warrants (the "Standby Warrants") entitling Mr. Garcia to purchase up to
500,000 additional shares of Common Stock at an exercise price equal to 120% of
the Subscription Price, or $8.40 per share (the "Warrant Price"), at any time
within five years following the Effective Date. Neither the Standby Warrants nor
the underlying Common Stock into which they are exercisable are registered under
the Securities Act and such securities may not be resold by Mr. Garcia unless
such securities are registered or unless an exemption from registration is
available. The Company will register at its expense the resale of the Common
Stock issued upon exercise of the Standby Warrants at the request of Mr. Garcia
at any time after one year following the Effective Date.
ADDITIONAL PURCHASE RIGHT AND D&O PURCHASE RIGHT
In addition to the shares of Common Stock that Mr. Garcia will purchase
through exercise of his Rights, the Over-Subscription Privilege associated with
his Rights, and the Standby Purchase Obligation, on the Effective Date, Mr.
Garcia and his affiliates will have the right at his election to purchase up to
an additional 714,286 shares of Common Stock at the Subscription Price (the
"Additional Purchase Right"). In addition, on the Effective Date, certain
individuals who are or will become directors and officers of the Company on the
Effective Date will have the right to purchase 214,286 additional shares of
Common Stock for $7.00 per share (the "D&O Purchase Right").
THE LENDER WARRANTS
Cygnet will be required to issue warrants to a third party lender (the
"Lender Warrants") to purchase 115,000 shares of Common Stock at an exercise
price of $8.40 per share, subject to a call feature by the Company if the
closing price of the Common Stock equals or exceeds $13.44 per share for a
period of 20 consecutive trading days, as incentive for a loan made to the
Company by the third-party lender of $5 million in subordinated indebtedness for
a three year term. The Lender Warrants will have a term of three years from
their date of issuance. Neither the Lender Warrants nor the underlying Common
Stock into which they are exercisable are registered under the Securities Act
and such securities may not be resold unless they are registered or unless an
exemption from registration is available. The Company has agreed to register at
its expense the resale of the Common Stock underlying the Lender Warrants on
demand of the holder thereof at any time after one year following the Effective
Date.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
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<PAGE> 31
PRINCIPAL AGREEMENTS RELATING TO THE RIGHTS OFFERING
In order to effectuate the Split-up, it is contemplated that at least the
following major agreements will be required. Each such agreement will be
executed in substantially the form described below. The descriptions of such
agreements contained herein are summaries only and are qualified in their
entirety by reference to the agreements which will be filed as exhibits to the
Registration Statement. Such agreements are expected to be substantially in the
forms so filed but may be revised prior to or following the effectuation of the
Split-up.
CAPITALIZATION AGREEMENT.
Prior to the Commencement Date, UDC and the Company will enter into the
Capitalization Agreement. The Capitalization Agreement sets forth, among other
things, and assuming the satisfaction or waiver of specified contingencies, (i)
the obligation of the Company to issue the Rights, (ii) the obligation of the
Company to issue the Common Stock on the Effective Date upon exercise of the
Rights, the Over-Subscription Privilege, and the Standby Purchase Obligation,
(iii) the obligation of UDC and its subsidiaries to transfer the Transferred
Assets to the Company on the Effective Date, (iv) the obligation of the Company
to issue the Preferred Stock to UDC and to make the Cash Payment, (v) the
obligation of the Company to issue other capital stock and warrants as described
herein, (vi) the operational arrangements and agreements between UDC and the
Company during a transition period, including arrangements for the sharing of
certain assets, leases, licenses, and employees, (vii) agreements between UDC
and the Company relating to employee matters, including the issuance or
adjustment of stock options under employee benefit plans, (viii) tax sharing and
indemnity matters, and (ix) certain agreements between UDC and the Company
relating to the FMAC and Reliance transactions and any Interim Transactions.
STANDBY PURCHASE AGREEMENT.
The Standby Purchase Agreement will be entered into between the Company and
Ernest C. Garcia, II prior to commencement of the Rights Offering. The Standby
Purchase Agreement sets forth the obligation of Mr. Garcia or his affiliates to
exercise their Rights and to purchase shares of Common Stock from the
Unexercised Pool of Rights either through the Over-Subscription Privilege
associated with their Rights or pursuant to the Standby Purchase Obligation. See
"The Standby Purchase Obligation" above. The Standby Purchase Agreement will
also require the issuance of the Standby Warrants to Mr. Garcia.
ESCROW AGREEMENT.
The Escrow Agreement will be entered into between the Company and Norwest
Bank Minnesota, National Association, as Escrow Agent prior to the commencement
of the Rights Offering and would govern the holding and distribution of the
subscription monies received from holders (other than Mr. Garcia) who elect to
exercise their Rights or the Over-Subscription Privilege.
TRANSFER OF ASSETS PURSUANT TO THE SPLIT-UP
If the Split-up Proposal is approved by the UDC shareholders and certain
other conditions are satisfied (see "Contingencies to the Split-up and the
Closing Thereof"), on the Effective Date, UDC and its subsidiaries will transfer
to the Company certain assets and liabilities (the "Transferred Assets.") The
Transferred Assets will include (i) UDC's bulk purchase and servicing operations
with respect to contracts originated by independent used car dealerships ("Third
Party Dealers"); (ii) the assets of Cygnet Finance, Inc., a wholly-owned
subsidiary of UDC through which UDC provides qualified Third Party Dealers with
warehouse purchase facilities and operating credit lines primarily secured by
the dealer's retail installment contract portfolios (the "Cygnet Dealer
Program"); (iii) substantially all of UDC's rights and obligations pursuant to
certain transactions with First Merchants Acceptance Corporation ("FMAC"),
including the servicing platform and rights and certain other rights and
residual interests, and the assumption by the Company of certain funding
obligations and guarantees of UDC in connection with the FMAC transaction,
certain of which are described under "Risk Factors -- Risks Relating to the
Business -- Risks Related to the FMAC Transaction" and in "Management's
Discussion and Analysis of Financial Condition and Results of
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Operations -- Liquidity and Capital Resources -- Transactions Regarding First
Merchants Acceptance Corporation"; and (iv) substantially all of the Company's
rights and obligations pursuant to certain transactions with Reliance Acceptance
Group, Inc. ("Reliance"), described generally above under "Risk Factors -- Risks
Relating to the Business -- Risks Related to the Reliance Transaction" and in
"Management's Discussion and Analysis of Results of Operations and Financial
Condition -- Liquidity and Capital Resources -- Transactions Regarding Reliance
Acceptance Group" including the servicing platform and certain servicing and
transition servicing arrangements. The Transferred Assets will not include cash
received by UDC prior to the Effective Date. The Transferred Assets had a net
book value of approximately $54.7 million and a net appraised value of
approximately $54.9 million as of June 30, 1998. However, it is expected that
the book value of the Transferred Assets will increase prior to the transfer
contemplated herein as additional contracts are acquired under warehouse
purchase facilities or additional advances are made under operating credit lines
through the Cygnet Dealer Program.
The Company is currently evaluating a certain transaction for the
acquisition or management of an operating insurance agency. For a description of
certain additional transactions that recently have been or may be effected by
the Company prior to the Split-up ("Interim Transactions"), see
"Business -- Recent Developments."
UDC would retain its used car dealership operations, its securitization
program, the servicing rights and its interests in the bankruptcy remote
subsidiaries that own residual interests in all securitization transactions
previously effected by UDC, and its rent-a-car franchise business which is
generally inactive. UDC would continue to service, through its loan servicing
and collection facilities located in Phoenix, Arizona, San Antonio, Texas,
Dallas, Texas, and Tampa, Florida, the automobile receivables in its various
securitized pools, receivables purchased through its Branch Office network that
was closed in the first quarter of 1998 (whether securitized or retained), as
well as the receivables serviced pursuant to the transactions effected in
September 1997 with Kars-Yes Holdings, Inc. and related companies ("Kars"). In
September 1997, UDC purchased substantially all of the dealership and loan
servicing assets of Kars, including 12 dealerships. Although UDC did not acquire
the contract portfolio of Kars, it did acquire the Kars' loan servicing assets
and began servicing Kars' retained portfolio and portfolios previously
securitized by Kars, which aggregated approximately $98.8 million at March 31,
1998. UDC would also retain certain rights and direct obligations relating to
the FMAC and Reliance transactions.
CONSIDERATION FOR THE TRANSFERRED ASSETS
As consideration for the Transferred Assets, on the Effective Date, the
Company would issue to UDC 40,000 shares of Cumulative Convertible Preferred
Stock, Series A, $.001 par value per share (the "Preferred Stock"), with an
aggregate liquidation preference of $40 million and make a cash or equivalent
payment (the "Cash Payment") equal to the difference between the greater of the
appraised value or the book value of the Transferred Assets and the $40 million
of Preferred Stock (except with respect to one intangible asset, with a current
book value of approximately $575,000 as to which no value has been assigned by
the parties). The Company may also be required to repay to UDC any Interim
Company Loans, would pay the excess, if any, of the aggregate appraised value,
as of the Effective Date, of the assets and rights and related liabilities
acquired by the Company in such Interim Transactions ("Interim Assets") over the
aggregate book value of such Interim Assets (the "Interim Consideration"), and
would distribute to UDC any earnings accrued prior to the Effective Date. UDC
may also require the release of any guarantee of Third Party Loans to the
Company. Alternatively, UDC and the Company may agree as to other treatment of
the Interim Transactions if UDC believes that such other treatment results in
adequate consideration to UDC at the time of the Split-up with respect to the
Interim Assets. The purpose for the payment by the Company to UDC of the Interim
Consideration is to place both parties in substantially the same economic
position each would be in if the Interim Transactions were effected by UDC
rather than the Company and the resulting assets and liabilities were
transferred to Cygnet.
The Preferred Stock, in preference to the Common Stock, would be entitled
to receive cumulative cash dividends, from the Effective Date through the first
anniversary of such date, at the initial annual rate of 7% of the Base
Liquidation Amount (defined below), and escalating 1% per annum on each
anniversary thereafter to
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<PAGE> 33
a maximum rate of 11% per annum on the aggregate Base Liquidation Amount, in
each case payable quarterly in arrears on the first day of March, June,
September, and December of each year, beginning December 1, 1998, when and as
declared by the Board of Directors of the Company out of funds legally available
for such payment. The Preferred Stock, in preference to the Common Stock, will
be entitled to receive, in the event of dissolution or liquidation of the
Company, $1,000 per share (the "Base Liquidation Amount") plus accrued and
unpaid dividends thereon (the "Liquidation Preference Amount").
The Preferred Stock will be redeemable at the Company's option in whole or
in part at any time at a redemption price of $1,000 per share, plus dividends
accrued and unpaid thereon to the redemption date; provided, however, that no
such redemption will be authorized unless, in the judgment of the Company and
UDC, the proceeds of such redemption would be treated for federal income tax
purposes as proceeds from a sale of such stock and not as dividends paid with
respect to such stock. The Preferred Stock will be convertible in whole or in
part at any time after the third anniversary following issuance at the option of
UDC into that number of shares of Common Stock determined by dividing the
Liquidation Preference Amount of the shares of Preferred Stock to be converted
by the lower of (a) the Subscription Price or (b) 80% of the average Market
Price (defined below) for the 10 consecutive trading days ending two business
days prior to the date notice of conversion is given, subject to adjustment upon
certain extraordinary events. In addition, the Preferred Stock will be
convertible during any period following the date that an amount equal to six
quarterly dividend payments on the Preferred Stock has accrued and is unpaid,
until the payment in full of all accrued dividends. For purposes of the
conversion of the Preferred Stock, "Market Price" means (i) if the Common Stock
is quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on a
national securities exchange, the daily per share closing price of the Common
Stock as quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or
on the principal stock exchange on which it is listed on the trading day in
question, as the case may be, whichever is the higher, or (ii) if the Common
Stock is traded in the over-the-counter market and not quoted on the Nasdaq
National Market or the Nasdaq SmallCap Market or on any national securities
exchange, the closing bid price of the Common Stock on the trading day in
question, as reported by Nasdaq or an equivalent generally accepted reporting
service. The Preferred Stock will not have any pre-emptive or other subscription
rights.
Except as described below, holders of the Preferred Stock will not be
entitled to vote for the election of directors or for other matters on which
holders of the Common Stock are entitled to vote. In the event that an amount
equal to two quarterly dividend payments on the Preferred Stock shall have
accrued and be unpaid, the holders of the Preferred Stock will have the right,
voting separately as a class, to elect two members to the Board of Directors of
Cygnet (in addition to the then authorized number of directors) at the next
meeting of stockholders of Cygnet and thereafter until all accrued dividends on
the Preferred Stock have been paid in full. The Preferred Stock shall also have
voting rights on certain extraordinary matters as described herein. See
"Description of Capital Stock -- Preferred Stock." In such case, each share of
Preferred Stock shall have one vote per Base Liquidation Amount.
If the Preferred Stock were converted to Common Stock at the subscription
price of $7.00 per share, UDC would obtain 5,714,286 shares, or approximately
61.6% of the then outstanding shares of the Company, assuming the sale by the
Company pursuant to the Rights Offering of 3,562,500 shares of Common Stock (the
Required Purchase Amount) and that no additional shares of Common Stock are
issued either on the Effective Date of the Split-up or thereafter. If the
Preferred Stock were converted to Common Stock at the subscription price of
$7.00 per share, and assuming the sale by the Company of 4,750,000 shares of
Common Stock pursuant to the Rights Offering and the sale of 714,286 additional
shares to Ernest C. Garcia, II and 214,286 shares available for purchase by
officers and directors of the Company (other than Mr. Garcia) and that no
additional shares of Common Stock are then outstanding, UDC would obtain
approximately 50.2% of the then outstanding shares of UDC.
The Preferred Stock and the Common Stock into which it is convertible are
not registered under the Securities Act and may not be sold by UDC unless such
securities are registered or unless an exemption from registration is available.
The Company will register the resale of the Common Stock issued upon conversion
of the Preferred Stock under the Securities Act, at its expense, upon request of
the Company.
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<PAGE> 34
For a description of certain risks relating to the Preferred Stock, see
"Risk Factors -- Risks Relating to the Rights Offering -- Risks Relating to the
Preferred Stock."
CONTINGENCIES TO THE SPLIT-UP AND THE CLOSING THEREOF
The making of the Rights Offering and the closing of the Split-up are
subject to certain contingencies in addition to approval of the Split-up
Proposal by UDC's stockholders and the requisite investment being made in the
Company either through the Rights Offering or otherwise, as described herein.
Various consents, waivers, and approvals are required to be obtained by UDC or
its subsidiaries prior to either the initiation of the Rights Offering or the
effectuation of the Split-up. These include, without limitation, (i) the consent
of certain parties that are required in order to allow a subsidiary of Cygnet to
service the contracts currently being serviced pursuant to the FMAC and Reliance
transactions, and (ii) the consent of General Electric Capital Corporation ("GE
Capital") as the primary lender to UDC under UDC's revolving credit facility. In
addition, the Company will be required to obtain certain regulatory approvals
and licenses. The Effective Date of the Split-up is expected to occur shortly
following the Expiration Date of the Rights Offering but may be delayed to a
date not later than 30 days following the Expiration Date. UDC has prepared or
is in the process of preparing such consents and has contacted or is contacting
various third parties to obtain such consents. UDC and the Company will attempt
to obtain all required consents before the Annual Meeting. However, there can be
no assurance that all required consents will be obtained by such date or at all.
More specifically, the issuance of the Rights following the requisite
approval by UDC's stockholders of the Split-up Proposal is conditioned upon,
among other things, (i) the execution and delivery of the Capitalization
Agreement described above under "Principal Agreements Relating to the Rights
Offering" and other required intercompany agreements; (ii) all required
authorizations, consents, approvals, and clearances of all federal, state,
local, and foreign governmental agencies and all other persons required therefor
having been obtained and in effect, without any conditions being imposed that
would have a material adverse effect; (iii) no preliminary or permanent
injunction or other order or decree, ruling issued in a court of competent
jurisdiction or by a governmental, regulatory, or administrative agency or
commission, and no statute, rule, regulation, or executive order promulgated or
enacted by any governmental authority, being in effect preventing the Rights
Offering; (iv) the satisfactory resolution of all legal and regulatory issues;
and (v) the Rights being deliverable in accordance with the applicable law. Even
if all of the above conditions are satisfied, the Rights Offering may be
abandoned or postponed, or conditions thereto waived, at any time prior to the
Commencement Date or thereafter for any reason in the sole discretion of UDC's
Board of Directors.
Similarly, the effectuation of the Split-up following the Rights Offering
and the achievement of the requisite investment in the Company is conditioned
upon, among other things, (i) certain transactions contemplated by the
Capitalization Agreement having been consummated in all material respects; (ii)
all required authorizations, consents, approvals, and clearances of all federal,
state, local, and foreign governmental agencies and all other persons required
to permit the valid consummation of the transactions contemplated by the
Capitalization Agreement having been obtained, without any conditions being
imposed that would have a material adverse effect; (iii) no preliminary or
permanent injunction or other order, decree, or ruling issued by a court of
competent jurisdiction or by a government, regulatory, or administrative agency
or commission, and no statute, rule, regulation, or executive order promulgated
or enacted by any governmental authority, being in effect preventing the
Split-up; (iv) the Common Stock being deliverable in accordance with applicable
law; (v) the execution and delivery of the required intercompany agreements; and
(vi) both UDC and the Company having in place separate financing facilities and
capital resources that will, in the judgment of the Board of Directors of each
such entity, be sufficient to allow the continuing operations of each such
entity without material disruption of business operations. These conditions may
be waived by the Board of Directors of UDC and/or Cygnet at any time. Even if
all the above conditions are satisfied, the Capitalization Agreement may be
amended or terminated, and the closing of the Split-up may be abandoned, or
conditions thereto may be waived, at any time prior to the Expiration Date or
thereafter for any reason in the sole discretion of UDC's Board of Directors.
UDC does not expect to effect the Split-up if the Rights Offering is not
consummated.
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OPINION OF APPRAISER
In connection with the Split-up, the Board of Directors of UDC engaged
Willamette Management Associates ("Willamette" or the "Appraiser") to estimate
the fair market value of the Transferred Assets, the Preferred Stock, and the
Rights and requested that Willamette render an appraisal (the "Appraisal")
regarding the fair market value of each. Willamette delivered its oral opinion
to the Boards of Directors of UDC and Cygnet on July 16, 1998, subsequently
confirmed in writing on July 21, 1998, to the effect that, based upon and
subject to the factors and assumptions set forth in such opinion, the fair
market value of the Transferred Assets, as of June 30, 1998, is $54.9 million,
the fair market value of the Preferred Stock on the date of its issuance will be
$40 million, and the Rights will have no value as of the date of their
distribution.
Willamette believes the Appraisal was prepared in conformity with the
Uniform Standards of Professional Appraisal Practice as promulgated by The
Appraisal Foundation and endorsed by the American Society of Appraisers. No
limitations were imposed by UDC or Cygnet with respect to the investigations
made or the procedures followed by Willamette in rendering its Appraisal.
Willamette's Appraisal indicates that it is provided for the use of UDC's and
Cygnet's Board of Directors in their determination of the consideration to be
paid by the Company for the Transferred Assets and for assessing the likely
consequences of the sale of the Transferred Assets for federal income tax
purposes, Willamette's Appraisal and presentation to the Boards of Directors of
UDC and Cygnet were among the many factors taken into consideration by the
Boards in making their determination to approve, and of the UDC Board to
recommend that UDC's stockholders approve, the Split-up. Willamette has
consented to inclusion of this summary in this Prospectus.
In making its Appraisal, Willamette reviewed certain information, including
drafts of this Prospectus and the Notice and Proxy Statement of UDC relating to
the Split-up, financial analyses of certain bulk portfolios of FMAC and
Reliance, and internal financial analyses and forecasts of UDC and the Company
prepared by the management. Willamette also had discussions with members of the
senior managements of the Company and UDC to discuss the Split-up and has
considered other matters deemed relevant to its inquiry. In performing its
analysis, Willamette made numerous assumptions with respect to industry
performance, general business and economic conditions, and the performance of
the Transferred Assets, such as the rate of industry growth, inflation, interest
rates, charge-off rates, and recovery rates, many of which are beyond the
control of UDC and the Company. The analyses performed by Willamette are not
necessarily indicative of actual values or actual future results which may be
significantly more or less favorable than those suggested by such analyses.
In connection with its analysis, Willamette assumed and relied upon the
accuracy and completeness of the foregoing information and did not assume any
responsibility for independent verification of such information. With respect to
portfolio forecasts, Willamette assumed that the forecasts and assumptions
provided to Willamette had been reasonably prepared on bases reflecting the best
currently available estimates and judgments of the management of UDC and the
Company, as the case may be, as to the future financial performance of the
respective portfolios, and that they provided a reasonable basis upon which
Willamette could form an opinion. The projections are based on numerous
variables and assumptions which are inherently unpredictable and must be
considered not certain of occurrence as projected. Accordingly, actual results
could vary significantly from those set forth in such projections. Willamette
also assumed that there had been no material changes to the Transferred Assets
since the respective dates of the last financial statement made available to
Willamette and that no material adverse change will subsequently occur to the
Transferred Assets. In addition, Willamette also assumed that the Split-up would
be consummated in accordance with the terms set forth in this Prospectus.
Willamette did not assume responsibility for making a physical inspection of the
Transferred Assets. Willamette will update its appraisal of the Transferred
Assets as of the Effective Date.
Transferred Assets. In the context of the appraisal of the Transferred
Assets, Willamette employed various valuation methodologies. For example,
Willamette used a discounted cash flow analysis with respect to the market value
of certain loan servicing contracts which contain back-end collection incentives
using a discounted cash flow analysis. This analysis involved (i) the projection
of future cash flows generated by the underlying portfolios of sub-prime
automobile finance receivables, (ii) the required distribution of projected
portfolio collections to creditors of the contract owners, (iii) the payment of
certain servicing, auditing, and
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<PAGE> 36
insurance fees, and (iv) an allocation of any residual cash flows based on the
terms and conditions of the governing servicing agreement. Where possible,
Willamette based its discounted cash flow assumptions on the historical
financial activity of the loan portfolios underlying the loan servicing
contracts.
With respect to loans securitized by FMAC, Willamette calculated the range
of net residual cash flows, based on varying assumptions, including projected
charge-offs, recoveries, prepayments, loan servicing and collection costs, and
distributions, if any, of net cash flows to the creditors of FMAC (including
with respect to a credit facility to be transferred to the Company at the
Effective Date, which at June 30, 1998 had a balance of $9.8 million), to be
$12.9 to $34.4 million, with a most likely result of $17.2 million. Willamette
concluded that the net present value of the residual cash flows of the FMAC
portfolio allocable to the Company is $77,133 in excess of the book value.
With respect to contracts owned by FMAC, sold to a third party and in which
the Company maintains a residual interest, Willamette calculated the range of
net residual cash flows, based on varying assumptions, including projected
charge-offs, recoveries, prepayments, loan servicing and collection costs, and
distributions, if any, of net cash flows to the current owner, to be $5.5 to
$13.2 million, with a most likely result of $9.5 million. Willamette concluded
that the net present value of the residual cash flows allocable to the Company,
is $2,003 in excess of the book value of the Company's residual interest.
With respect to the Reliance loan portfolio, Willamette calculated the
range of net residual cash flows, based on varying assumptions including
projected charge-offs, recoveries, prepayments, loan servicing and collection
costs, and distributions, if any, of net cash flows to creditors of Reliance, to
be negative $12.5 to positive $15.9 million, with a most likely result of
$683,756. Willamette concluded that the net present value of the residual cash
flows of the Reliance portfolio allocable to the Company, less the value of the
warrants issued in connection with the Reliance transaction, is $143,713 in
excess of the book value.
With respect to assets of a short-term nature that have a book value on the
June 30, 1998 financial statements of the Company that represent a net cash
realizable value, Willamette relied on the opinion of management of UDC and the
Company that the companies have adequately provided for net credit losses on
such assets. Willamette estimated that the book value of such assets is
reasonably representative of fair market value.
The following table summarizes the book value and the appraised value of
the Transferred Assets as of June 30, 1998 (in thousands):
<TABLE>
<CAPTION>
BOOK APPRAISED
VALUE VALUE DIFFERENCE
----- --------- ----------
<S> <C> <C> <C>
Assets:
Cash and Cash Equivalents............................ $ 232 $ 232 $ --
Finance Receivables.................................. 26,333 26,333 --
Notes Receivables.................................... 23,027 23,027 --
Property and Equipment............................... 2,335 2,335
Goodwill............................................. 1,138 1,138 --
Other Assets......................................... 4,338 4,560 222(1)
Assumed Liabilities:
Accrued Expenses and Other Liabilities............... 2,464 2,464 --
Note Payable......................................... 298 298 --
------- ------- ----
Transferred Assets......................... $54,641 $54,863 $222(1)
======= ======= ====
</TABLE>
- ---------------
(1) The difference between the appraised value and the book value of Other
Assets is due to an appraised value of $222,000 for incentive fees under
loan servicing agreements which have a book value of $0.
Preferred Stock. In the context of the appraisal of the Preferred Stock,
Willamette employed a dividend capitalization method, concluding that the most
important factor in the value of a preferred stock is the stock's dividend rate.
Willamette estimated the fair market value of the Preferred Stock by comparing
certain pro
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<PAGE> 37
forma financial and market information for the Company with the corresponding
publicly available data and statistics of 77 publicly traded convertible
preferred stocks, such as dividend and interest coverage ratios, liquidation
coverage ratio, interest expense coverage ratio, fixed charged ratio, earnings
before interest, taxes and return on total capital. Based on this comparison,
Willamette selected an appropriate preferred dividend capitalization yield to
apply to the indicated annual dividend of the Preferred Stock.
Willamette reviewed a number of preferred stock issues rated by the Value
Line Convertible Survey and S&P Stock Guide in analyzing the Preferred Stock.
The selected preferred stock issues reviewed by Willamette had median before-tax
yields to investors of 3.61% (rated C and D by Value Line), 6.19% (rated E),
7.18% (rated F), 6.91 (rated G), and 7.90% (rated H and I), with an overall
median yield of 6.69%. The selected preferred stock issues had median dividend
and interest coverage ratios of 3.97% (rated C and D), 3.41% (rated E), 2.12%
(rated F), 2.52 (rated G), and 2.44% (rated H and I), with an overall median
ratio of 2.79%. In addition, the selected preferred stock issues had median
liquidation interest coverage ratios of 7.84% (rated C and D), 3.04% (rated E),
3.18% (rated F), 3.07 (rated G), and 1.37% (rated H and I), with an overall
median ratio of 4.25%. Willamette noted that, although the Preferred Stock to be
issued by the Company is not expected to be rated by any of the recognized U.S.
rating agencies, the characteristics of the Company and the Preferred Stock were
most similar to the preferred stock issues rated F and G.
Based on its analysis, Willamette estimated that an appropriate dividend
capitalization yield for the Preferred Stock is 7.0% and determined that the
fair market value of the Preferred Stock should equal $40 million on the
Effective Date based upon such analysis.
Rights. With respect to the valuation of the Rights, Willamette concluded
that although analysts commonly rely on a variety of option pricing models to
determine the value of rights and other instruments to purchase common stock,
such option pricing models were inappropriate in connection with the Rights. For
example, a standard option provides the option holder with the ability to
observe the current trading price of the underlying common stock before deciding
to exercise the option. If the exercise price of the option is greater than the
current trading price of the underlying common stock, the option is generally
regarded as "out-of-the-money" and the option holder will not exercise the
option. If, however, the current trading price of the underlying common stock is
greater than the exercise price of the option, the option is regarded as being
"in-the-money" and the option holder will exercise such option. In contrast,
holders of Rights will be unable to observe the underlying Common Stock price
before deciding whether to exercise Rights.
