Filed pursuant to Rule
424(b)(3) Reg. No. 333-42973
PROSPECTUS SUPPLEMENT TO PROSPECTUS
DATED September 17, 1999
To Prosepectus Date August 4, 1999
5,666,190 Shares of Common Stock
and
666,190 Common Stock Purchase Warrants
Ugly Duckling Corporation operates a chain of used car dealerships. We also
service used car sales contracts that we own or service for third parties.
We acquired servicing and other rights in the bankruptcy proceedings of First
Merchants Acceptance Corporation.
The attached prospectus and this prospectus supplement relate to the sale from
time to time:
o By First Merchants of warrants to purchase up to 325,000 shares of our
common stock at $20.00 per share through April 1, 2001;
o By certain other selling securityholders who were originally lenders
to First Merchants of warrants to purchase up to 341,190 shares of our
common stock at $20.00 per share through February 20, 2000;
o By First Merchants or the other selling securityholders of up to
666,190 shares of our common stock issuable upon exercise of the
warrants; and
o By Ugly Duckling of up to 5,000,000 shares of our common stock to
First Merchants or its creditors or equityholders in exchange for cash
distributions that would otherwise be paid to First Merchants.
We are in the process of repurchasing all outstanding warrants currently held by
the selling securityholders other than First Merchants. If this repurchase is
successfully completed, all information in this prospectus relating to 341,190
of the offered warrants and the underlying common stock will no longer be
relevant.
RECENT DEVELOPMENTS
On August 31, 1999, we closed a securitization transaction through
Greenwich Capital. We securitized approximately $123 million of contracts and
issued approximately $87.5 million of Class A notes, $14.8 million of Class B
notes, and certificates representing residual interests. One of our
securitization subsidiaries currently holds the Class B notes, but we could sell
these notes in the future if we satisfy certain conditions. The notes and
certificates bear interest at 6.45% per year. We received approximately $77.8
million in cash (net of fees, expenses and other costs relating to the
securitization including the required spread account deposit) that we used to
repay our revolving line of credit.
On August 26, 1999, we closed the acquisition of certain assets of DCT
of Ocala Corporation, a Florida based sub-prime automobile sales and finance
company doing business under the name Best Chance. The assets acquired include
four used car dealerships operating in the greater Orlando market area, vehicle
inventory and a loan portfolio of approximately $15 million.
FINANCIAL INFORMATION
The following report on Form 10-Q for the quarter ended June 30, 1999
is added to the Prospectus for the purpose of updating the financial information
contained therein.
<PAGE>
===============================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 1999
Commission File Number 000-20841
UGLY DUCKLING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) Identification
no.)
2525 E. Camelback Road, Suite 500,
Phoenix, Arizona 85016
(Address of principal executive (Zip Code)
offices)
(602) 852-6600
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
[X] Yes [ ] No
---------------
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At August 6, 1999, there were approximately 14,879,000 shares of Common
Stock, $0.001 par value, outstanding.
This document serves both as a resource for analysts, shareholders, and
other interested persons, and as the quarterly report on Form 10-Q of Ugly
Duckling Corporation (Ugly Duckling) to the Securities and Exchange Commission,
which has taken no action to approve or disapprove the report or pass upon its
accuracy or adequacy. Additionally, this document is to be read in conjunction
with the consolidated financial statements and notes thereto included in Ugly
Duckling's Annual Report on Form 10-K, for the year ended December 31, 1998.
================================================================================
<PAGE>
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
Part I. -- FINANCIAL STATEMENTS
Item 1. FINANCIAL STATEMENTS...........................................................................
<S> <C>
Condensed Consolidated Balance Sheets-- June 30, 1999 and December 31, 1998........................... 1
Condensed Consolidated Statements of Operations-- Three and Six Months Ended June 30, 1999 and June 30, 1998 2
Condensed Consolidated Statements of Cash Flows-- Six Months Ended June 30, 1999 and June 30, 1998.... 3
Notes to Condensed Consolidated Financial Statements.................................................. 4
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.......... 10
Item 3. MARKET RISK ................................................................................... 31
Part II. -- OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS..............................................................................
32
Item 2. CHANGES IN SECURITIES.......................................................................... 32
Item 3. DEFAULTS UPON SENIOR SECURITIES................................................................ 32
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS............................................ 32
Item 5. OTHER INFORMATION.............................................................................. 32
Item 6. EXHIBITS AND REPORTS ON FORM 8-K............................................................... 32
SIGNATURES.............................................................................................. 34
Exhibit 10.1 Amendment No. 4 to the Amended and Restated Motor Vehicle and Installment Contract Loan and
Security Agreement between General Electric Capital Corporation and Registrant dated June
30, 1999
Exhibit 11 Statement regarding computation of per share earnings (see note 5 of Notes to Condensed Consolidated Financial
Statements)
Exhibit 27 Financial Data Schedule
Exhibit 99 Risk Factors
</TABLE>
<PAGE>
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------- ----------------
ASSETS
<S> <C> <C>
Cash and Cash Equivalents $ 1,302 $ 2,751
Finance Receivables, Net 307,199 163,209
Notes Receivable, Net 21,317 28,257
Inventory 37,810 44,167
Property and Equipment, Net 34,750 32,970
Intangible Assets, Net 14,985 15,530
Other Assets 22,997 20,575
Net Assets of Discontinued Operations 24,817 38,516
------------- ----------------
$ 465,177 $ 345,975
============= ================
</TABLE>
<TABLE>
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
<S> <C> <C>
Accounts Payable $ 4,892 $ 2,479
Accrued Expenses and Other Liabilities 30,992 19,694
Notes Payable 232,952 117,294
Subordinated Notes Payable 36,943 43,741
------------- ----------------
Total Liabilities 305,779 183,208
------------- ----------------
Stockholders' Equity:
Common Stock 19 19
Additional Paid in Capital 173,864 173,809
Retained Earnings 5,339 3,449
Treasury Stock (19,824) (14,510)
------------- ----------------
Total Stockholders' Equity 159,398 162,767
------------- ----------------
$ 465,177 $ 345,975
============= ================
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 1
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three and Six Months Ended June 30, 1999 and 1998
(In thousands, except earnings per share amounts)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
----------------------------- -----------------------------
1999 1998 1999 1998
------------ -------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales of Used Cars $ 97,876 $ 69,523 $ 204,319 $ 142,496
Less:
Cost of Used Cars Sold 55,559 39,237 115,656 78,968
Provision for Credit Losses 26,635 14,988 55,196 30,350
------------ -------------- ------------- -------------
15,682 15,298 33,467 33,178
------------ -------------- ------------- -------------
Other Income:
Interest Income 20,186 6,024 34,236 12,230
Gain on Sale of Finance Receivables -- 3,659 -- 8,273
Servicing and Other Income 7,670 9,531 17,295 13,442
------------ -------------- ------------- -------------
27,856 19,214 51,531 33,945
------------ -------------- ------------- -------------
Income before Operating Expenses 43,538 34,512 84,998 67,123
Operating Expenses:
Selling and Marketing 5,887 4,274 12,495 9,195
General and Administrative 27,022 22,567 55,381 41,353
Depreciation and Amortization 2,321 1,352 4,458 2,525
------------ -------------- ------------- -------------
35,230 28,193 72,334 53,073
------------ -------------- ------------- -------------
Operating Income 8,308 6,319 12,664 14,050
Interest Expense 5,817 1,369 9,473 2,871
------------ -------------- ------------- -------------
Earnings before Income Taxes 2,491 4,950 3,191 11,179
Income Taxes 1,021 2,007 1,301 4,507
------------ -------------- ------------- -------------
Income from Continuing Operations 1,470 2,943 1,890 6,672
Discontinued Operations:
Loss from Operations of Discontinued Operations, net of
income tax benefit of $492 -- -- -- (768)
Loss on Disposal of Discontinued Operations, net of
income tax benefit of $3,024 -- -- -- (4,827)
------------ -------------- ------------- -------------
Net Earnings $ 1,470 $ 2,943 $ 1,890 $ 1,077
============ ============== ============= =============
Earnings per Common Share from Continuing Operations:
Basic $ 0.10 $ 0.16 $ 0.12 $ 0.36
============ ============== ============= =============
Diluted $ 0.10 $ 0.16 $ 0.12 $ 0.35
============ ============== ============= =============
Net Earnings per Common Share:
Basic $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============== ============= =============
Diluted $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============== ============= =============
Shares Used in Computation:
Basic 14,940 18,590 5,292 18,570
============ ============== ============= =============
Diluted 15,210 18,980 15,495 18,930
============ ============== ============= =============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 2
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
------------- ------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings $ 1,890 $ 1,077
Adjustments to Reconcile Net Earnings to Net Cash Provided
by Operating Activities:
Provision for Credit Losses 55,196 30,350
Gain on Sale of Finance Receivables -- (8,273)
Depreciation and Amortization 4,458 2,525
Loss from Discontinued Operations -- 5,595
Purchase of Finance Receivables Held for Sale -- (161,018)
Increase in Deferred Income Taxes (5,188) (1,260)
Proceeds from Sale of Finance Receivables -- 109,711
Collections of Finance Receivables -- 26,026
(Increase) Decrease in Inventory 6,357 (2,370)
(Increase) Decrease in Other Assets 1,172 (3,143)
Increase in Accounts Payable, Accrued Expenses and Other
liabilities 13,922 7,733
Increase in Income Taxes Payable 2,926 703
------------- ------------
Net Cash Provided by Operating Activities 80,733 7,656
------------- ------------
Cash Flows Used in Investing Activities:
Purchase of Finance Receivables Held for Investment (256,684) --
Collections of Finance Receivables Held for Investment 62,148 --
Increase in Investments Held in Trust (5,983) (7,537)
Advances under Notes Receivable (5,195) (24,312)
Repayments of Notes Receivable 12,135 26,727
Proceeds from Disposal of Property and Equipment -- 21,893
Purchase of Property and Equipment (5,692) (12,759)
------------- ------------
Net Cash Provided by (Used in) Investing Activities (199,271) 4,012
------------- ------------
Cash Flows from Financing Activities:
Additions to Notes Payable 199,336 30,000
Repayment of Notes Payable (84,088) (46,631)
Net Issuance (Repayment) of Subordinated Notes Payable (6,798) 13,000
Proceeds from Issuance of Common Stock 55 40
Acquisition of Treasury Stock (5,314) --
Other, Net 199 (182)
------------- ------------
Net Cash Provided by (Used in) Financing Activities 103,390 (3,773)
------------- ------------
Cash Provided by (Used in) Discontinued Operations 13,699 (9,780)
------------- ------------
Net Decrease in Cash and Cash Equivalents (1,449) (1,885)
Cash and Cash Equivalents at Beginning of Period 2,751 3,537
------------- ------------
Cash and Cash Equivalents at End of Period $ 1,302 $ 1,652
============= ============
Supplemental Statement of Cash Flows Information:
Interest Paid $ 10,180 $ 2,706
============= ============
Income Taxes Paid $ 3,315 $ 1,106
============= ============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
Page 3
<PAGE>
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Our accompanying unaudited condensed consolidated financial statements 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 our opinion, such unaudited
interim information reflects all adjustments, consisting only of normal
recurring adjustments, necessary to present our financial position and results
of operations for the periods presented. Our results of operations for interim
periods are not necessarily indicative of the results to be expected for a full
fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 1998
was derived from our audited consolidated financial statements as of that date
but does not include all the information and footnotes required by generally
accepted accounting principles. We suggest that these condensed consolidated
financial statements be read in conjunction with the audited consolidated
financial statements included in our Annual Report on Form 10-K, for the year
ended December 31, 1998.
