<PAGE> 1
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934 (AMENDMENT NO. 1)
Filed by the Registrant [X]
Filed by a Party other than the Registrant [ ]
Check the appropriate box:
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<S> <C>
[X] Preliminary Proxy Statement [ ] Confidential, for Use of the Commission
[ ] Definitive Proxy Statement Only (as permitted by Rule 14a-6(e)(2))
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11(c) or Section 240.14a-12
</TABLE>
Ugly Duckling Corporation
- --------------------------------------------------------------------------------
(Name of Registrant as Specified In Its Charter)
- --------------------------------------------------------------------------------
(Name of Person(s) Filing Proxy Statement, if other than the Registrant)
Payment of Filing Fee (Check the appropriate box):
[ ] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(4) and 0-11.
(1) Title of each class of securities to which transaction applies:
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(2) Aggregate number of securities to which transaction applies:
- --------------------------------------------------------------------------------
(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined):
- --------------------------------------------------------------------------------
(4) Proposed maximum aggregate value of transaction:
$55,000,000*
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(5) Total fee paid:
$11,000
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[X] Fee paid previously with preliminary materials.
[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
(1) Amount Previously Paid:
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(2) Form, Schedule or Registration Statement No.:
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(3) Filing Party:
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(4) Date Filed:
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* Pursuant to Rule 0-11(c)(1) based upon the acquisition of securities of, and
other value to be received by the Registrant from, another person.
<PAGE> 2
[LETTER TO STOCKHOLDERS]
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, each of you 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 have committed to 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 have also agreed to
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
[ ], 1998
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UGLY DUCKLING CORPORATION
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
------------------------
NOTICE AND PROXY STATEMENT FOR 1998 ANNUAL MEETING
OF STOCKHOLDERS HELD ON 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
, 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 and on the date of this Notice.
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
, 1998
<PAGE> 4
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> 5
UGLY DUCKLING CORPORATION
------------------------
PROXY STATEMENT
1998 ANNUAL MEETING OF STOCKHOLDERS
, 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 , 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 , 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), 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> 6
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 21 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 21 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 has agreed to 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 Investors
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> 7
PROXY STATEMENT
TABLE OF CONTENTS
<TABLE>
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PAGE
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Summary..................................................... 1
Summary Selected Consolidated Financial Data................ 11
Risk Factors................................................ 13
Voting Securities Outstanding and Voting Rules.............. 19
Proposal No. 1 -- Election of Directors..................... 19
Proposal No. 2 -- Amendments to the Ugly Duckling
Corporation Long-Term Incentive Plan...................... 20
Proposal No. 3 -- Adoption of the Ugly Duckling Corporation
1998 Executive Incentive Plan............................. 25
Proposal No. 4 -- Approval of Split-up of the Company and
Its Subsidiaries into Two Publicly-Held Corporate
Groups.................................................... 28
Federal Income Tax Consequences of the Rights Offering and
Collateral Transactions................................... 44
Summary Selected Consolidated Financial Data................ 49
Management's Discussion and Analysis of Results of
Operations and Financial Condition of the Continuing
Company Businesses........................................ 51
Business of the Company after the Split-up.................. 72
Management of the Company................................... 78
Compensation of Directors and Executive Officers, Benefits,
and Related Matters....................................... 85
Experts..................................................... 97
Other Matters............................................... 97
Index to Consolidated Financial Statements.................. F-1
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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 ,
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> 9
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 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 greater of the appraised
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<PAGE> 10
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 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 the effect such
strategies and objectives may have on the
other. In
3
<PAGE> 11
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 would be redeemable
by Cygnet at any time and 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 62.1% of the then
outstanding shares of Cygnet, assuming the sale
by Cygnet pursuant to the Rights Offering of
3,487,500 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 4,650,000 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 50.6% 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 has agreed to 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.
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
4
<PAGE> 12
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 21 days (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 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."
5
<PAGE> 13
Information Agent........... The Information Agent for the Rights Offering
is Corporate Investors 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 has agreed to 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 ("Exchange 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 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
6
<PAGE> 14
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.
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
discontinued 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
7
<PAGE> 15
"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 21-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.