Willamette, therefore, determined that the Rights would be valuable only to
the extent that a Rights holder was able to acquire the underlying Common Stock
at a price below its market value. Taking into consideration the value of the
Transferred Assets, the purchase price payable therefor by the Company, and
taking into consideration the proceeds from the sale of the projected shares of
Common Stock, Willamette concluded that the Rights will merely provide the
Rights holders with the ability to acquire the Common Stock at its fair market
value. As a consequence, Willamette found the Rights to have no intrinsic value.
While the foregoing summary describes all analysis and examinations that
Willamette deems material to its Appraisal, it is not a comprehensive
description of all analyses and examinations actually conducted by Willamette.
The preparation of an appraisal necessarily is not susceptible to partial
analysis or summary description. Willamette believes that such analyses and the
summary set forth above must be considered as a whole and that selecting
portions of such analyses and of the factors considered without considering all
such analyses and factors would create an incomplete view of the process
underlying the analyses set forth in its presentation to the Boards of Directors
of UDC and Cygnet.
Willamette is a nationally recognized independent business valuation and
financial advisory firm regularly engaged in the valuation of publicly traded
and closely held investment securities in connection with mergers and
acquisitions, divestitures, employee stock ownership plans, public offerings,
gift and estate taxes, corporate and partnership recapitalizations, private
placements, and similar transactions. Willamette was selected by UDC to perform
the Appraisal because of its prior experience, reputation, and expertise in
valuation and corporate finance. Willamette has not provided any appraisal or
other services to UDC or the Company within the past two years, but could
provide such services to UDC, the Company, or affiliates in the future.
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In connection with Willamette's engagement, UDC will pay Willamette a fee
of $75,000. In addition, UDC has agreed to reimburse Willamette for all
reasonable out-of-pocket expenses incurred in connection with the services
provided by Willamette, and to indemnify and hold harmless Willamette to the
full extent lawful from and against certain liabilities, which may be construed
to include certain liabilities under the federal securities laws, in connections
with its engagement. Willamette is independent of the parties to the Split-up,
and its fee is not contingent in any way upon the completion or ultimate outcome
of the Split-up.
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FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of the material federal income tax consequences,
based upon current law, which is subject to prospective or retroactive change at
any time, of the distribution and ownership of Rights, the exercise of Rights,
the acquisition of Common Stock incident to the exercise of Rights, and the
transfer and lapse of Rights without exercise or transfer. These tax
consequences may vary depending upon a Rights Offering Participant's particular
situation. Certain Rights Offering Participants (including the Standby
Purchaser, insurance companies, tax-exempt organizations, financial
institutions, broker-dealers, foreign corporations and persons who are not
citizens or residents of the United States) may be subject to special rules not
discussed below. THIS SUMMARY IS FOR GENERAL INFORMATION PURPOSES ONLY.
ACCORDINGLY, EACH RIGHTS OFFERING PARTICIPANT SHOULD CONSULT HIS OWN TAX ADVISOR
AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OF THESE TRANSACTIONS, INCLUDING
THE APPLICABILITY AND EFFECT OF ALL FEDERAL, STATE, LOCAL, AND FOREIGN TAX LAWS.
The Company has been advised by Snell & Wilmer L.L.P. ("Tax Counsel") that
under current interpretations of case law, the Code, and applicable regulations,
all of which are subject to prospective or retroactive change at any time, it is
the opinion of Tax Counsel that the federal income tax consequences to holders
of UDC Common Stock with respect to the Rights will be as set forth below. No
rulings will be sought from the Internal Revenue Service with respect to the
treatment of the Rights. The opinion of Tax Counsel represents its best legal
judgment and has no binding effect or official status of any kind. The opinion
of Tax Counsel assumes that the Rights Offering will be effected in accordance
with the description thereof in this Prospectus and the applicable provisions of
the Capitalization Agreement. No assurance can be given that contrary positions
may not be taken by the Internal Revenue Service or by any court of law. Because
of the predominantly factual nature of the fair market value of the Rights, Tax
Counsel expresses no opinion with respect to the fair market value of the Rights
for purposes of the discussion below or elsewhere in this document.
Distribution of Rights to Holders of UDC Common Stock. The transfer from
Cygnet to the holders of UDC Common Stock of the Rights, representing the right
to acquire shares of Common Stock, will be treated, for federal income tax
purposes, as (1) a distribution of the Rights by Cygnet to UDC, followed by (2)
a distribution of the Rights from UDC to the holders of UDC Common Stock.
Holders of UDC Common Stock will recognize dividend income (taxable as ordinary
income) on the date of the distribution in an amount equal to the fair market
value, if any, of the Rights as of the date of distribution, but only to the
extent that the amount of the distribution is properly sourced in UDC's current
or accumulated earnings and profits (as determined for federal income tax
purposes) in its taxable year of the distribution. That portion, if any, by
which the fair market value of the Rights exceeded UDC's current or accumulated
earnings and profits would be treated as a return of capital to the extent of
the holder's tax basis in his UDC Common Stock and, then, as gain from the sale
of such stock to the extent of any remaining excess.
Corporate holders of UDC Common Stock (other than S corporations) receiving
Rights and recognizing dividend income would be entitled to the
dividends-received deduction for corporations (generally 70%, but 80% under
certain circumstances) with respect to such dividends, to the extent applicable,
taking into consideration all limitations on the claiming of the
dividends-received deduction. With respect to specific limitations on claiming
the dividends-received deduction, corporate holders of UDC Common Stock should
consider the effect of Code Section 246(c) which disallows the
dividends-received deduction with respect to any dividend on any share of stock
that is held for 45 days or less during the 90-day period beginning on the date
which is 45 days before the date on which such stock becomes ex-dividend with
respect to such dividend. Additionally, corporate holders of UDC Common Stock
that have incurred indebtedness directly attributable to an investment in UDC
Common Stock should consider the effect of Code Section 246A which reduces the
dividends-received deduction by a percentage generally computed based on the
amount of such indebtedness and the holder's total adjusted tax basis in the
shares.
The Appraiser has determined, pursuant to its opinion dated July 21, 1998,
that the value of the Rights as of the date of the distribution of the Rights
should be zero. However, the opinion of the Appraiser is not
39
<PAGE> 40
binding on the Internal Revenue Service. For example, the Internal Revenue
Service may assert that the price at which the Rights trade during the 20-day
trading period of the Rights is indicative of the fair market value of the
Rights on the date of their distribution. Accordingly, there can be no assurance
as to the exact amount of dividend income, if any, a holder of UDC Common Stock
will recognize upon the receipt of the Rights. If the Rights are trading for
value on the date of their distribution, UDC may, in its discretion, report to
holders of UDC Common Stock the receipt of dividend income in an amount equal to
the average of the high and low trading prices of the Rights on such date.
Ownership of Rights. Each Rights Offering Participant who receives Rights
will have a tax basis in the Rights equal to the fair market value thereof.
Further, each Rights Offering Participant who receives Rights will have a
holding period for his Rights that begins on the date of receipt of the Rights.
Exercise of Rights. Rights Offering Participants, whether corporate or
noncorporate, will recognize neither gain nor loss upon the exercise of Rights.
A Rights Offering Participant who receives shares of Common Stock upon exercise
of the Rights will acquire a tax basis in such shares equal to the sum of the
Subscription Price paid under the Rights Offering and the tax basis (if any) of
the Rights Offering Participant in the Rights.
Transfer of Rights. The transferable nature of the Rights will permit a
Rights Offering Participant to sell Rights prior to exercise. Pursuant to Code
Section 1234, a Rights Offering Participant who sells Rights prior to exercise
will be entitled to treat the difference between the amount received for the
Rights and the adjusted tax basis (if any) of the Rights Offering Participant in
the Rights as a short-term capital gain or capital loss, provided that the
shares of Common Stock subject to the Rights would have been a capital asset in
the hands of the Participant had it been acquired by such holder. The gain or
loss so recognized will be short-term since the Rights will have been held for
less than twelve months.
Non-Exercise of Rights. The federal income tax treatment applicable to
Rights Offering Participants who fail to exercise or transfer their Rights prior
to the Expiration Date also is set forth in Code Section 1234. Rights Offering
Participants who allow their Rights to lapse will be deemed under the Code to
have sold their Rights on the date on which the Rights expire. Since no
consideration will be received by Rights Offering Participants upon such lapse
and since the Rights will have been held for less than twelve months, a short-
term capital loss equal to the tax basis (if any) in the Rights will be
sustained by the holder on such lapse, provided that the shares of Common Stock
subject to the Rights would have been a capital asset in the hands of the
Participant had it been acquired by such holder.
Short-term capital losses incurred by non-corporate taxpayers may be used
to offset short-term or long-term capital gains realized, plus up to $3,000
($1,500 in the case of a married individual filing a separate return).
Non-corporate taxpayers may carry forward indefinitely, but may not carry back,
unused net capital losses. When carried forward by non-corporate taxpayers,
short-term capital losses retain their short-term character and are treated as
sustained in the taxable year to which they are carried forward. Short-term
capital losses incurred by corporations may be used only to offset short-term or
long-term capital gains. Unused capital losses, however, generally may be
carried back by corporate taxpayers to the three taxable years preceding the
loss year and carried forward to the five succeeding taxable years. When carried
back or carried forward, short-term capital losses retain their character as
short-term and are treated as sustained in the taxable year to which they are
carried. Accordingly, certain Rights Offering Participants who allow their
Rights to lapse may recognize ordinary income upon receipt of the Rights and a
potentially deferred or nondeductible capital loss upon the lapse of such
Rights. FOR THIS REASON, IN MOST INSTANCES, IT WILL BE IN A RIGHTS OFFERING
PARTICIPANT'S INTEREST TO EITHER EXERCISE OR SELL RIGHTS RATHER THAN TO ALLOW
RIGHTS TO LAPSE.
40
<PAGE> 41
USE OF PROCEEDS
The minimum net proceeds to the Company, assuming the sale of 75% of the
Offered Shares, the minimum necessary to satisfy the Required Purchase Amount
and complete the Rights Offering, are estimated to be approximately $23,662,500,
after deducting estimated offering expenses allocable to and payable by the
Company. If all of the Offered Shares (including shares available pursuant to
the Additional Purchase Right and D&O Purchase Right) are purchased pursuant to
the Rights Offering, the net proceeds to the Company, after deducting estimated
offering expenses allocable to and payable by the Company, are estimated to be
approximately $38,475,000.
The Company intends to use a portion of the net proceeds of this Rights
Offering to make the Cash Payment to UDC as partial consideration for the
transfer of the Transferred Assets from UDC to the Company. The Cash Payment
will be equal to the difference between the greater of the appraised value or
the book value (in each case net of assumed liabilities) of the Transferred
Assets and the $40 million of Preferred Stock. The Company does not believe that
the appraised value of the Transferred Assets will materially differ from their
book value and currently estimates that the Cash Payment will range from $10
million to $20 million. In lieu of cash, the Company may satisfy a portion of
the Cash Payment by delivering for cancellation an existing $10 million
subordinated note currently owed by UDC to Verde Investments, Inc. ("Verde"), an
affiliate of UDC wholly-owned by Mr. Garcia (the "Verde Note"), subject to the
receipt of certain required consents, but only if Verde elects to deposit the
Verde Note or any part thereof with the Company in payment of all or any portion
of the Subscription Price for exercise of Rights acquired by Verde from Mr.
Garcia or otherwise. The remainder of the net proceeds, which the Company
estimates will range (i) from $2.3 million to $12.3 million assuming the sale of
75% of the Offered Shares pursuant to the Rights Offering after deducting
offering expenses allocable to and payable by the Company, or (ii) from $27.2
million to $17.2 million assuming the sale of all of the Offered Shares
(including shares available pursuant to the Additional Purchase Right and D & O
Purchase Right) pursuant to the Rights Offering after deducting offering
expenses allocable to and payable by the Company, will be used for capital
expenditures of approximately $1.0 million for computer and telecommunication
equipment and the balance for working capital.
DIVIDEND POLICY
The Company does not anticipate paying cash dividends on the Common Stock
in the foreseeable future. Instead, the Company intends to retain any future
earnings to finance the operation and expansion of the Company's business. In
addition, the Company has secured a loan with a third party lender of $5 million
of subordinated debt, the terms of which require the Company to maintain a debt
to tangible equity ratio not greater than 3 to 1, calculated as of the end of
each quarterly period in each fiscal year. Accordingly, under the terms of the
subordinated debt, if a proposed payment of dividends would cause the Company to
exceed this ratio, the Company would be unable to pay such dividends even if it
were otherwise in a position to do so. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations." Pursuant to the terms of the
Preferred Stock, the Company will be required to pay cumulative cash dividends
to UDC, from the Effective Date through the first anniversary of such date, at
the initial annual rate of 7% of the Base Liquidation Amount (defined below),
and escalating 1% per annum on each anniversary thereafter to a maximum rate of
11% per annum on the aggregate Base Liquidation Amount, in each case payable
quarterly in arrears on the first day of March, June, September, and December of
each year, beginning December 1, 1998, when and as declared by the Board of
Directors of Cygnet out of funds legally available for such payment. The Company
intends to pay dividends on the Preferred Stock on a timely basis.
41
<PAGE> 42
CAPITALIZATION
The table sets forth below (i) the combined capitalization of the Company
as of June 30, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,750,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company and payment in full of the
Advance from Affiliate; and (iii) the pro forma as adjusted capitalization of
the Company to give effect to the sale of 4,750,000 shares of Common Stock
offered hereby and the sale of 214,286 shares of Common Stock pursuant to the
D&O Purchase Right and 714,286 shares of Common Stock pursuant to the Additional
Purchase Right, in each case at the Subscription Price of $7.00 per share, after
deducting estimated offering expenses allocable to and payable by the Company
and payment in full of the Advance from Affiliate.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1998
-----------------------------------------
ACTUAL PRO FORMA AS ADJUSTED
----------- ----------- -----------
<S> <C> <C> <C>
Debt................................................ $ 298,000 $ 298,000 $ 298,000
Advances from Affiliate............................. 15,818,000 -- --
Stockholders' equity
Preferred Stock, $.001 par value, 500,000 shares
authorized; none issued; 40,000 shares issued,
pro forma; 40,000 shares issued pro forma, as
adjusted....................................... -- 40,000,000 40,000,000
Common Stock, $.001 par value, 14,000,000 shares
authorized; 1 issued; 4,750,000 shares issued
pro forma; 5,679,000 shares issue pro forma, as
adjusted....................................... -- 4,750 5,679
Additional paid-in capital........................ 40,000,000 31,970,250 38,469,325
Retained earnings................................. -- -- --
----------- ----------- -----------
Total stockholders' equity................ 40,000,000 71,975,000 78,475,004
----------- ----------- -----------
Total capitalization...................... $56,116,000 $72,273,000 $78,773,004
=========== =========== ===========
</TABLE>
- ---------------
Excludes (i) approximately 284,000 shares of Common Stock issuable upon
exercise of stock options to be granted on the Effective Date, (ii) 115,000
shares of Common Stock issuable upon exercise of warrants anticipated to be
issued to the Company's subordinated debt lender, (iii) 500,000 shares of
Common Stock issuable upon exercise of the Standby Warrants, (iv) 41,429 shares
of Common Stock issuable upon the issuance of restricted stock grants to be
granted on the Effective Date, and (v) 28,571 shares of Common Stock issuable
upon exercise of stock options to be granted on the Effective Date.
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<PAGE> 43
SELECTED COMBINED FINANCIAL DATA
The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of the year
ended December 31, 1997, are derived from the combined financial statements of
Cygnet Financial Corporation, which combined financial statements have been
audited by KPMG Peat Marwick LLP, independent certified public accountants. The
combined financial statements as of December 31, 1997 and for the year then
ended, and the report thereon, are included elsewhere in this prospectus. The
selected data presented below for the six-month periods ended June 30, 1998 and
1997, and as of June 30, 1998, are derived from the unaudited condensed combined
financial statements of Cygnet Financial Corporation included elsewhere in this
prospectus. The results of operations of any interim period are not necessarily
indicative of results to be expected for a full fiscal year. For additional
information, see the combined financial statements and notes thereto of the
Company included elsewhere in this prospectus. The following table should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, DECEMBER 31, 1997
----------------- -----------------
1998 1997
------- ------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues......................................... $12,550 $ 137 $15,959
Interest Income..................................... 6,382 137 7,472
Servicing Fees...................................... 4,937 -- --
Net Gain on Sale of Repossessed Collateral.......... 1,108 -- --
Gain on Sale of Notes Receivable.................... -- -- 8,132
Other Income........................................ 123 -- 355
Operating Expenses:
Provision for Credit Losses......................... 965 -- 691
Selling and Marketing Expense....................... 36 9 18
General and Administrative.......................... 9,001 1,008 3,766
Depreciation and Amortization....................... 230 62 153
------- ------ -------
Total Operating Expenses............................... 10,232 1,079 4,628
------- ------ -------
Earnings (Loss) Before Interest Expense................ 2,318 (942) 11,331
Interest Expense....................................... 1,714 37 2,067
------- ------ -------
Earnings (Loss) before Income Taxes.................... 604 (979) 9,264
Income Taxes (Benefit)................................. 244 (394) 3,728
------- ------ -------
Net Earnings (Loss).................................... $ 360 $ (585) $ 5,536
======= ====== =======
Proforma Basic/Diluted Earnings (Loss) per Share(2).... $ (0.18) $(0.35) $ 0.48
======= ====== =======
Shares used in Computation(2).......................... 5,679 5,679 5,683
======= ====== =======
</TABLE>
43
<PAGE> 44
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30, 1998 YEAR ENDED
----------------------------------------- DECEMBER 31, 1997
PRO FORMA -----------------
ACTUAL PRO FORMA(1) AS ADJUSTED(1) ACTUAL
------- ------------ -------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents.......... $ 232 $16,167 $22,667 $ 1,225
Finance Receivables, Net........... 26,333 26,333 26,333 19,274
Notes Receivable, Net.............. 23,027 23,027 23,027 21,861
Total Assets....................... 58,580 74,515 81,015 50,034
Advances from Affiliate............ 15,818 -- -- 9,106
Total Note Payable................. 298 298 298 380
Total Stockholder's Equity......... 40,000 71,753 78,253 40,000
</TABLE>
- ---------------
(1) The table sets forth above (i) the combined capitalization of the Company as
of June 30, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,750,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company, a purchase price for the
Transferred Assets equivalent to UDC's June 30, 1998 net book value, and
payment in full of the Advances from Affiliate, which totaled $15,818,000 at
June 30, 1998; and (iii) the pro forma as adjusted capitalization of the
Company to give effect to the sale of 4,750,000 shares of Common Stock
offered hereby and the sale of 214,286 shares of Common Stock pursuant to
the D&O Purchase Right and 714,286 shares of Common Stock pursuant to the
Additional Purchase Right, assuming these rights are exercised in full, in
each case at the Subscription Price of $7.00 per share, after deducting
estimated offering expenses allocable to and payable by the Company, a
purchase price for the Transferred Assets equivalent to UDC's June 30, 1998
net book value, and payment in full of the Advances from Affiliate, which
totaled $15,818,000 at June 30, 1998. The Advances from Affiliate represents
the $14.9 million Cash Payment plus other working capital advances from UDC.
(2) For purposes of computing the proforma earnings per share for the periods
presented, the Company has assumed the maximum potential issuance of shares
of Common Stock totaling 5,678,572 shares pursuant to the planned Rights
Offering, the D&O Purchase Right and the Additional Purchase Right and for
dilutive stock options that will be granted on the effective date. See note
14 to the Company's audited financial statements included herein.
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<PAGE> 45
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
General. Cygnet Financial Corporation (the Company), a wholly-owned
subsidiary of Ugly Duckling Corporation (Ugly Duckling), was formed on June 1,
1998 for the purpose of consummating a transaction whereby Ugly Duckling would
split-up its operations into two publicly-held companies (the split-up). The
Company will purchase from Ugly Duckling, substantially all of Ugly Duckling's
non-dealership operations including, the bulk purchasing and certain servicing
operations (excluding the branch office network), it's third party dealer
financing operations, and substantially all other non-dealership assets and
contract rights including those acquired in the First Merchants Acceptance
Corporation Transaction and assume the liabilities related thereto (collectively
referred to as the acquired assets). In exchange for the acquired assets, the
Company will issue $40.0 million of its cumulative, convertible preferred stock
and a cash payment equivalent to the greater of the appraised value or the book
value of the acquired assets (in each case net of assumed liabilities), which
the Company does not expect to materially differ. These combined financial
statements reflect the results of operations, financial position, changes in
stockholder's equity and cash flows of the Company, as if the Company were a
separate entity operating the acquired assets for all periods presented. The
combined financial statements have been prepared using the historical basis in
the assets and liabilities and historical results of operations of the Company.
The Company provides qualified independent used car dealers with warehouse
purchase facilities and operating credit lines pursuant to its Cygnet Dealer
Program. In addition, the Company purchases loan portfolios in bulk and services
loan portfolios on behalf of third parties. The Company targets its products and
services primarily to the sub-prime segment of the automobile financing
industry, which focuses on selling and financing the sale of used cars to
Sub-Prime Borrowers.
Bulk Purchasing and Loan Servicing. The Company believes bulk purchase and
large servicing transactions are efficient methods of purchasing or obtaining
servicing rights to sub-prime automobile finance receivables. In this regard,
the Company has effected certain transactions with FMAC, pursuant to which the
Company has acquired significant servicing and other rights from FMAC, and
Reliance, pursuant to which the Company has entered into a servicing agreement
with Reliance through its bankruptcy case that, pursuant to bankruptcy court
approval, entitles the Company to service Reliance's finance receivable
portfolio. See "-- Transactions Regarding First Merchants Acceptance
Corporation" and "-- Transactions Regarding Reliance Acceptance Group."
Cygnet Dealer Program. Through the Cygnet Dealer Program, the Company
either purchases finance receivables under its Dealer Collection Program or
provides traditional revolving lines of credit under its Asset-Based Loan
Program. Under the Dealer Collection Program, the Company generally purchases
finance receivables on a full recourse basis from Third Party Dealers for 60% to
75% of the principal amount of the respective contract. The Company's Asset
Based Loan Program is similar to traditional asset-based lending relationships.
The Company generally advances 65% of the principal amount of the contract.
Under both programs, the Third Party Dealer retains responsibility for servicing
the contracts. The Third Party Dealer is generally entitled to a fee of 20% to
25% of gross collections for servicing the contracts purchased under the Dealer
Collection Program; however, the Company does not pay a servicing fee to Third
Party Dealers for servicing contracts under the Asset Based Loan Program.
Acquisition. In August 1997, the Company acquired substantially all of the
assets of American National Acceptance Corporation ("ANAC") in exchange for
approximately $9.1 million in cash. The acquisition was recorded in accordance
with the "purchase method" of accounting, and, accordingly, the purchase price
has been allocated to the assets purchased and the liabilities assumed based
upon the estimated fair values at the date of acquisition. The excess of the
purchase price over the fair values of the net assets acquired was approximately
$1.2 million and has been recorded as goodwill, which is being amortized over a
period of 15 years. The results of operations of ANAC have been included in the
Company's combined statement of operations from the acquisition date.
45
<PAGE> 46
The following discussion and analysis provides information regarding the
Company's combined financial position as of December 31, 1997 and June 30, 1998,
and its results of operations for the year ended December 31, 1997, and the six
month periods ended June 30, 1998 and 1997.
RESULTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Interest Income. Interest income consists of income recognized from the
Cygnet Dealer Program and interest income recognized from advances related to
the FMAC transaction.
Cygnet Dealer Program. Interest income from this category increased
by $5.2 million in the six month period ended June 30, 1998, from $137,000
in the six month period ended June 30, 1997. This increase is due to the
increase in finance receivables and advances under the Dealer Collection
and Asset Based Loan Programs, respectively, from the comparable period in
1997.
FMAC Transaction. Interest income for this category totaled $1.2
million in the six month period ended June 30, 1998 related to advances to
FMAC pursuant to various lending facilities. No such income was recognized
during the comparable period in 1997, as the Company did not begin
conducting business with FMAC until the third fiscal quarter of 1997.
Servicing Fees. The Company, which began it's third party loan servicing
operations in April 1998, generates servicing fees from the servicing of loan
portfolios. The fee is generally a percentage of the portfolio balance with a
minimum fee per loan serviced. Servicing fee revenue totaled $4.9 million in the
six month period ended June 30, 1998 compared to $0 in the comparable period in
1997.
Net Gain on Sale of Repossessed Collateral. In April 1998, the Company
purchased a pool of charged off loans from a third party. Future cash
collections are expected to come primarily from the repossession and sale of the
underlying collateral of the loans, and the amount and timing of such
collections cannot be reasonably estimated. Therefore, the Company is
recognizing revenue on the sale of the collateral using the cost-recovery
method. During the six month period ended June 30, 1998, the Company realized a
net gain on sale of repossessed collateral totaling $1.1 million compared to $0
in the comparable period in 1997.
Other Income. Other income generally represent revenues from services such
as periodic audits of borrowers and collateral monitoring and maintenance fees,
and loan commitment and processing fees. Other income increased from $0 in the
six month period ended June 30, 1997 to $123,000 in the six month period ended
June 30, 1998. This increase was due to the increase in finance receivables and
advances under the Dealer Collection and Asset Based Loan Programs,
respectively, from the comparable period in 1997.
Operating Expenses. Operating expenses consist of the provision for credit
losses, selling and marketing expenses, general and administrative expenses, and
depreciation and amortization.
Provision for Credit Losses. The provision for credit losses
increased from $0 in the six month period ended June 30, 1997 to $965,000
in the six month period ended June 30, 1998. This increase was due to the
increase in finance receivables and advances under the DCP and ABL
programs, respectively, from the comparable period in 1997.
General and Administrative Expenses. General and administrative
expenses increased by 793.0% during the six month period ended June 30,
1998 to $9.0 million from $1.0 million in the comparable period in 1997.
This increase was primarily due to overhead required to manage expansion of
the Cygnet Dealer Program, expansion of the Company's senior management
team, and costs of operating the bulk purchasing and loan servicing
businesses. In addition, during the six month period ended June 30, 1998,
pursuant to the Cygnet Dealer Program, the Company paid participating Third
Party Dealers loan servicing fees totaling $2.1 million.
Depreciation and Amortization. Depreciation and amortization expense
increased by 271.0% in the six month period ended June 30, 1998 to $230,000
from $62,000 for the comparable period in the prior year, due primarily to
depreciation of the Company's servicing platform and an increase in
amortization of goodwill related to the Company's acquisition of ANAC in
August 1997.
46
<PAGE> 47
Interest Expense. Interest expense increased from $37,000 in the six
month period ended June 30, 1997 to $1.7 million in the six month period
ended June 30, 1998. This increase was due to the increase in the carrying
costs of the assets under the Cygnet Dealer Program, as well as the
carrying cost of the Company's investment in the notes receivable and other
assets related to the FMAC transaction.
YEAR ENDED DECEMBER 31, 1997
Interest Income. Interest income consists of income recognized from the
Cygnet Dealer Program and FMAC transaction.
Cygnet Dealer Program. Interest income for this category during the
year ended December 31, 1997 totaled $3.7 million. This consisted of $3.2
million in interest income from finance receivables under the Dealer
Collection Program and $521,000 in interest income from notes receivable
under the Asset Based Loan Program. The effective average yield during
1997, net of loan servicing fees paid to Third Party Dealers, was 22.9% and
15.6% on the finance receivables and notes receivable portfolios,
respectively.
FMAC Transaction. Interest income from this category during the year
ended December 31, 1997 totaled $3.8 million. The Company recognized a
total of $3.6 million in interest income on the senior bank debt (the
"Senior Bank Debt") acquired from the FMAC bank group and $261,000 in
interest income on the "debtor-in-possession" financing made available to
FMAC (the "DIP Facility".) No future interest income will be realized on
the Senior Bank Debt, which was sold in the fourth quarter of 1997. See
"-- Transactions Regarding First Merchants Acceptance Corporation" below.