Note 2. Summary of Finance Receivables
Following is a summary of our Finance Receivables, Net, as of June 30, 1999
and December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
June 30, 1999 December 31, 1998
---------------------------------------- ---------------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
------------- ------------- ------------- ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Installment Sales Contract Principal Balances $ 256,645 $ 77,366 $ 334,011 $ 93,936 $ 51,282 $ 145,218
Add: Accrued Interest 2,755 868 3,623 877 473 1,350
Loan Origination Costs 4,450 -- 4,450 2,237 -- 2,237
------------- ------------- ------------- ------------ ------------ ------------
Principal Balances, Net 263,850 78,234 342,084 97,050 51,755 148,805
Residuals in Finance Receivables Sold 22,559 2,625 25,184 33,331 2,625 35,956
Investments Held in Trust 35,249 -- 35,249 20,564 -- 20,564
------------- ------------- ------------- ------------ ------------ ------------
321,658 80,859 402,517 150,945 54,380 205,325
Allowance for Credit Losses (66,905) (2,990) (69,895) (24,777) (2,024) (26,801)
Discount on Acquired Loans -- (25,423) (25,423) -- (15,315) (15,315)
------------- ------------- ------------- ------------ ------------ ------------
Finance Receivables, Net $ 254,753 $ 52,446 $ 307,199 $ 126,168 $ 37,041 $ 163,209
============= ============= ============= ============ ============ ============
Classification of Principal Balances:
Finance Receivables Held for Investment $ 99,049 $ 77,366 $ 176,415 $ 26,852 $ 51,282 $ 78,134
Finance Receivables Held as Collateral for
Securitization Notes Payable 157,596 -- 157,596 67,084 -- 67,084
============= ============= ============= ============ ============ ============
Installment Sales Contract Principal Balances $ 256,645 $ 77,366 $ 334,011 $ 93,936 $ 51,282 $ 145,218
============= ============= ============= ============ ============ ============
</TABLE>
Page 4
<PAGE>
As of June 30, 1999 and December 31, 1998, our Residuals in Finance
Receivables Sold from dealership operations were comprised of the following (in
thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
----------------- -----------------
<S> <C> <C>
Retained interest in subordinated securities (B
Certificates) $ 33,080 $ 51,243
Net interest spreads, less present value discount 14,596 25,838
Reduction for estimated credit losses (25,117) (43,750)
----------------- -----------------
Residuals in finance receivables sold $ 22,559 $ 33,331
================= =================
Securitized principal balances outstanding $ 126,945 $ 198,747
================= =================
Estimated credit losses as a % of securitized principal
balances outstanding 19.8% 22.0%
================= =================
</TABLE>
The following table reflects a summary of activity for our Residuals in
Finance Receivables Sold from dealership operations for the periods ended June
30, 1999 and 1998, respectively (in thousands):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ----------- ------------
<S> <C> <C> <C> <C>
Balance, Beginning of Period $ 28,480 $ 24,741 $ 33,331 $ 13,277
Additions -- 10,396 -- 24,254
Amortization (5,921) (6,719) (10,772) (9,113)
------------ ------------ ----------- ------------
Balance, End of Period $ 22,559 $ 28,418 $ 22,559 $ 28,418
============ ============ =========== ============
</TABLE>
Note 3. Notes Receivable
Our Cygnet dealer program has various notes receivable from used car
dealers. Under Cygnet's asset based loan program, our commitments for revolving
notes receivable totaled $9.6 million at June 30, 1999.
In July 1997, First Merchants Acceptance Corporation (First Merchants) filed
for bankruptcy. Immediately subsequent to the bankruptcy filing, we executed a
loan agreement to provide First Merchants with debtor in possession financing
(DIP facility). The maximum commitment under the DIP facility was $11.5 million
at June 30, 1999. The outstanding balance on the DIP facility totaled $11.5
million and $12.2 million at June 30, 1999 and December 31, 1998, respectively.
Following is a summary of Notes Receivable at June 30, 1999 and December 31,
1998 (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------------- ----------------
<S> <C> <C>
Notes Receivable under the asset based loan program, net of
allowance for doubtful accounts of $103, and $500, respectively $ 7,433 $ 8,311
First Merchants Debtor in Possession Note Receivable 11,502 12,228
First Merchants Bank Group Participation 1,279 6,856
Other Notes Receivable 1,103 862
-------------- ----------------
Notes Receivable, Net $ 21,317 $ 28,257
============== ================
</TABLE>
Page 5
<PAGE>
Note 4. Notes Payable
The following is a summary of Notes Payable at June 30, 1999 and December
31, 1998 (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Revolving Facility with GE Capital $ 76,647 $ 51,765
Securitization Notes Payable 119,325 50,607
Note Payable Collateralized by the Common Stock of our Securitization Subsidiaries 37,500 12,234
Mortgage Loan with Finance Company -- 3,386
Others 735 967
---------------- ---------------
Subtotal 234,207 118,959
Less: Unamortized Loan Fees 1,255 1,665
---------------- ---------------
Notes Payable $ 232,952 $ 117,294
================ ===============
</TABLE>
Note 5. Common Stock Equivalents
Net Earnings per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding for the periods
ended June 30, 1999, and 1998 as follows (in thousands, except for per share
amounts):
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
--------------------------- ------------------------
1999 1998 1999 1998
------------ ------------- ----------- -----------
<S> <C> <C> <C> <C>
Income from Continuing Operations $ 1,470 $ 2,943 $ 1,890 $ 6,672
============ ============= =========== ===========
Net Earnings $ 1,470 $ 2,943 $ 1,890 $ 1,077
============ ============= =========== ===========
Basic EPS-Weighted Average Shares Outstanding 14,940 18,590 15,292 18,570
============ ============= =========== ===========
Basic Earnings Per Share from:
Continuing Operations $ 0.10 $ 0.16 $ 0.12 $ 0.36
============ ============= =========== ===========
Net Earnings $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============= =========== ===========
Basic EPS-Weighted Average Shares Outstanding 14,940 18,590 15,292 18,570
Effect of Diluted Securities:
Warrants -- 44 -- 35
Stock Options 270 346 203 325
------------ ------------- ----------- -----------
Dilutive EPS-Weighted Average Shares Outstanding 15,210 18,980 15,495 18,930
============ ============= =========== ===========
Diluted Earnings Per Share from:
Continuing Operations $ 0.10 $ 0.16 $ 0.12 $ 0.35
============ ============= =========== ===========
Net Earnings $ 0.10 $ 0.16 $ 0.12 $ 0.06
============ ============= =========== ===========
Warrants Not Included in Diluted EPS Since Antidilutive 1,439 1,214 1,510 715
============ ============= =========== ===========
Stock Options Not Included in Diluted EPS since Antidilutive 905 571 1,035 96
============ ============= =========== ===========
</TABLE>
Note 6. Business Segments
We have two divisions: dealership operations and non-dealership operations.
Within our divisions, we have six distinct business segments. Within the
dealership operations division, the segments consist of retail car sales
operations (company dealerships), the income generated from the finance
receivables generated at the Ugly Duckling dealerships and corporate and other
operations. Under the non-dealership operations division, the segments consist
of the Cygnet dealer program, bulk purchasing and loan servicing, and corporate
and other operations.
Page 6
<PAGE>
A summary of operating activity by business segment for the periods ended
June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non Dealership Operations
------------------------------------- -------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ------------- ----------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Three months ended June 30, 1999:
Sales of Used Cars $ 97,876 $ -- $ -- $ -- $ -- $ -- $ 97,876
Less: Cost of Used Cars Sold 55,559 -- -- -- -- -- 55,559
Provision for Credit Losses 20,131 5,658 -- 846 -- -- 26,635
----------- ------------- ----------- ------------ ------------ ----------- ------------
22,186 (5,658) -- (846) -- -- 15,682
----------- ------------- ----------- ------------ ------------ ----------- ------------
Interest Income -- 15,647 109 4,114 315 1 20,186
Servicing and Other Income 6 2,296 133 -- 5,235 -- 7,670
----------- ------------- ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 22,192 12,285 242 3,268 5,550 1 43,538
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 5,864 -- -- 23 -- -- 5,887
General and Administrative 11,101 4,567 4,621 974 4,986 773 27,022
Depreciation and Amortization 859 280 537 107 370 168 2,321
----------- ------------- ----------- ------------ ------------ ----------- ------------
17,824 4,847 5,158 1,104 5,356 941 35,230
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 4,368 $ 7,438 $ (4,916) $ 2,164 $ 194 $ (940) $ 8,308
=========== ============= =========== ============ ============ =========== ============
Three months ended June 30, 1998:
Sales of Used Cars $ 69,523 $ -- $ -- $ -- $ -- $ -- $ 69,523
Less: Cost of Used Cars Sold 39,237 -- -- -- -- -- 39,237
Provision for Credit Losses 14,263 10 -- 715 -- -- 14,988
----------- ------------- ----------- ------------ ------------ ----------- ------------
16,023 (10) -- (715) -- -- 15,298
----------- ------------- ----------- ------------ ------------ ----------- ------------
Interest Income -- 3,506 54 2,012 452 -- 6,024
Gain on Sale of Loans -- 3,659 -- -- -- -- 3,659
Servicing and Other Income 17 4,015 56 -- 5,443 -- 9,531
----------- ------------- ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 16,040 11,170 110 1,297 5,895 -- 34,512
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 4,218 -- -- 44 12 -- 4,274
General and Administrative 9,329 4,279 3,456 593 4,203 707 22,567
Depreciation and Amortization 615 311 249 23 154 -- 1,352
----------- ------------- ----------- ------------ ------------ ----------- ------------
14,162 4,590 3,705 660 4,369 707 28,193
----------- ------------- ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 1,878 $ 6,580 $ (3,595) $ 637 $ 1,526 $ (707) $ 6,319
=========== ============= =========== ============ ============ =========== ============
</TABLE>
Page 7
<PAGE>
<TABLE>
<CAPTION>
Dealership Operations Non Dealership Operations
------------------------------------ ---------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ------------ ----------- ------------ ------------ ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Six months ended June 30, 1999:
Sales of Used Cars $ 204,319 $ -- $ -- $ -- $ -- $ -- $204,319
Less: Cost of Used Cars Sold 115,656 -- -- -- -- -- 115,656
Provision for Credit Losses 42,024 11,529 -- 1,643 -- -- 55,196
----------- ------------ ----------- ------------ ------------ ----------- ------------
46,639 (11,529) -- (1,643) -- -- 33,467
----------- ------------ ----------- ------------ ------------ ----------- ------------
Interest Income -- 25,959 170 7,478 627 2 34,236
Servicing and Other Income 13 5,178 178 -- 11,926 -- 17,295
----------- ------------ ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 46,652 19,608 348 5,835 12,553 2 84,998
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 12,433 -- -- 59 3 -- 12,495
General and Administrative 22,010 9,150 9,959 1,937 10,807 1,518 55,381
Depreciation and Amortization 1,653 562 1,058 185 692 308 4,458
----------- ------------ ----------- ------------ ------------ ----------- ------------
36,096 9,712 11,017 2,181 11,502 1,826 72,334
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 10,556 $ 9,896 $ (10,669) $ 3,654 $ 1,051 $ (1,824) $ 12,664
=========== ============ =========== ============ ============ =========== ============
Six months ended June 30, 1998:
Sales of Used Cars $ 142,496 $ -- $ -- $ -- $ -- $ -- $142,496
Less: Cost of Used Cars Sold 78,968 -- -- -- -- -- 78,968
Provision for Credit Losses 29,297 10 -- 1,043 -- -- 30,350
----------- ------------ ----------- ------------ ------------ ----------- ------------
34,231 (10) -- (1,043) -- -- 33,178
----------- ------------ ----------- ------------ ------------ ----------- ------------
Interest Income -- 7,323 118 3,610 1,179 -- 12,230
Gain on Sale of Loans -- 8,273 -- -- -- -- 8,273
Servicing and Other Income 58 7,839 102 -- 5,443 -- 13,442
----------- ------------ ----------- ------------ ------------ ----------- ------------
Income before Operating Expenses 34,289 23,425 220 2,567 6,622 -- 67,123
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Expenses:
Selling and Marketing 9,096 -- -- 87 12 -- 9,195
General and Administrative 19,835 8,834 6,075 1,108 4,203 1,298 41,353
Depreciation and Amortization 1,228 648 450 45 154 -- 2,525
----------- ------------ ----------- ------------ ------------ ----------- ------------
30,159 9,482 6,525 1,240 4,369 1,298 53,073
----------- ------------ ----------- ------------ ------------ ----------- ------------
Operating Income (Loss) $ 4,130 $ 13,943 $ (6,305) $ 1,327 $ 2,253 $ (1,298) $ 14,050
=========== ============ =========== ============ ============ =========== ============
</TABLE>
Note 7. Discontinued Operations
In February 1998, we announced our intention to close our branch office
network, through which we purchased retail installment contracts from third
party dealers, and exit this line of business. We completed the branch office
closure as of March 31, 1998. As a result of the branch office network closure,
we reclassified the results of operations of the branch office network in the
accompanying condensed consolidated balance sheets and condensed consolidated
statements of operations to discontinued operations.
Page 8
<PAGE>
The components of Net Assets of Discontinued Operations as of June 30, 1999
and December 31, 1998 follow (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
---------------- ---------------
<S> <C> <C>
Finance Receivables, net $ 19,195 $ 30,649
Residuals in Finance Receivables Sold 4,503 7,875
Investments Held in Trust 2,638 3,665
Other Assets, net of Accounts Payable and
Accrued Liabilities 1,569 2,351
Disposal Liability (3,088) (6,024)
---------------- ---------------
Net Assets of Discontinued Operations $ 24,817 $ 38,516
================ ===============
</TABLE>
Note 8. Use of Estimates
The preparation of our consolidated financial statements requires us to make
estimates and assumptions that affect the reported amount of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from our estimates.
Note 9. Certain Bankruptcy Remote Entities
Ugly Duckling Receivables Corporation (UDRC) and Ugly Duckling Receivables
Corporation II (UDRC II) (collectively referred to as Securitization
Subsidiaries), are our wholly-owned special purpose "bankruptcy remote
entities." Their assets, including assets classified as Discontinued Operations,
include Residuals in Finance Receivables Sold and Investments Held In Trust.
Total assets for UDRC and UDRC II are approximately $183.4 million and $5.3
million, respectively, at June 30, 1999. These amounts would not be available to
satisfy claims of our creditors on a consolidated basis.
Note 10. Reclassifications
We have made certain reclassifications to previously reported information to
conform to the current presentation.