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
8
<PAGE> 16
the Interim Assets exceeds their adjusted tax
basis, management of the Company believes that
the fair market value of each of the Interim
Assets will 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 21-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
exceeds the value asserted 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. Although Cygnet is obligated to pay
consideration to the Company 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 each net of liabilities, the
Appraiser has concluded in its opinion that, as
of June 30, 1998, only a limited number of
Transferred Assets had a fair market value in
excess of their respective book values as of
such date. Further, the Appraiser has concluded
that the value of the Cygnet Preferred 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. 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.
9
<PAGE> 17
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> 18
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 9,164 66,509 29,890 27,964 12,577 6,089
Provision for Credit Losses... 15,034 3,261 22,354 9,657 8,359 8,024 3,292
-------- -------- -------- -------- ------- ------- -------
17,575 5,786 34,951 14,221 11,501 7,167 4,588
-------- -------- -------- -------- ------- ------- -------
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 9,871 66,556 29,280 20,036 12,406 7,096
Operating Expenses:
Selling and Marketing......... 5,326 1,532 10,538 3,585 3,856 2,402 1,293
General and Administrative.... 16,669 6,379 45,261 14,210 13,446 8,749 3,625
Depreciation and
Amortization................ 1,152 529 3,150 1,382 1,225 713 557
-------- -------- -------- -------- ------- ------- -------
23,147 8,440 58,949 19,177 18,527 11,864 5,475
-------- -------- -------- -------- ------- ------- -------
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> 19
<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> 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.
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
13
<PAGE> 21
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 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.
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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. The Company will retain a security interest
in certain assets being transferred to Cygnet in order to secure these
contingent liabilities.
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 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
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<PAGE> 23
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 has agreed to 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 has further agreed to 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 has agreed to 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. The
Company will retain a security interest in certain assets being transferred to
Cygnet in order to secure this contingent liability.
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.
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
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<PAGE> 24
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 21-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 will 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 21-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
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<PAGE> 25
fair market value of the Transferred Assets exceeds the value asserted 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. Although Cygnet is obligated to pay consideration to the
Company 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 each net of liabilities, the Appraiser has concluded in its
opinion that as of June 30, 1998, only a limited number of Transferred Assets
had a fair market value in excess of their respective book values as of such
date. Further, the Appraiser has concluded in its opinion that the value of the
Cygnet Preferred 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.
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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
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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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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 17, 1998, the closing price of the Company's Common Stock on Nasdaq was
$8.9375 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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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 17, 1998, the closing price of the Company's Common Stock
on Nasdaq was $8.9375 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 $
million and a net appraised value of approximately $ 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. If Cygnet decides to proceed with
the transaction, a portion of the proceeds from the Rights Offering may be
utilized to repay indebtedness related thereto. For a further description of
certain additional transactions that may be 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 equal to the difference between the greater of the appraised value or
the book value of the Transferred Assets and the $40 million of Cygnet Preferred
Stock (the "Cash Payment"). If Cygnet has effected any Interim Transactions,
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 such 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
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<PAGE> 38
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 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. 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 not more than 15 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 62.1% of the then outstanding shares of Cygnet,
assuming the sale by Cygnet pursuant to the Rights Offering of 3,487,500 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 4,650,000 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 50.6% 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 has agreed to 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 OTHER 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 4,650,000 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. 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 21 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 dated as of ,
1998 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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<PAGE> 41
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, Frank P. Willey,
Christopher D. Jennings, and Gary L. Trujillo. Ernest C. Garcia, II is
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<PAGE> 42
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 "Certain Considerations Relating
to the Split-up Proposal -- 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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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 D 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.
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 Williamette 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 projections or the assumptions on which
they are based. CIBC Oppenheimer's opinion is necessarily based
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<PAGE> 46
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 appraised
value (as defined by an independent third party) or the 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 equity, net
income for the most recently reported trailing 12-month period, and
estimated net income for 1998 and 1999.
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<PAGE> 47
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 the Company.
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 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
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<PAGE> 48
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 Company Board of Directors 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 $ 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 with respect to the investigations made
or the procedures followed by Willamette in rendering its Appraisal.
Willamette's Appraisal indicates that it is provided solely for the use of the
Company's Board of Directors in its determination of the consideration to be
paid by Cygnet for the Transferred Assets and for federal income tax purposes.