Gain on Sale of Notes Receivable. During the year ended December 31, 1997,
the Company acquired directly and indirectly 100% of FMAC's Senior Bank Debt. On
December 15, 1997, the bankruptcy court in the FMAC bankruptcy entered an order
approving a transfer, whereby the agent for the holders (at such time, the
Company) of the Senior Bank Debt credit bid this debt and purchased the
contracts which secured the debt (the "Owned Contracts"), and immediately sold
the Owned Contracts to a third party purchaser (the "Contract Purchaser"). The
Company recorded a one-time gain of approximately $8.1 million from this
transaction. See "-- Transactions Regarding First Merchants Acceptance
Corporation" below.
Other Income. Other income generally represent revenues from services such
as periodic audits of borrowers and collateral monitoring and maintenance fees,
and loan commitment and processing fees. Fee and other income totaled $355,000
during the year ended December 31, 1997.
Operating Expenses. Operating expenses consist of the provision for credit
losses, selling and marketing expenses, general and administrative expenses, and
depreciation and amortization.
Provision for Credit Losses. The provision for credit losses totaled
$691,000 for the year ended December 31, 1997. Of this amount, $200,000 was
allocated to the allowance for credit losses for notes receivable, with the
balance allocated to the allowance for credit losses for finance
receivables under DCP.
General and Administrative Expenses. General and administrative
expenses for the year ended December 31, 1997 totaled $3.8 million. The
largest component of general and administrative expenses was payroll and
benefits, which totaled $1.4 million, reflecting establishment of the
Company's management team and infrastructure to purchase finance
receivables and originate loans under its Cygnet Dealer Program as well as
the hiring of personnel to manage the bulk purchasing and loan servicing
business. In addition, pursuant to the Cygnet Dealer Program, the Company
paid participating Third Party Dealers loan servicing fees totaling $1.3
million.
Depreciation and Amortization. Depreciation and amortization consists
of depreciation and amortization on the Company's property and equipment
and amortization of the Company's goodwill. Depreciation and amortization
expense totaled $153,000 during 1997.
Interest Expense. Interest expense totaled $2.1 million in the year ended
December 31, 1997. Substantially all of the interest expense was incurred on the
loan that was carried back by the members of the FMAC senior bank group, which
financed 80% of the Company's purchase price related to the acquisition of
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<PAGE> 48
the Senior Bank Debt. Interest expense on this loan totaled $1.4 million during
the year ended December 31, 1997. This loan was paid in full in conjunction with
the sale of the Senior Bank Debt in December 1997.
Income Taxes. Income taxes totaled $3.7 million in 1997, which is an
effective corporate tax rate of approximately 40.2%.
FINANCE RECEIVABLES AND NOTES RECEIVABLE
During the six months ended June 30, 1998 and the year ended December 31,
1997, the Company purchased finance receivable contracts with a total principal
balance of approximately $24.4 million and $36.8 million, respectively.
A summary of the Company's finance receivables follows (in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
ENDED YEAR ENDED
JUNE 30, 1998 DECEMBER 31, 1997
-------------- -----------------
<S> <C> <C>
Balance, Beginning of Period.................. $27,481 $ --
Purchases................................... 24,365 36,819
Principal Payments.......................... (6,293) (4,357)
Chargeoffs.................................. (1,281) (8)
Recourse to Seller.......................... (6,262) (4,973)
------- -------
Balance, End of Period........................ $38,010 $27,481
======= =======
</TABLE>
Finance receivables were comprised of the following as of June 30, 1998 and
December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
-------- ------------
<S> <C> <C>
Finance Receivable Contract Principal Balances........ $38,010 $27,481
Add: Accrued Interest Receivable...................... 209 147
------- -------
Principal Balances, Net............................... 38,219 27,628
Allowance for Credit Losses......................... (1,202) (485)
Acquired Allowance.................................. (10,394) (7,706)
Refundable Security Deposits........................ (290) (163)
------- -------
Finance Receivables, net.............................. $26,333 $19,274
======= =======
</TABLE>
As of June 30, 1998 and December 31, 1997, the Company maintained notes
receivable with 10 and 12 Third Party Dealers, respectively. The total balance
of notes receivables with Third Party Dealers totaled $6.8 million and $5.8
million as of June 30, 1998 and December 31, 1997, respectively.
The Company has established an allowance for credit losses ("Allowance") to
cover anticipated credit losses on the finance receivables and notes receivable
currently in its portfolio. The Allowance has been established through
nonrefundable acquisition discounts ("Acquired Allowance") and a provision for
credit losses. The Allowance as a percentage of the principal amounts
outstanding on the finance receivables was 30.5% and 29.8% at June 30, 1998 and
December 31, 1997, respectively.
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<PAGE> 49
The following table reflects activity in the Allowance for the six months
ended June 30, 1998 and the year ended December 31, 1997 (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR ENDED
JUNE 30, 1998 DECEMBER 31, 1997
-------------------------- --------------------------
FINANCE NOTES FINANCE NOTES
RECEIVABLES RECEIVABLES RECEIVABLES RECEIVABLES
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of
Period................... $ 8,191 $200 $ -- $ --
Provision for Credit
Losses................... 935 30 491 200
Acquired Allowance.......... 3,410 -- 7,706 --
Net Charge Offs............. (940) -- (6) --
------- ---- ------ ----
Balance, End of Period........ $11,596 $230 $8,191 $200
======= ==== ====== ====
Allowance as % of Period Ended
Principal Balance........... 30.5% 1.0% 29.8% 0.9%
======= ==== ====== ====
</TABLE>
The Company's policy is to charge off contracts when they are deemed
uncollectible. Generally, contracts delinquent for 90 days are considered
uncollectible and are charged-off. There is no allowance related to the FMAC
transactions as, in the opinion of management, all amounts due under advances to
FMAC are believed to be collectible. However, there can be no assurance that the
allowance will prove adequate.
The following table sets forth the percentage of the principal amount
outstanding of finance receivables in the Company's portfolio that were 30 to 44
days delinquent and over 44 days delinquent, as of June 30, 1998 and December
31, 1997, respectively:
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
DAYS DELINQUENT 1998 1997
- --------------- -------- ------------
<S> <C> <C>
30 to 44 days................................ 5.8% 8.0%
Over 44 days................................. 4.1% 5.3%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support lending activities under its Cygnet
Dealer Program, the purchase of bulk finance receivable portfolios, the purchase
of property and equipment, and for working capital and general corporate
purposes. The Company historically has funded its capital requirements through
equity contributions and advances by UDC and operating cash flow.
Cash Flows. The Company's Net Cash Provided by Operating Activities
totaled $6.7 million in the year ended 1997. Earnings of $5.5 million plus the
effect of the provision for credit losses and an increase in accrued expenses
and other liabilities offset deferred income taxes and cash used to purchase
other assets.
The Company's Net Cash Provided by Operating Activities increased by 687.3%
or $2.8 million to $2.4 million for the six month period ended June 30, 1998
from ($401,000) Used in Operating Activities for the six month period ended June
30, 1997. The increase was primarily due to a significant net loss for the six
month period ended June 30, 1997, the provision for credit losses, and an
increase in accrued expenses and other liabilities.
Net Cash Used in Investing Activities totaled $26.7 million in the year
ended 1997. The Company used cash to purchase finance receivables totaling $20.9
million, to make notes receivable advances aggregating $12.7 million, and to
fund the purchase of assets of $9.1 million. These uses were offset by the
collection of $9.3 million in finance receivables and the collection of $6.9
million in notes receivable.
The Net Cash Used in Investing Activities increased by 15.5% or $1.3
million to $9.6 million for the six month period ended June 30, 1998 from $8.3
million for the six month period ended June 30, 1997. The Company used cash for
the purchase of finance receivables totaling $17.2 million in the six month
period ended June 30, 1998, compared to the six month period ended June 30,
1997, when no such purchases took
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<PAGE> 50
place. Additionally, the Company used cash for notes receivable advances
aggregating $16.9 million in the six month period ended June 30, 1998 compared
to $8.8 million in the six month period ended June 30, 1997. These uses were
offset by the collections of finance receivables of $9.2 million and collections
of notes receivables of $15.7 million in the six month period ended June 30,
1998, as compared to $504,000 of collections in the six month period ended June
30, 1997.
Net Cash Provided by Financing Activities for 1997 was $21.2 million, all
of which was provided by UDC.
The Company's Net Cash Provided by Financing Activities decreased by 28.6%
or $2.5 million to $6.3 million for the six month period ended June 30, 1998
from $8.8 million for the six month period ended June 30, 1997, due to a net
decrease in financing provided by UDC.
Capital Expenditures and Commitments. The Company intends to pursue an
aggressive growth strategy. During 1997, the Company acquired substantially all
of the assets of ANAC for $9.1 million in cash. Further, the Company increased
its finance receivables and notes receivable portfolios by approximately $41.1
million during 1997. In addition, the Company expects to acquire certain
computer and telecommunication equipment with a cost of approximately $1.0
million with proceeds from the Rights Offering.
On July 11, 1997, the Company entered into an agreement to provide a DIP
Facility to FMAC in an amount up to $10 million. On March 31, 1998, the
effective date of FMAC's plan of reorganization, the DIP Facility was amended to
increase the maximum commitment to $21.5 million, subject to future adjustment
downward by an amount not to exceed $10 million. As of June 30, 1998, the
maximum commitment had been reduced to $12.4 million. The Company had advanced
$9.8 million against this commitment as of June 30, 1998.
The Company has secured a credit facility with a third party lender
pursuant to which the lender has provided the Company $5 million in the form of
subordinated debt. The debt bears interest at 12% per annum, payable quarterly
in arrears, with the principal balance and all accrued but unpaid interest
payable in full on the third anniversary of the initial funding date. The debt
is subordinated in right of payment to all existing and future debt of the
Company. The Company is also required to maintain a debt to tangible equity
ratio not greater than 3 to 1, calculated as of the end of each quarterly
period. As additional consideration for the subordinated debt, on the Effective
Date the Company is required to issue warrants to acquire 115,000 shares of
Common Stock, exercisable for a period of three years at an exercise price of
$8.40 per share, subject to a call feature by the Company if the closing price
of the Common Stock equals or exceeds $13.44 per share for a period of 20
consecutive trading days. The loan is guaranteed by UDC, although the Company
anticipates UDC's guarantee will be released on the Effective Date. The lender
also will be granted certain registration rights with respect to the shares of
the Common Stock underlying the warrants.
The Company intends to finance its future capital requirements through the
proceeds of the Rights Offering, operating cash flows and supplemental
borrowings. The Company believes that these sources will be adequate to support
its anticipated financial requirements at least through the end of 1998.
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, certain of these companies have filed for bankruptcy protection.
These announcements have had a disruptive effect on the market for securities of
sub-prime automobile finance companies, have resulted in a tightening of credit
to the sub-prime markets, and could lead to enhanced regulatory oversight. A
reduction in access to the capital markets or to credit sources could have a
material adverse affect on the Company.
Transactions Regarding First Merchants Acceptance Corporation. UDC was
actively involved in the FMAC bankruptcy proceedings. FMAC was in the business
of purchasing and securitizing loans made primarily to sub-prime borrowers by
various Third Party Dealers. In various transactions relating to the FMAC
bankruptcy proceedings and by and through the FMAC plan of reorganization, UDC,
among other things, (1) purchased the beneficial interest in the Senior Bank
Debt held by certain creditors of FMAC, participated in the sale of the
contracts securing such claims at a profit to a third party purchaser,
guaranteed
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<PAGE> 51
the purchaser a specified return on the contracts and obtained a related
guarantee from FMAC secured by, among other things, the stock of certain
entities holding residual interests and certain equity certificates in various
securitized loan pools of FMAC, and entered into servicing arrangements with
respect to such contracts; (2) made loans under the DIP Facility to FMAC, which
at July 1, 1998 carried a remaining maximum commitment of $12.4 million, of
which $9.8 million was outstanding on such date, and received interest income
therefrom; (3) entered into various servicing agreements with respect to
receivables in the securitized pools of FMAC; (4) obtained rights to receive
certain payments with respect to distributions on residual interests in such
securitized pools and obtained certain interests in charged off receivables in
such pools; (5) obtained rights to certain fees; (6) obtained the FMAC servicing
platform; and (7) issued certain warrants to purchase UDC Common Stock
consisting of (a) warrants issued to FMAC's bank group to purchase up to 389,800
shares of UDC's Common Stock at an exercise price of $20.00 per share at any
time through February 20, 2000, subject to a call feature by UDC if the closing
market price of UDC Common Stock equals or exceeds $27.00 per share for a period
of five consecutive trading days, and (b) warrants issued to FMAC to purchase
325,000 shares of UDC Common Stock at any time through April 1, 2001 at a price
of $20.00 per share, subject to a call feature by UDC if the closing market
price of the UDC Common Stock equals or exceeds $28.50 per share for a period of
10 consecutive trading days. UDC also contributed to FMAC all of its shares of
FMAC common stock as additional consideration for UDC's acquisition of the
assets constituting FMAC's servicing platform.
In connection with the Split-up, subject to receipt of any required
consents, UDC will transfer all of the rights and substantially all of the
liabilities related to the FMAC transaction accruing on or after the Effective
Date to the Company. However, UDC will remain liable with respect to certain
liabilities related to the FMAC transaction. For additional information
concerning the FMAC transaction and the rights and liabilities assumed by the
Company in connection with the Split-up, see "Business -- Bulk Purchase and
Servicing Operations -- Transactions Regarding First Merchants Acceptance
Corporation" and "Risk Factors -- Risks Relating to the Business -- Risks
Relating to the FMAC Transaction."
Transactions Regarding Reliance Acceptance Group. In February 1998, UDC
entered into receivables servicing and transition services arrangements with
Reliance, after Reliance had filed a voluntary petition for relief under Chapter
11 of the Bankruptcy Code the same month. Reliance confirmed its proposed plan
in open court on June 29, 1998. The bankruptcy court signed the order formally
confirming the plan on July 2, 1998. The effective date of the confirmed plan is
the close of business on July 31, 1998. Pursuant to the servicing agreement
entered into between UDC and Reliance (the "Servicing Agreement"), following the
effective date of Reliance's plan of reorganization, UDC will service certain
receivables of Reliance in exchange for (i) a monthly servicing fee of the
greater of four percent (4%) per annum of the aggregate outstanding principal
balance of all non-defaulted receivables computed monthly on the basis of the
declining balance of the receivables portfolio (consisting of Reliance's
portfolio of (A) prime receivables and (B) sub-prime receivables), or fifteen
dollars ($15.00) per receivable per month plus reimbursement of certain costs
and expenses; (ii) $1.3 million in proceeds realized from the sale of a pool of
charged-off receivables existing as of the Reliance petition date ("Charged-Off
Proceeds"); (iii) a total of (A) four percent (4%) of the outstanding principal
balance of each receivable (exclusive of defaulted and certain other
receivables) sold in any bulk sale to a person other than UDC or an affiliate of
UDC, and (B) $3.25 million in net collections, recovery, and sale proceeds from
the receivables portfolio and certain other cash receipts of Reliance reduced by
any amount previously paid under clause (A) above, following payment of
Reliance's primary bank debt and, if applicable, repayment to Reliance of any
proceeds of litigation, the Reliance Warrants (as defined below), and equity
proceeds used by Reliance to pay its primary bank debt ("Post-Bank Debt
Proceeds"); and (iv) following UDC's receipt of the Post-Bank Debt Proceeds,
fifteen percent (15%) of the net collections, recovery, and sale proceeds from
the receivables portfolio and certain other cash receipts of Reliance (the
"Incentive Fee"). Reliance, in consideration for entering into the Servicing
Agreement, will receive privately issued warrants ("Reliance Warrants") to
purchase shares of UDC Common Stock as follows: 50,000 Reliance Warrants will be
granted to Reliance upon UDC's receipt of the Charged-Off Proceeds; up to
100,000 Reliance Warrants will be granted to Reliance based upon UDC's receipt
of up to $3.25 million of Post-Bank Debt Proceeds; and Reliance will be granted
an additional 75,000 Reliance Warrants for every $1 million actually received by
UDC through the Incentive Fee. The Reliance Warrants will have a strike
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<PAGE> 52
price of $12.50 for the first 150,000 Reliance Warrants and a strike price for
all other Reliance Warrants of the greater of $12.50 or 120% of the market price
of UDC Common Stock on the date of issuance of the Reliance Warrants. The
Reliance Warrants will be exercisable as follows: (i) the first 50,000 Reliance
Warrants will be exercisable for three years from the Reliance Petition Date and
(ii) all remaining Reliance Warrants will be exercisable for three years from
their date of issuance.
On the effective date of the plan, UDC will purchase Reliance's furniture,
fixtures, and equipment, including computer software and hardware related
licenses for $250,000, and will have a period of sixty days to require Reliance
to assume and assign to UDC any of the leases or other contracts not previously
rejected by Reliance.
Subject to receipt of any required consents, UDC will transfer all contract
rights and substantially all liabilities related to the Reliance transaction to
the Company on the Effective Date. However, UDC will remain liable as to certain
obligations in the Reliance transaction. See "Business -- Bulk Purchase and
Servicing Operations -- Transactions Regarding Reliance Acceptance Group" and
"Risk Factors -- Risks Relating to the Business -- Risks Relating to the
Reliance Transaction."
THIRD PARTY CONSENTS
The Company has prepared or is in the process of preparing consents and has
contacted or is contacting various third parties to obtain such consents in
connection with the transactions contemplated by the Split-up and the Rights
Offering. Based on a review of existing contractual arrangements between various
third parties and either UDC or the Company, the Company believes that any
required consents will be obtained before the Annual Meeting of UDC's
shareholders, although there can be no assurance that all required consents will
be obtained by such date or at all.
YEAR 2000
The Company has performed a preliminary study (review and assessment) of
its computer systems and third parties' (e.g. vendors and customers) computer
systems in order to evaluate its exposure to Year 2000 issues. The Company
continues to plan and evaluate appropriate courses of corrective action,
including replacement of certain systems whose associated costs would be
recorded as assets and amortized, or modification of its existing systems, which
costs would be expensed as incurred. The Company expects to make the necessary
replacements, modifications or changes to its computer information systems to
enable proper processing of transactions relating to the Year 2000 and beyond.
The Company also has had discussions with certain of its vendors and customers
regarding actions to be taken to resolve any Year 2000 issues arising from the
Company's dependence on third parties' computer systems. The amount expensed by
the Company on Year 2000 issues to date has not been material. In addition, the
Company does not believe that the costs of modifying or replacing its computer
information systems to enable proper processing of transactions relating to the
Year 2000 and beyond will be material to its financial position or results of
operations. The Company believes, however, that resolution of all Year 2000
issues will be significant to the Company's business and operations and there
can be no assurance that the Company will be able to completely resolve all Year
2000 issues in a timely fashion or that the ultimate impact of the Year 2000
issues will not be material to the Company. Accordingly, failure to resolve Year
2000 issues in a timely fashion could have a material adverse effect on the
Company's business, financial condition, and results of operations. See "Risk
Factors -- Risks Relating to the Business -- Data Processing and Technology and
Year 2000."
As discussed herein, the Company is in the process of converting its loan
processing and collections systems to ACS, a third party service bureau that
processes transactions using Shaw Systems Associates, Inc. ("Shaw") software and
other products ("Shaw Products"). Shaw has certified to ACS that a significant
portion of the Shaw Products that ACS uses to process the Company's transactions
are Year 2000 compliant. Based upon a Shaw certification and a representation
from ACS to the Company, the Company believes that Shaw has also undertaken to
provide additional Year 2000 compliant Shaw Products to ACS as such systems
become compliant. ACS would then make available for the Company's processing of
transactions these additional Year 2000 compliant Shaw Products. The ACS
Agreement requires that the ACS systems
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<PAGE> 53
processing the Company's transaction be fully Year 2000 compliant by January 1,
1999. However, the Company's sole remedy if ACS does not comply with this
requirement is to terminate the ACS Agreement and convert to another system,
which would be costly and disruptive to operations and could have a material
adverse effect on the Company's business and operations. The Company's business
and operations also could be adversely affected if other entities (e.g., vendors
and customers) not affiliated with the Company do not appropriately address
their own Year 2000 compliance issues. Further, certain of the Company's own
applications are not Year 2000 compliant at this time.
INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's expected borrowings would decrease the
profitability of the Company's existing portfolio. The Company has sought to
limit this risk by (i) maintaining a portion of its investment portfolio in the
floating rate Asset Based Loan Program and (ii) limiting the maturity of finance
receivable contracts. If the Company's borrowing rates increase, then the
Company will seek to further limit the negative impact on earnings by increasing
the purchase discount at which the Company purchases finance receivables and/or
require higher stated annual percentage rates on finances receivables which are
purchased. To date, inflation has not had a significant impact on the Company's
operations.
ACCOUNTING MATTERS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130) which became effective for the Company on January 1, 1998. SFAS No. 130
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general purpose financial statements. The Company
had no comprehensive income.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131), which became effective for
the Company on January 1, 1998. SFAS No. 131 establishes standards for the way
that public enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim reports issued to stockholders.
Management does not expect the adoption of SFAS No. 131 to have a material
impact on the Company's disclosures.
FORWARD LOOKING STATEMENTS
This Prospectus 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
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 Company undertakes no obligation to publicly
update or revise any forward looking statements, whether as a result of new
information, future events, or otherwise. The following disclosures, as well as
other statements in this Prospectus, including those contained in "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
in the Notes to the Company's Combined Financial Statements, describe factors,
among others, that could contribute to or cause such differences, or that could
affect the Company's stock price.
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<PAGE> 54
BUSINESS
GENERAL
Assuming successful completion of the Rights Offering and consummation of
the Split-up, the Company will engage in the business of providing various
financial services primarily to the sub-prime segment of the automobile
financing industry, which focuses on selling and financing the sale of new and
used cars to persons who have limited credit histories, low incomes, or past
credit problems ("Sub-Prime Borrowers"). The Company will (i) engage in the bulk
purchase and servicing of pools of finance receivables generated from the sale
of new and used automobiles by independent third party dealers ("Third Party
Dealers"), including pools of charged-off receivables, deficient loans, or other
receivables; (ii) service pools of various types of finance receivables; (iii)
operate a collateralized dealer financing program (the "Cygnet Dealer Program"),
pursuant to which it will provide qualified Third Party Dealers with warehouse
purchase facilities and revolving lines of credit primarily secured by the
dealers' finance receivable portfolios; and (iv) pursue other opportunities in
the financial services market.
In connection with the Split-up, the Company will acquire the bulk
purchasing and certain servicing operations and related assets from UDC and
substantially all of UDC's servicing and other rights and obligations pursuant
to transactions with First Merchants Acceptance Corporation ("FMAC") and
Reliance Acceptance Corporation ("Reliance"). The Company intends to consider
the bulk purchase and servicing of other portfolios of finance receivables,
including instances in which the holders of the portfolios are experiencing
financial difficulties. For a description of the Company's bulk purchase and
servicing operations and the Company's rights and obligations with respect to
the FMAC and Reliance transactions, see "Business-Bulk Purchasing and Servicing
Operations."
The Company also will acquire the operations and related assets associated
with the Cygnet Dealer Program, which provides qualified Third Party Dealers
with warehouse purchase facilities and revolving lines of credit primarily
secured by the dealers' finance receivable portfolios. Unlike other typical
financing programs available to dealers, the Cygnet Dealer Program permits
participating dealers to retain servicing rights with respect to their finance
receivable portfolios, which enables dealers to generate servicing income and
maintain relationships with their customers, which dealers believe is a key
factor in generating referrals for additional sales and improving the chances of
repeat business. For a description of the Cygnet Dealer Program, see
"Business -- Cygnet Dealer Program."
In late 1997, UDC, which operates the largest publicly-held chain of "buy
here-pay here" used car dealerships in the United States, began a strategic
evaluation of its operations, determining to separate its dealership operations
from its non-dealership operations pursuant to the Split-up. Cygnet is a
Delaware corporation formed in June 1998 to acquire and operate the
non-dealership operations of UDC and will, upon successful completion of the
Rights Offering and consummation of the Split-up, be a separately-traded public
company.
RECENT DEVELOPMENTS
The Company and UDC are in the process of evaluating a number of ordinary
course transactions and may identify and pursue other transactions that, if
consummated prior to the Split-up, would be assigned to, or concluded by, the
Company ("Interim Transactions"). In addition, Cygnet has recently closed two
Interim Transactions. The Company does not believe any of the Interim
Transactions recently concluded or currently under consideration are material to
its financial condition or results of operations, individually or in the
aggregate, or that any of such transactions would constitute the acquisition of
a business for which separate financial statements would be required to be
publicly disclosed by the Company. None of the transactions described below
requires shareholder approval of the Company or UDC, nor are any of such
transactions with an affiliate of the Company or UDC. The consummation of any of
these transactions currently under consideration is subject to a number of
contingencies, which may include the negotiation and preparation of definitive
agreements, completion of due diligence, and the receipt of required consents
from third parties. As a result, there can be no assurance that any of these
potential transactions will be completed by the Company.
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<PAGE> 55
To effect Interim Transactions, the Company may borrow money from a third
party lender ("Third Party Loans"), or from UDC ("Interim Company Loans"). Third
Party Loans made to the Company prior to the Effective Date may be guaranteed by
UDC, and the Company and UDC will seek to have any such guarantee released as of
the Effective Date, with the Company likely providing a replacement guarantee.
Interim Company Loans may become due and payable on the Effective Date.
Moreover, on the business day immediately preceding the Effective Date, the
Company will distribute to UDC all earnings accrued to such date. In addition,
the Company will pay to UDC on the Effective Date the excess, if any, of the
aggregate appraised value of the assets and rights and related liabilities
acquired by the Company in Interim Transactions (the "Interim Assets"), as of
the Effective Date, over the aggregate book value of the Interim Assets (the
"Interim Consideration"). UDC and the Company may agree to other terms with
respect to how Interim Transactions will be structured or treated if UDC
believes that such structure or treatment results in adequate consideration to
UDC at the time of the Split-up with respect to the Interim Assets. The purpose
for the payment by the Company to UDC of the Interim Consideration is to place
both parties as close as possible to the economic situation each would confront
if the Interim Transactions were effected by UDC rather than the Company.
Interim Transactions recently concluded include the following:
Servicing Agreement. On July 31, 1998, the Company closed a transaction
pursuant to which the Company will service a $50 million portfolio of automobile
finance receivables owned by a third party. The servicing agreement provides
that: (i) the Company will receive a servicing fee equal to the greater of 3.75%
of the outstanding principal balance or $17.50 for each contract in the
portfolio that is not a defaulted contract and 63.75% of all net collections and
proceeds on defaulted contracts, provided that if the net losses of the
portfolio do not exceed 7%, the Company will receive an additional servicing fee
of .25% on non-defaulted contracts, (ii) the Company will receive all late fees
and certain other fees and reimbursable expenses associated with the servicing;
and (iii) the servicing agreement can be terminated without cause upon payment
to the Company of 3 months of servicing fees. The Company also purchased all
assets utilized by the current owner in servicing the portfolio including
furniture, fixtures and equipment, for a purchase price of $500,000, and will
assume the existing lease of the service facility and all amounts due thereunder
from and after the closing date.
Until the Effective Date of the Split-up, UDC will provide subservicing of
the portfolio on the same terms as the servicing agreement described above.
Assumption of Special Servicing Agreements. On July 31, 1998, the Company
closed a transaction pursuant to which the Company will assume the obligations
of an existing special servicer of six pools of automobile finance receivables,
including four securitized pools. The Company will receive a monthly servicing
fee equal to the greater of 4% of the outstanding principal balance of each
contract or $14.00 per contract. The Company will also be paid certain incentive
fees, will be reimbursed for certain expenses, will be permitted to collect and
retain late fees, modification fees and extension fees, and will be indemnified
by the parent company of the existing special servicer for certain obligations
being assumed. During an interim period, which should not exceed 60 days, while
certain modifications are being made to the special servicing agreements to be
assumed by the Company and certain consents are being obtained, the Company will
act as special subservicer of the pools on the same terms as outlined above, but
will not be responsible for such indemnified obligations. If such modifications
are not effected or such consents obtained, the Company can be removed as
special subservicer following this interim period. The Company has agreed upon
the resignation or removal of the servicer of the pools to assume the
obligations of servicer for no additional compensation.