Page 9
<PAGE>
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Our Quarterly Report on Form 10-Q contains forward looking statements. We
may make additional written or oral forward looking statements from time to time
in filings with the Securities and Exchange Commission or otherwise. Such
forward looking statements are within the meaning of that term in Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. Such statements may include, but are not
limited to, projections of revenues, income, or loss, capital expenditures,
plans for future operations, financing needs or plans, Year 2000 readiness, and
plans relating to our products or services, 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 herein, contemplated by, or underlying
the forward looking statements. We undertake no obligation to publicly update or
revise any forward looking statements, whether as a result of new information,
future events, or otherwise. Statements in this Quarterly Report, including the
Notes to the Condensed Consolidated Financial Statements and "Management's
Discussion and Analysis of Financial Condition and Results of Operations,"
describe factors, among others, that could contribute to or cause such
differences. Additional risk factors that could cause actual results to differ
materially from those expressed in such forward looking statements are set forth
in Exhibit 99 which is attached hereto and incorporated by reference into this
Quarterly Report on Form 10-Q.
Introduction
General. We operate the largest chain of buy here-pay here used car
dealerships in the United States. We sell and finance our used vehicles to
customers within the sub-prime segment of the used car market. Our customers
typically have limited credit histories, low incomes or past credit problems. At
June 30, 1999, we operated 59 dealerships located in several large markets,
including Los Angeles, Atlanta, Tampa, San Antonio, Phoenix and Dallas.
In addition to our dealership and financing operations, we also
o provide financing to other independent used car dealers through our
Cygnet dealer program,
o service and collect large portfolios of finance receivables owned by
others, and
o manage selected financial assets that we acquire from financially
distressed third parties.
From 1994 through the first quarter of 1998, we maintained a national branch
office network that acquired and serviced retail installment contracts from
numerous independent third party dealers. We discontinued these operations in
1998.
Below is a summary of our businesses by division and their related segments:
[Organizational Chart of Business Segments]
The chart above shows Ugly Duckling with two operating divisions. Dealership
operations is the first division. Dealership operations has three distinct
segments. Retail sales is its first segment. This is the segment that operates
our chain of Ugly Duckling Car Sales dealerships. Portfolio and loan servicing
is the second segment of dealership operations. This segment holds and services
the loan portfolios originated or acquired by our dealership operations.
Finally, dealership operations has an administration segment that provides
corporate administration to the division. Our non-dealership operations division
also contains three segments. The first non-dealership operations segment is the
bulk purchasing/loan servicing segment. In this segment, we acquire loan
portfolios in bulk from third parties and provide loan servicing for third
parties. The second segment of non-dealership operations is the Cygnet dealer
program under which we provide various credit facilities to independent used car
dealers. Finally, the non-dealership operations also have an administration
segment that provides corporate administration to the non-dealership operations.
Last, the chart shows our discontinued operations, which contains our branch
office network that we closed in February 1998 and the loans we acquired through
that network.
Page 10
<PAGE>
Company Dealership Operations
We commenced dealership operations in 1992 with the acquisition of two
dealerships in Arizona, and have expanded aggressively since then through a
combination of acquisitions and development of new stores. Our most significant
growth occurred in 1997, when
o we acquired from Seminole Finance, Inc. and related companies (Seminole),
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million;
o we purchased from E-Z Plan, Inc. (E-Z Plan), seven dealerships in San
Antonio and a contract portfolio of approximately $24.3 million;
o we purchased from Kars-Yes Holdings, Inc. and related companies (Kars),
six dealerships in the Los Angeles market, two in the Miami market, two
in the Atlanta market, and two in the Dallas market; and
o we opened our first used car dealership in the Las Vegas market, two
additional dealerships in the Albuquerque market and one additional
dealership in the Phoenix market. We also closed a dealership in
Arizona.
We continued our aggressive growth in 1998, adding 17 new dealerships in our
existing markets. We opened one dealership in the Albuquerque market, four
dealerships in the Atlanta market, three dealerships in the Dallas market, two
dealerships in the Los Angeles market, two dealerships in the Phoenix market,
two dealerships in the San Antonio market, and three dealerships in the Tampa
market. We also closed two dealerships in Miami and exited that market.
In the first quarter of 1999, we opened one dealership in the Dallas market
and one in the Tampa market. In the second quarter of 1999, we added a
dealership in the Los Angeles market, which brought our total number of
dealerships to 59.
The following table summarizes the number of stores we had in operation by
major market as of June 30, 1999, and each of the last three years ended
December 31, 1998, 1997, and 1996:
Number of Stores by Market
-------------------------------------------
June 30, December 31,
---------- -------------------------------
1999 1998 1997 1996
---------- --------- --------- ---------
Phoenix 9 9 7 5
San Antonio 9 9 7 --
Atlanta 9 9 5 --
Los Angeles 9 8 6 --
Tampa 9 8 5 --
Dallas 7 6 3 --
Tucson 3 3 3 3
Albuquerque 3 3 2 --
Las Vegas 1 1 1 --
Miami -- -- 2 --
---------- --------- --------- ---------
59 56 41 8
========== ========= ========= =========
Non-Dealership Operations
Cygnet Dealer Program. In 1997 we began operating the Cygnet dealer program,
which provides qualified dealers with warehouse purchase facilities and
revolving lines of credit primarily secured by the dealers' finance receivable
portfolios. We extend credit facilities that are subject to various collateral
coverage ratios, maximum advance rates, and performance measurements, depending
on the financial condition of the dealer and the quality of the finance
receivables originated. The dealer remains responsible for collection of finance
receivable payments and retains control of the customer relationship. As a
condition to providing financing, each dealer is required to satisfy certain
criteria to qualify for the program, report collection activities to us on a
daily basis and provide us with periodic financial statements. In addition, our
dealers are "audited" by our audit department on a periodic basis.
Bulk Purchasing and Loan Servicing Operations. We have entered into several
large servicing and/or bulk purchasing transactions involving third party dealer
contract portfolios. Under these transactions, we have acquired loan portfolios
or participation interests in loan portfolios that we also service. During the
second quarter of 1999, we closed our loan servicing facility in Nashville,
Tennessee, and consolidated our non-dealership loan servicing operations into
our two remaining facilities, which are located in Aurora, Colorado and Plano,
Texas.
Page 11
<PAGE>
In April 1998, we announced that our Board of Directors had directed our
management team to separate our dealership operations and non-dealership
operations into separate, publicly held companies. Our stockholders approved a
proposal to split-up the company through a rights offering at the annual
stockholders meeting held in August 1998. Due to a lack of stockholder interest,
however, we canceled the rights offering. In the first quarter of 1999, we
reclassified the Cygnet dealer program and bulk purchasing and loan servicing
operations into continuing operations for all periods presented in this
quarterly report.
Discontinued Operations
In 1994, we acquired Champion Financial Services, Inc., an independent
automobile finance company. In April 1995, we initiated an aggressive plan to
expand Champion's branch office network and, by December 31, 1997, we operated
83 branch offices across the country. In February 1998, we announced our
intention to close the branch office network and exit this line of business in
the first quarter of 1998. We recorded a pre-tax charge to discontinued
operations totaling approximately $9.1 million (approximately $5.6 million, net
of income taxes) during the first quarter of 1998. In addition, a $6.0 million
charge (approximately $3.6 million, net of income taxes) was taken during the
third quarter of 1998 due primarily to higher than anticipated loan losses and
servicing expenses. The branch office closure was substantially complete by the
end of the first quarter of 1998.
In the following discussion and analysis, we explain the general financial
condition and the results of operations of Ugly Duckling and its subsidiaries.
In particular, we analyze and explain the changes in the results of operations
of our various business segments for the quarter and six month periods ended
June 30, 1999 compared to the quarter and six month periods ended June 30, 1998.
Results of Operations for the Three Months Ended June 30, 1999 and 1998
Income items in our Statement of Operations consist of:
o Sales of Used Cars
less Cost of Used Cars Sold
less Provision for Credit Losses
o Interest Income
o Gain on Sale of Loans
o Servicing and Other Income
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended
June 30,
(Dollars in Thousands)
---------------------------
1999 1998
------------ -----------
Used Cars Sold (Units) 11,416 8,631
============ ===========
Sales of Used Cars $ 97,876 $ 69,523
Cost of Used Cars Sold 55,559 39,237
------------ -----------
Gross Margin $ 42,317 $ 30,286
============ ===========
Gross Margin % 43.2% 43.6%
============ ===========
Per Unit Sold:
Sales of Used Cars $ 8,574 $ 8,055
Cost of Used Cars Sold 4,867 4,546
------------ -----------
Gross Margin $ 3,707 $ 3,509
============ ===========
The number of cars we sold (units) increased by 32.3% for the three months
ended June 30, 1999 over the same period in 1998. Same store unit sales for the
three months ended June 30, 1999 increased 3.3% compared to the three month
period ended June 30, 1998. The increase in our same store unit sales was
primarily a result of the maturation of stores purchased or opened in late 1997.
We anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Page 12
<PAGE>
Our Used Car Sales revenues increased by 40.8% for the three months ended
June 30, 1999 over the same period ended June 30, 1998. The growth for this
period reflects increases in the number of dealerships in operation and the
average unit sales price. The Cost of Used Cars Sold increased by 41.6% for the
three months ended June 30, 1999 over the same period ended June 30, 1998. The
gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold
excluding Provision for Credit Losses) increased by 39.7% for the three months
ended June 30, 1999 over the same period ended June 30, 1998. The gross margin
per car sold for the second quarter of 1999 is comparable to the second quarter
of 1998.
Our average sales price per car increased by 6.4% for the three months ended
June 30, 1999 over the three months ended June 30, 1998. The increase in the
average sales price was necessary to offset the increase in the Cost of Used
Cars Sold. On a per unit basis, the Cost of Used Cars Sold increased by 7.0% for
the three months ended June 30, 1999 over the three months ended June 30, 1998.
The increase in our average cost per used car sold is primarily due to an
increase in the direct cost of the cars we sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Three Months Ended
June 30,
--------------------------
1999 1998
------------ ------------
Provision for Credit Losses (in thousands) $ 25,789 $ 14,273
============ ============
Provision per contract originated $ 2,275 $ 1,676
============ ============
Provision as a percentage of
principal balances originated 26.9% 21.3%
============ ============
The Provision for Credit Losses in our dealership operations increased by
80.7% in the three months ended June 30, 1999 over the three months ended June
30, 1998. The Provision for Credit Losses per unit originated at our dealerships
increased by $599 or 35.7% in the three months ended June 30, 1999 over the
three months ended June 30, 1998. When we changed how we structure
securitizations for accounting purposes in the fourth quarter of 1998, we also
changed the timing of providing for credit losses. For periods prior to the
fourth quarter of 1998, we generally provided a Provision for Credit Losses of
approximately 21% of the loan principal balance at the time of origination to
record the loan at the lower of cost or market. However, as a consequence of our
revised securitization structure, we will now be retaining securitized loans on
our balance sheet for accounting purposes and recognizing income over the life
of the contracts. We record a provision for credit losses of approximately 27%
of the principal balance at the time of origination.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 18.3% to $846,000 in the three months
ended June 30, 1999 from $715,000 in the three months ended June 30, 1998. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our securitization transactions that were
structured as sale transactions for accounting purposes (Securitized Contract
Sales). Interest Income increased by 342.6% to $15.8 million for the three
months ended June 30, 1999 from $3.6 million for the three months ended June 30,
1998. The increase was primarily due to the increase in the average finance
receivables retained on our balance sheet. Because we structured most of our
securitizations to recognize income as sales for accounting purposes prior to
1999, there were fewer receivables retained on our balance sheet and Interest
Income was lower in these periods. See "Securitizations-Dealership Operations"
below for additional discussion of our securitization transactions and our on
balance sheet portfolio.
Page 13
<PAGE>
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Three Months Ended
June 30,
---------------------
1999 1998
--------- ---------
Percentage of sales revenue financed 97.8% 96.2%
Percentage of sales units financed 99.3% 98.7%
The average effective yield on finance receivables from our dealerships was
approximately 26.3% for the three months ended June 30, 1999 and 25.3% for the
three months ended June 30, 1998. Our policy is to charge 29.9% per year on our
dealership contracts. However, in those states that impose interest rate limits,
such as Texas and Florida, we charge the maximum interest rate permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from our Cygnet dealer program and from a loan we made
to First Merchants as part of its bankruptcy proceedings. Interest Income from
the First Merchants transaction decreased by 30.3% to $315,000 for the three
months ended June 30, 1999 from $452,000 for the three months ended June 30,
1998. Interest Income from the Cygnet dealer program increased by 104.5% to $4.1
million for the three months ended June 30, 1999 from $2.0 million for the three
months ended June 30, 1998. The increase in interest income in the Cygnet dealer
program reflects a significant increase in the amount of loans outstanding
during the three months ended June 30, 1999 compared to the three months ended
June 30, 1998.
Gain on Sale of Loans
Dealership Operations. The gain on sale of finance receivables we have
recorded prior to the fourth quarter of 1998 was generated from securitizations
that were structured as sale transactions. During the fourth quarter of 1998, we
began structuring our securitization transactions as financings for accounting
purposes (securitized borrowings) instead of sales transactions and, therefore,
we have not recognized gains on the sale of loans from securitization
transactions subsequent to the change. We recorded Gains on Sale of Loans
related to securitized contract sales of zero for the three months ended June
30, 1999 and $3.7 million during the three months ended June 30, 1998. See
"Securitizations-Dealership Operations" below for a summary of the structure of
our securitizations.