Willamette's Appraisal and presentation to the Company's Board were among the
many factors taken into consideration by the Company's Board in making its
determination to approve, and to recommend that the Company stockholders
approve, the Split-up.
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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 Cygnet prepared by the management of Cygnet.
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 is 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
bulk 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.
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 collection losses on
such assets. Willamette estimated that the book value of such assets is
reasonably representative of fair market value.
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
and earnings before interest and taxes 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 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
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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, according to Willamette, 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 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 Company Board.
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 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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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. 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.
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
44
<PAGE> 52
binding on the Internal Revenue Service. For example, the Internal Revenue
Service may assert that the price at which the Rights trade during the 30-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.
BECAUSE OF THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, EACH HOLDER OF
COMPANY COMMON STOCK IS ADVISED TO CONSULT HIS OWN TAX ADVISOR WITH RESPECT TO
THESE AND OTHER FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE
DISTRIBUTION, OWNERSHIP, EXERCISE, TRANSFER, AND LAPSE OF RIGHTS.
45
<PAGE> 53
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.
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 will 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 21-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 exceeds the value asserted 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.
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. Although Cygnet is obligated to
pay consideration to the Company 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 each net of liabilities,
the Appraiser has concluded in its opinion that as of June 30, 1998, only a
limited number of Transferred Assets had a fair market value in excess of their
respective book values as of such date. Further, the Appraiser has concluded in
its opinion that the value of the Cygnet Preferred 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,
46
<PAGE> 54
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.
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 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
Cygnet Preferred Stock will be treated as a dividend to the extent of Cygnet's
current or accumulated earnings and profits (as determined for federal income
tax purposes) unless generally the redemption results in a complete termination
of the Company's stock interest in the Cygnet under Code Section 302(b)(3). The
amount of the distribution in
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<PAGE> 55
excess of Cygnets earnings and profits 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 redeemed
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.
If a redemption of the Cygnet Preferred Stock does not constitute a
dividend in whole or in part, the redemption will be treated as a sale of the
Cygnet Preferred Stock resulting in gain or loss to the Company consolidated
group in an amount equal to the excess, if any, of the redemption proceeds over
the adjusted tax basis of the redeemed shares.
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.
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<PAGE> 56
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 9,164 66,509 29,890 27,964 12,577 6,089
Provision for Credit Losses... 15,034 3,261 22,354 9,657 8,359 8,024 3,292
-------- -------- -------- -------- ------- ------- -------
17,575 5,786 34,951 14,221 11,501 7,167 4,588
-------- -------- -------- -------- ------- ------- -------
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 9,871 66,556 29,280 20,036 12,406 7,096
Operating Expenses:
Selling and Marketing......... 5,326 1,532 10,538 3,585 3,856 2,402 1,293
General and Administrative.... 16,669 6,379 45,261 14,210 13,446 8,749 3,625
Depreciation and
Amortization................ 1,152 529 3,150 1,382 1,225 713 557
-------- -------- -------- -------- ------- ------- -------
23,147 8,440 58,949 19,177 18,527 11,864 5,475
-------- -------- -------- -------- ------- ------- -------
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>
49
<PAGE> 57
<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>
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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 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 the largest publicly-held chain of Buy
Here-Pay Here used car dealerships in the United States and underwrites,
finances and services retail installment contracts generated from the sale of
used cars by its Company Dealerships and by Third Party Dealers located in
selected markets throughout the country. As part of its financing activities,
the Company has initiated 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
dealerships in the Los Angeles market, two in the Miami market, two in the
Atlanta market and two in the
51
<PAGE> 59
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 Company has reclassified
to discontinued operations in the accompanying consolidated balance sheets and
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<PAGE> 60
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.
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<PAGE> 61
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> 62
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold
increased by 122.5% to $66.5 million for the year ended December 31, 1997 from
$29.9 million for the year ended December 31, 1996, which was an increase of
44.4% from $20.7 million (pro forma) for the year ended December 31, 1995. On a
per unit basis, the Cost of Used Cars Sold increased by 1.2% to $3,998 for the
year ended December 31, 1997 from $3,951 for the year ended December 31, 1996,
which was an increase of 20.8% from $3,270 (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
140.0% to $57.3 million for the year ended December 31, 1997 from $23.9 million
for the year ended December 31, 1996, which was an increase of 35.0% from $17.7
million (pro forma) for the year ended December 31, 1995. As a percentage of
sales, the gross margin was 46.3%, 44.4% , and 46.1% (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 $3,445, $3,156, and $2,795 (pro forma) for the
years ended December 31, 1997, 1996, and 1995, respectively.