Until the Effective Date of the Split-up, UDC will provide subservicing of
these portfolios on the same terms as the servicing and related agreements.
The Company has also agreed to purchase the charged off receivables from
five of the pools for a purchase price of approximately $600,000.
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Interim Transactions under consideration include the following:
Insurance Agency. The Company is currently evaluating the acquisition of
or a management arrangement with an operating insurance agency, which offers
insurance-related products and services designed to reduce the risk of loss to
holders of portfolios of automobile finance receivables and residential mortgage
loans, including banks, savings and loan associations, finance companies, credit
unions, securitization participants and automobile dealers, among others. The
Company anticipates paying approximately $4 million for this business.
Charge-Offs. UDC is negotiating the purchase of a pool of charged-off
automobile finance receivables of approximately $33.3 million (as of February
28, 1998) for a purchase price based upon a formula. If purchased by UDC, the
pool would be transferred to the Company at the Effective Date.
Purchase of Bank Debt. The Company has agreed to purchase the interests of
a bank in a bank group credit facility. The purchased interest is 18% of the
approximately $48 million current outstanding principal balance of the facility
(or approximately $8.6 million). The purchase price for the interest equals
90.5% of the principal amount of the interest as of the closing date of the
purchase (expected to approximate $7.8 million). The purchase price will be paid
$3 million in cash, with the balance evidenced by a promissory note providing
for interest at a fixed rate based on LIBOR plus 150 basis points. This
promissory note will be guaranteed by UDC until the occurrence of both (i) the
Split-up and (ii) Cygnet having a total shareholders' equity of at least $50
million (which is expected to occur at the time of the Split-up). The credit
facility is secured by a pool of receivables and a residual interest in a
securitized pool of receivables.
Loan, Servicing Agreement and Investment. The Company is negotiating a
transaction in which the Company would make a loan to a third party entity
("Borrower") of $2 million (the "Loan") with interest payable at 12% per annum
and maturing on October 31, 1998; provided that if, prior to October 31, 1998,
Borrower either receives an equity investment from a third party of (i) not less
than $10 million or (ii) not less than $5 million and receives a loan of not
less than $5 million that is subordinate to the Loan and other existing credit
facilities of Borrower, then the maturity date of the Loan will be extended to
the second anniversary of the closing date of the Loan. The Loan is expected to
be secured by all of Borrower's assets, subject to a senior security interest
supporting Borrower's $35 million senior secured credit facility. In
consideration for the Loan, the Company would receive warrants to purchase up to
5% of Borrower's outstanding common stock as of the closing date exerciseable
for three years at an exercise price of $.01 per share. The Company would also
be granted certain additional investment rights in Borrower and would obtain the
right to service a portfolio of receivables for a fee equal to the greater of 4%
per annum of the outstanding principal balance of the receivables or $17.50 for
each contract in the portfolio, plus all collected late fees and modification
fees and reimbursement of costs and expenses. Borrower would have the right to
terminate the Company as servicer for cause or without cause after the later of
(i) six months after commencement of servicing and (ii) payment in full of the
Loan upon payment of a termination fee equal to three months servicing fees.
Until the Effective Date of the Split-up, UDC will provide subservicing of
the portfolio on the same terms as the servicing agreement described above.
OVERVIEW OF USED CAR FINANCE INDUSTRY
The automobile financing industry is the third-largest consumer finance
market in the country, after mortgage debt and credit card revolving debt. The
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. The Company's
servicing and financing services historically have been directed primarily to
the sub-prime segment of the market. The Company believes that traditional
providers of financing, servicing, and related services typically avoid this
market because of its high credit risk and the higher costs associated with
increased collection efforts.
Recently, a number of automobile financing companies have decided to exit
the market, sell a substantial portion of their receivables, or rely on an
outside servicer to service their portfolios. The primary factors for
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these changes in the market include the rapid growth and increased competition
in the sub-prime segment of the market, lowered underwriting standards,
increased credit losses, and a tightening of credit to participants in this
market. On the basis of its access to capital and experience in providing
financing and servicing to the sub-prime industry, the Company has taken
advantage of these market opportunities by bulk purchasing the loan receivables
in and servicing rights to certain large portfolios owned by FMAC and Reliance.
The Company intends to continue to pursue opportunities to purchase loan
portfolios in bulk and the servicing rights to those portfolios from companies
operating in the sub-prime automobile financing market.
Due to the risks involved in providing financing to the sub-prime segment
of the automobile financing industry, many independent used car dealers are
unable to obtain working capital from traditional lending sources such as banks,
credit unions, or major finance companies. These dealers typically finance their
operations through the sale of finance receivables at a substantial discount.
The Company believes that independent dealers prefer to finance their operations
through credit facilities that permit them to retain their receivables, which
enables such dealers to generate servicing income, and prefer to maintain their
relationships with their customers, which the Company, unlike traditional
providers of collateral financing, affords through its Cygnet Dealer Program.
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
Company's Cygnet Dealer Program is intended to fill this niche.
COMPETITIVE STRENGTHS AND BUSINESS STRATEGIES
The Company's goal is to become a leading provider of financing, servicing,
and other complementary services related to finance and other loan receivables,
particularly with respect to the sub-prime segment of the automobile financing
industry. In recent periods, the sub-prime automobile market has been
characterized by rapid growth and increased competition, which has led to
lowered underwriting standards, increased credit losses, and a tightening of
credit. The Company believes these conditions afford significant opportunities
for well-capitalized industry participants with experience in the bulk purchase,
servicing, and financing of receivables in this market segment.
The Company intends to pursue the following business strategies to achieve
its goal:
- Pursue Additional Bulk Purchasing and Servicing Opportunities. The
Company will leverage its financial strength, access to capital, and
experience in the industry to provide creative solutions to financing
companies that desire to sell their sub-prime portfolios in bulk or that
wish to outsource the servicing of their portfolios, including companies
that are experiencing financial difficulties. The Company plans to
continue to seek out opportunities such as its transactions with FMAC and
Reliance as described below.
- Expand the Cygnet Dealer Program. The Cygnet Dealer Program fulfills the
needs of buy here-pay here dealers by providing them working capital
while allowing them to retain their servicing rights and customer
relationships. The program enables the Company to earn finance income at
favorable rates through a diversified asset base. The Company intends to
expand this program in selected markets throughout the country, taking
advantage of the tightening of financing in the sub-prime market
generally.
- Pursue Opportunities to Provide Other Complementary Services. The
Company intends to pursue other opportunities to provide services that
complement its financing and servicing operations. The Company currently
is negotiating the acquisition of or a management arrangement with an
insurance agency that provides insurance-related products and services
designed to decrease the risk of loss to portfolios such as those the
Company currently owns and services. The Company believes that the
combination of its existing financing and servicing operations with other
complementary services will further enhance its ability to provide
turn-key solutions to independent used car dealers, financial
institutions, and other market participants.
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The Company believes it will possess the following competitive strengths
and intends to leverage these strengths to pursue its business strategies:
- Capitalized for Growth. Assuming the purchase of all of the Offered
Shares pursuant to the Rights Offering, the Company would have had, on a
pro forma basis on June 30, 1998, approximately $72.0 million (or $78.5
million if the Additional Purchase Right and the D&O Purchase Right are
exercised) in stockholders' equity to expand its operations following the
Rights Offering. The Company believes this level of equity will provide
it with the financial strength to take advantage of the opportunities
available in the sub-prime segment of the automobile financing industry
or other market opportunities identified by management.
- Established Track Record. The Company has significant experience in
handling large transactions involving companies operating in the
sub-prime vehicle financing industry. The Company intends to leverage the
experience it has gained in these transactions with additional bulk
purchases of pools of auto loan receivables and related servicing rights
from other market participants and others who desire to transfer these
operations to independent providers. The Company also has significant
experience in underwriting and purchasing sub-prime finance receivable
contracts and in providing credit facilities to independent dealers.
- Experienced Management. The Company's management has extensive
experience providing financing, servicing, and other complementary
services to third party participants in the sub-prime automobile market.
In addition, management has extensive experience in the car dealership
business. The Company intends to leverage its experience in the car
dealership, financing, and servicing businesses to continue to seek out
new opportunities through its bulk purchasing and servicing operations
and the Cygnet Dealer Program.
BULK PURCHASING AND SERVICING OPERATIONS
The Company will pursue opportunities to bulk purchase and acquire the
rights to service portfolios of finance receivables from third-party financing
companies, including companies that are experiencing financial difficulties. The
Company's current focus is on finance receivables in the sub-prime segment of
the vehicle financing market. The Company's access to capital, experience and
expertise in managing complex financial transactions involving distressed
companies, and approved servicing capabilities, particularly with respect to
loan receivables in the sub-prime vehicle financing market, enable the Company
to provide turn-key solutions to financial institutions that encounter
difficulties arising from the ownership and maintenance of large portfolios of
vehicle related loan receivables. As a result of the Company's experience in
managing and understanding the nature of the risks associated with holding and
servicing such portfolios, the Company is able to creatively structure
transactions in which it shares the risk associated with the portfolio in
exchange for a more substantial discount on the purchase price or an increased
share of the return from such portfolios arising from workout situations.
The Company maintains loan servicing facilities in Nashville, Tennessee,
Denver, Colorado and Dallas, Texas to support its bulk servicing operations. As
of May 31, 1998, these facilities employed approximately 260 employees, a number
that enables the Company to service large volumes of finance receivable
contracts. When the Company makes a bulk purchase, it typically employs the
collection personnel, system and software utilized by the existing servicer, and
migrates the collection processes to the Company's system as practicable.
The Company's collectors utilize collections software that 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 the Company's policy, collections department personnel contact a
customer as soon as their account becomes delinquent 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 retain the vehicle securing the finance receivable. The Company's
early detection of a customer's delinquent status, as well as its commitment to
work with borrowers, allows it to identify problems quickly, thereby reducing
the amount of credit losses incurred in the portfolios it services.
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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 the collateral securing the loan in default. Frequently, delinquent
customers will recognize their inability to honor their contractual obligations
and will work with the Company to coordinate "voluntary repossessions" of their
car. In the cases involving uncooperative customers the Company retains
independent firms to repossess the cars pursuant to prescribed legal procedures.
In recent periods, the Company has entered into several large servicing or
bulk purchasing transactions involving independent third party dealer finance
receivable portfolios and, in some cases, has sold or securitized these
portfolios, with servicing retained. The two most significant of such
transactions are described below.
Transactions Regarding First Merchants Acceptance Corporation. UDC was
actively involved in the bankruptcy proceedings of FMAC. On the Effective Date,
the Company will assume all rights and substantially all liabilities related to
the FMAC transaction accruing on or after the Effective Date from UDC, subject
to the consent of certain participants in the bankruptcy proceedings.
FMAC was in the business of purchasing and securitizing loans made
primarily to Sub-Prime Borrowers by various Third Party Dealers. On July 11,
1997 (the "FMAC Petition Date"), FMAC filed a voluntary petition for relief
under Title 11 of the United States Code (the "Bankruptcy Code"). FMAC emerged
from bankruptcy on March 31, 1998, the effective date of FMAC's plan of
reorganization (the "Plan of Reorganization").
During the pendency of the FMAC bankruptcy proceedings, UDC purchased
approximately 78% of FMAC's Senior Bank Debt held by seven members (the "Selling
Banks") of FMAC's original nine-member bank group for approximately $69 million,
which represented a discount of 10% of the outstanding principal amount of such
debt. In December 1997, UDC purchased the remaining 22% of FMAC's Senior Bank
Debt. The Senior Bank Debt was originally secured by (1) automobile receivables
directly owned by FMAC (the "Owned Contracts"), (2) all personal property of
FMAC, (3) accounts, accounts receivable, including tax refunds, contract rights
and other general intangibles, and (4) the common stock of FMARC and FMARC II
(defined below) (collectively, the "Collateral").
On December 15, 1997, LaSalle National Bank, as Agent (the "Agent") for
UDC, as the holder of the Senior Bank Debt, credit bid the entire amount of the
Senior Bank Debt plus certain interest and fees, costs and expenses relating to
the Owned Contracts (collectively, the "Credit Bid Purchase Price"), and the
United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") approved the proposed purchase subject to execution by FMAC of
appropriate transfer documents. On December 18, 1997, FMAC executed the
necessary transfer documents assigning the Owned Contracts to the Agent (the
"Transfer"), and the Agent then sold the Owned Contracts on behalf of UDC to a
third party purchaser (the "Contract Purchaser") for 86% of the principal
balance of certain eligible Owned Contracts (approximately $78.9 million) (the
"Base Price") plus a residual interest in the Owned Contracts. In connection
with this transfer, UDC guaranteed to the Contract Purchaser a net return on the
Owned Contracts equal to the Base Price plus interest at the rate of 10.35% per
annum (the "Guaranteed Return"), subject to a maximum guarantee amount of $10
million. As between the Company and UDC, the Company has agreed to assume the
liabilities with respect to this guarantee. UDC, however, will remain directly
liable on the guarantee to the Contract Purchaser (the "UDC Retained
Guarantee"). UDC has the option to purchase the Owned Contracts from the
Contract Purchaser at certain times upon certain events, including at any time
after three years and if the principal balance on the remaining contracts is
less than 10% of the balance of the Owned Contracts on the date of purchase and
certain other conditions are satisfied, for a price to yield the Contact
Purchaser the Guaranteed Return. UDC will assign this repurchase right to the
Company on the Effective Date of the Split-up.
Concurrently with the Transfer, the Agent released the lien of UDC on the
Collateral, allowing FMAC to retain all assets constituting any part of the
Collateral other than the Owned Contracts (the "Retained Assets"), including but
not limited to uncollected state and federal income tax refunds for 1996 and
prior years (the "Tax Refunds"), certain receivables and related vehicles
pledged to Greenwich Capital (the "Greenwich Collateral"), and FMAC's furniture,
fixtures, equipment, general intangibles, and causes of
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action. In consideration for UDC's release of its lien on the Retained Assets,
FMAC subsequently (A) guaranteed on a non-recourse basis full and timely payment
to UDC of any shortfall between (i) the Credit Bid Purchase Price of the Owned
Contracts plus interest thereon at the rate of 11% per annum from December 15,
1997, plus an additional charge for servicing the Owned Contracts (the "Owned
Contracts Servicing Fee"), calculated on a monthly basis, of the greater of
1/12 of 3 1/4% of the outstanding principal balance of the Owned Contracts or
$15.00 per Owned Contract, applied only to Owned Contracts that are less than
120 days past due and for which the related vehicle has not been repossessed and
(ii) collections and proceeds (subject to certain limitations) with respect to
the Owned Contracts (collectively, the "Secured Claim Recovery Amount"), and (B)
granted a lien (the "Replacement Lien") to the Agent for the benefit of UDC on
the issued and outstanding stock of First Merchants Auto Receivables Corporation
("FMARC") and First Merchants Auto Receivables Corporation II ("FMARC II"), the
holders of the residual interests and certain equity certificates (collectively,
the "B Pieces") of the various securitized loan pools ("Securitized Pools") of
FMAC, to secure the Secured Claim Recovery Amount and the Modified UDC Fee
(defined below). The Replacement Lien is not a first priority lien and is junior
to a lien in favor of Greenwich Capital with respect to certain obligations of
FMAC to Greenwich Capital and UDC with respect to the DIP Facility. In the event
that the Owned Contracts are not being serviced by UDC, a wholly-owned
subsidiary of UDC or another affiliate or assignee of UDC that meets certain
qualifications and conditions (an "Authorized Servicer"), without the prior
written consent of FMAC (an "Owned Loan Servicing Change"), which consent will
not be unreasonably withheld, the Secured Claim Recovery Amount will be limited
to $10 million. Following the Split-up, UDC's rights described herein with
respect to FMAC's non-recourse guarantee of the Secured Claim Recovery Amount
and in the Replacement Lien will be assigned to the Company. The Company will
also begin servicing the Owned Contracts, subject to the consent of the Contract
Purchaser. The Company believes that it will qualify as an Authorized Servicer,
and therefore, FMAC's consent will not be required to avoid an Owned Loan
Servicing Charge.
Any recovery on the Owned Contracts in excess of the Secured Claim Recovery
Amount will be shared with FMAC on the basis of 82.5% for the benefit of FMAC
and 17 1/2% for the benefit of UDC (the "Excess Collections Split"). After
payment in full of the Secured Claim Recovery Amount, the DIP Facility, the
Modified UDC Fee (defined below), and certain other amounts, any further
distributions from the B Pieces will be shared between FMAC and UDC on the same
basis as the Excess Collections Split. In the event that an Owned Loan Servicing
Change occurs, the Excess Collections Split will change to 85% for the benefit
of FMAC and 15% to UDC with respect to the B Pieces and, subject to certain
adjustments, 100% for the benefit of FMAC and 0% to UDC with respect to the
Owned Contracts. UDC will not be entitled to receive any share of the Excess
Collections Split relating to a Securitized Pool for any period during which it
is not acting as servicer for such Securitized Pool. In addition, UDC has agreed
in a contingent sharing agreement to pay 10% of the Excess Collections Split
received by UDC to Financial Security Assurance ("FSA"), the insurer of certain
obligations to the holders of the senior certificates representing interests in
the Securitized Pools, in exchange for FSA's consent to amendments to documents
governing servicing of the Securitized Pools as described below. All of UDC's
rights and the Excess Collections Split and the obligations with respect thereto
under the Contingent Sharing Agreement with FSA will be assigned to the Company
on the Effective Date of the Split-up.
At the option of UDC, UDC may distribute shares of UDC Common Stock (the
"Stock Option Shares") to FMAC or, at the request of FMAC and pursuant to its
instructions, directly to the unsecured creditors of FMAC, in lieu of FMAC's
right to receive all or a portion of distributions under the Excess Collections
Split (including both recoveries under the Excess Collections Split from the
Owned Contracts and the B Pieces) in cash (the "Stock Option"). If UDC decides
to exercise the Stock Option, UDC must give FMAC at least 15 days advance
written notice (the "Option Notice") (and make a public announcement on the same
date as the giving of the notice) of the date on which UDC will exercise the
Stock Option (the "Exercise Date") and the number of Stock Option Shares that
UDC will issue on the Exercise Date. The number of shares of UDC Common Stock to
be issued will be based on the trading range of the shares prior to the exercise
date. In this regard, the Stock Option Shares would be valued at 98% of the
average of the closing prices for the previous 10 trading days of UDC Common
Stock on Nasdaq or such other market on which such stock may be traded (the
"Stock Option Value"). Pursuant to the Capitalization Agreement, the
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Company will be required to give notice to UDC at least a stated number of days
prior to the date when cash distributions of the Excess Cash Split to FMAC are
likely to begin and the Company's estimate of the amount and timing of such
distributions. If UDC issues the Stock Option Shares, the Company will be
required to pay over to UDC all of FMAC's share of cash distributions under the
Excess Collections Split up to the Stock Option Value.
At the commencement of FMAC's bankruptcy case, UDC agreed to provide a DIP
Facility to FMAC of up to $10 million. Borrowings under the DIP Facility
originally were to mature on February 28, 1998 and accrue interest at the rate
of 12% per annum. The DIP Facility was originally secured by super priority
liens on all of FMAC's assets then existing or thereafter acquired. The DIP
Facility was subsequently amended to provide for (i) additional advances to pay
administrative and post-plan confirmation operating expenses of FMAC, provided
that total advances under the DIP Facility could not exceed $21.5 million, (ii)
security in the form of the Retained Assets, including the Tax Refunds, (iii) a
reduction in the interest rate on borrowings outstanding under the DIP Facility
to 10% per annum; and (iv) a waiver of the February 28, 1998 maturity date of
the DIP Facility. The first $10 million of Tax Refunds was to be used to pay
down the DIP Facility and permanently reduced the amount of the DIP Facility. To
date, approximately $9.1 million of Tax Refunds have been used to pay down the
DIP Facility and the maximum amount available to be borrowed has been reduced
from $21.5 million to $12.4 million. After application of the Tax Refunds, the
DIP Facility will be permanently paid down from distributions on the B Pieces,
after payment of the Secured Claim Recovery Amount. Payments made from other
sources on the DIP Facility will not permanently reduce the amount thereof and
FMAC will be allowed to reborrow such amounts under the DIP Facility. Following
the Split-up, the Company will assume all of UDC's rights and liabilities with
respect to the DIP Facility and in the Tax Refunds and other collateral securing
the same. UDC, however, will remain directly liable on the DIP Facility.
The increase in the DIP Facility to $21.5 million was agreed to in exchange
for an agreement by the parties involved, among other things, to assign to UDC
the receivables in the Securitized Pools that were charged off prior to February
28, 1998. Pursuant to that agreement, UDC is entitled to retain a servicing fee
of 27.5% of every dollar collected on the charged off receivables. The remaining
72.5% out of every dollar collected will be accumulated in an interest bearing
escrow account ("Charged Off Receivable Funds"). The Charged Off Receivable
Funds will be held in the escrow account until an amount equal to the purchase
price, which was equal to one percent of the remaining principal amount of all
receivables charged off prior to or on November 30, 1997, and two percent of the
remaining principal amount of all receivables charged off from December 1, 1997
to and including February 28, 1998, has been deposited to the escrow account at
which time such amount shall be allocated and paid to Securitized Pools from
which the receivables were transferred and, thereafter if the securitized pools
have inadequate funds to satisfy certain payments and distributions with respect
to the senior certificates issued with respect to such pools, then future
deposits to the escrow account shall be withdrawn to satisfy such payments and
distributions. When the aggregate of the spread accounts in the Securitized
Pools reaches a certain coverage (the "Coverage Point"), to the extent
available, all monies previously transferred to the escrow account to satisfy
such payments and distributions will be deposited back into the escrow account
and the Charged Off Receivable Funds will be released from the escrow account
and paid to the Company. Any additional collections with respect to charged-off
receivables relating to a Securitized Pool that has reached the Coverage Point
would be retained by the Company. Following the Split-up, all rights and
obligations with respect to the Charged Off Receivable Funds will be assigned to
the Company.
FMAC has guaranteed to pay UDC $450,000 on a non-recourse basis prior to
any payments pursuant to the Excess Collections Split solely from collections of
the B Pieces, which obligation is secured by a pledge of the stock of FMARC and
FMARC II, subordinate only to the DIP Facility, the Secured Claim Recovery
Amount and prior pledges of the FMARC II stock (the "Modified UDC Fee").
Following the Split-up, the right to receive the Modified UDC Fee will be
assigned to the Company.
UDC entered into a Servicing Agreement dated December 18, 1997 (the "Owned
Contracts Servicing Agreement") between UDC and the Contract Purchaser, pursuant
to which the Owned Contracts would be serviced by UDC in the event that FMAC
ceased to service the Owned Contracts. UDC began servicing the
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Owned Contracts on April 1, 1998, and therefore is entitled to receive a
servicing fee under the Owned Contracts Servicing Agreement. On April 1, 1998,
UDC also entered into amendment(s) with FMAC and other parties to the existing
Pooling and Servicing Agreements and Sale and Servicing Agreements that
currently govern servicing of the receivables in the securitized pools of FMAC,
which amendments provide for UDC to service the receivables in such securitized
pools beginning April 1, 1998. Under these agreements, UDC will receive a
servicing fee equal to the greater of (i) 3.25% per annum of the aggregate
outstanding principal balance of the non-defaulted receivables computed monthly
on the basis of the declining balance of the receivables portfolio or (ii) $15
per receivable per month, plus, in either case, reimbursement of certain costs
and expenses. The Company's right to receive such servicing fee and
reimbursement will be in part contingent on the past and future collections on
each Securitized Pool and the monies available in the applicable spread account
of each such Securitized Pool. All rights and obligations under the Owned
Contracts Servicing Agreement, subject to the consent of the contract purchaser,
and with respect to servicing the arrangements on the Securitized Pools, subject
to the consent of FSA, will be assigned to the Company following the Split-up.
On March 31, 1998, UDC contributed to FMAC all of its shares of FMAC common
stock as additional consideration for UDC's acquisition of the furniture,
leasehold improvements and equipment constituting FMAC's servicing platform.
Following the Split-up, the FMAC servicing platform will be transferred to the
Company.
Following the Split-up, all of UDC's rights and substantially all of UDC's
obligations in connection with the FMAC transaction accruing on or after the
Effective Date will be assigned to the Company, except as described above.
Transactions Regarding Reliance Acceptance Group. On February 9, 1998, UDC
announced that it had agreed to enter into servicing and transition servicing
arrangements with Reliance. Reliance filed a voluntary petition for relief under
Chapter 11 of the Bankruptcy Code on February 9, 1998. Reliance confirmed its
proposed plan in open court on June 29, 1998. The bankruptcy court signed the
order formally confirming the plan on July 2, 1998. The effective date of the
plan confirmed plan is the close of business on July 31, 1998. Reliance is a
national specialty finance company, primarily engaged in the business of
purchasing and servicing finance receivables for the purchase of new or used
automobiles, trucks, vans and sport utility vehicles by Sub-Prime Borrowers.
Pursuant to a servicing agreement entered into between UDC and Reliance
(the "Servicing Agreement"), as amended, on the effective date of the plan, UDC
will begin servicing certain receivables of Reliance in exchange for (i) a
monthly servicing fee of the greater of 4% per annum of the aggregate
outstanding principal balance of all non-defaulted receivables computed monthly
on the basis of the declining balance of the receivables portfolio (consisting
of Reliance's portfolio of (A) prime receivables and (B) sub-prime receivables),
or $15 per receivable per month plus reimbursement of certain costs and
expenses; (ii) $1.3 million in proceeds realized from the sale of a pool of
charged off receivables existing as of the Reliance Petition Date ("Charged-Off
Proceeds"); (iii) a total of (A) 4% of the outstanding principal balance of each
receivable (exclusive of defaulted and certain other receivables) sold in any
bulk sale to a person other than UDC or an affiliate of UDC, and (B) $3.25
million in net collections, recovery and sale proceeds from the receivables
portfolio and certain other cash receipts of Reliance reduced by any amount
previously paid under clause (A) above, following payment of Reliance's primary
bank debt and, if applicable, repayment to Reliance of any proceeds of
litigation, the Reliance Warrants (as defined below) and equity proceeds used by
Reliance to pay its primary bank debt ("Post-Bank Debt Proceeds"); and (iv)
following the Company's receipt of the Post-Bank Debt Proceeds, 15% of the net
collections, recovery and sale proceeds from the receivables portfolio and
certain other cash receipts of Reliance (the "Incentive Fee"). Reliance, in
consideration for entering into the Servicing Agreement, will receive privately
issued warrants (the "Reliance Warrants") to purchase shares of UDC Common Stock
as follows: 50,000 Reliance Warrants will be granted to Reliance upon the
Company's receipt of the Charged-Off Proceeds; up to 100,000 Reliance Warrants
will be granted to Reliance based upon the Company's receipt of up to $3.25
million of Post-Bank Debt Proceeds; and Reliance will be granted an additional
75,000 Reliance Warrants for every $1 million actually received by the Company
through the Incentive Fee. The Reliance Warrants have an exercise price of
$12.50 per share for
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the first 150,000 Reliance Warrants and an exercise price for all other Reliance
Warrants of the greater of $12.50 or 120% of the market price of the UDC Common
Stock on the date of issuance of the Reliance Warrants. The Reliance Warrants
will be exercisable as follows: (i) the first 50,000 Reliance Warrants will be
exercisable for three years from the Reliance Petition Date; and (ii) all
remaining Reliance Warrants will be exercisable for three years from their
respective dates of issuance. The Servicing Agreement has not yet been approved
by the Bankruptcy Court. The Company has agreed to pay to UDC consideration upon
the issuance of each Reliance Warrant equal to the fair value of the Reliance
Warrants (as determined by UDC for financial reporting purposes) on their date
of issuance.