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the three months ending June 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
-------------- -------------- --------------
June 30, 1999 $ 2,435 $ 5,235 $ 7,670
============== ============== ==============
June 30, 1998 $ 4,088 $ 5,443 $ 9,531
============== ============== ==============
Dealership Operations. Servicing and Other Income decreased by 40.4% to $2.4
million in the three months ended June 30, 1999 compared to the $4.1 million
recognized in the three months ended June 30, 1998. We service the securitized
contracts that were included in the Securitized Contract Sales transactions for
monthly fees ranging from .25% to .33% of the beginning of month principal
balances (3.0% to 4.0% per year). We do not, however, recognize service fee
income on the contracts included in our Securitized Borrowings. The significant
decrease in Servicing and Other Income is primarily due to the decrease in the
principal balance of (1) contracts being serviced under the previous
securitization structure and (2) a portfolio we service on behalf of a third
party. We anticipate that our future Servicing and Other Income will continue to
decline as the principal balance of the contracts serviced under the Securitized
Contract Sales agreements and the third party portfolio continues to decrease.
Page 14
<PAGE>
Non-Dealership Operations. Our Servicing and Other Income decreased 3.8% to
$5.2 million in the three months ended June 30, 1999 compared to the $5.4
million recognized in the three months ended June 30, 1998. Our servicing fee is
generally a percentage of the portfolio balance (generally 3.25% to 4.0% per
year) with a minimum fee per loan serviced (generally $14 to $17 per month). The
decrease in our Servicing and Other income is due to an approximately $200,000
decrease in service fees earned by our loan servicing operations. Our service
fee income is tied to the contract principal dollars and units that we service
and will continue to decline, subject to the incentive compensation discussed
below, unless we increase the number and amount of contracts we are servicing.
We have not entered into any loan servicing agreements thus far in 1999 and
expect that our service fee income will continue to decline as the principal
balances of the portfolios that we are currently servicing decrease. We did not
recognize any servicing income in the first quarter 1998, as we did not begin
servicing loans in our non-dealership operations until April 1998.
Our non-dealership operations have entered into servicing agreements with
two companies that have filed and subsequently emerged from bankruptcy and
continue to operate under their approved plans of reorganization. Under the
terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, we are entitled to certain incentive compensation in excess of the
servicing fees that we have earned to date. As of June 30, 1999, we estimate
that the total incentive compensation from both agreements could range from $0
to $8.0 million. We have not accrued any fee income from these incentives as an
amount is not determinable at this time
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 26.2% to $43.5 million for the three months ended June 30, 1999 from
$34.5 million for the three months ended June 30, 1998. Growth of Sales of Used
Cars and Interest Income, were the primary contributors to the increase.
Operating Expenses
Operating Expenses consist of:
o Selling and Marketing Expenses,
o General and Administrative Expenses, and
o Depreciation and Amortization.
A summary of operating expenses for our business segments for the three
months ended June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
--------------------------------- -----------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ---------- ------------ ----------- ---------- ----------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999:
Selling and Marketing $ 5,864 $ -- $ -- $ 23 $ -- $ -- $ 5,887
General and Administrative 11,101 4,567 4,621 974 4,986 773 27,022
Depreciation and Amortization 859 280 537 107 370 168 2,321
----------- ---------- ------------ ----------- ---------- ----------- ---------------
$ 17,824 $ 4,847 $ 5,158 $ 1,104 $ 5,356 $ 941 $ 35,230
=========== =========== ============ =========== ============ =========== ===========
1998:
Selling and Marketing $ 4,218 $ -- $ -- $ 44 $ 12 $ -- $ 4,274
General and Administrative 9,329 4,279 3,456 593 4,203 707 22,567
Depreciation and Amortization 615 311 249 23 154 -- 1,352
----------- ---------- ------------ ----------- ---------- ----------- ---------------
$ 14,162 $ 4,590 $ 3,705 $ 660 $ 4,369 $ 707 $ 28,193
=========== =========== ============ =========== ============ =========== ===========
</TABLE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
for the three months ended June 30, 1999 and 1998 as a percentage of Sales of
Used Cars and Selling and Marketing Expense per car sold from our company
dealership segment follows:
Page 15
<PAGE>
1999 1998
---------- ---------
Selling and Marketing Expense as a
Percentage of Sales of Used Cars 6.0% 6.1%
Selling and Marketing Expense
per Car Sold $ 514 $ 489
For the three months ended June 30, 1999 and 1998, Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Total Selling and Marketing Expenses increased by
37.7% to $5.9 million for the three months ended June 30, 1999 from $4.3 million
for the three months ended June 30, 1998. Selling and Marketing Expense as a
percentage of Sales of Used Cars is comparable for the three months ended June
30, 1999 and 1998. Selling and Marketing Expense per car sold increased due to
an increase in advertising expenditures for the three months ended June 30, 1999
compared to the three months ended June 30, 1998.
General and Administrative Expenses. A summary of General and Administrative
Expenses as a percentage of Sales of Used Cars ad General and Administrative
Expenses per car sold from our company dealership segment follows:
1999 1998
----------- ----------
General and Administrative Expense
as a Percentage of Used Car Sales 11.3% 13.4%
General and Administrative Expense
per Car Sold $ 972 $ 1,081
For the three months ended June 30, 1999 total General and Administrative
Expenses increased by 19.7% to $27.0 million from $22.6 million for the three
months ended June 30, 1998. The increase in General and Administrative Expenses
was primarily a result of the addition of new dealerships, our bulk purchasing
and loan servicing operations, the expansion of infrastructure to administer the
increased number of used car dealerships in operation, and the growth of the
Cygnet dealer program.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 71.9% to
$2.3 million for the three months ended June 30, 1999 from $1.4 million for the
three months ended June 30, 1998. The increase in 1999 was primarily due to
depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 325.0% to $5.8 million for the three months
ended June 30, 1999 from $1.4 million for the three months ended June 30, 1998.
The increase in the second quarter of 1999 was primarily due to increased
borrowings under our Securitization Notes Payable, Notes Payable and
Subordinated Notes Payable. The increased borrowings were used primarily to fund
the increases in Finance Receivables.
Income Taxes
Income taxes totaled $1.0 million for the three months ended June 30, 1999,
and $2.0 million for the three months ended June 30, 1998. Our effective tax
rate was 41.0% for the three months ended June 30, 1999 and 40.5% for the three
months ended June 30, 1998.
Page 16
<PAGE>
Results of Operations for the Six Months Ended June 30, 1999 and 1998
Sales of Used Cars and Cost of Used Cars Sold
Six Months Ended
June 30,
(Dollars in Thousands)
-------------------------------
1999 1998
------------- --------------
Used Cars Sold (Units) 24,170 18,070
============= ==============
Sales of Used Cars $ 204,319 $ 142,496
Cost of Used Cars Sold 115,656 78,968
------------- --------------
Gross Margin $ 88,663 $ 63,528
============= ==============
Gross Margin % 43.4% 44.6%
============= ==============
Per Unit Sold:
Sales of Used Cars $ 8,453 $ 7,886
Cost of Used Cars Sold 4,785 4,370
------------- --------------
Gross Margin $ 3,668 $ 3,516
============= ==============
The number of cars we sold (units) increased by 33.8% for the six months
ended June 30, 1999 over the same period in 1998. Same store unit sales for the
six months ended June 30, 1999 increased 24.7% compared to the six month period
ended June 30, 1998. The increase in our same store unit sales was primarily a
result of the maturation of stores purchased or opened in late 1997. We
anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Our Used Car Sales revenues increased by 43.4% for the six months ended June
30, 1999 over the same period ended June 30, 1998. The growth for this period
reflects increases in the number of dealerships in operation and the average
unit sales price. The Cost of Used Cars Sold increased by 46.5% for the six
months ended June 30, 1999 over the same period ended June 30, 1998. The gross
margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold
excluding Provision for Credit Losses) increased by 39.6% for the six months
ended June 30, 1999 over the same period ended June 30, 1998. The gross margin
per car sold for the six months ended June 30, 1999 is comparable to the six
months ended June 30, 1998.
Our average sales price per car increased by 7.2% for the six months ended
June 30, 1999 over the six months ended June 30, 1998. The increase in the
average sales price was necessary to offset the increase in the Cost of Used
Cars Sold. On a per unit basis, the Cost of Used Cars Sold increased by 9.5% for
the six months ended June 30, 1999 over the six months ended June 30, 1998. The
increase in our average cost per used car sold is primarily due to an increase
in the direct cost of the cars we sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
Six Months Ended
June 30,
---------------------------
1999 1998
------------- ------------
Provision for Credit Losses (in thousands) $ 53,553 $ 29,307
============= ============
Provision per contract originated $ 2,234 $ 1,641
============= ============
Provision as a percentage of
principal balances originated 26.9% 21.5%
============= ============
Page 17
<PAGE>
The Provision for Credit Losses in our dealership operations increased by
82.7% in the six months ended June 30, 1999 over the six months ended June 30,
1998. The Provision for Credit Losses per unit originated at our dealerships
increased by $593 or 36.1% in the six months ended June 30, 1999 over the six
months ended June 30, 1998. The increase is primarily a result of the change in
how we structure securitizations for accounting purposes.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 57.5% to $1.6 million in the six months
ended June 30, 1999 from $1.0 million in the six months ended June 30, 1998. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our Securitized Contract Sales. Interest Income
increased by 251.2% to $26.1 million for the six months ended June 30, 1999 from
$7.4 million for the six months ended June 30, 1998. The increase was primarily
due to the increase in the average finance receivables retained on our balance
sheet. Because we structured most of our securitizations to recognize income as
sales for accounting purposes prior to 1999, there were fewer receivables
retained on our balance sheet and Interest Income was lower in these periods.
See "Securitizations-Dealership Operations" below for additional discussion of
our securitization transactions and our on balance sheet portfolio.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Six Months Ended
June 30,
----------------------------------
1999 1998
--------------- -------------
Percentage of sales revenue financed 97.3% 95.9%
Percentage of sales units financed 99.2% 98.8%
The average effective yield on finance receivables from our dealerships was
approximately 26.3% for the six months ended June 30, 1999 and 25.7% for the six
months ended June 30, 1998.
Non-Dealership Operations. Interest Income from the First Merchants
transaction decreased by 46.8% to $627,000 for the six months ended June 30,
1999 from $1.2 million for the six months ended June 30, 1998. Interest Income
from the Cygnet dealer program increased by 107.1% to $7.5 million for the six
months ended June 30, 1999 from $3.6 million for the six months ended June 30,
1998. The increase in interest income in the Cygnet dealer program reflects a
significant increase in the amount of loans outstanding during the six months
ended June 30, 1999 compared to the six months ended June 30, 1998.
Gain on Sale of Loans
Dealership Operations. Because of the change in the way we structure our
securitization transactions for accounting purposes in the fourth quarter of
1998, we no longer recognize gains on the sale of loans from securitization
transactions. We recorded Gains on Sale of Loans related to securitized contract
sales of zero for the six months ended June 30, 1999 and $8.3 million during the
six months ended June 30, 1998. See "Securitizations-Dealership Operations"
below for a summary of the structure of our securitizations.
Page 18
<PAGE>
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the six months ending June 30, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
------------- ------------------ -------------
June 30, 1999 $ 5,369 $ 11,926 $ 17,295
============= ================== =============
June 30, 1998 $ 7,999 $ 5,443 $ 13,442
============= ================== =============
Dealership Operations. Servicing and Other Income decreased by 32.9% to $5.4
million in the six months ended June 30, 1999 compared to the $8.0 million
recognized in the six months ended June 30, 1998. As previously noted, we
anticipate that our future Servicing and Other Income will decline as the
principal balance of the contracts serviced under the Securitized Contract Sales
agreements and the third party portfolio will continue to decrease.
Non-Dealership Operations. Our Service Fee and Other Income increased 119.1%
to $11.9 million in the six months ended June 30, 1999 compared to the $5.4
million recognized in the six months ended June 30, 1998. Our Service Fee and
Other Income increased because our non-dealership operations did not begin
servicing loans until April 1998. As previously noted, we have not entered into
any loan servicing agreements thus far in 1999 and expect that our service fee
income will continue to decline as the principal balances of the portfolios that
we are currently servicing decrease.
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 26.6% to $85.0 million for the six months ended June 30, 1999 from $67.1
million for the six months ended June 30, 1998. Growth of Sales of Used Cars,
Interest Income, and Servicing and Other Income were the primary contributors to
the increase.