The Cost of Used Cars Sold increased by 340.5% to $40.4 million for the
three month period ended March 31, 1998 from $9.2 million for the three month
period ended March 31, 1997. On a per unit basis, the Cost of Used Cars Sold
increased by 15.3% to $4,276 for the three month period ended March 31, 1998
from $3,707 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 260.4% to $32.6 million for the three
month period ended March 31, 1998 from $9.0 million for the three month period
ended March 31, 1997. As a percentage of sales, the gross margin was 44.7% and
49.7% 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 $3,660 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> 63
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> 64
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 $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> 65
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> 66
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..................... 23,064 12,303 9,894 45,261
Depreciation and Amortization.................. 1,536 1,108 506 3,150
------- ------- ------- -------
$35,099 $13,411 $10,439 $58,949
======= ======= ======= =======
Year ended December 31, 1996:
Selling and Marketing.......................... $ 3,568 $ -- $ 17 $ 3,585
General and Administrative..................... 8,295 2,859 3,056 14,210
Depreciation and Amortization.................. 318 769 295 1,382
------- ------- ------- -------
$12,181 $ 3,628 $ 3,368 $19,177
======= ======= ======= =======
Year ended December 31, 1995:
Selling and Marketing.......................... $ 3,856 $ -- $ -- $ 3,856
General and Administrative..................... 8,210 2,563 2,673 13,446
Depreciation and Amortization.................. 279 479 467 1,225
------- ------- ------- -------
$12,345 $ 3,042 $ 3,140 $18,527
======= ======= ======= =======
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..................... 3,244 1,488 1,647 6,379
Depreciation and Amortization.................. 200 206 123 529
------- ------- ------- -------
$ 4,969 $ 1,694 $ 1,777 $ 8,440
======= ======= ======= =======
</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> 67
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 218.5% to $45.3 million for the year ended December 31, 1997 from
$14.2 million for the year ended December 31, 1996, which was an increase of
14.5% from $12.4 million (pro forma) for the year ended December 31, 1995. These
expenses represented 29.1%, 20.6%, and 23.9% 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 161.3% to $16.7 million
for the three month period ended March 31, 1998 from $6.4 million for the three
month period ended March 31, 1997. These expenses represented 19.5% and 28.6% 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> 68
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> 69
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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<PAGE> 70
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).
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% 9.9% 13.3% 17.8% 20.2% 20.8% 20.9% 100.0%
2nd Quarter........... $ 5,664 2.8% 10.4% 14.1% 19.5% 21.5% 22.0% 22.1% 100.0%
3rd Quarter........... $ 6,130 2.8% 8.0% 11.9% 16.2% 18.2% 19.0% 19.1% 100.0%
4th Quarter........... $ 5,490 2.4% 7.6% 11.2% 16.6% 19.5% 20.4% 20.4% 100.0%
1995:
1st Quarter........... $ 8,191 1.1% 7.3% 12.3% 17.4% 19.9% 20.8% 20.9% 99.8%
2nd Quarter........... $ 9,846 1.7% 7.0% 11.8% 16.3% 18.9% 20.5% 20.7% 98.3%
3rd Quarter........... $10,106 1.9% 6.9% 10.8% 17.6% 21.1% 22.7% 23.0% 94.6%
4th Quarter........... $ 8,426 1.2% 5.6% 10.7% 17.2% 21.8% 23.4% 23.6% 91.7%
1996:
1st Quarter........... $13,635 1.3% 7.5% 13.0% 20.0% 24.0% x 25.2% 85.9%
2nd Quarter........... $13,462 2.2% 9.1% 13.3% 22.1% 25.9% -- 26.3% 78.4%
3rd Quarter........... $11,082 1.6% 6.7% 12.4% 21.0% x -- 25.0% 70.4%
4th Quarter........... $10,817 1.6% 8.4% 15.8% 24.0% -- -- 26.0% 63.6%
1997:
1st Quarter........... $16,279 2.1% 10.4% 17.2% x -- -- 23.2% 55.8%
2nd Quarter........... $25,875 1.4% 8.0% 12.8% -- -- -- 15.5% 41.5%
3rd Quarter........... $32,147 1.1% 6.4% x -- -- -- 9.4% 25.7%
4th Quarter........... $42,529 .9% x -- -- -- -- 3.9% 12.8%
1998:
1st Quarter........... $69,708 x -- -- -- -- -- .2% 6.3%
</TABLE>
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<PAGE> 71
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> 72
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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<PAGE> 73
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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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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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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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, and was fined
$50 (the minimum fine the court could assess). In separate actions arising out
of this matter Mr. Garcia has been banned from affiliating with insured
financial institutions and securities firms, without governmental approval, has
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
Company's subordinated debt payable to Verde from 18.0% to 10.0% per annum and
lowered from 12.0% to
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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> 91