Following the Split-up, all of UDC's rights and substantially all of UDC's
obligations in connection with the Reliance transaction accruing on or after the
Effective Date will be assigned to the Company, except that the Reliance
Warrants will be issued from time to time as required by UDC.
There can be no assurance that the Reliance transaction will be concluded
on the terms and conditions outlined above or at all, or if concluded, that such
transaction will prove profitable to the Company.
CYGNET DEALER PROGRAM
The Company believes that many independent used car dealers have difficulty
obtaining traditional working capital and, as a result, are forced to sell the
finance receivables that they originate from used car sales at significant
discounts in order to obtain the working capital necessary to operate their
businesses. In addition, most financing programs available to independent used
car dealers lessen or terminate the customer relationship between the dealer and
the buyer of the used car, which dealers would otherwise maintain in order to
generate referrals and/or repeat business. To capitalize on this opportunity,
the Company initiated the Cygnet Dealer Program, pursuant to which the Company
provides qualified dealers with warehouse purchase facilities and revolving
lines of credit primarily secured by the dealers' finance receivable portfolios.
Under both of these credit facilities, the dealer remains responsible for
collection of finance receivable payments and retains control of the customer
relationship. The credit facilities are for specified amounts and are 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 finance receivables originated. As a condition to providing such
financing, each dealer is required to report its collection activities to the
Company on a daily basis and provide the Company with periodic financial
statements. In addition, the Company has initiated an internal audit program
whereby dealers are audited by its internal audit department on a periodic
basis. The goal of these controls is to allow the Company's account officers,
who oversee the operations of each dealer participating in the program, to
better ensure dealer compliance with program covenants and determine the
appropriateness of continued funding under the credit facilities.
The Company believes that the Cygnet Dealer Program fulfills the need of
independent used car dealers for working capital to expand their businesses
while enabling the Company to earn finance income at favorable rates and
diversify its earning asset base. The Company began full-scale marketing of the
program during the first quarter of 1997. As of March 31, 1998, the Company had
lending relationships with a total of 43 independent dealers with advances
totaling approximately $31 million.
Targeted Dealers. The Company provides credit facilities to qualified "buy
here-pay here" dealers primarily throughout the southeastern and western U.S.
through the Cygnet Dealer Program. To qualify for the Cygnet Dealer Program, a
dealer must generally meet the following minimum requirements:
- Monthly sales of at least 25 cars.
- Established management with "buy here-pay here" experience.
- Net worth of at least $150,000 to qualify for the Dealer Collection
Program and at least $500,000 for the Asset Based Loan Program.
- Computerized inventory, receivable and collection system.
- Satisfactory inventory and facilities.
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The Company's strategy is to establish active relationships with a select
group of qualified dealers to which it is a primary source of funding for their
finance receivables. The Company currently has made advances to dealers in 14
states, and intends to expand its operations in selected markets throughout the
country.
The independent dealer financing industry consists of a number of national
and regional finance companies, plus certain institutional lenders, that
typically fund finance receivables on behalf of dealers based upon either
"collection" or "point of sale" programs. Pursuant to the "collection" program,
the dealer submits finance receivables to a finance company for collection and
the dealer is advanced a portion of the finance receivables stream of payments
as an advance, which is non-recourse to the dealer. These finance receivables
are then placed into a pool for collection. The finance company performs all of
the collection activity on these accounts and retains 20% of each dollar
collected as a servicing fee. The remaining 80% of each dollar collected is paid
to the finance company until the up-front advance to the dealer plus accrued
interest is paid in full. If and when the advance to the dealer plus accrued
interest is paid in full, then 80% of the remaining payments collected are
remitted back to the dealer. Under the "point of sale" program, the dealer
submits credit applications to the finance company, and upon approval, the
finance receivable is forwarded to the finance company for funding. Finance
companies may or may not provide financing depending on their own internal
underwriting guidelines. Assuming financing is approved, finance receivables
typically are purchased at a discount with the finance company assuming all
responsibility for collection and servicing. The Company believes that its
Dealer Collection and Asset Based Loan Programs are preferred by many dealers
because they allow the dealers, rather than the finance company, to control
collection activity and thus allow the dealers to retain servicing income and
maintain the relationship with the purchaser of the automobile, which is
important for customer referrals and repeat business.
Dealer Collection Program. The Dealer Collection Program is the Company's
primary program offered to independent dealers. Pursuant to this program, the
Company purchases finance receivables from a qualified dealer on a full recourse
basis. The dealer remains responsible for the collection of the contract
payments and retains control of the customer relationship. The Company typically
purchases finance receivable contracts at 65% to 75% of the principal balance
subject to a maximum of 170% of the Kelly Blue Book wholesale price. All cash
collections, including regular monthly payments, payoffs and repurchases, are
deposited directly by the dealer into a bank account maintained by the Company.
The Company retains all regular monthly cash payments and payoffs, subject to
the payment of a servicing fee to the dealer generally equal to 20% to 25% of
the regular monthly cash payments collected, payable on the 10th day following
the month of collection. Finance receivables must have a minimum annual
percentage rate of 21% or the maximum allowed by applicable state usury law. If
the interest rate of finance receivables is less than 21%, then the purchase
price is lowered to increase the effective yield to the Company.
Generally, each dealer pays a nonrefundable initial audit fee plus a
processing fee per contract or provides a security deposit. The dealer is
required to repurchase all finance receivable contracts that are 45 days
delinquent at a price equal to the original purchase percentage multiplied by
the outstanding principal balance plus accrued and unpaid interest on that
contract. The Dealer Collection Program is full recourse to the dealer and
typically includes personal guarantees by the principal owners of the
dealership.
Asset Based Loan Program. The Company also provides the Asset Based Loan
Program to dealers pursuant to which the Company provides to qualified dealers a
secured revolving line of credit. Pursuant to the Asset Based Loan Program, the
Company advances to qualified dealers, on a full recourse basis, up to 65% of
the principal amount of finance receivables subject to a maximum of 170% of the
Kelly Blue Book wholesale price of the underlying collateral. The Company also
charges an annual commitment fee of 1% to 2% of the available line and interest
on any amounts outstanding at the rate of prime plus 5% to 9%. In addition, each
dealer generally pays a nonrefundable initial audit fee plus a processing fee
per contract.
Under the Asset Based Loan Program, the dealer is responsible for
collection of contract payments and maintaining the customer relationship. All
cash collections, including regular monthly payments, payoffs and repurchases,
are deposited directly into a bank account maintained by the Company. Finance
receivables that are 45 days delinquent are deemed to be ineligible collateral
and are excluded from the calculation of the
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amount available under the line of credit. If the exclusion of ineligible
collateral causes the line to become over funded, then the dealer must either
pay down the line or assign additional qualifying finance receivables to the
Company. Each line of credit provides for full recourse to the dealer, typically
with full guarantees by the principal owners of the dealership.
In certain instances when a dealer reaches the maximum commitment amount
under the credit facility, the Company will consider purchasing the finance
receivables from the dealer as part of the overall lending relationship. In such
event, the Company typically purchases the finance receivables for an amount
equal to between 70% to 85% of the net principal balance depending on the
interest rates on the finance receivables, the seasoning of the finance
receivables, and the extent of limited recourse to the dealer.
Qualification Process and Underwriting Guidelines. Each dealer that wishes
to qualify to participate in the Cygnet Dealer Program must provide a fully
completed application form and supporting documentation, including financial
statements, tax returns, contract receivable aging reports, and vehicle
inventory reports, among others. After review of the application form and
supporting documentation, assuming compliance with the Company's minimum
requirements, a proposal letter is sent to the dealer outlining the proposed
terms of the financing program. To participate in the program, the dealer then
must sign and deliver the proposal letter to the Company, together with a
non-refundable deposit of $2,500, after which an initial on-site audit is
performed by the Company's internal audit department. The audit consists of
reviewing and testing payments, inventory, down payments, repos/charge-offs,
systems, collections/servicing, and financial statements. In addition, a member
of the Company's Internal Credit Review Committee typically will visit the
dealer and meet with its owners and key personnel to review its operations.
Following the initial on-site audit, a formal written audit report is prepared
and presented to the Company's Internal Credit Review Committee for approval. A
unanimous vote of this committee is required for approval. After approval has
been received, the Company prepares legal documents, which must be signed and
delivered by the dealer prior to participating in the program.
Each dealer participant in the Cygnet Dealer Program must follow certain
guidelines with respect to originating finance receivables. These guidelines
include customer-related guidelines that focus on the customer's stability,
ability to pay, and willingness to pay, and term, vehicle and rate related
guidelines that deal specifically with the minimum requirements for the car's
mileage as related to the term of finance receivables, and the minimum annual
percentage rate of the finance receivables. Each dealer is required to package
originated finance receivables in accordance with guidelines established by the
Company, which require the dealer to provide certain documentation identified on
a checklist from each borrower. The dealer then sends the finance receivable
packages to the Company's processing center where the contents are reviewed to
ensure compliance with the Company's guidelines. After verification of certain
information by the Company's personnel, the information with respect to each
file is keyed into the Company's loan processing system. Typically, the time
from receipt of the finance receivable packages to actual funding takes from 48
to 72 hours.
The Company follows a variety of procedures to limit losses from defaults
under the Dealer Collection and Asset Based Loan Programs. Prior to making an
advance under one of its programs, the Company performs an initial review and
audit of each dealer, verifies finance receivables before funding (which
verification may include an interview of the borrower, verification of the
borrower's employment, residence, and a reference) to ensure compliance with
Cygnet Dealer Program credit guidelines, and obtains agreements and personal
guarantees from the dealer and its owners that provide a variety of remedies to
the Company in case of a default. After an advance has been made, the Company
maintains a loan tracking system that monitors collection activities by the
dealer and keeps track of delinquencies, collections, repurchases and quality of
finance receivables, conducts on-site audits of each dealer at least
semiannually, reviews dealer financial statements on a quarterly basis and, if
advances exceed $2.5 million for a single dealer, requires annual audits to be
performed by an independent certified public accounting firm. In the event of
default by a dealer, the Company is capable of assuming all collection efforts
with respect to the dealer's portfolio. In anticipation of such event, the
Company maintains updated computerized records on all finance receivables and
has the infrastructure in place to directly perform collections with respect to
the portfolio. The Company also may pursue other remedies involving the pursuit
of additional collateral, providing assistance to a dealer
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with respect to the collection of payments and workout related items, and
pursuing personal guarantees of the owners.
PURSUIT OF OPPORTUNITIES IN INSURANCE MARKET
The finance receivables that the Company purchases in bulk generally
require borrowers to obtain casualty insurance within 30 days of their vehicle
purchase. While all borrowers are free to obtain such coverage from an insurer
of their choice, if a borrower fails to obtain the required coverage, the
Company may purchase a policy on the borrower's behalf and charge back to the
customer the cost of the premiums and fees associated with such policy.
To facilitate its ability to force place mandated insurance coverage, and
to provide continual monitoring of the primary insurance status of each loan
within the Company's portfolio, the Company recently began negotiating the
acquisition of or a management agreement with an insurance agency that offers
insurance-related products and services primarily to holders of large portfolios
of vehicle and residential mortgage loans, including banks, savings and loan
associations, finance companies, credit unions, and automobile dealers, among
others. The Company anticipates that this transaction, if completed, would
enable the Company to more effectively manage the risk of loss related to its
portfolios of loan receivables and offer more a comprehensive set of products
and services to financial institutions and independent used car dealers
participating in the sub-prime segment of the automobile financing industry.
SERVICING SYSTEMS AND SOFTWARE
In its bulk purchase and servicing operations, the Company currently uses a
third party service bureau to process loan collection information. The agreement
with this service bureau expires at the end of December 1998, although the
Company may extend this arrangement on a month-to-month basis at increasing
rates. The Company has entered into an agreement with a new third party service
bureau, Affiliated Computer Services, Inc. ("ACS"), and expects to convert its
loan processing and collection systems by year-end 1998. The Company anticipates
that this service bureau will provide enhanced collection support. ACS will also
provide disaster recovery and Year 2000 compliance services. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations -- Year
2000."
In its Cygnet Dealer Program, the Company currently utilizes a proprietary
loan collection system. Pursuant to this system, the Company inputs data on each
finance receivable independently of, but consistently with each dealer's system
in order to effectively monitor portfolio performance. The Company recently
signed a separate agreement with ACS to process the Cygnet Dealer Program. Due
to the unique characteristics of the Cygnet Dealer Program, ACS will make a
number of custom software enhancements to enable the program to run on the ACS
system. The custom software changes and conversion from the Company's in-house
system to ACS is scheduled for completion prior to year end 1998. In addition to
the ACS system, the Company is developing a custom loan underwriting and funding
software module that will also serve as an interface between the individual
dealers' systems and the ACS system. During 1999, the Company intends to migrate
the dealers from their separate, stand alone loan systems to the ACS system for
purposes of loan servicing and collections. Upon full implementation of the ACS
system, dealers will be able to enter transactions directly into the loan
system, eliminating the redundancy of Company input. This system will provide
the Company with real time access to information regarding each dealer's finance
receivable portfolio and allow the Company to audit more closely the activities
of each dealer. In addition, this system will enable the Company to promptly
assume servicing from dealers that go into default to help preserve the
Company's investment. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Year 2000."
COMPETITION
The markets in which the Company competes are highly competitive. With
respect to its Cygnet Dealer Program and bulk purchasing and servicing
operations, the Company competes with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater
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resources, including access to lower priced capital. In addition, there are
numerous financial services companies serving, or capable of serving, these
markets. While traditional financial institutions, such as commercial banks,
savings and loans, credit unions, and captive finance companies of major
automobile manufacturers, have not consistently served the sub-prime markets,
the yields earned by companies involved in sub-prime financing have encouraged
certain of these traditional institutions to enter, or contemplate entering,
these markets. Increased competition may adversely affect the rates earned under
the Cygnet Dealer Program and the Company's yields and fees under its bulk
purchasing and servicing arrangements.
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
finance receivables that the Company bulk 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 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.
EMPLOYEES
As of the Effective Date, the Company expects to employ approximately 280
persons. None of the Company's employees are covered by a collective bargaining
agreement.
PROPERTIES
As of the Effective Date, the Company will assume leases, or sublease from
UDC, headquarters facilities located at Phoenix, Arizona and servicing
facilities at Nashville, Tennessee, Denver, Colorado, and Plano, Texas. These
leases have expiration dates ranging from September 30, 1998 to June 14, 2002.
The Company believes these facilities are sufficient for its present operations.
LEGAL PROCEEDINGS
The Company currently is not a party to any material pending legal
proceedings. Notwithstanding the foregoing, the Company, in the ordinary course
of business, expects to receive complaints from borrowers relating to alleged
violations of federal and state consumer lending or other similar laws and
regulations. While most of these complaints typically are made directly to the
lender or to various consumer protection organizations and are subsequently
resolved, the Company may be named occasionally as a defendant in civil suits
filed by borrowers 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.
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MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Information concerning the names, ages, terms, positions with the Company,
and business experience of those persons who will become the Company's directors
and executive officers on the Effective Date of the Split-up is set forth below
as of July 1, 1998.
<TABLE>
<CAPTION>
TERM AS
DIRECTOR
NAME AGE POSITION EXPIRES
- ---- --- -------- --------
<S> <C> <C> <C>
Ernest C. Garcia, II................. 41 Chairman of the Board, Chief 1999
Executive Officer, and President
Robert J. Abrahams(1)................ 71 Director 1999
Christopher D. Jennings(1)(2)........ 44 Director 1999
Gary L. Trujillo..................... 37 Director 1999
Frank P. Willey(2)................... 44 Director 1999
Steven P. Johnson.................... 38 Senior Vice President and General
Counsel
Donald L. Addink..................... 48 Senior Vice President and Senior
Analyst
Eric J. Splaver...................... 35 Chief Financial Officer
Raymond C. Fidel..................... 40 President -- Cygnet Dealer Finance,
Inc.
Gregory R. Ciccolini................. 42 Chief Information Officer
</TABLE>
- ---------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Ernest C. Garcia II has served as the Chairman of the Board and Chief
Executive Officer of UDC since its founding in 1992, and served as President
from 1992 to 1996. Since 1991, Mr. Garcia has served as President of Verde
Investments, Inc. ("Verde"), a real estate investment corporation that is
wholly-owned by Mr. Garcia. Prior to 1992, when he founded UDC, Mr. Garcia was
involved in various real estate, securities, and banking ventures. Upon the
Effective Date Mr. Garcia will continue as the Chairman of the Board of UDC. Mr.
Garcia's sister is married to Mr. Johnson. See below, "Management -- Involvement
in Certain Legal Proceedings," "Principal Stockholders," and "Certain
Relationships and Related Transactions."
Robert J. Abrahams has served as a director of UDC since June 1996. Mr.
Abrahams has served since 1988 as a consultant to the financing industry,
including service as a consultant to UDC from 1994 to 1995. From 1960 to 1988,
Mr. Abrahams was an executive officer of Heller Financial, Inc., a finance
company. Prior to joining Heller Financial, Inc., Mr. Abrahams co-founded
Financial Acceptance Company in 1948. Upon the Effective Date Mr. Abrahams will
continue as a director of UDC. Mr. Abrahams is also a director of Smart Choice
Automotive Group, Inc., a retail automotive and finance company, and HMI
Industries, Inc., a manufacturing and direct selling company.
Christopher D. Jennings has served as a director of UDC since June 1996.
Mr. Jennings currently serves as Managing Director of Friedman, Billings, Ramsey
& Co., Inc., an investment banking firm. Mr. Jennings served as a managing
director of Cruttenden Roth Incorporated, an investment banking firm, from 1995
to April 1998. From 1992 to 1994, Mr. Jennings served as Managing Director of
investment banking at Sutro & Co., an investment banking firm. From 1989 to
1992, Mr. Jennings served as Senior Managing Director at Maiden Lane Associates,
Ltd., a private equity fund. Prior to 1989, Mr. Jennings served in various
positions with, among others, Dean Witter Reynolds, Inc., and Warburg Paribas
Becker, Inc., both of which are investment banking firms. Upon the Effective
Date Mr. Jennings will continue as a director of UDC. See "Certain Relationships
and Related Transactions" and "-- Principal Stockholders."
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Gary L. Trujillo is the founder of and has served as President and Chief
Executive Officer of Southwest Harvard Group, a privately held company engaged
in asset management and venture capital activities, since 1990. Prior to forming
Southwest Harvard Group, from 1983 to 1990 Mr. Trujillo was a Wall Street
investment banker working in New York City, initially with Salomon Brothers Inc.
Mr. Trujillo currently is a board member at Norwest Bank, N.A.
Frank P. Willey has served as a director of UDC since June 1996. Mr. Willey
has served as the President of Fidelity National Financial, Inc., one of the
nation's largest title insurance underwriters, since January 1995. From 1984 to
1995, Mr. Willey served as the Executive Vice President and General Counsel of
Fidelity National Title. Mr. Willey is also a director of Fidelity National
Financial, Inc., CKE Restaurants, Inc., an operator of various quick-service
restaurant chains, and Southern Pacific Funding Corporation, a specialty finance
company that originates, purchases, and sells high-yield, non-conforming
mortgage loans.
Steven P. Johnson has served as Senior Vice President, Secretary, and
General Counsel of UDC since its founding in 1992. Since 1991, Mr. Johnson has
also served as the Senior Vice President and General Counsel of Verde. Prior to
1991, Mr. Johnson practiced law in Tucson, Arizona. Mr. Johnson is licensed to
practice law in Arizona and Colorado and is married to the sister of Mr. Garcia.
Donald L. Addink has served as the Vice President -- Senior Analyst of UDC
since 1995 and also serves as the Vice President of Verde. From 1988 to 1995,
Mr. Addink served as Executive Vice President of Pima Capital Co., a life
insurance holding company. Prior to 1988, Mr. Addink served in various
capacities with a variety of insurance companies. Mr. Addink is a Fellow of the
Society of Actuaries and a Member of the American Academy of Actuaries.
Eric J. Splaver has served as Corporate Controller of UDC since May 1994.
From 1986 to 1994, Mr. Splaver worked as a certified public accountant with KPMG
Peat Marwick LLP.
Ray Fidel has served as President of Cygnet Dealer Finance, Inc., since
February 1997. On the Effective Date, Mr. Fidel will continue in his position
with Cygnet Dealer Finance, Inc. Prior to February 1997, Mr. Fidel served as
Managing Director of two financial corporations engaged in the asset-based
lending industry. Mr. Fidel was so employed from July 1995 to February 1997 with
Fidelity Funding Corporation and from March 1991 to June 1995 with DVI Business
Credit, a subsidiary of DVI, Inc., a New York Stock Exchange listed company. See
below "Management -- Involvement in Certain Legal Proceedings."
Gregory R. Ciccolini has served as Chief Information Officer since June
1998. From 1997 to 1998, Mr. Ciccolini was a Consulting Manager for SunGard
Planning Solutions, a company engaged in data center disaster recovery planning
and testing for Fortune 500 companies. From 1993 to 1997, Mr. Ciccolini served
as Vice President and Systems Director for Bank of America Arizona. Prior to
1993, Mr. Ciccolini served as Vice President and Information Systems Audit
Manager for several southwestern financial institutions.
Directors of the Company are elected for one year terms. Each director of
the Company serves until the following annual meeting of the Company, until his
successor is duly elected and qualified, or until retirement, resignation, or
removal. Executive officers of the Company serve at the discretion of the Board
of Directors.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
Prior to 1992, when he founded UDC, Mr. Garcia was involved in various real
estate, securities, and banking ventures. Arising out of two transactions in
1987 between Lincoln Savings & Loan Association ("Lincoln") and entities
controlled by Mr. Garcia, the Resolution Trust Corporation (the "RTC"), which
ultimately took over Lincoln, asserted that Lincoln improperly accounted for the
transactions and that Mr. Garcia's participation in the transactions facilitated
the improper accounting. Facing severe financial pressures, Mr. Garcia agreed to
plead guilty to one count of bank fraud, but, in light of his cooperation with
authorities both before and after he was charged, was sentenced to only three
years probation (which has expired), was fined $50 (the minimum fine the court
could assess), and, during the period of his probation, which ended in 1996, was
banned from becoming an officer, director or employee of any federally-insured
financial institution or a securities firm without governmental approval.
Because Cygnet is not a federally-insured institution and Mr. Garcia's
probationary period has expired, this ban does not apply to Mr. Garcia's
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activities on behalf of Cygnet. In separate actions arising out of this matter,
Mr. Garcia agreed not to violate the securities laws, and filed for bankruptcy
both personally and with respect to certain entities he has controlled. The
bankruptcies were discharged by 1993. In certain circumstances, Mr. Garcia could
acquire a controlling interest in the Company. See "-- Risks Relating to the
Rights Offering -- Ownership of Common Stock by Mr. Garcia." As a result of his
position as Chairman of the Board, Chief Executive Officer, and President of
Cygnet and by virtue of his ability to acquire a significant percentage of the
Common Stock after the Rights Offering, Mr. Garcia will have significant
influence over the Company's activities.
From February 1982 to April 1989, Lincoln employed Mr. Fidel, between 1988
and 1989, as its President. Following the takeover of Lincoln by the RTC in
1989, Mr. Fidel and others were charged with fraud (the "Complaint") arising out
of the sale of bonds at Lincoln of its parent company, American Continental
Corporation ("ACC"). With the filing of the Complaint, Mr. Fidel, without
admitting or denying any of the allegations in the Complaint, consented to the
entry of a permanent injunction against further violations of the securities
laws. Mr. Fidel pled guilty in 1991 to two counts of federal securities fraud,
and to six counts in California State court (five relating to fraud and one
relating to the sale of securities without qualification) arising out of this
matter. In light of Mr. Fidel's cooperation with authorities in their
prosecution of executives of ACC, including Charles H. Keating, Jr., and Mr.
Fidel's efforts in stopping bond sales at Lincoln, Mr. Fidel was given three
years of probation, which has expired.
EXECUTIVE COMPENSATION
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities to UDC during the three
fiscal years ended December 31, 1997, of those persons who will be, as of the
Effective Date: (i) the chief executive officer of the Company and (ii) the
three other executive officers of the Company whose compensation from UDC
exceeded $100,000 in the fiscal year ended December 31, 1997 (the "Named
Executive Officers"). The following information is provided in accordance with
SEC rules and regulations and is not necessarily indicative of the compensation
structure that will exist at the Company following the Split-up, although the
Company does not anticipate that such compensation structure will materially
differ from the information below.
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
----------------------------
ANNUAL COMPENSATION SECURITIES
--------------------------- UNDERLYING ALL OTHER
SALARY BONUS OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) AWARDS(#)(1) ($)(2)
--------------------------- ---- -------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Ernest C. Garcia, II................ 1997 $131,677 -- -- $ 3,935(3)
Chairman of the Board, Chief 1996 121,538 -- -- 3,873(3)
Executive Officer, and President 1995 100,000 -- -- 3,151(3)
Donald L. Addink.................... 1997 139,671 $10,000 -- 950
Senior Vice President -- Senior 1996 122,142 10,000 42,000 485
Analyst 1995 71,026 10,000 58,000 984
Steven P. Johnson................... 1997 131,677 -- 20,000 820
Senior Vice President and General 1996 121,538 -- 25,000 566
Counsel 1995 100,000 -- -- 177
Raymond C. Fidel.................... 1997 132,692 -- 75,000 11,000(4)
President -- Cygnet Dealer
Finance, 1996 -- -- -- --
Inc. 1995 -- -- -- --
</TABLE>
- ---------------
(1) The amounts shown in this column represent stock options granted pursuant to
UDC's Long-Term Incentive Plan. Generally, options are subject to vesting
over a five-year period, with 20.0% of the options becoming exercisable on
each successive anniversary of the date of grant.
(2) The amounts shown in this column include the dollar value of 401(k) plan
contributions made by UDC for the benefit of the Named Executive Officers.
(3) This amount includes a $2,985 car allowance during 1997, and a $2,950 car
allowance during both 1996 and 1995, respectively, for Mr. Garcia.
(4) This amount represents a car allowance for Mr. Fidel during 1997.
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<PAGE> 71
OPTION GRANTS IN LAST FISCAL YEAR
The table below sets forth information with respect to UDC options granted
during the fiscal year ended December 31, 1997 to the Named Executive Officers.
As set forth in the Capitalization Agreement between UDC and the Company,
generally, on the Effective Date, each stock option for UDC Common Stock held by
a Cygnet employee will be surrendered and, in exchange therefor, a new option
will be granted under the Cygnet Financial Corporation 1998 Stock Incentive Plan
(the "1998 Plan") for a number of shares of Cygnet Common Stock, and at an
exercise price, intended to preserve for such Cygnet employee the economic value
of the shares subject to the UDC option, including the spread between the
exercise price and the fair market value of the shares subject to the UDC
option. See "-- Cygnet Financial Corporation 1998 Stock Incentive Plan."
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------
PERCENT
NUMBER OF OF TOTAL POTENTIAL REALIZABLE VALUE AT
SECURITIES OPTIONS/ ASSUMED ANNUAL RATE OF
UNDERLYING SARS STOCK APPRECIATION FOR
OPTIONS/ GRANTED TO EXERCISE OPTION TERM
SARS EMPLOYEES IN PRICE EXPIRATION ------------------------------
NAME GRANTED FISCAL YEAR (PER SHARE) DATE 5% 10%
---- ---------- ------------ ----------- ---------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia, II........ -- -- -- -- -- --
Donald L. Addink(1)......... -- -- -- -- -- --
Steven P. Johnson(2)........ 20,000 3.4% $15.75 5/27/03 $107,130 $ 243,042
Raymond C. Fidel(3)......... 75,000 12.9% 18.75 2/07/07 893,389 2,250,200
</TABLE>
- ---------------
(1) During January 1998, Mr. Addink was granted options to purchase 25,000
shares of UDC Common Stock under the UDC 1998 Executive Incentive Plan (the
"UDC Executive Plan") at an exercise price of $8.25 per share. Such options
will be converted, on the Effective Date, to options to purchase 25,000
shares of Common Stock under the 1998 Plan at an exercise price of $7.00 per
share.