A summary of operating expenses for our business segments for the six months
ended June 30, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
---------------------------------- ---------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
---------- ---------- ---------- --------- ---------- ---------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999:
Selling and Marketing $ 12,433 $ -- $ -- $ 59 $ 3 $ -- $ 12,495
General and 22,010 9,150 9,959 1,937 10,807 1,518 55,381
Administrative
Depreciation and 1,653 562 1,058 185 692 308 4,458
Amortization
---------- ---------- ---------- --------- ---------- ---------- ------------
$ 36,096 $ 9,712 $ 11,017 $ 2,181 $11,502 $ 1,826 $ 72,334
========== ========== ========== ========= ========== ========== ============
1998:
Selling and Marketing $9,096 $ -- $ -- $ 87 $ 12 $ -- $ 9,195
General and 19,835 8,834 6,075 1,108 4,203 1,298 41,353
Administrative
Depreciation and 648 450 45 154 -- 2,525
Amortization 1,228
---------- ---------- ---------- --------- ---------- ---------- ------------
$30,159 $ 9,482 $ 6,525 $ 1,240 $ 4,369 $ 1,298 $ 53,073
========== ========== ========== ========== ========== =========== ============
</TABLE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
for the six months ended June 30, 1999 and 1998 as a percentage of Sales of Used
Cars and Selling and Marketing Expense per car sold from our company dealership
segment follows:
Page 19
<PAGE>
1999 1998
----------- ----------
Selling and Marketing Expense as a
Percent of Sales of Used Cars 6.1% 6.4%
=========== ==========
Selling and Marketing Expense
per Car Sold $ 514 $ 503
=========== ==========
For the six months ended June 30, 1999 and 1998, total Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Total Selling and Marketing Expenses increased by
35.9% to $12.5 million for the six months ended June 30, 1999 from $9.2 million
for the six months ended June 30, 1998. Selling and Marketing Expense as a
percentage of Sales of Used Cars and on a per unit basis is comparable for the
six months ended June 30, 1999 compared to the six month period in 1998.
General and Administrative Expenses. A summary of General and Administrative
Expenses for the six months ended June 30, 1999 and 1998 as a percentage of
Sales of Used Cars and General and Administrative Expenses per car sold from our
Company Dealership segment follows:
1999 1998
---------- ----------
General and Administrative Expense
as a Percentage of Used Car Sales 10.8% 13.9%
General and Administrative Expense
per Car Sold $ 911 $ 1,098
For the six months ended June 30, 1999 total General and Administrative
Expenses increased by 33.9% to $55.4 million from $41.4 million for the six
months ended June 30, 1998. The increase in General and Administrative Expenses
was primarily a result of an increase in the number of dealerships in operation,
the addition of our bulk purchasing and loan servicing operations, the expansion
of infrastructure to administer the increased number of used car dealerships in
operation, and the growth of the Cygnet dealer program.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 76.6% to
$4.5 million for the six months ended June 30, 1999 from $2.5 million for the
six months ended June 30, 1998. The increase in 1999 was primarily due to
depreciation on an increased dealership base, depreciation from our
non-dealership operations, and an increase in software amortization of our
investment in our integrated car sales and loan servicing system.
Interest Expense
Interest expense increased by 230.0% to $9.5 million for the six months
ended June 30, 1999 from $2.9 million for the six months ended June 30, 1998.
The increase for the six months ended June 30, 1999 was primarily due to
increased borrowings under our Securitization Notes Payable, Notes Payable and
Subordinated Notes Payable. The increased borrowings were used primarily to fund
the increases in Finance Receivables.
Income Taxes
Income taxes totaled $1.3 million for the six months ended June 30, 1999,
and $4.5 million for the six months ended June 30, 1998. Our effective tax rate
was 40.8% for the six months ended June 30, 1999 and 40.3% for the six months
ended June 30, 1998.
Discontinued Operations
We recorded a pre-tax charge to discontinued operations totaling
approximately $9.1 million (approximately $5.6 million, net of income taxes)
during the first quarter of 1998 related to the closure of our branch office
network. In addition, we recorded a $6.0 million charge (approximately $3.6
million, net of income taxes) during the third quarter of 1998 due primarily to
higher than anticipated loan losses and servicing expenses. The charges we
recorded to Discontinued Operations represent the total estimated net loss we
expect to realize from the branch office network closure. As a result, there was
no income or loss from Discontinued Operations for the six months ended June 30,
1999.
Page 20
<PAGE>
Financial Position
Total assets increased by 34.5% to $465.2 million at June 30, 1999 from
$346.0 million at December 31, 1998. The increase was due primarily to an
increase in Finance Receivables of $144.0 million to $307.2 million at June 30,
1999 from $163.2 million at December 31, 1998. Our dealership operations'
Finance Receivables increased approximately $128.6 million due primarily to the
change in our securitization structure, and our non-dealership operations'
Finance Receivables increased approximately $15.4 million primarily as a result
of growth of the Cygnet dealer program.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable. Notes Payable increased by $115.7
million to $233.0 million at June 30, 1999 from $117.3 million at December 31,
1998. The increase in our Notes Payable is attributable to an increase of $24.9
million in our revolving line of credit, which totaled approximately $76.7
million at June 30, 1999, compared to $51.8 million at December 31, 1998. Our
Securitization Notes Payable increased by $68.7 million as a result of the
securitization transaction we closed in April 1999. Our Note Payable
Collateralized by the Common Stock of our Securitization Subsidiaries increased
by $25.3 million as a result of a loan obtained from an unrelated third party in
May 1999. We also repaid $3.4 million in mortgage loans from an unrelated
finance company.
Growth in Finance Receivables. As a result of our continued expansion,
contract receivables managed by our dealership operations have continued to
increase. The following table reflects the growth in period end balances of our
dealership operations measured in terms of the principal amount and the number
of contracts outstanding.
The following table reflects the growth in contract originations measured in
terms of the principal amount and the number of contracts.
<TABLE>
<CAPTION>
Total Contracts Outstanding - Dealership Operations
(In thousands, except number of contracts)
June 30, 1999 December 31, 1998
---------------------------- -----------------------------
Principal Number of Principal Number of
Amount Contracts Amount Contracts
------------- ------------- -------------- ------------
<S> <C> <C> <C> <C>
Managed Portfolio $ 383,596 61,661 $ 292,683 49,501
Less: Portfolios Securitized and Sold 126,951 27,596 198,747 37,186
-------------- ------------ -------------- ------------
Total Retained Principal $ 256,645 34,065 $ 93,936 12,415
============== ============ ============== ============
</TABLE>
In addition to the loan portfolio summarized above, we also service loan
portfolios totaling approximately $69.7 million ($27.2 million for Kars and
$42.5 million from branch office originations) as of June 30, 1999 and $121.2
million ($47.9 million for Kars and $73.3 million from branch office
originations) as of December 31, 1998.
Three Months Ending Six Months Ending
June 30, June 30,
----------------------- ---------------------------
1999 1998 1999 1998
----------- ---------- ------------ -------------
Principal Amount $ 96,098 $ 66,908 $ 198,831 $ 136,616
Number of Contracts 11,335 8,518 23,969 17,857
Average Principal $ 8,478 $ 7,855 $ 8,295 $ 7,651
Finance Receivable principal balances generated or acquired by our
dealership operations during the three months period ended June 30, 1999
increased by 43.6% to $96.1 million from $66.9 million for the three months
ended June 30, 1998. For the six months ended June 30, 1999, Finance Receivables
increased by 45.5% to $198.8 million from $136.6 million for the six months
ended June 30, 1998. The increase in average principal financed is due to the
increase in our average sales price per car sold.
Our non-dealership operations began servicing loans on behalf of First
Merchants in April 1998, and began servicing additional loan portfolios on
behalf of other third parties throughout 1998. At June 30, 1999 our
non-dealership bulk purchasing/loan servicing operations were servicing a total
of approximately $356.3 million in finance receivables (approximately 56,000
contracts) compared to $587.3 million in finance receivables (approximately
80,000 contracts) at December 31, 1998.
Page 21
<PAGE>
Cygnet dealer's net investment in finance receivables purchased from a third
party dealer totaled approximately $10.8 million representing approximately
18.0% of Cygnet dealer's net finance receivables portfolio as of June 30, 1999.
We did not have any other third party dealer loans that exceeded 10% of our
Cygnet dealer finance receivable portfolio as of June 30, 1999.
Allowance for Credit Losses
We have established an Allowance for Credit Losses (Allowance) to cover
anticipated credit losses on the contracts currently in our portfolio. We
established the Allowance by recording an expense through the Provision for
Credit Losses.
For Finance Receivables generated at our dealerships, our policy is to
charge off a contract the earlier of:
o when we believe it is uncollectible, or
o when it is delinquent for more than 90 days.
The following table reflects activity in the Allowance for our dealership
operations, as well as information regarding charge off activity for the three
and six months ended June 30, 1999 and 1998, in thousands.
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
------------------------------- ------------------------------
1999 1998 1999 1998
-------------- --------------- -------------- --------------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period $ 48,628 $ 6,153 $ 24,777 $ 10,356
Provision for Credit Losses 25,789 14,273 53,553 29,307
Reduction Attributable to Loans Sold -- (13,082) -- (30,722)
Net Charge Offs (7,512) (1,394) (11,425) (2,991)
-------------- --------------- -------------- --------------
Balance, End of Period $ 66,905 $ 5,950 $ 66,905 $ 5,950
============== =============== ============== ==============
Allowance as a Percent of Period End Balances 26.1% 18.5% 26.1% 18.5%
============== =============== ============== ==============
Charge off Activity:
Principal Balances $ (9,570) $ (2,068) $ (14,580) $ (4,331)
Recoveries, Net 2,058 674 3,155 1,340
-------------- --------------- -------------- --------------
Net Charge Offs $ (7,512) $ (1,394) $ (11,425) $ (2,991)
============== =============== ============== ==============
Net Charge Offs as a Percent of Average Principal Outstanding 3.4% 2.9% 6.4% 5.0%
============== =============== ============== ==============
Average Principal Balance Outstanding $ 220,655 $ 48,172 $ 178,758 $ 60,242
============== =============== ============== ==============
</TABLE>
The Allowance on contracts from dealership operations was 26.1% of the
outstanding principal balances as of June 30, 1999 and 26.4% of outstanding
principal balances as of December 31, 1998. We changed the structure of our
securitization transactions for accounting purposes in the fourth quarter of
1998, which resulted in us retaining the securitized loans from securitization
transactions closed subsequent to the third quarter of 1998. We increased the
provision for credit losses to approximately 27% of the principal balance for
loans originated beginning in the fourth quarter of 1998 as we intend to hold
the balance sheet portfolio for investment and not for sale.
A Summary of the Allowance on contracts from non-dealership operations
follows:
<TABLE>
<CAPTION>
Non-Dealership Operations
------------------------------------------------------------------
June 30, December 31,
------------------------------- ---------------------------------
<S> <C> <C> <C> <C>
1999 1998 1998 1997
--------------- --------------- --------------- ----------------
As Percent of Period End Balances:
Allowance 3.9% 3.2% 3.9% 3.8%
Non-refundable discount and security deposits 32.9% 28.1% 29.9% 26.0%
--------------- --------------- --------------- ----------------
Total Allowance, discount and security deposits 36.8% 31.3% 33.8% 29.8%
=============== =============== =============== ================
</TABLE>
Page 22
<PAGE>
Even though a contract is charged off, we continue to attempt to collect the
contract. Recoveries as a percentage of principal balances charged off from
dealership operations averaged 21.5% for the three months ended June 30, 1999
compared to 32.6% for the three months ended June 30, 1998. Such recoveries for
the six month periods ended June 30, 1999 and 1998 averaged 21.6% and 30.9%,
respectively. Recoveries as a percentage of principal balances charged off from
non-dealership operations averaged 37.7% for the three months ended June 30,
1999 compared to 27.6% for the three months ended June 30, 1998. Such recoveries
for the six month periods ended June 30, 1999 and 1998 averaged 34.7% and 29.3%,
respectively.
For Finance Receivables acquired by our non-dealership operations with
recourse to the seller, our general policy is to exercise the recourse
provisions in our agreements under the Cygnet dealer program when a contract is
delinquent for 45 days. For contracts not purchased with recourse, our policy is
similar to that for our dealership operations.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for contracts we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge offs for each pool
separately. We calculate the cumulative net charge offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge off. The table below
displays the cumulative net charge offs of each pool as a percentage of original
contract cumulative balances, based on the quarter the loans were originated.
The table is further stratified by the number of payments made by our customers
prior to charge off. For periods denoted by "x", the pools have not seasoned
sufficiently to allow us to compute cumulative losses. For periods denoted by
"-", the pools have not yet reached the indicated cumulative age. While we
monitor static pools on a monthly basis, for presentation purposes, we are
presenting the information in the table below on a quarterly basis.
Currently reported cumulative losses may vary from those previously reported
for the reasons listed below, however, management believes that such variation
will not be material:
o ongoing collection efforts on charged off accounts, and
o the difference between final proceeds on the sale of repossessed
collateral versus our estimates of the sale proceeds.
The following table sets forth as of July 31, 1999, 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 customers before charge off. The table also shows the
percent of principal reduction for each pool since inception and cumulative
total net losses incurred (TLI).