(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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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 $30,000 ("Director Stock"), which is generally subject to
vesting in equal annual increments over a three-year period as provided for
under the plan. As stated above, Mr. Moreno resigned from the Company's Board of
Directors effective June 30, 1998 due to time constraints relating to family and
other business interests. In consideration for Mr. Moreno's invaluable services
as a director to the Company for over the past two years, the Company has
decided to accelerate the vesting of the final one-third of Mr. Moreno's
Director Stock. Directors who are also officers of the Company are not
compensated for their service as directors and are not entitled to participate
in the Director Incentive Plan.
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<PAGE> 93
SUMMARY COMPENSATION TABLE FOR NAMED EXECUTIVE OFFICERS
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities to the Company during the
three fiscal years ended December 31, 1997 of the Named Executive Officers:
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
------------------------------
ANNUAL COMPENSATION SECURITIES
---------------------------- UNDERLYING ALL OTHER
SALARY BONUS OPTIONS -- COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) AWARDS (#)(1) ($)(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 $2,850 car allowance for Mr.
Vonsh during 1997, 1996, and 1995, respectively.
(7) Effective as of March 16, 1998, Mr. Vonsh resigned his officer position of
Senior Vice President -- Credit for the Company. Mr. Vonsh continues to be
employed by the Company in another capacity.
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<PAGE> 94
OPTION GRANTS IN LAST FISCAL YEAR
There were no stock options granted pursuant to the Company's Incentive
Plan or otherwise during the fiscal year ended December 31, 1997 to the Named
Executive Officers.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AS OF DECEMBER
31, 1997 OF NAMED EXECUTIVE OFFICERS
The table below sets forth information with respect to option exercises and
the number and value of options outstanding at December 31, 1997 held by the
Named Executive Officers. The Company has never issued any other forms of stock
based awards.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES FISCAL YEAR END(#)(1) FISCAL YEAR END($)(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 17, 1998 was $8.9375 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> 95
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> 96
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> 97
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> 98
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> 99
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.
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<PAGE> 100
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.
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
93
<PAGE> 101
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
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
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<PAGE> 102
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 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.
95
<PAGE> 103
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>
96
<PAGE> 104
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 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.
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<PAGE> 105
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
ERNEST C. GARCIA II
Chairman of the Board and
Chief Executive Officer
, 1998
98
<PAGE> 106
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> 107
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> 108
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> 109
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.................................... 66,509 29,890 27,964
Provision for Credit Losses............................... 22,354 9,657 8,359
-------- ------- -------
34,951 14,221 11,501
-------- ------- -------
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............................ 66,556 29,280 20,036
-------- ------- -------
Operating Expenses:
Selling and Marketing..................................... 10,538 3,585 3,856
General and Administrative................................ 45,261 14,210 13,446
Depreciation and Amortization............................. 3,150 1,382 1,225
-------- ------- -------
58,949 19,177 18,527
-------- ------- -------
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> 110
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> 111
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> 112
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
F-7
<PAGE> 113
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
(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
F-8
<PAGE> 114
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
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
F-9
<PAGE> 115
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-10
<PAGE> 116
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-11
<PAGE> 117
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
F-12
<PAGE> 118
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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.