(2) During January 1998, Mr. Johnson was granted options to purchase 25,000
shares of UDC Common Stock under the UDC Executive Plan at an exercise price
of $8.25 per share. Such options will be converted, on the Effective Date,
to options to purchase 25,000 shares of Common Stock under the 1998 Plan at
an exercise price of $7.00 per share. In addition, Mr. Johnson's remaining
options to purchase UDC Common Stock will be cancelled as of the Effective
Date, and in consideration Mr. Johnson will be granted, on the Effective
Date, 15,000 shares of restricted Common Stock vesting over a specified
period of time from the Effective Date. See "-- Contracts with Directors and
Executive Officers."
(3) On the Effective Date, Mr. Fidel's options listed above will be converted to
options to purchase 84,000 shares of Common Stock under the 1998 Plan at an
exercise price of $7.00 per share. In addition, during January 1998 these
UDC Long Term-Incentive Plan options were repriced at an exercise price of
$9.75 per share.
71
<PAGE> 72
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AS OF DECEMBER
31, 1997 OF NAMED EXECUTIVE OFFICERS
The table below sets forth information with respect to UDC Common Stock
options exercised during fiscal year 1997 and held as of December 31, 1997 by
the Named Executive Officers. UDC has never issued any other forms of stock
based awards to its Named Executive Officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES FISCAL YEAR END(#)(1) FISCAL YEAR END($)(2)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia, II... -- -- -- -- -- --
Donald L. Addink....... 63,000 $622,490(3) 17,000 20,000 -- $35,000
Steven P. Johnson(4)... -- -- 5,000 40,000 $3,500 $14,000
Raymond C. Fidel....... -- -- -- -- -- --
</TABLE>
- ---------------
(1) Generally, UDC options are subject to vesting over a five-year period, with
20.0% of the options becoming exercisable on each successive anniversary of
the date of grant under UDC's Long-Term Incentive Plan.
(2) In-the-money UDC options are options for which the option exercise price
(the fair market value on the date of grant) was lower than the market price
of UDC's Common Stock on December 31, 1997, which market price of $8.50 per
share was based on the closing price of UDC's Common Stock on that date as
reported by Nasdaq. The values in the last two columns have not been, and
may never be, received by the Named Executive Officers. Actual gains, if
any, on option exercises will depend on the value of UDC's Common Stock as
applicable on the exercise dates. Accordingly, there can be no assurance
that the values shown in the last two columns will be realized. The closing
price of UDC's Common Stock on July 28, 1998 was $7.6875 per share.
(3) The value realized represents the value of stock options exercised by Mr.
Addink during the last fiscal year. During this period, he exercised options
to acquire 63,000 shares of UDC's Common Stock. The value realized was
calculated by subtracting the exercise price of Mr. Addink's options from
the fair market value of UDC's Common Stock underlying the options as of the
exercise date. The fair market value of UDC's Common Stock was based on the
closing price of the stock on the date of exercise as reported by Nasdaq.
Pursuant to UDC's Long-Term Incentive Plan documents, the exercise date was
the date Mr. Addink provided notice of his exercise to the Company and
method of payment.
(4) Does not include $105,000 worth of restricted Common Stock at the $7.00
Subscription Price (15,000 shares) to be issued to Mr. Johnson upon the
Effective Date of the Split-up. The restricted stock will vest over a
specified period from the Effective Date. See "-- Contracts with Directors
and Executive Officers."
CYGNET FINANCIAL CORPORATION 1998 STOCK INCENTIVE PLAN
The Compensation Committee of the Company's Board of Directors will
administer the 1998 Plan. Under the 1998 Plan, the Company may grant incentive
stock options, non-qualified stock options, stock appreciation rights,
performance shares, restricted stock, and performance-based awards to employees,
consultants, independent directors, and advisors of the Company. The Company
believes that the 1998 Plan will promote the success and enhance the value of
the Company by linking the personal interests of participants to those of the
Company's stockholders and providing participants with an incentive for
outstanding performance. Upon the Effective Date, the total number of shares of
Common Stock available for awards under the 1998 Plan will be 1,050,000, subject
to a proportionate increase or decrease in the event of a stock split, reverse
stock split, stock dividend, or other adjustment to the Company's total number
of issued and outstanding shares of Common Stock. Except with respect to options
to purchase UDC Common Stock held by Mr. Splaver and another employee, each
option to purchase UDC Common Stock held by each employee of UDC who will become
an employee of the Company will be cancelled as of the Effective Date and new
options to purchase Common Stock will be issued under the 1998 Plan
("Replacement Options").
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<PAGE> 73
Thus, it is expected that as of the Effective Date, Replacement Options to
purchase approximately 284,000 shares of Common Stock will be outstanding under
the 1998 Plan. For additional information concerning the Replacement Options,
see "-- Aggregated Option Exercises in the Last Fiscal Year and Option Values as
of December 31, 1997 of Named Executive Officers."
The 1998 Plan is administered by the Board of Directors or a committee of
the Board who qualify as non-employee directors and outside directors, which has
the authority to administer the 1998 Plan, including the power to determine
eligibility, the type and number of awards to be granted, and the terms and
conditions of any award granted, including the price and timing of awards,
vesting, and acceleration of such awards (other than performance-based awards).
The 1998 Plan limits the awards that can be granted to a single participant to
no more than 250,000 shares of Common Stock during any single calendar year. The
exercise price of options granted under the 1998 Plan will generally equal the
fair market value of the Common Stock on the date of grant except that the
committee is permitted to grant options at below fair market value. However, the
Replacement Options will be granted with exercise prices designed to approximate
the value of the UDC options previously held by the optionees. The committee
may, with the Board's approval, terminate, amend, or modify the 1998 Plan at any
time but no such termination, amendment, or modification may affect any stock
options, SARs, or restricted stock awards then outstanding under the 1998 Plan
without the participant's consent. Also, any such termination, amendment, or
modification is subject to any stockholder approval required under applicable
law or by any national securities exchange or association on which the Common
Stock is then listed or reported. The committee may amend the term of any award
or option theretofore granted, retroactively or prospectively, but no such
amendment shall adversely affect any such award or option without the holder's
consent.
401(k) PLAN
The Company anticipates that it will adopt a 401(k) plan, under which
eligible employees may direct that a portion of their compensation, up to a
legally established maximum, be withheld by the Company and contributed to their
account. All 401(k) plan contributions will be placed in a trust fund to be
invested by the 401(k) plan's trustee, although the 401(k) plan will permit
participants to direct the investment of their account balances among mutual or
investment funds available under the plan. The 401(k) plan will provide a
matching contribution of 10% of a participant's contributions and discretionary
additional matchings if authorized by the Company.
CHANGE OF CONTROL ARRANGEMENTS
In the event of a "Change of Control" of the Company: (i) all options and
other share-based awards granted under the 1998 Plan will become immediately
exercisable; (ii) any restriction periods and restrictions imposed on restricted
stock granted under the 1998 Plan will lapse; and (iii) the target value
attainable under all performance units and other performance-based awards
granted under the 1998 Plan shall be deemed to have been fully earned, unless,
in each case, the surviving entity agrees to assume the awards in a manner that
substantially preserves the participants' rights and benefits. Under the 1998
Plan, a Change in Control occurs upon any of the following events: (a) any
person (other than a current stockholder or any employee benefit plan) becoming
the beneficial owner of 20% or more of the Company's Common Stock; (b) during
any two-year period, the persons who are on the Company's Board of Directors at
the beginning of such period and any new person elected by two-thirds of such
directors cease to constitute a majority of the persons serving on the Board of
Directors; or (c) the Company's stockholders approve (1) a merger or
consolidation of the Company with another corporation where the Company is not
the surviving entity other than a merger in which the Company's stockholders
before the merger have the same proportionate ownership after the merger, (2) a
plan of complete liquidation or dissolution, or (3) any sale, lease, or other
transfer of 40% or more of the Company's assets, other than pursuant to a
sale-leaseback, structured finance, or other form of financing transaction. See
also additional change of control arrangements at "Management -- Contracts with
Directors and Executive Officers."
73
<PAGE> 74
CONTRACTS WITH DIRECTORS AND EXECUTIVE OFFICERS
On January 1, 1996, UDC entered into a three-year employment agreement with
Mr. Ernest C. Garcia II. The agreement establishes Mr. Garcia's base salary for
1997 at $132,000 per year and provides a minimum 10.0% increase in the base
salary each year throughout the term of the agreement. In addition, the
agreement provides for the continuation of Mr. Garcia's base salary and certain
benefits for a period of one year in the event Mr. Garcia is terminated by UDC
without cause prior to the expiration of that agreement. The agreement also
contains confidentiality and non-compete covenants. On the Effective Date, Mr.
Garcia's employment agreement will be assigned to and assumed by the Company.
On June 1, 1995, UDC entered into a five-year employment agreement with Mr.
Donald L. Addink, which was amended and restated effective August 1, 1997. The
restated agreement establishes Mr. Addink's base salary at $165,000 per year
beginning on or around the effective date of the restated employment agreement,
a $10,000 bonus payment upon execution of the restated employment agreement,
certain benefits, and the continuation of Mr. Addink's base salary and certain
benefits for a period of one year in the event Mr. Addink is terminated by UDC
without cause prior to expiration of the restated employment agreement. The
restated employment agreement also contains confidentiality and non-compete
covenants. On the Effective Date, Mr. Addink's employment agreement will be
assigned to and assumed by the Company.
On May 14, 1998, the Company entered into an employment agreement with Mr.
Gregory R. Ciccolini, the Company's chief information officer. The agreement
establishes Mr. Ciccolini's base salary at $120,000 per year, beginning on or
around the effective date of the agreement and other benefits. The agreement
also provides for a stock option grant of 20,000 shares of Common Stock, and a
grant of 7,143 shares (estimated value of $50,000) of restricted Common Stock,
both effective as of the Effective Date. The option grant and restricted stock
grant were made at the $7.00 Subscription Price. The initial option grant
consisted of a NQSO under the 1998 Plan, with terms and conditions consistent
with the plan's general terms. The restricted stock award consisted of Common
Stock of the Company, which vests on June 1, 2002, provided Mr. Ciccolini is
then employed by the Company. The agreement provides for the continuation of Mr.
Ciccolini's base salary for a six month period in the event Mr. Ciccolini is
terminated by the Company without cause prior to his one year anniversary date
with the Company (i.e., prior to June 1, 1999) ("Severance Benefit"). The
agreement contains a "Change of Control" provision that provides that upon such
an event occurring and either (a) Mr. Ciccolini himself terminates his
employment with the Company within 12 months after the change of control; or (b)
the Company terminates Mr. Ciccolini without cause within 90 days prior to the
change of control or within 12 months after the change of control, then in any
such event, Mr. Ciccolini's initial NQSO award and restricted stock grant under
the agreement will automatically fully vest. If this automatic vesting occurs,
no Severance Benefit shall be due to Mr. Ciccolini. The agreement provides for a
definition of a "Change of Control" substantially similar to the 1998 Plan's
definition, but adds an additional change of control event if Ernest C. Garcia,
II is removed and/or resigns as Chairman of the Board of the Company. See
"Management -- Change of Control Arrangements."
In June 1998, the Company agreed, subject to certain conditions, to grant
Mr. Johnson 15,000 shares (estimated value of $105,000) of restricted Company
Common Stock on or around the Effective Date at the $7.00 Subscription Price.
On June 16, 1998, the Company entered into an employment agreement with Mr.
Eric J. Splaver, the Company's chief financial officer. The agreement
establishes Mr. Splaver's base salary at $120,000 per year, beginning on or
around the Effective Date and other benefits. The agreement also provides for a
stock option grant of 30,000 shares of Common Stock and a grant of 14,286 shares
(estimated value of $100,000) of restricted Common Stock, both effective as of
the Effective Date. The option grant and restricted stock grant were made at the
$7.00 Subscription Price. The initial option grant is made under the 1998 Plan,
with terms and conditions consistent with the plan's general terms. The
restricted stock award consisted of Common Stock of the Company, which vests pro
rata over a four-year period. The agreement provides for the continuation of Mr.
Splaver's base salary and certain benefits for one year in the event Mr. Splaver
is terminated by the Company without cause prior to the third anniversary of the
Effective Date. The agreement contains a "Change of Control" provision that
provides that upon such an event occurring and either
74
<PAGE> 75
(a) Mr. Splaver himself terminates his employment with the Company within 12
months after the change of control; or (b) the Company terminates Mr. Splaver
without cause within 90 days prior to the change of control or within 12 months
after the change of control, then in any such event all stock option and
restricted stock granted under the agreement and thereafter, which are not yet
vested, shall automatically be fully vested. The agreement provides for a
definition of a "Change of Control" substantially similar to the 1998 Plan's
definition, but adds an additional change of control event if Ernest C. Garcia,
II is removed and/or resigns as Chairman of the Board of the Company. See
"Management -- Change of Control Arrangements."
COMMITTEES OF THE BOARD OF DIRECTORS
The Company will establish a Compensation Committee and an Audit Committee.
The Compensation Committee will consist of Messrs. Jennings and Willey, and will
review executive salaries and administer any bonus, incentive compensation, and
stock option plans of the Company, including the 1998 Plan. In addition, the
Compensation Committee will consult with management of the Company regarding
compensation policies and practices of the Company. The Audit Committee will
consist of Messrs. Abrahams and Jennings, and will review the professional
services provided by the Company's independent auditors, the annual financial
statements of the Company, and the Company's system of internal controls.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
There will be no compensation committee interlocks and no Company officer
or former officer will be a member of the Company's Compensation Committee.
COMPENSATION OF DIRECTORS
The Company's independent directors will be compensated $1,000 for physical
attendance at meetings of the Board of Directors and at meetings of committees
of the Board of Directors of which they are members, and will be reimbursed for
reasonable travel expenses incurred in connection with attendance at each Board
and committee meeting. Board and committee members will not be compensated for
their telephonic attendance at meetings. If a Board and committee meeting are
held on the same day, a member who attends both meetings will receive combined
total compensation of only $1,000. In addition, pursuant to the 1998 Plan
expected to be adopted by the Company, upon initial appointment or initial
election to the Board of Directors, each independent director of the Company
will receive Company Common Stock valued at $50,000, which will be subject to
vesting in equal annual increments over a three-year period as provided for
under the 1998 Plan. Directors who are also officers of the Company will not be
compensated for their services as directors and will not be entitled to
participate in the directors' portion of the 1998 Plan.
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<PAGE> 76
PRINCIPAL STOCKHOLDERS
UDC currently owns all of the outstanding shares of the Company's Common
Stock. The following table sets forth the estimated beneficial ownership of the
Company's Common Stock immediately following the Effective Date, based on
beneficial ownership of UDC Common Stock on July 1, 1998 (unless another date is
indicated), by: (1) each director of the Company; (2) the Named Executive
Officers of the Company; (3) all directors and executive officers of the Company
as a group; and (4) each anticipated beneficial owner of more than 5% of the
outstanding Common Stock immediately following the completion of the Rights
Offering. To the knowledge of the Company, each person listed below has sole
voting and investment power with respect to his share of UDC Common Stock,
except (a) to the extent that authority is shared by his spouse under applicable
law, or (b) as otherwise indicated below. The estimated number of shares
beneficially owned and the percentage of ownership each assume the sale of
4,750,000 shares of Common Stock in the Rights Offering, 714,286 shares of
Common Stock to Mr. Garcia pursuant to the Additional Purchase Right, 500,000
additional shares of Common Stock that Mr. Garcia has the right to purchase
pursuant to the exercise of the Standby Warrants, and the issuance of 36,429
restricted shares of Common Stock to certain officers of the Company.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF
NAME OF BENEFICIAL OWNER(2)(3) BENEFICIALLY OWNED(1) OWNERSHIP(1)
- ------------------------------ --------------------- -------------
<S> <C> <C>
Ernest C. Garcia II(4)(5)................................... 2,386,161 39.6%
Robert J. Abrahams(6)....................................... 7,143 *
Christopher D. Jennings(6).................................. 7,143 *
Gary L. Trujillo(6)......................................... 7,143 *
Frank P. Willey(6).......................................... 7,143 *
Steven P. Johnson........................................... 77,750 1.3%
Donald L. Addink............................................ 24,500 *
Raymond C. Fidel............................................ 2,500 *
Harris Associates L.P.(5)(7)................................ 456,250 9.9%
Wellington Management Company, LLP(5)(8).................... 416,125 9.0%
Merrill Lynch & Co., Inc.(5)(9)............................. 403,750 8.8%
FMR Corp.(5)(10)............................................ 321,000 6.9%
All directors and executive officers as a group (10
persons).................................................. 2,532,833 42.0%
</TABLE>
- ---------------
* Represents less than one percent of the outstanding Common Stock.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired within 60 days following July 1, 1998 through the exercise of any
option, warrant, or right. Shares of Common Stock subject to options,
warrants, or rights that are currently exercisable or exercisable within 60
days are deemed outstanding for computing the percentage of the person
holding such options, warrants, or rights, but are not deemed outstanding
for computing the percentage of any other person. As described above, the
amounts and percentages are based upon an estimate of 6,029,287 shares of
Common Stock outstanding immediately following the completion of the Rights
Offering, including 500,000 shares of the Company's Common Stock that Mr.
Garcia has the right to purchase pursuant to the Standby Warrants.
(2) Unless otherwise noted, the address of each of the listed stockholders is
2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016.
(3) Excludes 214,286 shares of Common Stock that may be purchased pursuant to
the D&O Purchase Right as described herein. Also excludes certain
restricted Common Stock of the Company held by its officers, which has not
vested and will not vest within 60 days following July 1, 1998.
(4) Includes 714,286 shares of Common Stock that Mr. Garcia has the right to
purchase at the Subscription Price and 500,000 additional shares of Common
Stock that Mr. Garcia has the right to purchase pursuant to the exercise of
the Standby Warrants. Also includes shares of Common Stock held indirectly
by Mr. Garcia through a nonprofit corporation and Verde Investments, Inc.
("Verde"), an
76
<PAGE> 77
affiliate of Mr. Garcia. Mr. Garcia has sole voting and dispositive power
over these shares of Common Stock.
(5) The Company knows of no other person who would beneficially own more than
five percent of the Common Stock as of the Effective Date based upon
beneficial ownership of UDC Common Stock as of July 1, 1998 (unless another
date is indicated).
(6) The total for each independent Board of Director member includes 7,143
shares of Common Stock granted under the Company's 1998 Plan. Shares having
a total value of $50,000 on or about the date of grant (i.e., approximately
7,143 shares of Common Stock) will be granted and issued to each
independent Board member upon his appointment or election to the Board of
Directors as of the Effective Date. Pursuant to the 1998 Plan, these shares
generally vest over a three-year period at an annual rate of 33%, beginning
on the first anniversary date after the date of grant.
(7) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by Harris
Associates L.P. ("Harris") and an affiliate of Harris, Harris Associates
Investment Trust and related funds ("Harris Trust"), all located at Two
North LaSalle Street, Suite 500, Chicago, Illinois 60602. According to
these Schedule 13Gs, Harris has shared voting and dispositive power over
1,825,000 shares of UDC Common Stock (including 1,750,000 shares
attributable to Harris Trust) and Harris Trust has shared voting and
dispositive power over 1,750,000 shares of UDC Common Stock. The Company
makes no representation as to the accuracy or completeness of the
information provided in this footnote or the above beneficial ownership
table related to the same, which is based solely on the Schedule 13G
filings of Harris and Harris Trust.
(8) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by
Wellington Management Company, LLP, at 75 State Street, Boston,
Massachusetts 02109. According to the Schedule 13G filings, Wellington
Management Company, LLP has shared voting power over 767,100 shares of UDC
Common Stock and shared dispositive power over 1,664,500 shares of UDC
Common Stock. The Company makes no representation as to the accuracy or
completeness of the information provided in this footnote or the above
beneficial ownership table related to the same, which is based solely on
Wellington Management Company, LLP's Schedule 13G filing.
(9) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by
Merrill Lynch & Co., Inc. ("Merrill Parent") and four (4) of its
subsidiaries and/or affiliates, including Merrill Lynch Global Allocation
Fund, Inc. ("Merrill Global"). Merrill Parent and one of its
subsidiary/affiliates that is included within this Merrill Schedule 13G
filing are located at 250 Vesey Street, New York, New York 10281. Merrill
Global and the other two (2) subsidiaries/affiliates that are included
within this Merrill Schedule 13G filing are located at 800 Scudders Mill
Rd., Plainsboro, New Jersey 08536. According to the Schedule 13G, Merrill
Global has shared voting and dispositive power over 1,530,000 shares of UDC
Common Stock and Merrill Parent along with each of its other three
subsidiaries and/or affiliates have shared voting and dispositive power
over 1,615,000 shares of UDC Common Stock. The Company makes no
representation as to the accuracy or completeness of the information
provided in this footnote or the above beneficial ownership table related
to the same, which is based solely on Merrill's Schedule 13G filing.
(10) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by FMR
Corp., along with certain of its affiliates ("FMR"), at 82 Devonshire
Street, Boston, Massachusetts 02019. According to the Schedule 13G, FMR has
no voting power over shares and has sole dispositive power over 1,284,000
shares of UDC Common Stock. The Company makes no representation as to the
accuracy or completeness of the information provided in this footnote or
the above beneficial ownership table related to the same, which is based
solely on FMR's Schedule 13G filing.
77
<PAGE> 78
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company will engage in certain transactions with the affiliated parties
described below. Any future transactions between the Company and its affiliated
entities, executive officers, directors, or significant stockholders will
require the approval of a majority of the independent directors of the Company
and will be on terms no less favorable to the Company than the Company could
obtain from non-affiliated parties.
Ernest C. Garcia, II, the Chairman of the Board, Chief Executive Officer,
and President of Cygnet, will be granted on the Effective Date, in consideration
for the Standby Purchase Obligation, the Standby Warrants, which will entitle
Mr. Garcia to purchase up to 500,000 additional shares of Common Stock at an
exercise price equal to 120% of the Subscription Price, or $8.40 per share. In
addition, on the Effective Date, Mr. Garcia will have the Additional Purchase
Right, which gives him the right, at his election, to purchase up to an
additional 714,286 shares of Common Stock at the Subscription Price. As the
Standby Purchaser, Mr. Garcia may be able to purchase significant amounts of
Common Stock at the Subscription Price to the extent such stock is not purchased
upon exercise of the Rights or pursuant to the Over-Subscription Privilege by
holders of the Rights, which could result in Mr. Garcia's acquiring a
controlling interest in the Company. In addition, the Cash Payment by the
Company to UDC may be used in whole or in part to repay the Verde Note currently
held by a corporation wholly owned by Mr. Garcia.
On the Effective Date, certain directors and officers of the Company
(excluding Mr. Garcia) will be able to exercise the D&O Purchase Right which
will give them the right, at their election, to purchase in the aggregate
214,286 shares of Common Stock at the Subscription Price.
Prior to the Effective Date, the Company and UDC will enter into the
Capitalization Agreement. The Capitalization Agreement sets forth, among other
things, and assuming the satisfaction or waiver of specified contingencies, (i)
the obligation of the Company to issue the Rights, (ii) the obligation of the
Company to issue the Common Stock on the Effective Date upon exercise of the
Rights, the Over-Subscription Privilege, and the Standby Purchase Obligation,
(iii) the obligation of UDC and its subsidiaries to transfer the Transferred
Assets to the Company on the Effective Date, (iv) the obligation of the Company
to issue the Preferred Stock to UDC and to make the Cash Payment, (v) the
obligation of the Company to issue other capital stock and warrants as described
herein, (vi) the operational arrangements and agreements between the Company and
UDC during a transition period, including arrangements for the sharing of
certain assets, leases, licenses, and employees, (vii) agreements between the
Company and UDC relating to employee matters, including the issuance or
adjustment of stock options under employee benefit plans, (viii) tax sharing and
indemnity matters, and (ix) certain agreements between the Company and UDC
relating to the FMAC and Reliance transactions.
The Company currently is a wholly-owned subsidiary of UDC. After the
successful completion of the Rights Offering, UDC will hold $40 million of the
Company's Preferred Stock. In connection with the Split-up, UDC will transfer
substantially all of the rights and liabilities related to the FMAC and Reliance
transactions. However, UDC will remain liable with respect to certain
liabilities related to these transactions. As consideration for retaining these
liabilities, UDC will be entitled to certain rights from the Company. For a
description of the respective rights and liabilities of UDC and the Company as
they relate to the FMAC and Reliance transactions, see "Business -- Bulk
Purchasing and Servicing Operations -- Transactions Regarding First Merchants
Acceptance Corporation" and "-- Transactions Regarding Reliance Acceptance
Group."
78
<PAGE> 79
DESCRIPTION OF CAPITAL STOCK
The Company is a Delaware corporation and its affairs are governed by its
Certificate of Incorporation and Bylaws and the Arizona Revised Statutes. The
following description of the Company's capital stock, which is complete in all
material respects, is qualified in its entirety by reference to the provisions
of the Company's Certificate of Incorporation and Bylaws.
The authorized capital stock of the Company consists of 14,000,000 shares
of Common Stock, par value $.001 per share, and 500,000 shares of Preferred
Stock, par value $.001 per share. At July 29, 1998, one share of Common Stock
(issued to UDC) and no shares of Preferred Stock were issued and outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held of
record on all matters on which stockholders are entitled to vote. Holders of
Common Stock do not have cumulative voting rights, and therefore holders of a
majority of the shares voting for the election of directors can elect all of the
directors. In such event, the holders of the remaining shares will not be able
to elect any directors.
Holders of Common Stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. The Company does not anticipate paying cash dividends in the
foreseeable future. See "Dividend Policy." In the event of liquidation,
dissolution, or winding up of the Company, the holders of Common Stock are
entitled to share ratably in any corporate assets remaining after payment of all
debts, subject to any preferential rights of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive, conversion, or redemption
rights and are not subject to further calls or assessments by the Company. All
of the outstanding shares of Common Stock are validly issued, fully paid, and
nonassessable.
PREFERRED STOCK
If the Rights Offering is successfully concluded, Cygnet will issue to UDC
40,000 shares of Cumulative Convertible Preferred Stock, Series A, $.001 par
value per share (the "Preferred Stock") with an aggregate liquidation preference
of $40 million. The Preferred Stock, in preference to the Common Stock, will be
entitled to receive cumulative cash dividends, from the Effective Date through
the first anniversary of such date, at the initial annual rate of 7% of the Base
Liquidation Amount (defined below), and escalating 1% per annum on each
anniversary thereafter to a maximum rate of 11% per annum on the aggregate Base
Liquidation Amount, in each case payable quarterly in arrears on the first day
of March, June, September, and December of each year, beginning December 1,
1998, when and as declared by the Board of Directors of Cygnet out of funds
legally available for such payment. The Preferred Stock, in preference to the
Common Stock, will be entitled to receive, in the event of dissolution or
liquidation of Cygnet, $1,000 per share (the "Base Liquidation Amount") plus
accrued and unpaid dividends thereon (the "Liquidation Preference Amount").
The Preferred Stock will be redeemable at Cygnet's option in whole or in
part at a redemption price of $1,000 per share, plus dividends accrued and
unpaid thereon to the redemption date; provided, however, that no such
redemption will be authorized unless, in the judgment of the Company and UDC,
the proceeds of such redemption will be treated for federal income tax purposes
as proceeds from a sale of such stock and not as dividends paid with respect to
such stock. As a consequence, redemptions of the Preferred Stock may be limited
and may be confined to a single redemption of all outstanding Preferred Stock.
The Company will be authorized to redeem shares of Common Stock held by holders
of Preferred Stock to the extent necessary to assure that the proceeds from a
redemption of Preferred Stock will receive favorable income tax treatment.