Page 23
<PAGE>
<TABLE>
<CAPTION>
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
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>
1994:
1st Quarter $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter $ 8,191 1.6% 9.1% 14.7% 20.4% 22.7% 23.6% 23.8% 100.0%
2nd Quarter $ 9,846 2.0% 8.5% 13.3% 18.1% 20.7% 22.1% 22.5% 100.0%
3rd Quarter $ 10,106 2.5% 7.9% 12.2% 18.8% 22.1% 23.5% 24.2% 99.7%
4th Quarter $ 8,426 1.5% 6.6% 11.7% 18.2% 22.5% 24.0% 24.6% 99.6%
1996:
1st Quarter $ 13,635 1.6% 8.0% 13.7% 20.6% 24.7% 26.1% 27.0% 98.9%
2nd Quarter $ 13,462 2.2% 9.2% 13.4% 22.0% 25.9% 27.6% 28.8% 97.3%
3rd Quarter $ 11,082 1.6% 6.8% 12.5% 21.3% 25.5% 27.7% 28.6% 94.9%
4th Quarter $ 10,817 0.6% 8.4% 15.9% 24.8% 29.2% 31.0% 31.7% 92.4%
1997:
1st Quarter $ 16,279 2.1% 10.5% 17.8% 24.4% 29.4% 31.8% 32.0% 88.8%
2nd Quarter $ 25,875 1.5% 9.9% 15.8% 22.7% 27.4% 29.3% 29.3% 82.3%
3rd Quarter $ 32,147 1.4% 8.4% 13.2% 22.5% 27.1% 27.7% 27.7% 75.9%
4th Quarter $ 42,529 1.4% 6.8% 12.6% 21.9% 25.3% 25.3% 25.3% 69.6%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.5% 21.1% 22.6% -- 22.6% 62.2%
2nd Quarter $ 66,908 1.1% 8.0% 14.3% 19.9% -- -- 20.0% 50.4%
3rd Quarter $ 71,027 1.0% 8.0% 13.6% -- -- -- 16.3% 39.6%
4th Quarter $ 69,583 0.9% 6.8% -- -- -- -- 10.6% 25.6%
1999:
1st Quarter $ 102,733 0.8% -- -- -- -- -- 4.5% 0.0%
2nd Quarter $ 96,098 -- -- -- -- -- -- 0.5% 0.0%
</TABLE>
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of outstanding contract
principal balances from dealership operations.
Retained Securitized Managed
---------- ----------- ---------
June 30, 1999:
31 to 60 days 3.9% 6.4% 4.7%
61 to 90 days 2.2% 3.3% 2.6%
December 31, 1998:
31 to 60 days 2.3% 5.2% 4.6%
61 to 90 days 0.5% 2.2% 1.9%
In accordance with our charge off policy, there are no accounts more than 90
days delinquent as of June 30, 1999 and December 31, 1998.
Securitizations--Dealership Operations
Structure of Securitizations. In the fourth quarter of 1998 we announced
that we were changing the way we structure transactions for accounting purposes
under our securitization program. Through September 30, 1998, we had structured
these transactions as sales for accounting purposes (Securitized Contract
Sales). However, beginning in the fourth quarter of 1998, we began structuring
Page 24
<PAGE>
securitizations for accounting purposes to retain the contract, and the related
Securitization Note Payable on our balance sheet and recognize the income over
the life of the contracts (Securitized Borrowings). This change will not affect
our prior securitizations. Historically, Gains on Sale of Loans have been
material to our reported revenues and net earnings. Altering the structure of
these transactions so that no gain is recognized at the time of a securitization
transaction will have a material effect on our reported revenues and net
earnings until such time as we accumulate Finance Receivables on our balance
sheet sufficient to generate interest income (net of interest, credit losses,
and other expenses) equivalent to the revenues that we had historically
recognized on our securitization transactions.
Under our securitization program, we transfer the securitized Finance
Receivables to our securitization subsidiaries who then assign and transfer the
Finance Receivables to separate trusts for either Securitized Contract Sales or
Securitized Borrowings. The trusts issue Class A certificates and subordinated
Class B certificates (Residuals in Finance Receivables Sold) to the
securitization subsidiaries. The securitization subsidiaries then sell the Class
A certificates to the investors and retain the Class B certificates. We continue
to service the securitized contracts.
Residuals in Finance Receivables Sold. The residuals are a component of
Finance Receivables and represent our retained interest (the Class B
certificates) in the Finance Receivables included in our Securitized Contract
Sales. We utilize a number of assumptions to determine the initial value of the
Residuals in Finance Receivables Sold. The Residuals in Finance Receivables Sold
represent the present value of the expected net cash flows of the securitization
trusts using the out of the trust method. The net cash flows out of the trusts
are the collections on the loans in the trust in excess of the Class A
certificate principal and interest payment and certain other trust expenses. The
assumptions used to compute the Residuals in Finance Receivables Sold include,
but are not limited to:
o charge off rates,
o repossession recovery rates,
o portfolio delinquency,
o prepayment rates, and
o trust expenses.
The Residuals in Finance Receivables Sold are adjusted monthly to
approximate the present value of the expected remaining net cash flows out of
the trusts. If actual cash flows on a securitization are below our original
estimates, and those differences appear to be other than temporary in nature, we
are required to revalue Residuals in Finance Receivables Sold and record a
charge to earnings based upon the reduction. The cumulative net loss at
origination assumption inherent in the securitization transactions we entered
into in 1996 and 1997 is approximately 27.5%. For the securitizations that we
completed during the nine month period ended September 30, 1998, net losses were
estimated using total expected cumulative net losses at loan origination of
approximately 29.0%. The remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts was approximately 19.8% as of June 30, 1999, compared to
22.0% as of December 31, 1998. Because we now structure our securitization
transactions to retain the Finance Receivables securitized, we will no longer be
adding to our Residuals in Finance Receivables Sold. Further, the remaining
Residuals in Finance Receivables Sold that were originated under our prior
method will continue to decline as the underlying loan portfolios mature.
Consequently, the remaining net charge offs in our Residuals in Finance
Receivables Sold as a percentage of the remaining principal balances of
securitized contracts will continue to decline as the related loan portfolios
mature. The balance of the Residuals in Finance Receivables sold was $22.6
million at June 30, 1999 and $33.3 million as of December 31, 1998. We classify
the residuals as "held-to-maturity" securities in accordance with SFAS No. 115.
Spread Account Requirements. We maintain a spread account under our
securitization agreements. The spread account is a reserve account that would be
used to repay the Class A certificates in the event collections on a particular
pool of finance receivables was insufficient to make the required payments. At
the time a securitization transaction is entered into, our securitization
subsidiary makes an initial cash deposit into the spread account, generally
equivalent to 4% to 6% of the initial underlying Finance Receivables principal
balance, and pledges this cash to the spread account. The trustee then makes
additional deposits to the spread account out of collections on the securitized
receivables as necessary to maintain the spread account to a specified
percentage, ranging from 6.0% to 10.5%, of the underlying Finance Receivables'
principal balance. The trustee will not make distributions to the securitization
subsidiaries on the Class B certificates unless:
o the spread account has the required balance,
o the required periodic payments to the Class A certificate holders are
current, and
o the trustee, servicer and other administrative costs are current.
Page 25
<PAGE>
At June 30, 1999, we met the targeted spread account balances under our
securitization agreements of $27.9 million. We also maintain spread accounts for
the securitization transactions that were consummated by our discontinued
operations. We had satisfied the spread account funding obligation of $2.6
million as of June 30, 1999 with respect to these securitization transactions.
Certain financial information regarding securitizations. During April 1999
we closed a Securitized Borrowing transaction in which we securitized $119.7
million of contracts, issuing $87.4 million in Class A certificates. During the
first two quarters of 1998, we securitized $152.9 million in contracts, issuing
$110.1 million in Class A certificates, and $42.8 million in Class B
certificates. We recorded the carrying value of the related Residuals in Finance
Receivables Sold at $25.5 million for the first and second quarters of 1998. Due
to the change in the structure of our securitization transactions, we did not
record any Residuals in Finance Receivables for the securitization transaction
we closed in April 1999.
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have increased
in connection with the growth of our business. We require capital for:
o increases in our contract portfolio,
o expansion of our dealership network,
o our commitments under the First Merchants transaction,
o expansion of the Cygnet dealer program,
o common stock repurchases,
o the purchase of inventories,
o the purchase of property and equipment, and
o working capital and general corporate purposes.
We fund our capital requirements primarily through:
o operating cash flow,
o our revolving facility with General Electric Capital Corporation (GE
Capital),
o securitization transactions,
o supplemental borrowings, and
o in the past, equity offerings.
While to date we have met our liquidity requirements as needed, there can be
no assurance that we will be able to continue to do so in the future.
Operating Cash Flow
Net Cash Provided by Operating Activities increased by $73.1 million in the
six months ended June 30, 1999 to $80.7 million compared to the six months ended
June 30, 1998 of $7.7 million. The change in inventory and accounts payable and
accrued expenses contributed to the increase in operating cash flow for the
quarter. The changes in the Net Cash Provided by Operating activities and Net
Cash Used in Investing Activities is largely due to a change in classification
of portfolio activity related to the change in the structure of our
securitization transactions. Under our old structure contracts were held for
sale and, consequently, Finance Receivable purchases and related sales proceeds
were considered operating activities. Under our revised structure, contracts are
held for investment and such purchases are considered investing activities.
Net Cash Used in Investing Activities increased by $203.3 million to $199.3
million in the six months ended June 30, 1999 compared to $4.0 million of Net
Cash Provided by Investing Activities in the six months ended June 30, 1998. The
increase is primarily due to increases in Cash Used in Investing Activities from
purchases of Finance Receivables, net decreases in Cash advanced under our Notes
Receivable, which were offset by increased collections of Finance Receivables
and Notes Receivable.
Net Cash Provided by Financing Activities increased by $107.2 million to
$103.4 million in the six months ended June 30, 1999 compared to $3.8 million of
Net Cash Used in Financing Activities in the six months ended June 30, 1998. The
increase is due to increases in Notes Payable, net of increases in repayments of
Notes Payable and the acquisition of Treasury Stock.
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Financing Resources
Revolving Facility. The maximum commitment under our revolving credit
facility with GE Capital is $125.0 million. Under the revolving facility, we may
borrow:
o up to 65.0% of the principal balance of eligible contracts originated from
the sale of used cars,
o up to 86.0% of the principal balance of eligible contracts previously
originated by our branch office network,
o the lesser of $20 million or 58% of the direct vehicle costs for eligible
vehicle inventory, and
o the lesser of $15 million or 50% of eligible contracts or loans originated
under the Cygnet dealer program.
However, an amount up to $8.0 million of the borrowing capacity under the
revolving facility is not available at any time while our guarantee to the
purchaser of contracts acquired from First Merchants is outstanding. The
revolving facility expires in June 2000 and contains a provision that requires
us to pay GE Capital a termination fee of $200,000 if we terminate the revolving
facility prior to the expiration date. We secure the facility with substantially
all of our assets.
As of June 30, 1999, our borrowing capacity under the revolving facility was
$105.9 million, the aggregate principal amount outstanding under the revolving
facility was approximately $76.6 million, and the amount available to be
borrowed under the facility was $29.3 million. The revolving facility bears
interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.06% as
of June 30, 1999).
The revolving facility contains covenants that, among other things, limit
our ability to do the following without GE Capital's consent:
o incur additional indebtedness,
o make any change in our capital structure,
o 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, and
o make certain investments and capital expenditures.
The revolving facility also provides that an event of default will occur if
Mr. Ernest C. Garcia II owns less than 15.0% of our voting stock. Mr. Garcia
owned approximately 32.1% of our common stock at June 30, 1999.
We were also required to be Year 2000 compliant no later than June 30, 1999
(see discussion below under the Year 2000 Readiness Disclosure), and we are also
required to maintain specified financial ratios, including a debt to equity
ratio of 2.2 to 1 and a net worth of at least $150 million.
Securitizations. Our securitization program is a primary source of our
working capital. Since September 30, 1997, we have closed all of our
securitizations with private investors through Greenwich Capital Markets, Inc.
(Greenwich Capital). In March 1999, we executed a commitment letter with
Greenwich Capital to act as our exclusive agent in placing up to $300 million of
surety wrapped securities under our securitization program.
Securitizations generate cash flow for us from:
o the sale of Class A certificates,
o ongoing servicing fees, and
o excess cash flow distributions from collections on the contracts
securitized after:
o payments on the Class A certificates sold to third party investors,
o payment of fees, expenses, and insurance premiums, and
o required deposits to the spread account.
In April 1999, we closed a securitization transaction through Greenwich
Capital. Under this transaction, we securitized approximately $119.7 million of
contracts and issued approximately $87.4 million of Class A certificates with an
annual interest rate of 5.7%.
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Securitization also allows us to fix our cost of funds for a given contract
portfolio. Failure to regularly engage in securitization transactions will
adversely affect us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Securitizations--Dealership operations" for
a more complete description of our securitization program.
Supplemental Borrowings
Verde Debt. Prior to our public offering in September 1996, we historically
borrowed substantial amounts from Verde Investments, Inc. (Verde), which is
owned by our Chairman, Ernest C. Garcia II. The Subordinated Notes Payable
balances outstanding to Verde totaled $8.0 and $10.0 million as of June 30, 1999
and as of December 31, 1998. Under the terms of this note, we are required to
make monthly payments of interest and annual payments of principal in the amount
of $2.0 million. These borrowings accrue interest at an annual rate of 10.0%.
Except for the debt incurred related to our exchange offer, this debt is junior
to all of our other indebtedness and we may suspend interest and principal
payments if we are in default on obligations to any other creditors. In July
1997, our Board of Directors approved the prepayment of the total balance of the
Verde subordinated debt after the earlier of the following:
o the completion of a debt offering,
o the First Merchants transactions have been completed or the cash
requirements for completion of the transaction are known, or
o we either have cash in excess of our current needs or have funds
available under our financing sources in excess of our current needs.
No such prepayment has been made as of the date of filing of this Form 10-Q.