F-13
<PAGE> 119
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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>
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
F-14
<PAGE> 120
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
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
F-15
<PAGE> 121
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$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, 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> 122
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> 123
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> 124
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> 125
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> 126
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> 127
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> 128
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> 129
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> 130
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> 131
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> 132
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........................ 66,509 -- -- 66,509
Provision for Credit Losses.................... 22,354 -- -- 22,354
-------- -------- -------- --------
34,951 -- -- 34,951
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............... 36,449 28,094 2,013 66,556
-------- -------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 10,499 -- 39 10,538
General and Administrative..................... 23,064 12,303 9,894 45,261
Depreciation and Amortization.................. 1,536 1,108 506 3,150
-------- -------- -------- --------
35,099 13,411 10,439 58,949
-------- -------- -------- --------
Income 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> 133
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........................ 29,890 -- -- 29,890
Provision for Credit Losses.................... 9,657 -- -- 9,657
-------- -------- -------- --------
14,221 -- -- 14,221
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............... 14,416 14,238 626 29,280
-------- -------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 3,568 -- 17 3,585
General and Administrative..................... 8,295 2,859 3,056 14,210
Depreciation and Amortization.................. 318 769 295 1,382
-------- -------- -------- --------
12,181 3,628 3,368 19,177
-------- -------- -------- --------
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........................ 27,964 -- -- 27,964
Provision for Credit Losses.................... 8,359 -- -- 8,359
-------- -------- -------- --------
11,501 -- -- 11,501
Interest Income................................ -- 8,227 -- 8,227
Other Income................................... -- -- 308 308
-------- -------- -------- --------
Income before Operating Expenses............... 11,501 8,227 308 20,036
-------- -------- -------- --------
Operating Expenses:
Selling and Marketing.......................... 3,856 -- -- 3,856
General and Administrative..................... 8,210 2,562 2,673 13,446
Depreciation and Amortization.................. 279 479 467 1,225
-------- -------- -------- --------
12,345 3,041 3,140 18,527
-------- -------- -------- --------
Income (loss) before Interest Expense.......... $ (844) $ 5,186 $ (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> 134
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...... 9,871 16,451 20,201 20,033 66,556
======= ======= ======= ======= ========
Operating Expenses.................... 8,440 12,550 15,576 22,383 58,949
======= ======= ======= ======= ========
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...... 7,374 7,552 6,685 7,669 29,280
======= ======= ======= ======= ========
Operating Expenses.................... 4,790 5,250 3,925 5,212 19,177
======= ======= ======= ======= ========
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> 135
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> 136
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 9,164
Provision for Credit Losses............................... 15,034 3,261
------- -------
17,575 5,786
------- -------
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 9,871
------- -------
Operating Expenses:
Selling and Marketing..................................... 5,326 1,532
General and Administrative................................ 16,669 6,379
Depreciation and Amortization............................. 1,152 529
------- -------
23,147 8,440
------- -------
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> 137
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> 138
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> 139
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> 140
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> 141
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> 142
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......................... 9,164 -- -- 9,164
Provision for Credit Losses .................. 3,261 -- -- 3,261
------- ------- ------- -------
5,786 -- -- 5,786
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................ 5,990 3,228 653 9,871
------- ------- ------- -------
Operating Expenses:
Selling and Marketing......................... 1,525 -- 7 1,532
General and Administrative.................... 3,244 1,488 1,647 6,379
Depreciation and Amortization ................ 200 206 123 529
------- ------- ------- -------
4,969 1,694 1,777 8,440
------- ------- ------- -------
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).
F-37
<PAGE> 143
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.
F-38
<PAGE> 144
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),
A-1
<PAGE> 145
(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.
A-2
<PAGE> 146
(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.
A-3
<PAGE> 147
(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 exclusive use of the Board of Directors of
UDC in connection with the Transaction, does not constitute a recommendation to
any shareholder of UDC as to how such shareholder should vote with respect to
the Split-Up, and may not be relied upon by any other person or entity,
including affiliates of the Company. 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
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PROXY PROXY
UGLY DUCKLING CORPORATION
PROXY SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
FOR THE ANNUAL MEETING OF STOCKHOLDERS--[ ], 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 ___________, ______, 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.
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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.
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