The Preferred Stock will be convertible in whole or in part at any time
after the third anniversary following issuance at the option of UDC into that
number of shares of Common Stock determined by dividing the Liquidation
Preference Amount of the shares of Preferred Stock to be converted by the lower
of (a) the Subscription Price or (b) 80% of the average Market Price (defined
below) for the 10 consecutive trading days ending two business days prior to the
date notice of conversion is given, subject to adjustment upon
79
<PAGE> 80
certain extraordinary events. In addition, the Preferred Stock will be
convertible during any period following the date that an amount equal to six
quarterly dividend payments on the Preferred Stock has accrued and is unpaid,
until the payment in full of all accrued dividends. For purposes of the
conversion of the Preferred Stock, "Market Price" means (i) if the Common Stock
is quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or on a
national securities exchange, the daily per share closing price of the Common
Stock as quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or
on the principal stock exchange on which it is listed on the trading day in
question, as the case may be, whichever is the higher, or (ii) if the Common
Stock is traded in the over-the-counter market and not quoted on the Nasdaq
National Market or the Nasdaq SmallCap Market or on any national securities
exchange, the closing bid price of the Common Stock on the trading day in
question, as reported by Nasdaq or an equivalent generally accepted reporting
service. The Preferred Stock will not have any pre-emptive or other subscription
rights.
Except as described below, holders of the Preferred Stock will not be
entitled to vote for the election of directors or for other matters on which
holders of the Common Stock are entitled to vote. In the event that an amount
equal to two quarterly dividend payments on the Preferred Stock shall have
accrued and be unpaid, the holders of the Preferred Stock will have the right,
voting separately as a class, to elect two members to the Board of Directors of
Cygnet (in addition to the then authorized number of directors) at the next
meeting of stockholders of Cygnet and thereafter until all accrued dividends on
the Preferred Stock have been paid in full. The Preferred Stock shall also have
voting rights on certain extraordinary matters including: (i) the authorization,
creation, or issuance, or the increase in the authorized or issued amount, of
any class or series of stock senior to the Preferred Stock as to the payment of
dividends and distribution of assets upon dissolution, liquidation, or winding
up of the Company; or (ii) the amendment, alteration, or repeal of the
Certificate of Incorporation or the certificate of designation through which the
Preferred Stock will be issued, that would materially and adversely change the
voting powers, rights or preferences of the Preferred Stock. In such case, each
share of Preferred Stock shall have one vote per Base Liquidation Amount.
If the Preferred Stock were converted to Common Stock at the Subscription
Price of $7.00 per share, UDC would obtain 5,714,286 shares, or approximately
61.6% of the then outstanding shares of the Company, assuming the sale by the
Company pursuant to the Rights Offering of 3,562,500 shares of Common Stock (the
Required Purchase Amount) and that no additional shares of Common Stock are
issued either on the Effective Date of the Split-up or thereafter. If the
Preferred Stock were converted to Common Stock at the Subscription Price of
$7.00 per share, and assuming the sale by the Company of 4,750,000 shares of
Common Stock pursuant to the Rights Offering and the sale of 714,286 additional
shares to Ernest C. Garcia, II and 214,286 additional shares available for
purchase by officers and directors of Cygnet (other than Mr. Garcia) and that no
additional shares of Common Stock are then outstanding, UDC would obtain
approximately 50.2% of the then outstanding shares of the Company.
The Preferred Stock and the Common Stock into which it is convertible are
not registered under the Securities Act and may not be sold by UDC unless such
securities are registered or unless an exemption from registration is available.
The Company has agreed to register the resale of the Common Stock issued upon
conversion of the Preferred Stock under the Securities Act, at its expense upon
request of UDC.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Certificate of Incorporation provides that to the fullest
extent permitted by Delaware law, a director of the Company shall not be
personally liable to the Company or its stockholders for monetary damages for
breach of such director's fiduciary duty, except for liability: (i) for any
breach of the director's duty of loyalty to the Company or its stockholders;
(ii) for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law; (iii) in respect of certain unlawful
dividend payments or stock redemptions or repurchases; and (iv) for any
transaction from which the director derives an improper benefit. The effect of
the provision of the Company's Certificate of Incorporation is to eliminate the
rights of the Company and its stockholders (through stockholders' derivative
suits on behalf of the Company) to recover monetary damages against a director
for breach of the fiduciary duty of care as a director (including breaches
resulting from negligent or grossly negligent behavior), except in the
situations described in
80
<PAGE> 81
clauses (i) through (iv) above. This provision does not limit or eliminate the
rights of the Company or any stockholder to seek nonmonetary relief such as an
injunction or recision in the event of a breach of a director's duty of care. In
addition, the Company's Certificate of Incorporation provides that the Company
shall indemnify any person who is or was a director or officer of the Company,
or who is or was serving at the request of the Company as a director, officer,
employee, or agent of another corporation or entity, against expenses,
liabilities, and losses incurred by any such person by reason of the fact that
such person is or was acting in such capacity. The Company will obtain insurance
on behalf of its directors and officers for any liability arising out of such
person's actions in such capacity.
The Company will enter into agreements to indemnify its directors and
officers. These agreements, among other things, will indemnify the Company's
directors and officers for certain expenses (including attorneys' fees),
judgments, fines, and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of the Company,
arising out of such person's services as a director or officer of the Company,
any subsidiary of the Company, or any other company or enterprise to which such
person provides services at the request of the Company. To the extent that the
Board of Directors or the stockholders of the Company may in the future wish to
limit or repeal the ability of the Company to provide indemnification as set
forth in the Company's Certificate of Incorporation, such repeal or limitation
may not be effective as to directors or officers who are parties to the
indemnification agreements because their rights to full protection would be
contractually assured by such agreements. It is anticipated that similar
contracts may be entered into, from time to time, with future directors of the
Company. The Company believes that the indemnification provisions in its
Certificate of Incorporation and in the indemnification agreements are necessary
to attract and retain qualified persons as directors and officers.
CERTAIN BYLAW PROVISIONS
The Company's Bylaws, as amended, contain several provisions that regulate
the nomination of directors and the submission of proposals in connection with
stockholder meetings. The Company's Bylaws require that, subject to certain
exceptions, any stockholder desiring to propose business or nominate a person to
the Board of Directors at a stockholders meeting must give notice of any
proposals not less than 60 days nor more than 90 days prior to the anniversary
date of the immediately preceding annual meeting of stockholders. Such notice is
required to contain certain information as set forth in the Bylaws. No business
matter shall be transacted nor shall any person be eligible for election as a
director of the Company unless proposed or nominated, as the case may be, in
strict accordance with this procedure set forth in the Company's Bylaws.
Although the Bylaws do not give the Board of Directors any power to approve
or disapprove of stockholder nominations for the election of directors or of any
other business desired by stockholders to be conducted at an annual or any other
meeting, the Bylaws may have the effect of precluding a nomination for the
election of directors or the conduct of business at a particular annual meeting
if the proper procedures are not followed or may discourage or deter a third
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of the Company, even if the
conduct of such solicitation or such attempt might be beneficial to the Company
and its stockholders. The Company's procedures with respect to all stockholder
proposals and the nomination of directors will be conducted in accordance with
Section 14 of the Exchange Act and the rules promulgated thereunder.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock of the Company is
Norwest Bank Minnesota, National Association.
SHARES ELIGIBLE FOR FUTURE SALE
Assuming the maximum potential issuance of shares of Common Stock pursuant
to the Rights Offering (and no purchase of shares pursuant to the Standby
Purchase Obligation), the Additional Purchase Right, and the D&O Purchase Right,
the Company will have 5,678,573 shares of Common Stock outstanding as of the
Effective Date. Of these shares, 1,863,025 will be freely tradeable without
restriction or further registration under the Act and 3,815,547 shares of Common
Stock (the "Control Shares") will be subject to certain restrictions as on
resale under Rule 144 as described below. Certain restrictions apply to any
shares of
81
<PAGE> 82
Common Stock purchased pursuant to the Rights Offering by affiliates of the
Company, which may generally only be sold in compliance with the limitations of
Rule 144, except for the holding period requirements thereunder.
In general, under Rule 144 as currently in effect, if two years have
elapsed since the date of acquisition of restricted securities from the Company
or any affiliate and the acquiror or subsequent holder is not deemed to have
been an affiliate of the Company for at least 90 days prior to a proposed
transaction, such person would be entitled to sell such shares under Rule 144(k)
without regard to the limitations described below. If one year has elapsed since
the date of acquisition of restricted securities from the Company or any
affiliate, the acquiror or subsequent holder thereof (including persons who may
be deemed affiliates of the Company) is entitled to sell within any three-month
period a number of shares that does not exceed the greater of 1% of the then-
outstanding shares of Common Stock or the average weekly trading volume in the
Common Stock an exchange during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain provisions regarding the manner
of sale, notice requirements and the availability of current public information
about the Company. Approximately 3,815,547 Control Shares will be eligible for
future sale subject to the holding period and other conditions imposed by Rule
144. In addition, as of the Effective Date, up to 969,000 additional shares of
Common Stock will be issued pursuant to restricted stock grants or will be
subject to issuance upon the exercise of certain options and warrants.
Substantially all of the shares of Common Stock to be issued pursuant to the
restricted stock grants, options and warrants are subject to certain
registration rights agreements that will enable the holders thereof to resell
the shares without restriction or will be covered by a registration statement on
Form S-8 enabling resale without restriction.
Rule 144A under the Act provides a nonexclusive safe harbor exemption from
the registration requirements of the Act of specified resales of restricted
securities to certain institutional investors. In general, Rule 144A allows
unregistered resales of restricted securities to a "qualified institutional
buyer," which generally includes an entity, acting for its own account or for
the account of other qualified institutional buyers, that in the aggregate owns
or invests on a discretionary basis at least $100 million in securities of
issuers that are not affiliated with the entity, as long as these securities
when issued were not of the same class as securities listed on a national
securities exchange or quoted on the Nasdaq National Market or Nasdaq SmallCap
Market. The shares of Common Stock outstanding as of the date of this Prospectus
would be eligible for resale under Rule 144A because such shares, when issued,
were not of the same class as any listed or quoted securities.
LEGAL MATTERS
The validity of the securities offered hereby is being passed upon for the
Company by Snell & Wilmer L.L.P., Phoenix, Arizona.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (the "Registration
Statement") under the Securities Act with respect to the Rights and shares of
Common Stock offered hereby. This Prospectus constitutes a part of the
Registration Statement and does not contain all of the information set forth
therein and in the exhibits thereto, certain portions of which have been omitted
as permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Rights and shares of Common
Stock offered hereby, reference is hereby made to such Registration Statement
and exhibits. Statements contained in this Prospectus as to the contents of any
document are not necessarily complete and in each instance are qualified in
their entirety by reference to the copy of the appropriate document filed with
the Commission. The Registration Statement, including the exhibits thereto, may
be examined without charge at the Commission's public reference facility at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. In
addition, copies of all or any part of the Registration Statement, including
such exhibits thereto, may be obtained from the Commission at its principal
office in Washington, D.C., upon payment of the fees prescribed by the
Commission.
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<PAGE> 83
EXPERTS
The combined financial statements of the Company as of December 31, 1997
and for the year then ended, have been included herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
The statements in this Prospectus under the captions "Prospectus
Summary -- The Rights Offering," "The Rights Offering -- Opinion of Appraiser,"
and "Federal Income Tax Consequences," insofar as they relate to the Appraisal,
have been reviewed and approved by Willamette Management Associates, as experts
in such matters, and are included herein in reliance on such review and
approval.
83
<PAGE> 84
CYGNET FINANCIAL CORPORATION
INDEX TO COMBINED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Combined Financial Statements:
Combined Balance Sheets as of June 30, 1998 (unaudited)
and December 31, 1997.................................. F-3
Combined Statements of Operations for the six months ended
June 30, 1998 (unaudited) and 1997 (unaudited) and the
year ended December 31, 1997........................... F-4
Combined Statements of Stockholder's Equity for the year
ended December 31, 1997, and the six months ended June
30, 1998 (unaudited)................................... F-5
Combined Statements of Cash Flows for the six months ended
June 30, 1998 (unaudited) and 1997 (unaudited) and the
year ended December 31, 1997........................... F-6
Notes to Combined Financial Statements.................... F-7
</TABLE>
F-1
<PAGE> 85
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder
Cygnet Financial Corporation:
We have audited the accompanying combined balance sheet of Cygnet Financial
Corporation as of December 31, 1997, and the related combined statements of
operations, stockholder's equity, and cash flows for the year ended December 31,
1997. These combined financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
combined financial statements based on our audit.
We conducted our audit 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 audit provides a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Cygnet Financial
Corporation as of December 31, 1997, and the results of their operations and
their cash flows for the year ended December 31, 1997 in conformity with
generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Phoenix, Arizona
June 5, 1998
F-2
<PAGE> 86
CYGNET FINANCIAL CORPORATION
COMBINED BALANCE SHEETS
JUNE 30, 1998 AND DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and Cash Equivalents................................. $ 232 $ 1,225
Finance Receivables, Net.................................. 26,333 19,274
Notes Receivable, Net..................................... 23,027 21,861
Property and Equipment, Net............................... 2,335 646
Goodwill, Net............................................. 1,138 1,178
Other Assets.............................................. 5,515 5,850
------- -------
$58,580 $50,034
======= =======
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Accrued Expenses and Other Liabilities................. $ 2,464 $ 548
Advances from Affiliate................................ 15,818 9,106
Note Payable........................................... 298 380
------- -------
Total Liabilities................................. 18,580 10,034
------- -------
Stockholder's Equity:
Preferred Stock; $.001 par value, 500,000 shares
authorized, none issued and outstanding............... -- --
Common Stock; $.001 par value, 14,000,000 shares
authorized, one share issued and outstanding.......... -- --
Additional Paid-in Capital............................. 40,000 40,000
Retained Earnings...................................... -- --
------- -------
Total Stockholder's Equity........................ 40,000 40,000
------- -------
Commitments and Contingencies............................. -- --
------- -------
$58,580 $50,034
======= =======
</TABLE>
See accompanying notes to Combined Financial Statements.
F-3
<PAGE> 87
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF OPERATIONS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT EARNINGS (LOSS) PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED YEAR
JUNE 30, ENDED
---------------- DECEMBER 31,
1998 1997 1997
------ ------ ------------
(UNAUDITED)
<S> <C> <C> <C>
Revenues:
Interest Income........................................... $6,382 $ 137 $ 7,472
Servicing Fees............................................ 4,937 -- --
Net Gain on Sale of Repossessed Collateral................ 1,108 -- --
Gain on Sale of Notes Receivable.......................... -- -- 8,132
Other Income.............................................. 123 -- 355
------ ------ -------
12,550 137 15,959
------ ------ -------
Operating Expenses:
Provision for Credit Losses............................... 965 -- 691
Selling and Marketing..................................... 36 9 18
General and Administrative................................ 9,001 1,008 3,766
Depreciation and Amortization............................. 230 62 153
------ ------ -------
10,232 1,079 4,628
------ ------ -------
Earnings (Loss) before Interest Expense..................... 2,318 (942) 11,331
Interest Expense............................................ 1,714 37 2,067
------ ------ -------
Earnings (Loss) before Income Taxes......................... 604 (979) 9,264
Income Taxes (Benefit)...................................... 244 (394) 3,728
------ ------ -------
Net Earnings (Loss)......................................... $ 360 $ (585) $ 5,536
====== ====== =======
Basic/Diluted Earnings (Loss) per share..................... $ 360 $ (585) $ 5,536
====== ====== =======
Shares used in computation.................................. 1 1 1
====== ====== =======
Pro Forma Basic Earnings (Loss) per Share (unaudited)....... $(0.18) $(0.35) $0.48
------ ------ --------
------ ------ --------
Pro Forma Diluted Earnings (Loss) per Share (unaudited)..... $(0.18) $(0.35) $0.48
------ ------ --------
------ ------ --------
Pro Forma Shares used in computation - basic (unaudited).... 5,679 5,679 5,679
----- ----- --------
----- ----- --------
Pro Forma Shares used in computation - diluted
(unaudited)............................................... 5,679 5,679 5,683
----- ----- --------
----- ----- --------
</TABLE>
See accompanying notes to Combined Financial Statements.
F-4
<PAGE> 88
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 1998 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
---------------- PAID-IN RETAINED STOCKHOLDER'S
SHARES AMOUNT CAPITAL EARNINGS EQUITY
------ ------ ---------- -------- -------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1996............ -- $-- $ -- $ -- $ --
Issuance of Common Stock................. 1 -- -- -- --
Contributed Capital...................... -- -- 40,000 -- 40,000
Distributions to Ugly Duckling
Corporation............................ -- -- -- (5,536) (5,536)
Net Earnings for the Year................ -- -- -- 5,536 5,536
-- -- ------- ------ -------
Balances at December 31, 1997............ 1 -- 40,000 -- 40,000
Six Months Ended June 30, 1998
(unaudited)
Distributions to Ugly Duckling
Corporation (unaudited)................ -- -- -- (360) (360)
Net Earnings for the Period
(unaudited)............................ -- -- -- 360 360
-- -- ------- ------ -------
Balances at June 30, 1998 (unaudited).... 1 $-- $40,000 $ -- $40,000
== == ======= ====== =======
</TABLE>
See accompanying notes to Combined Financial Statements.
F-5
<PAGE> 89
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 1998 AND 1997 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------- DECEMBER 31,
1998 1997 1997
-------- ------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss)..................................... $ 360 $ (585) $ 5,536
Adjustments to Reconcile Net Earnings (Loss) to Net
Cash Provided by Operating Activities:
Provision for Credit Losses.......................... 965 -- 691
Depreciation and Amortization........................ 230 62 153
Increase in Other Assets............................. (1,116) (7) (87)
Increase in Accrued Expenses and Other Liabilities... 1,916 129 396
-------- ------- --------
Net Cash Provided by (Used In) Operating
Activities.................................... 2,355 (401) 6,689
-------- ------- --------
Cash Flows from Investing Activities:
Increase in Finance Receivables......................... (17,213) -- (20,941)
Collections of Finance Receivables...................... 9,219 -- 9,330
Increase in Notes Receivable............................ (16,937) (8,829) (12,700)
Collections of Notes Receivable......................... 15,741 504 6,900
Purchase of Property and Equipment...................... (428) -- (146)
Payment for Acquisition of Assets....................... -- -- (9,098)
-------- ------- --------
Net Cash Used in Investing Activities........... (9,618) (8,325) (26,655)
-------- ------- --------
Cash Flows from Financing Activities:
Payment of note payable................................. (82) (120) (120)
Advances from Affiliate................................. 6,352 8,900 9,106
Contribution of Additional Paid-in Capital.............. -- -- 12,205
-------- ------- --------
Net Cash Provided by Financing Activities....... 6,270 8,780 21,191
-------- ------- --------
Net Increase (Decrease) in Cash and Cash Equivalents...... (993) 54 1,225
Cash and Cash Equivalents at Beginning of Period.......... 1,225 -- --
-------- ------- --------
Cash and Cash Equivalents at End of Period................ $ 232 $ 54 $ 1,225
======== ======= ========
Supplemental Statement of Cash Flows Information:
Contribution of certain assets to the Company........... $ -- $ 601 $ 27,795
======== ======= ========
Assumption of note payable.............................. $ -- $ 500 $ 500
======== ======= ========
</TABLE>
See accompanying notes to Combined Financial Statements.
F-6
<PAGE> 90
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS
JUNE 30, 1998 AND DECEMBER 31, 1997
(1) ORGANIZATION, PURPOSE, BASIS OF PRESENTATION AND ACQUISITION
Cygnet Financial Corporation (the Company), a wholly-owned subsidiary of
Ugly Duckling Corporation (Ugly Duckling), was formed on June 1, 1998 for the
purpose of consummating a transaction whereby Ugly Duckling would split-up its
operations into two publicly-held companies (the split-up). The Company will
purchase from Ugly Duckling, substantially all of Ugly Duckling's non-dealership
operations including, the bulk purchasing and certain servicing operations
(excluding the branch office network), it's third party dealer financing
operations, and substantially all other non-dealership assets and contract
rights including those acquired in the First Merchants Acceptance Corporation
Transaction and assume the liabilities related thereto (collectively referred to
as the acquired assets). In exchange for the acquired assets, the Company will
issue $40.0 million of its cumulative, convertible preferred stock and a cash
payment equivalent to the greater of the appraised value or the book value of
the acquired assets, which the Company does not expect to materially differ.
These combined financial statements reflect the results of operations, financial
position, changes in stockholder's equity and cash flows of the Company, as if
the Company were a separate entity operating the acquired assets for all periods
presented. The combined financial statements have been prepared using the
historical basis in the assets and liabilities and historical results of
operations of the Company. In connection with the split-up, the Company intends,
through a rights offering to Ugly Duckling stockholders, to issue up to 5.6
million shares of common stock at an offering price of $7.00 per share.
The accompanying unaudited combined financial statements of the Company as
of June 30, 1998 and for the six month periods ended June 30, 1998 and 1997,
have been prepared in accordance with generally accepted accounting principles
for interim financial information and pursuant to rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for a complete financial statement presentation. In the opinion of management,
such unaudited interim information reflects all adjustments, consisting only of
normal recurring adjustments, necessary to present the Company's financial
position and results of operations for the periods presented. The results of
operations for interim periods are not necessarily indicative of the results to
be expected for a full fiscal year.
General corporate overhead related to the Company's corporate headquarters
and common support functions has been allocated to the Company, to the extent
such amounts are applicable to the Company. However, the costs of these services
charged to the Company are not necessarily indicative of the costs that would
have been incurred if the Company had performed these functions as a stand-alone
entity. As a result of the split-up, the Company will be required to perform
these functions using its own resources or purchased services and will be
responsible for the costs and expenses associated with the management of a
public corporation. The financial information included herein may not
necessarily reflect the combined results of operations, financial position,
changes in stockholder's equity and cash flows of the Company in the future or
amounts that would have been reported had it been a separate, stand-alone entity
during the periods presented.
The Company operates various business segments. The Company operates it's
Cygnet Dealer Program, whereby the Company provides independent used car dealers
(Third Party Dealers) with warehouse purchase facilities and operating credit
lines primarily secured by the dealers' retail installment contract portfolio.
In addition, the Company operates a bulk purchasing business segment in which
the Company acquires via bulk purchase large portfolios of retail installment
contract loan portfolios. Further, in conjunction with acquisition of the
contributed assets, the Company received certain rights to service the finance
receivable portfolios of various parties. The Third Party Dealers' retail
installment contract portfolios are substantially comprised of loans to persons
who have limited credit histories, low incomes, or past credit problems.
In August 1997, the Company acquired substantially all of the assets of
American National Acceptance Corporation (ANAC) in exchange for approximately
$9.1 million in cash. The acquisition was recorded in accordance with the
"purchase method" of accounting, and, accordingly, the purchase price has been
F-7
<PAGE> 91
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
allocated to the assets purchased and the liabilities assumed based upon the
estimated fair values at the date of acquisition. The excess of the purchase
price over the fair values of the net assets acquired was approximately $1.2
million and has been recorded as goodwill, which is being amortized over a
period of 15 years. The results of operations of ANAC have been included in the
accompanying statement of operations from the acquisition date.
The following summary, prepared on a pro forma basis, combines the results
of operations (unaudited) as if the acquisition had taken place on January 1,
1997. Such pro forma amounts are not necessarily indicative of what the actual
results of operations might have been if the acquisition had been effective on
January 1, 1997, (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
------------
<S> <C>
Interest Income............................................. $ 10,920
Fee Income.................................................. $ 861
Other Income................................................ $ 8,198
Total Revenues.............................................. $ 19,979
Net Earnings................................................ $ 4,210
Basic/Diluted Earnings Per Share............................ $ 4,210
Proforma Basic Earnings Per Share........................... $ 0.25
Proforma Diluted Earnings Per Share......................... $ 0.25
</TABLE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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.
Concentration of Credit Risk
As of December 31, 1997, the Company had warehouse purchase facilities and
revolving lines of credit with a total of 42 Third Party Dealers. The finance
receivables balance of loans the Company had purchased from one third party
dealer totaled $7,756,000, representing approximately 28.1% of the Company's
total finance receivables portfolio as of December 31, 1997. There were no other
Third Party Dealer's loans which exceeded 10% of the Company's total finance
receivables portfolio as of December 31, 1997.
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 are deferred and charged against finance income over the life
of the related installment sales contract as an adjustment of yield
F-8
<PAGE> 92
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
using the interest method. The accrual of interest is suspended if collection
becomes doubtful, generally 90 days past due, and is resumed when the loan
becomes current.
Fee income generally represents revenues from services such as periodic
audits of borrowers, collateral monitoring and maintenance fees and is
recognized when the services have been performed.
Servicing income is recognized when earned. Servicing costs are charged to
expense as incurred. In the event delinquencies and/or losses on the respective
serviced portfolios exceed specified levels, the Company may be required to
transfer the servicing of the portfolio to another servicer.
Net gain on sale of repossessed collateral is recognized using the cost
recovery method.
Finance Receivables and Allowance for Credit Losses
The largest portion of the Company's business is with Third Party Dealers
who participate in the "Dealer Collection Program." Under this program, the
Company purchases retail installment sales contracts from Third Party Dealers on
a full recourse basis. The dealer retains servicing rights and collects the
contract on behalf of the Company. The purchase price of the contracts is
generally 65% to 75% of the principal balance of the respective contracts. The
difference between the par value of the purchased contracts and the amount paid
by the Company is nonrefundable acquisition discount (the "acquired allowance").
The acquired allowance is allocated between acquired allowance available for
credit losses and acquired allowance available for accretion to interest income.
The portion of acquired allowance allocated to the allowance for credit losses
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 acquired allowance, if
any, is deferred and accreted to income using the interest method.
Finance receivables consist of contractually scheduled payments from the
installment sales contracts net of unearned finance charges, accrued interest
receivable, direct loan origination costs, and an allowance for credit losses,
including acquired allowances.
Notes Receivable
Notes receivable are recorded at cost, less related allowance for impaired
notes receivable. Management, considering information and events regarding the
borrowers ability to repay their obligations, including an evaluation of the
estimated value of the related collateral, considers a note to be impaired when
it is probable that the Company will be unable to collect all amounts due
according to the contractual terms of the note agreement. When a loan is
considered to be impaired, the amount of impairment is measured based on the
present value of expected future cash flows discounted at the note's effective
interest rate. Impairment losses are included in the allowance for credit losses
through a charge to provision for credit losses. Cash receipts on impaired notes
receivable are applied to reduce the principal amount of such notes until the
principal has been received and are recognized as interest income, thereafter.
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". Accordingly,
direct loan origination costs are offset against loan origination fees with the
difference capitalized and amortized to finance income using a method.
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. Leasehold 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.
F-9
<PAGE> 93
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
The Company has recognized income taxes pursuant to a Tax Sharing Agreement
between the Company and its parent. Under the terms of the agreement, the
Company is obligated to pay to its parent, amounts approximating the federal and
state income taxes incurred by the parent as a result of the Company's actual
contribution to the consolidated income taxes of its parent.
Stock Option Plan
The Company has 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 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
Basic earnings per share is computed by dividing income available to the
common stockholder by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company. For purposes of computing the pro
forma earnings per share for the periods presented, the Company has assumed the
maximum potential issuance of shares of common stock pursuant to its planned
rights offering, and the payment of dividends at a rate of 7.0% per annum as if
preferred stock totaling $40.0 million was outstanding for the periods
presented.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable.
F-10
<PAGE> 94
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future undiscounted 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.