Any prepayment would require the consent of certain of our lenders.
Exchange Offer. In the fourth quarter of 1998, we acquired approximately 2.7
million shares of our common stock in exchange for approximately $17.5 million
of subordinated debentures. The debentures are unsecured and are subordinate to
all of our existing and future indebtedness. We must pay interest on the
debentures twice a year at 12% per year. We are required to pay the principal
amount of the debentures on October 23, 2003.
We issued the debentures at a premium of approximately $3.9 million over the
market value of the shares of our common stock that were exchanged for the
debentures. Accordingly, the debt was recorded at $13.6 million on our balance
sheet. The premium will be amortized over the life of the debentures and results
in an effective annual interest rate of approximately 18.8%. We can redeem all
or part of the debentures at any time, subject to the subordination provision of
the debentures. The balance of the subordinated debentures was $13.9 million at
June 30, 1999.
Senior Subordinated Notes. In February 1998, we borrowed a total of $15.0
million of subordinated debt from unrelated third parties for a three year term.
We pay interest on this debt quarterly at 12% per annum. This debt is:
o senior to the Verde subordinated note (described above) and the
subordinated debentures issued in our exchange offer (also described
above), and
o subordinate to our other indebtedness.
We issued warrants to the lenders of this debt to purchase up to 500,000
shares of our common stock at an exercise price of $10.00 per share, exercisable
at any time until the later of February 2001, or when the debt is paid in full.
In July 1998, we borrowed a total of $5.0 million in subordinated debt from
unrelated third parties for a three-year term. In the first quarter of 1999, we
prepaid $3.0 million of the loans. We repaid the remaining $2.0 million in June
1999.
Additional Financing. On November 12, 1998, we borrowed $15.0 million for a
term of 364 days from Greenwich Capital. We pay interest on this loan at an
interest rate equal to LIBOR plus 400 basis points. We secured the loan with the
common stock of our securitization subsidiaries. In March 1999, we borrowed
$20.0 million for a term of 278 days from Greenwich Capital. $1.5 million was
used to repay the remaining balance of the $15 million Greenwich Capital loan.
The new loan was secured by the common stock of our securitization subsidiaries.
The interest rate is at LIBOR plus 500 basis points and we paid an origination
fee of 100 basis points. We repaid this loan in the second quarter of 1999.
On March 26, 1999, we borrowed approximately $28.9 million from Greenwich
Capital under a repurchase facility with a 62% advance rate, bearing interest at
8.5%, and maturing May 31, 1999. This repurchase facility was repaid in April
1999.
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In March 1999, we executed a commitment letter with Greenwich Capital in
which, subject to satisfaction of certain conditions, Greenwich Capital agreed
to provide us with a $100 million surety-wrapped warehouse line of credit at a
rate equal to LIBOR plus 110 basis points.
On May 14, 1999, we borrowed approximately $38.0 million from an unrelated
party for a term of three years maturing on May 1, 2001.The note calls for
monthly principal payments of generally not less than $500,000 plus interest at
a rate equal to LIBOR plus 550 basis points. The loan is secured by our
Residuals in Finance Receivables Sold and certain Finance Receivables.
Debt Shelf Registration. In 1997, we registered up to $200 million of our
debt securities under the Securities Act of 1933. There can be no assurance that
we will be able to use this registration statement to sell debt securities, or
successfully register and sell other debt securities in the future.
Capital Expenditures and Commitments
During the three months ended June 30, 1999, we opened one new dealership.
We also have three additional dealerships under development. The direct cost of
opening a dealership is primarily a function of whether we lease a facility or
construct a facility. A leased facility costs approximately $650,000 to develop,
while a facility we construct costs approximately $1.7 million. In addition, we
require capital to finance the portfolio that we carry on our balance sheet for
each store. It takes approximately $2.2 million in cash to support a typical
stabilized store portfolio with our existing 65% advance rate under our GE
facility. Additionally, it takes approximately 30 months for a store portfolio
to reach a stabilized level.
On July 11, 1997, we entered into an agreement to provide debtor in
possession financing to First Merchants (DIP facility). As of June 30, 1999, the
maximum commitment on the DIP facility was $11.5 million and the outstanding
balance on the DIP facility totaled $11.5 million. When First Merchants
defaulted on the DIP facility, we negotiated a settlement agreement with them
that has increased our funding obligation by $2.0 million, subject to
satisfaction of certain conditions, and in exchange for other concessions. These
conditions were satisfied in August 1999 and the loan is no longer in default.
We intend to finance the construction of new dealerships and the DIP
facility financing through operating cash flows and supplemental borrowings,
including amounts available under the revolving facility and the securitization
program.
Common Stock Repurchase Program. During the first quarter of 1999 we
repurchased approximately 928,000 shares of our common stock for $5.2 million
under our stock repurchase program. We have repurchased a total of one million
shares of our common stock under the program, which is the total number of
shares the Board of Directors authorized. In April 1999, our Board of Directors
authorized, subject to certain conditions and lender approval, a second stock
repurchase program that would allow us to repurchase up to 2.5 million
additional shares of our common stock. Purchases may be made depending on market
conditions, share price, and other factors. We did not repurchase any of our
common stock during the second quarter of 1999.
Year 2000 Readiness Disclosure
Many older computer programs refer to years only in terms of their final two
digits. Such programs may interpret the year 2000 to mean the year 1900 instead.
The problem affects not only computer software, but also computer hardware and
other systems containing processors and embedded chips. Business systems
affected by this problem may not be able to accurately process date related
information before, during or after January 1, 2000. This is commonly referred
to as the Year 2000 issue. Failures of our own business systems due to Year 2000
issues as well as those of our suppliers and business partners could materially
adversely affect our business. We are in the process of addressing these issues.
Our Year 2000 compliance program consists of:
o identification and assessment of critical computer programs, hardware and
other business equipment and systems,
o remediation and testing,
o assessment of the Year 2000 readiness of our critical suppliers, vendors
and business partners, and
o contingency planning.
Identification and Assessment
The first component of our Year 2000 compliance program is complete. We have
identified our critical computer programs, hardware, and other equipment to
determine which systems are compliant, or must be replaced or remediated.
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Remediation and Testing
Dealership Operations. We have finished remediating the program code and
underlying data, testing the remediated code modifications and have implemented
these changes into operation for our integrated car sales and loan servicing
system (CLASS System). We placed the modified program code into production in
April 1999 and have completed performing date testing on the modified code.
Non-Dealership Operations. Our non-dealership loan servicing operations
currently utilize several loan processing and collections programs provided
through third party service bureaus. Based upon certifications we have received
from the software vendors, and independent testing we have performed, we believe
that our loan processing and collections programs are Year 2000 compliant.
Our Cygnet dealer program utilizes one of the same loan processing and
collections programs used by our loan servicing operations. The service bureau
that provides the program has written a custom module for us and has stated the
custom module is Year 2000 compliant. In addition, we have performed independent
Year 2000 compliance testing on the Cygnet dealer program's custom module, and
believe it is year 2000 compliant.
The remediation and testing of the critical business systems used by our
dealership and non-dealership operations was completed during the second quarter
of 1999.
Assessment of Business Partners
We have also identified critical suppliers, vendors, and other business
partners and have taken steps to determine their Year 2000 readiness. These
steps include interviews, questionnaires, and other types of inquiries. Because
of the large number of business systems that our business partners use and their
varying levels of Year 2000 readiness, it is difficult to determine how any Year
2000 issues of our business partners will affect us. We are not currently aware
of any business relationships with third parties that we believe will likely
result in a significant disruption of our businesses. We believe that our
greatest risk is with our utility suppliers, banking and financial institution
partners, and suppliers of telecommunications services, all of which are
operating within the United States. Potential consequences if we, or our
business partners, are not Year 2000 compliant include:
o failure to operate from a lack of power,
o shortage of cash flow,
o disruption or errors in loan collection and processing efforts, and
o delays in receiving inventory, supplies, and services.
If any of these events occurred, the results could have a material adverse
impact on us and our operations.
Contingency Plans
We are also developing contingency plans to mitigate the risks that could
occur in the event of a Year 2000 business disruption. Contingency plans may
include:
o increasing inventory levels,
o securing additional financing,
o relocating operations to unaffected sites,
o vendor/supplier replacement,
o utilizing temporary manual or spreadsheet-based processes, or
o other prudent actions,
We are currently working on updating our disaster recovery plan and
formulating our Year 2000 contingency plans. We will continue to develop our
contingency plans throughout the rest of the year and expect to complete them by
December 31, 1999.
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Costs
We currently estimate that remediation and testing of our business systems
will cost between $2.4 million and $2.7 million. Most of these costs will be
expensed and funded by our operating line of credit. Costs incurred as of June
30, 1999 approximate $2.4 million, including approximately $231,000 of internal
payroll costs, substantially all of which have been charged to general and
administrative expense. Costs incurred in the six month period ended June 30,
1999 approximate $970,000. No such costs were incurred in the comparable period
in 1998. We believe costs associated with developing and implementing
contingency measures will not be material to our operating results. The
scheduled completion dates and costs associated with the various components of
our Year 2000 compliance program described above are estimates and are subject
to change.
Accounting Matters
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132) which became
effective for us January 1, 1999. SFAS No. 132 establishes standards for the
information that public enterprises report in annual financial statements. The
adoption of SFAS No. 132 did not have a material impact on us.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133) which becomes effective for us June 15,
2000. We believe the adoption of SFAS No. 133 will not have a material impact on
us.
ITEM 3.
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use instruments for trading purposes or to manage
interest rate risk. Our earnings are substantially affected by our net interest
income, which is the difference between the income earned on interest-bearing
assets and the interest paid on interest bearing notes payable. Increases in
market interest rates could have an adverse effect on profitability.
Our financial instruments consist primarily of fixed rate finance
receivables, residual interests in pools of fixed rate finance receivables,
short term variable rate revolving Notes Receivable, and variable and fixed rate
Notes Payable. Our finance receivables are classified as subprime loans and
generally bear interest at the lower of 29.9% or the maximum interest rate
allowed in states that impose interest rate limits. At June 30, 1999, the
scheduled maturities on our finance receivables range from one to 52 months with
a weighted average maturity of 31.3 months. The interest rates we charge our
customers on finance receivables has not changed as a result of fluctuations in
market interest rates, although we may increase the interest rates we charge in
the future if market interest rates increase. A large component of our debt at
June 30, 1999 is the Collateralized Note Payable (Class A certificates) issued
under our securitization program. Issuing debt through our securitization
program allows us to mitigate our interest rate risk by reducing the balance of
the variable revolving line of credit and replacing it with a lower fixed rate
note payable. We are subject to interest rate risk on fixed rate Notes Payable
to the extent that future interest rates are higher than the interest rates on
our existing Notes Payable.
We believe that our market risk information has not changed materially from
December 31, 1998.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
We sell our cars on an "as is" basis. We require all customers to
acknowledge in writing on the date of sale that we disclaim any obligation for
vehicle-related problems that subsequently occur. Although we believe that these
disclaimers are enforceable under applicable laws, there can be no assurance
that they will be upheld in every instance. Despite obtaining these disclaimers,
in the ordinary course of business, we receive complaints from customers
relating to vehicle condition problems as well as alleged violations of federal
and state consumer lending or other similar laws and regulations. Most of these
complaints are made directly to us or to various consumer protection
organizations and are subsequently resolved. However, customers occasionally
name us as a defendant in civil suits filed in state, local, or small claims
courts. Additionally, in the ordinary course of business, we are a defendant in
various other types of legal proceedings. Although we cannot determine at this
time the amount of the ultimate exposure from these lawsuits, if any, we, based
on the advice of counsel, do not expect the final outcome to have a material
adverse effect on our financial position.
Item 2. Changes in Securities and Use of Proceeds.
(a) None
(b) None
(c) None
(d) Not Applicable
Item 3. Defaults Upon Senior Securities.
Under the terms of the revolving facility, we are required to maintain an
interest coverage ratio that we failed to satisfy during the three months ended
March 31, 1999. We failed to meet this covenant primarily due to the reduction
in earnings we recognized as a result of the change in our securitization
structure. GE Capital waived the covenant violation as of March 31, 1999.
Subsequently, the revolving facility was amended to take into account the change
in structure of our securitization transactions and as a result of this change
there was no default as of June 30, 1999.
Item 4. Submission of Matters to a Vote of Security Holders.
Set forth below is information concerning the sole matter submitted to a
vote at Ugly Duckling's Annual Meeting of Stockholders on June 2, 1999:
Election of Directors. Each of the following persons was elected as a
director of Ugly Duckling to hold office until the 2000 Annual Meeting of
Stockholders, until his successor is duly elected and qualified, or until
retirement, resignation or removal: Ernest C. Garcia II, Christopher D.
Jennings, John N. MacDonough, Gregory B. Sullivan, and Frank P. Willey. Each of
these persons received 13,919,162 votes "for" reelection and 292,896 votes
"withheld."
Item 5. Other Information.