(3) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
A summary of finance receivables as of June 30, 1998 and December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Installment Sales Contract Principal Balances....... $38,010 $27,481
Add: Accrued Interest Receivable.................... 209 147
------- -------
Principal Balances, Net............................. 38,219 27,628
Allowance for Credit Losses:
Finance Receivables............................... (1,202) (485)
Acquired Allowance................................ (10,394) (7,706)
Refundable Security Deposits...................... (290) (163)
------- -------
Finance Receivables, Net............................ $26,333 $19,274
======= =======
</TABLE>
A summary of allowance for credit losses on finance receivables for the
periods ended June 30, 1998 and December 31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Balance, Beginning of Period......................... $ 8,191 $ --
Provision for Credit Losses........................ 935 491
Acquired Allowance................................. 3,410 7,706
Net Charge Offs.................................... (940) (6)
------- ------
Balance, End of Period............................... $11,596 $8,191
======= ======
</TABLE>
(4) NOTES RECEIVABLE
In July 1997, First Merchants Acceptance Corporation (FMAC) filed for
bankruptcy. Immediately subsequent to the bankruptcy filing, the Company
executed a loan agreement with FMAC to provide FMAC with up to $10.0 million in
debtor in possession (the DIP facility) financing. The DIP facility accrues
interest at 12.0%, was initially scheduled to mature on February 28, 1998, and
is secured by substantially all of FMAC's assets. The Company and FMAC
subsequently amended the DIP facility to increase the maximum commitment to
$21.5 million, decrease the interest rate to 10.0% per annum, and extend the
maturity date indefinitely. In connection with the amendment, FMAC pledged the
first $10.0 million of income tax refunds receivable, which FMAC anticipates
collecting in 1998, to the Company. The maximum commitment under the DIP
facility had been reduced to $12.4 million (unaudited) at June 30, 1998. Once
the proceeds from the income tax refunds are remitted to the Company, such
amounts permanently reduce the maximum commitment under the DIP facility.
Thereafter, the Company anticipates collecting the balance of the DIP facility
from distributions to FMAC from FMAC's residual interests in certain
securitization transactions. The outstanding balance on the DIP facility totaled
$10,312,000 (unaudited) and $10,868,000 at June 30, 1998 and December 31, 1997,
respectively.
F-11
<PAGE> 95
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
During the third and fourth fiscal quarters of 1997, the Company acquired
the senior bank debt of FMAC from the bank group members holding such debt. In
December 1997, a credit bid for the outstanding balance of the senior bank debt
plus certain fees and expenses (the "credit bid purchase price") was entered and
approved in the bankruptcy court resulting in the transfer of the senior bank
debt for the loan portfolio which secured the senior bank debt (the "owned
loans"). Simultaneous with the transfer to the Company, General Electric Capital
Corporation purchased the owned loans for 86% of the principal balance of the
loan portfolio, and the Company retained a 14% participation in the loan
portfolio (See note 7). FMAC has guaranteed that the Company will receive an
11.0% return on the credit bid purchase price from the cash flows generated by
the owned loans, and further collateralized by FMAC's residual interests in
certain securitization transactions. The balance of the participation totaled
$6,155,000 (unaudited) and $5,399,000 at June 30, 1998 and December 31, 1997,
respectively.
Various revolving notes receivable from used car dealers with a total
commitment of $11,700,000 (unaudited) and $8,750,000 at June 30, 1998 and
December 31, 1997, respectively, expiring through September 1999 with interest
rates ranging from prime plus 5.50% to prime plus 9.75% per annum (14% to 18.25%
at December 31, 1997), interest payable monthly. The respective revolving notes
subject the borrower to borrowing base requirements with advances on eligible
collateral (retail installment contracts) of sixty-five percent of the par value
of the underlying collateral. The balance outstanding on these revolving notes
receivable totaled $6,560,000 (unaudited), net of allowance for credit losses of
$230,000 (unaudited), at June 30, 1998 and $5,594,000, net of an allowance for
credit losses of $200,000, at December 31, 1997.
A summary of the allowance for credit losses for notes receivable for the
periods ended June 30, 1998 and December 31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Balance, Beginning of Period...... $200 $ --
Provision for Credit Losses....... 30 200
Net Charge Offs................... -- --
---- ----
Balance, End of Period............ $230 $200
==== ====
</TABLE>
(5) PROPERTY AND EQUIPMENT
A summary of Property and Equipment as of June 30, 1998 and December 31,
1997 follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Furniture and Equipment (note
7).............................. $2,545 $ 666
Leasehold Improvements............ 44 44
Vehicles.......................... 63 63
------ ------
2,652 773
Less Accumulated Depreciation and
Amortization.................... (317) (127)
------ ------
Property and Equipment, Net....... $2,335 $ 646
====== ======
</TABLE>
Depreciation expense relating to property and equipment totaled $190,000
(unaudited) and $127,000 for the periods ended June 30, 1998 and December 31,
1997, respectively.
F-12
<PAGE> 96
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(6) GOODWILL
A summary of goodwill as of June 30, 1998 and December 31, 1997 follows (in
thousands):
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Goodwill.......................... $1,204 $1,204
Accumulated Amortization.......... (66) (26)
------ ------
Goodwill, Net..................... $1,138 $1,178
====== ======
</TABLE>
Amortization expense relating to goodwill totaled $40,000 (unaudited) and
$26,000 for the periods ended June 30, 1998 and December 31 1997, respectively.
(7) OTHER ASSETS
A summary of Other Assets as of June 30, 1998 and December 31, 1997 follows
(in thousands):
<TABLE>
<CAPTION>
JUNE 30, 1998 DECEMBER 31, 1997
------------- -----------------
(UNAUDITED)
<S> <C> <C>
Servicing Fees Receivable...... $2,983 $ --
Due from GE Capital
Corporation.................. 700 3,000
Offering Costs................. 601 --
Investment in Marketable
Securities (note 5).......... -- 1,451
Due from First Merchants
Acceptance Corp.............. -- 971
Other Assets................... 1,231 428
------ ------
$5,515 $5,850
====== ======
</TABLE>
In connection with the GE Capital Corporation purchase of the owned loans,
a sum of $3,000,000 was held in escrow pending completion of certain conditions
precedent. Such conditions were substantially satisfied subsequent to December
31, 1997 and $2.3 million of the funds were remitted to the Company. The Company
expects to begin collecting the remaining balance in December 1998.
During March 1998, the Bankruptcy Court handling the bankruptcy of FMAC
(note 4) approved the exchange of the $1,451,000 investment in common stock of
FMAC held by the Company for the property and equipment that constitute FMAC's
loan servicing platform.
(8) ADVANCES FROM AFFILIATE
Advances from Affiliate represent balances due to Ugly Duckling to fund the
Company's bulk purchase, servicing and third party dealer financing operations.
The balance will be paid in full at such time that the Company consummates the
split-up. The Advances to Affiliate balance outstanding to Ugly Duckling totaled
$15,818,000 (unaudited) and $9,106,000 at June 30, 1998 and December 31, 1997,
respectively.
The Company recorded interest expense totaling $1,696,000 (unaudited)
during the six month period ended June 30, 1998 and $2,017,000 during the year
ended December 31, 1997 related to this advance.
(9) NOTE PAYABLE
The Company has executed a note payable with an unrelated party which calls
for annual payments of $120,000. Interest has been imputed at 10%. The note
which matures in May 2000 is secured by certain
F-13
<PAGE> 97
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
furniture and equipment. The balance related to this note payable totaled
$298,000 (unaudited) and $380,000 at June 30, 1998 and at December 31, 1997,
respectively.
(10) INCOME TAXES
Income taxes amounted to $3,728,000, for the year ended December 31, 1997
(an effective corporate income tax rate of 40.2%). A reconciliation between
taxes computed at the federal statutory rate of 34% in 1997 (the "Expected"
income taxes) and the Company's effective taxes follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
Computed "Expected" Income Taxes.................... $3,150
State Income Taxes, Net of Federal Effect........... 585
Other, Net.......................................... (7)
------
$3,728
======
</TABLE>
Components of income taxes (benefit) for the year ended December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------- -------- ------
<S> <C> <C> <C>
Federal.................................................. $2,841 $ -- $2,841
State.................................................... 887 -- 887
------ ----- ------
$3,728 $ -- $3,728
====== ===== ======
</TABLE>
(11) LEASE COMMITMENTS
The Company leases certain office space and equipment from unrelated
entities under various operating leases which expire through August 2001. The
leases require monthly rental payments aggregating approximately $30,000 and
contain various renewal options from one to ten years. The Company is also
responsible for occupancy and maintenance costs, including real estate taxes,
insurance, and utility costs. Rent expense totaled $315,000 (unaudited) for the
six months ended June 30, 1998 and $270,000 for the year ended December 31,
1997.
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, 1997 follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, AMOUNT
- ------------ ------
<S> <C>
1998................................................ $ 293
1999................................................ 302
2000................................................ 320
2001................................................ 213
------
Total..................................... $1,128
======
</TABLE>
(12) STOCKHOLDER'S EQUITY
The Company has authorized 14,000,000 shares of $.001 par value common
stock. There was one share issued and outstanding at December 31, 1997. However,
in connection with the proposed split-up, the Company expects to issue up to a
maximum number of shares of common stock totaling approximately 5,679,000 upon
closure of the proposed rights offering. The accompanying proforma earnings per
share
F-14
<PAGE> 98
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
amounts included in these combined financial statements have been presented to
reflect the expected issuance of these shares.
The Company has authorized 500,000 shares of $.001 par value preferred
stock. There were no shares issued and outstanding at June 30, 1998 or at
December 31, 1997.
(13) STOCK OPTION PLAN
Concurrent with the split-up of Ugly Duckling, the Company will adopt a
long-term incentive plan (stock option plan). The stock option plan will set
aside 1,050,000 shares of common stock to be granted to employees at a price of
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.
Concurrent with the establishment of the plan, the Company's Board of
Directors intend to approve the grant of certain options to employees of the
Company who had formerly received stock option grants under the Ugly Duckling
long-term incentive plan. These employees forfeited their Ugly Duckling stock
options in exchange for the grants they received under this plan. In the opinion
of management, the value of these grants approximates the value of the options
forfeited by the respective employees.
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 combined 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 for the year ended
December 31, 1997, as if the options granted by Ugly Duckling had been granted
by the Company, would have been reduced to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
AMOUNT
----------
<S> <C> <C>
Net Earnings As reported.......................... $5,536,000
Pro forma............................ $5,397,000
Basic/Diluted Earnings As reported.......................... $5,536,000
per share Pro forma............................ $5,397,000
Proforma Basic Earnings As reported.......................... $ 0.48
per Share Pro forma as adjusted................ $ 0.46
Proforma Diluted Earnings As reported.......................... $ 0.48
per Share Pro forma as adjusted................ $ 0.46
</TABLE>
F-15
<PAGE> 99
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(14) EARNINGS (LOSS) PER SHARE
A reconciliation from basic earnings (loss) per share to diluted earnings
(loss) per share for the periods ended June 30, 1998, June 30 1997 and December
31, 1997 follows:
<TABLE>
<CAPTION>
JUNE 30, JUNE 30, DECEMBER 31,
1998 1997 1997
----------- ----------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Net Earnings (Loss)................. $ 360,000 $ (585,000) $5,536,000
=========== =========== ==========
Income (Loss) available to Common
Stockholders...................... $ 360,000 $ (585,000) $5,536,000
=========== =========== ==========
Basic EPS -- Weighted Average Shares
Outstanding....................... 1 1 1
=========== =========== ==========
Basic EPS -- Proforma Weighted
Average Shares Outstanding........ 5,679,000 5,679,000 5,679,000
=========== =========== ==========
Basic/Diluted EPS -- Weighted
Average Shares Outstanding........ 5,679,000 5,679,000 5,679,000
Effect of Dilutive Securities:
Stock Options..................... -- -- 4,000
----------- ----------- ----------
Diluted EPS -- Proforma Weighted
Average Shares Outstanding........ 5,679,000 5,679,000 5,683,000
=========== =========== ==========
Basic/Diluted Earnings (Loss) Per
Share............................. $ 360,000 $ (585,000) $5,536,000
=========== =========== ==========
Net Earnings (Loss)................. $ 360,000 $ (585,000) $5,536,000
Proforma Dividends on Preferred
Stock............................. (1,400,000) (1,400,000) (2,800,000)
----------- ----------- ----------
Proforma Net Earnings (Loss)
Available to Common
Stockholders...................... $(1,040,000) $(1,985,000) $2,736,000
=========== =========== ==========
Proforma Basic Earnings (Loss) Per
Share............................. $(0.18) $(0.35) $0.48
------ ------ ------
------ ------ ------
Proforma Diluted Earnings (Loss) Per
Share............................. $(0.18) $(0.35) $0.48
------ ------ ------
------ ------ ------
</TABLE>
Pro forma net earnings (loss) per share calculations give effect to the
maximum potential issuance of shares of common stock totaling approximately
5,679,000 shares offered pursuant to the rights offering and annual preferred
dividends of 7% paid quarterly.
(15) COMMITMENTS AND CONTINGENCIES
The Company has commenced a study of its computer systems in order to
assess its exposure to year 2000 issues. The Company expects to make the
necessary modifications or changes to its computer information systems to enable
proper processing of transactions relating to the year 2000 and beyond. The
Company will evaluate appropriate courses of action, including replacement of
certain systems whose associated costs would be recorded as assets and
subsequently amortized, or modification of its existing systems which costs
would be expensed as incurred.
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
material adverse effect on the Company. No provision has been made in the
accompanying
F-16
<PAGE> 100
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
combined financial statements for losses, if any, that might result from the
ultimate disposition of these matters.
During 1997, the Company acquired certain notes receivable collateralized
by a loan portfolio. Thereafter, the Company exchanged the notes receivable for
the underlying collateral (the acquired collateral) and received a guarantee
from the borrower of an 11.0% return on the acquired collateral. General
Electric Capital Corporation purchased the acquired collateral, and Ugly
Duckling guaranteed to General Electric Capital Corporation a return of 10.35%,
not to exceed $10,000,000. The Company has agreed to indemnify Ugly Duckling
related to this guarantee.
During 1997, the Company acquired approximately 2.5% of the outstanding
common stock of FMAC with a cost of approximately $1,450,000. In connection with
FMAC's proposed plan of reorganization, and subject to bankruptcy court
approval, the Company and FMAC have agreed to exchange the Company's common
stock in FMAC for the property and equipment that constitute FMAC's servicing
platform. The Company received bankruptcy court approval for the plan of
reorganization during the first fiscal quarter of 1998 and exchanged the common
stock in FMAC for the servicing platform immediately thereafter.
The Company has executed agreements with FMAC and other interested parties
whereby the Company has agreed to replace FMAC as servicer on loan portfolios
which totaled approximately $525 million at December 31, 1997. The agreements
were approved by the bankruptcy court and the Company began servicing the loan
portfolios on April 1, 1998.
(16) RETIREMENT PLAN
During 1995, Ugly Duckling established a qualified 401(k) retirement plan
(defined contribution plan) which became effective on October 1, 1995. Under the
terms of the plan, employees of the Company are eligible to participate in the
plan subject to the eligibility criteria of the plan. The plan, as amended,
covers substantially all employees having no less than three months 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
for the six months ended June 30, 1998 and year ended December 31, 1997 was
immaterial. Concurrent with the completion of the planned split-up of Ugly
Duckling, the Company expects to adopt a separate plan which will be similar in
all material respects to the plan described herein.
(17) 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, 1997, the amounts that
will actually be realized or paid in settlement of the instruments could be
significantly different.
F-17
<PAGE> 101
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Cash and Cash Equivalents
The carrying amount is estimated to be the fair value because of the
liquidity of these instruments.
Finance Receivables and Notes Receivable
The carrying amount is estimated to be the fair value because of the
relative short maturity and repayment terms of the portfolio as compared to
similar instruments.
Accrued Expenses and Other Liabilities and Note Payable
The carrying amount approximates fair value because of the short maturity
of these instruments. The terms of the Company's note payable approximate the
terms in the market place at which it could be replaced. Therefore, the fair
market value approximates the carrying value of these financial instruments.
(18) BUSINESS SEGMENTS
Operating results and other financial data are presented for the principal
business segments of the Company for the year ended December 31, 1997. The
Company has three distinct business segments. These consist of finance income
generated from third party finance receivables, bulk purchasing operations, 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>
CYGNET BULK CORPORATE
PROGRAM PURCHASING AND OTHER TOTAL
------- ---------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest Income................................... $ 3,654 $ 3,818 $ -- $ 7,472
Gain on Sale of Loans............................. -- 8,132 -- 8,132
Other Income...................................... 355 -- -- 355
------- ------- --------- -------
4,009 11,950 -- 15,959
------- ------- --------- -------
Operating Expenses:
Provision for Credit Losses..................... 691 -- -- 691
Selling and Marketing........................... 18 -- -- 18
General and Administrative...................... 2,194 437 1,135 3,766
Depreciation and Amortization................... 28 -- 125 153
------- ------- --------- -------
2,931 437 1,260 4,628
------- ------- --------- -------
Earnings (Loss) before Interest Expense........... $ 1,078 $11,513 $ (1,260) $11,331
======= ======= ========= =======
Capital Expenditures.............................. $ 17 $ -- $ 129 $ 146
======= ======= ========= =======
Identifiable Assets............................... $27,539 $21,525 $ 970 $50,034
======= ======= ========= =======
</TABLE>
F-18
<PAGE> 102
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(19) QUARTERLY FINANCIAL DATA -- UNAUDITED
A summary of the quarterly data for the year ended December 31, 1997
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Total Revenue............................... $ 5 $ 132 $3,337 $12,485 $15,959
====== ====== ====== ======= =======
Operating Expenses.......................... 509 570 1,332 2,217 4,628
====== ====== ====== ======= =======
Earnings (Loss) before Interest Expense..... (504) (438) 2,005 10,268 11,331
====== ====== ====== ======= =======
Net Earnings (Loss)......................... $ (306) $ (279) $ 757 $ 5,364 $ 5,536
====== ====== ====== ======= =======
Basic/Diluted Earnings (Loss) Per Share..... $ (306) $ (279) $ 757 $ 5,364 $ 5,536
====== ====== ====== ======= =======
Proforma Basic Earnings (Loss) Per Share.... $(0.18) $(0.17) $0.01 $0.82 $0.48
====== ====== ====== ======= =======
Proforma Diluted Earnings (Loss) Per
Share..................................... $(0.18) $(0.17) $0.01 $0.82 $0.48
====== ====== ====== ======= =======
</TABLE>
A summary of the quarterly data for the six months ended June 30, 1998
follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Total Revenue............................... $3,382 $9,168 $ -- $ -- $12,550
====== ====== ====== ======= =======
Operating Expenses.......................... 2,526 7,706 -- -- 10,232
====== ====== ====== ======= =======
Earnings before Interest Expense............ 856 1,462 -- -- 2,318
====== ====== ====== ======= =======
Net Earnings................................ $ 2 $ 358 $ -- $ -- $ 360
====== ====== ====== ======= =======
Basic/Diluted Earnings Per Share............ $ 2 $ 358 $ -- $ -- $ 360
====== ====== ====== ======= =======
Proforma Basic Earnings (Loss) Per Share.... $(0.12) $(0.06) $ -- $ -- $ (0.18)
====== ====== ====== ======= =======
Proforma Diluted Earnings (Loss) Per
Share..................................... $(0.12) $(0.06) $ -- $ -- $ (0.18)
====== ====== ====== ======= =======
</TABLE>
F-19
<PAGE> 103
- ------------------------------------------------------
- ------------------------------------------------------
NO DEALER, SALESMAN, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OTHER PERSONS. NEITHER THE DELIVERY
OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY SINCE THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF
ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN
OFFER OR SOLICITATION WOULD BE UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 13
The Rights Offering................... 26
Federal Income Tax Consequences....... 39
Use of Proceeds....................... 41
Dividend Policy....................... 41
Capitalization........................ 42
Selected Combined Financial Data...... 43
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 45
Business.............................. 54
Management............................ 68
Principal Stockholders................ 76
Certain Relationships and Related
Transactions........................ 78
Description of Capital Stock.......... 79
Shares Eligible for Future Sale....... 81
Legal Matters......................... 82
Available Information................. 82
Experts............................... 83
Index to Financial Statements......... F-1
</TABLE>
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
5,678,572
SHARES OF COMMON STOCK
AND
4,750,000
RIGHTS TO PURCHASE COMMON STOCK
[CYGNET FINANCIAL CORP. LOGO]
------------------------
PROSPECTUS
------------------------
August 4, 1998
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM T-1
Statement of Eligibility
Under the Trust Indenture Act of 1939
of a Corporation Designated to Act as Trustee
Check if an Application to Determine Eligibility
of a Trustee Pursuant to Section 305(b)(2)__________
HARRIS TRUST AND SAVINGS BANK
(Name of Trustee)
Illinois 36-1194448
(State of Incorporation) (I.R.S. Employer Identification No.)
111 West Monroe Street, Chicago, Illinois 60603
(Address of principal executive offices)
Megan Francis, Harris Trust and Savings Bank,
311 West Monroe Street, Chicago, Illinois, 60606
312-461-6030 phone 312-461-3525 facsimile
(Name, address and telephone number for agent for service)
UGLY DUCKLING CORPORATION
(Note Issuer)
Delaware 86-0721358
(State of Incorporation) (I.R.S. Employer Identification No.)
2525 E. Camelback Road, Suite 1150
Phoenix Arizona 85016
(Address of principal executive offices)
Subordinated Debt Securities
(Title of indenture securities)
<PAGE> 2
1. GENERAL INFORMATION. Furnish the following information as to the Trustee:
(a) Name and address of each examining or supervising authority to which it
is subject.
Commissioner of Banks and Trust Companies, State of Illinois,
Springfield, Illinois; Chicago Clearing House Association, 164 West
Jackson Boulevard, Chicago, Illinois; Federal Deposit Insurance
Corporation, Washington, D.C.; The Board of Governors of the Federal
Reserve System, Washington, D.C.
(b) Whether it is authorized to exercise corporate trust powers.
Harris Trust and Savings Bank is authorized to exercise corporate trust
powers.
2. AFFILIATIONS WITH OBLIGOR. If the Obligor is an affiliate of the Trustee,
describe each such affiliation.
The Obligor is not an affiliate of the Trustee.
3. thru 15.
NO RESPONSE NECESSARY
16. LIST OF EXHIBITS.
1. A copy of the articles of association of the Trustee as now in effect
which includes the authority of the trustee to commence business and to
exercise corporate trust powers.
A copy of the Certificate of Merger dated April 1, 1972 between Harris
Trust and Savings Bank, HTS Bank and Harris Bankcorp, Inc. which
constitutes the articles of association of the Trustee as now in effect
and includes the authority of the Trustee to commence business and to
exercise corporate trust powers was filed in connection with the
Registration Statement of Louisville Gas and Electric Company, File No.
2-44295, and is incorporated herein by reference.
2. A copy of the existing by-laws of the Trustee.
A copy of the existing by-laws of the Trustee was filed in connection
with the Registration Statement of Commercial Federal Corporation, File
No. 333-20711, and is incorporated herein by reference.
3. The consents of the Trustee required by Section 321(b) of the Act.
(included as Exhibit A on page 2 of this statement)
4. A copy of the latest report of condition of the Trustee published
pursuant to law or the requirements of its supervising or examining
authority.
(included as Exhibit B on page 3 of this statement)
1
<PAGE> 3
SIGNATURE
Pursuant to the requirements of the Trust Indenture Act of 1939, the Trustee,
HARRIS TRUST AND SAVINGS BANK, a corporation organized and existing under the
laws of the State of Illinois, has duly caused this statement of eligibility to
be signed on its behalf by the undersigned, thereunto duly authorized, all in
the City of Chicago, and State of Illinois, on the 16th day of September, 1998.
HARRIS TRUST AND SAVINGS BANK
By: /s/ Megan Francis
------------------------
/s/ Megan Francis
Assistant Vice President
EXHIBIT A
The consents of the trustee required by Section 321(b) of the Act.
Harris Trust and Savings Bank, as the Trustee herein named, hereby consents
that reports of examinations of said trustee by Federal and State authorities
may be furnished by such authorities to the Securities and Exchange Commission
upon request therefor.
HARRIS TRUST AND SAVINGS BANK
By: /s/ Megan Francis
------------------------
/s/ Megan Francis
Assistant Vice President
2
<PAGE> 4
EXHIBIT B
Attached is a true and correct copy of the statement of condition of Harris
Trust and Savings Bank as of March 31, 1998, as published in accordance with a
call made by the State Banking Authority and by the Federal Reserve Bank of the
Seventh Reserve District.
[HARRIS BANK LOGO]
Harris Trust and Savings Bank
111 West Monroe Street
Chicago, Illinois 60603
of Chicago, Illinois, And Foreign and Domestic Subsidiaries, at the close of
business on March 31, 1998, a state banking institution organized and operating
under the banking laws of this State and a member of the Federal Reserve
System. Published in accordance with a call made by the Commissioner of Banks
and Trust Companies of the State of Illinois and by the Federal Reserve Bank of
this District.
Bank's Transit Number 71000288
<TABLE>
<CAPTION>
THOUSANDS
ASSETS OF DOLLARS
<S> <C> <C>
Cash and balances due from depository institutions:
Non-interest bearing balances and currency and coin............. $1,039,854
Interest bearing balances....................................... $290,921
Securities:.......................................................
a. Held-to-maturity securities $0
b. Available-for-sale securities $4,266,201
Federal funds sold and securities purchased under agreements to resell $82,000
Loans and lease financing receivables:
Loans and leases, net of unearned income............................. $8,726,578
LESS: Allowance for loan and lease losses............................ $101,318
----------
Loans and leases, net of unearned income, allowance, and reserve
(item 4.a minus 4.b)................................................. $8,625,260
Assets held in trading accounts........................................ $120,674
Premises and fixed assets (including capitalized leases)............... $219,475
Other real estate owned................................................ $699
Investments in unconsolidated subsidiaries and associated companies.... $120
Customer's liability to this bank on acceptances outstanding........... $46,688
Intangible assets...................................................... $266,411
Other assets........................................................... $733,386
-----------
TOTAL ASSETS $15,731,689
===========
</TABLE>
3
<PAGE> 5
<TABLE>
<S> <C> <C>
LIABILITIES
Deposits:
In domestic offices..................................................... $8,270,648
Non-interest bearing............................................... $2,684,862
Interest bearing................................................... $5,585,786
In foreign offices, Edge and Agreement subsidiaries, and IBF's.......... $1,307,928
Non-interest bearing............................................... $23,432
Interest bearing................................................... $1,284,496
Federal funds purchased and securities sold under agreements to repurchase
in domestic offices of the bank and of its Edge and Agreement subsidiaries,
and in IBF's:
Federal funds purchased & securities sold under agreements to repurchase..... $3,599,510
Trading Liabilities 74,487
Other borrowed money:
a. With remaining maturity of one year or less $471,692
b. With remaining maturity of more than one year $0
Bank's liability on acceptances executed and outstanding $46,688
Subordinated notes and debentures............................................ $325,000
Other liabilities............................................................ $386,442
--------------------------
TOTAL LIABILITIES $14,482,395
==========================
EQUITY CAPITAL
Common stock................................................................. $100,000
Surplus...................................................................... $601,026
a. Undivided profits and capital reserves.................................. $545,185
b. Net unrealized holding gains (losses) on available-for-sale securities $2,802
--------------------------
TOTAL EQUITY CAPITAL $1,249,294
==========================
Total liabilities, limited-life preferred stock, and equity capital.......... $15,731,689
==========================
</TABLE>
I, Pamela Piarowski, Vice President of the above-named bank, do hereby
declare that this Report of Condition has been prepared in conformance with the
instructions issued by the Board of Governors of the Federal Reserve System and
is true to the best of my knowledge and belief.
PAMELA PIAROWSKI
1/30/98
We, the undersigned directors, attest to the correctness of this Report of
Condition and declare that it has been examined by us and, to the best of our
knowledge and belief, has been prepared in conformance with the instructions
issued by the Board of Governors of the Federal Reserve System and the
Commissioner of Banks and Trust Companies of the State of Illinois and is true
and correct.
EDWARD W. LYMAN,
ALAN G. MCNALLY,
RICHARD E. TERRY
Directors.
4