On July 26, 1999, Gregory B. Sullivan, President, Chief Operating Officer
and a director of Ugly Duckling, was appointed Chief Executive Officer by our
Board of Directors. Mr. Sullivan replaced Ernest C. Garcia II, who remains as
Chairman of the Board and our largest stockholder with over 32% of Ugly
Duckling's stock.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.1-- Amendment No. 4 to the Amended and Restated Motor Vehicle
Installment Contract Loan and Security Agreement between General
Electric Capital Corporation and Registrant dated June 30, 1999
Exhibit 11 -- Statement regarding computation of per share earnings (see
note 5 of Notes to condensed consolidated Financial Statements)
Exhibit 27 -- Financial Data Schedule
Exhibit 99 -- Risk Factors
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(b) Reports on Form 8-K.
During the second quarter of 1999, Ugly Duckling did not file any reports
on Form 8-K. In addition, after the second quarter of 1999, Ugly Duckling has
not filed any reports on Form 8-K.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
UGLY DUCKLING CORPORATION
/s/ STEVEN T. DARAK
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: August 13, 1999
<PAGE>
[LOGO]
5,666,190 SHARES OF COMMON STOCK
AND
666,190 COMMON STOCK PURCHASE WARRANTS
Ugly Duckling Corporation operates a chain of used car dealerships. We also
service used car sales contracts that we own or service for third parties.
We acquired servicing and other rights in the bankruptcy proceedings of First
Merchants Acceptance Corporation.
This prospectus relates to the sale from time to time:
o By First Merchants of warrants to purchase up to 325,000 shares of our
common stock at $20.00 per share through April 1, 2001;
o By certain other selling securityholders who were originally lenders to
First Merchants of warrants to purchase up to 341,190 shares of our
common stock at $20.00 per share through February 20, 2000;
o By First Merchants or the other selling securityholders of up to 666,190
shares of our common stock issuable upon exercise of the warrants; and
o By Ugly Duckling of up to 5,000,000 shares of our common stock to First
Merchants or its creditors or equityholders in exchange for cash
distributions that would otherwise be paid to First Merchants.
Except for the proceeds from the exercise of the warrants, we will not receive
any of the proceeds from the sale of the warrants or common stock acquired on
exercise of the warrants by First Merchants or the other selling
securityholders.
Our common stock is traded on the Nasdaq National Market ("Nasdaq") under the
symbol "UGLY." On July 6, 1999, the last reported price of our common stock was
$7.25 per share.
First Merchants will be deemed to be an underwriter of the warrants that they
hold, the related warrant shares, and the shares offered by Ugly Duckling in
this prospectus, to the extent that First Merchants participates, directly or
indirectly, in the distribution of such securities. See "Plan of Distribution."
Investing in our warrants and common stock involves certain risks. See "Risk
Factors" beginning on page 5.
----------------
Neither the Securities and Exchange Commission nor any state securities
commission has approved or disapproved these securities, or determined if this
prospectus is truthful or complete. Any representation to the contrary is a
criminal offense.
----------------
The date of this Prospectus is August 4, 1999.
1
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
<S> <C>
Prospectus Summary........................................................................................... 3
Risk Factors................................................................................................. 5
Forward Looking Statements................................................................................... 11
Use of Proceeds.............................................................................................. 11
Dividend Policy.............................................................................................. 12
Capitalization............................................................................................... 13
Selected Consolidated Financial and Operating Data........................................................... 14
Management's Discussion and Analysis of Financial Condition and Results of Operations........................ 15
Business..................................................................................................... 41
Management................................................................................................... 49
Description of Capital Stock................................................................................. 63
Selling Security holders..................................................................................... 68
Plan of Distribution......................................................................................... 69
Legal Matters................................................................................................ 71
Experts...................................................................................................... 71
Where You Can Find More Information.......................................................................... 71
Index to Consolidated Financial Statements and to Condensed Consolidated Financial Statements................ F-1
</TABLE>
2
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PROSPECTUS SUMMARY
This summary highlights information contained elsewhere in this prospectus.
Because it is a summary, it does not contain all of the information that you
should consider before investing in our common stock or warrants. You should
read the entire prospectus carefully, including the "Risk Factors" section and
the consolidated financial statements and the notes to those statements.
Ugly Duckling
We sell used cars through 59 wholly-owned used car dealerships in Arizona,
California, Georgia, Texas, Florida, Nevada, and New Mexico and finance the
sales through retail installment contracts that we service. We target our
products and services to the sub-prime segment of the automobile financing
industry, which focuses on selling and financing the sale of used cars to
persons who have limited credit histories, low incomes, or past credit problems.
The competition for our dealerships are the numerous small independent used car
dealerships, also known as "buy here-pay here" dealers, that sell and finance
used cars to sub-prime borrowers. We estimate that there are over 63,000
independent used car dealers in the United States, a substantial portion of
which are buy here-pay here dealers. We distinguish our dealership operations
from those of typical buy here-pay here dealers by our:
o multiple locations,
o upgraded facilities,
o large inventories of used automobiles,
o centralized purchasing on a regional basis,
o value-added marketing programs, and
o dedication to customer service.
Through our Cygnet dealer program, we also purchase and service contracts
originated by third party dealers, and provide secured, operating lines of
credit to participating dealers. In addition, in the past we entered into
several large servicing or bulk purchase transactions involving third party
dealer contract portfolios.
We service loans that we originate at our dealerships out of facilities in
Phoenix, Arizona, Dallas, Texas and Tampa, Florida. Our non-dealership
operations currently maintain servicing facilities in Aurora, Colorado, and
Plano, Texas.
Prior to February, 1998, we purchased automobile sales contracts from third
party dealers through a branch office network. We operated 83 branch offices at
December 31, 1997. We closed our branch office network in the first quarter of
1998.
Our principal executive offices are located at 2525 East Camelback Road,
Suite 500, Phoenix, Arizona 85016. The phone number of our executive offices is
602-852-6600.
We conducted a series of transactions with First Merchants Acceptance
Corporation.
First Merchants Acceptance Corporation was in the business of purchasing and
securitizing loans made primarily to sub-prime borrowers by various third party
used car dealers. FMAC filed for reorganization under Title 11 of the United
States Code in July 1997. In connection with FMAC's bankruptcy transactions, we
purchased FMAC's senior bank debt at a discount, and issued warrants to members
of the bank group previously holding such debt. 341,190 of those warrants are
being offered in this prospectus. We then sold the contracts which secured the
debt to a third party purchaser and recorded a gain from this transaction. We
obtained the right to service those contracts and the contracts in all but one
of FMAC's securitized pools and acquired FMAC's servicing platform. We issued
325,000 of the warrants that are being offered in this prospectus to FMAC in
that transaction. We also acquired an interest in the contracts we service. We
have the option, if we can satisfy certain conditions, to increase our interest
3
<PAGE>
in the distributions from the contracts that we service by issuing the shares of
our common stock being offered in this prospectus in exchange for the increased
distributions.
The Offering
FMAC Warrants offered 325,000 warrants offered by FMAC, each to
purchase one share of common stock at $20.00 per
share, at any time on or prior to April 1, 2001.
We may redeem the warrants for $.10 per warrant
if our common stock closes at or above $28.50
per share during any ten consecutive trading
days.
Bank Group Warrants
offered.............. 341,190 warrants offered by the selling
securityholders, each to purchase one share of
common stock at $20.00 per share, at any time on
or prior to February 20, 2000. We may redeem the
warrants for $.10 per warrant if our common
stock closes at or above $27.00 per share during
any five consecutive trading days.
Common Stock offered Up to 5,666,190 shares, including 5,000,000
shares that we may offer and 666,190 shares
issuable upon exercise of the warrants offered
in this prospectus.
Common Stock
outstanding(1)....... 14,941,253
Use of Proceeds...... We may issue up to 5,000,000 shares of our
common stock in lieu of making cash
distributions otherwise payable to FMAC from
contracts that we obtained the right to service
in the FMAC proceedings. Distributions that we
choose to retain will be used for general
corporate purposes. The FMAC warrants, bank
group warrants and related warrant shares may be
offered from time to time in the future by FMAC
or the selling securityholders. Except for
proceeds from the exercise of the FMAC warrants
or bank group warrants, we will not receive any
of the proceeds from the sale of the warrants
and related warrant shares offered in this
prospectus.
Nasdaq Symbol........ "UGLY"
- ----------
(1) As of May 31, 1999. Does not include 3,699,028 shares of common stock
held in treasury and 3,506,775 shares of common stock issuable upon
exercise of outstanding options and warrants.
4
<PAGE>
<TABLE>
<CAPTION>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(In thousands, except per share data)
Three Months Ended
March 31, Years Ended December 31,
--------- ------------------------
1999 1998 1998 1997 1996
---- ---- ---- ---- ----
Statement of Operations Data:
<S> <C> <C> <C> <C> <C>
Total Revenues................. $130,118 $ 87,704 $ 366,170 $ 170,083 $ 68,827
Sales of Used Cars........... 106,443 72,973 287,618 123,814 53,768
Interest Income.............. 14,003 6,205 27,828 18,736 8,597
Gain on Sale of Loans........ -- 4,614 12,093 14,852 3,925
Servicing and Other Income... 9,672 3,912 38,631 12,681 2,537
Cost of Used Cars Sold......... 60,097 39,731 167,014 72,358 31,879
Provision for Credit Losses.... 28,561 15,362 67,634 23,045 9,657
Income before Operating Expenses 41,460 32,611 131,522 74,680 27,291
Total Operating Expenses....... 37,104 24,880 118,702 55,741 18,085
Income Before Interest Expense. 4,356 7,731 12,820 18,939 9,206
Interest Expense............... 3,656 1,502 6,904 2,774 2,429
Earnings from Continuing 700 3,729 3,520 9,528 6,677
Operations.....................
Loss from Discontinued Operations -- (5,595) (9,223) (83) (811)
Net Earnings (Loss) ........... $ 420 $ (1,866) $ (5,703) $ 9,445 $ 5,866
Diluted Earnings (Loss) per Share $ 0.03 $ (0.10) $ (0.31) $ 0.52 $ 0.60
Shares used in Computation..... 15,785 19,093 18,405 18,234 8,298
March 31, December 31,
-------------------- -----------------------------------
1999 1998 1998 1997 1996
---- ---- ---- ---- ----
Balance Sheet Data:
Cash and Cash Equivalents...........$ 4,387 $ 514 $ 2,751 $ 3,537 $ 18,455
Finance Receivables, Net............ 237,928 91,213 163,209 90,573 51,063
Total Assets........................ 406,616 288,041 345,975 276,426 118,083
Notes Payable....................... 78,433 63,304 55,093 64,821 12,904
Collateralized Notes Payable........ 93,471 -- 62,201 -- --
Subordinated Notes Payable.......... 40,815 27,000 43,741 12,000 14,000
Total Debt.......................... 212,719 90,304 161,035 76,821 26,904
Total Stockholders' Equity (1)....$ 157,890 $ 181,010 $ 162,767 $181,774 $ 82,319
- ----------
<FN>
(1) Excludes 3,506,775 shares of common stock issuable upon exercise of
outstanding stock options and warrants with exercise prices ranging from
$0.86 to $20.00.
</FN>
</TABLE>
RISK FACTORS
Investment in our warrants and common stock involves certain risks. In
addition to the other information included elsewhere in this prospectus, you
should carefully consider the following factors before purchasing the securities
offered in this prospectus.
Future losses could impair our ability to raise capital or borrow money, as
well as affect our stock price.
Although we recorded earnings of $420,000 in the first quarter of 1999, we
incurred a net loss of $5.7 million in 1998. We cannot assure you that we will
be profitable in future periods. Losses in subsequent periods could impair our
ability to raise additional capital or borrow money as needed, and could
adversely affect our stock price. The net loss in 1998 was due in large part to:
o a charge of approximately $9.1 million ($5.6 million, net of income
taxes) to discontinued operations in the first quarter of 1998 for the
closure of our branch office network;
5
<PAGE>
o a charge of approximately $6.0 million ($3.6 million, net of income
taxes) to discontinued operations during the third quarter of 1998 due
primarily to higher than anticipated loan losses and servicing expenses
in connection with our branch office loan portfolio;
o a charge of $2.0 million ($1.2 million, net of income taxes) during the
third quarter of 1998 to write off costs associated with our attempt to
spin off Cygnet Financial Corporation through a rights offering to our
stockholders; and
o a change in the fourth quarter of 1998 in the way we structure
securitization transactions for accounting purposes.
We may not be able to continue to obtain the financing we need to fund our
operations.
We have borrowed, and will continue to borrow, substantial amounts to fund
our operations. Our operations require large amounts of capital. If we cannot
obtain the financing we need on a timely basis and on favorable terms, our
business will be adversely affected. We currently obtain our financing through
three primary sources:
o a revolving credit facility with General Electric Capital Corporation;
o securitization transactions; and
o loans from other sources.
Revolving Credit Facility with GE Capital. Our revolving facility with GE
Capital is our primary source of operating capital. We have pledged
substantially all of our assets to GE Capital to secure the borrowings we make
under this facility. Although this facility has a maximum commitment of $125
million, the amount we can borrow is limited by the amount of certain types of
assets that we own. In addition, we cannot borrow approximately $8 million of
the capacity while our guarantee to the FMAC contract purchaser is in effect. As
of May 31, 1999, we owed approximately $53.1 million under the revolving
facility, and had the ability to borrow an additional $31.9 million. The
revolving facility expires in June 2000. Even if we continue to satisfy the
terms and conditions of the revolving facility, we may not be able to extend its
term beyond the current expiration date.
Securitization Transactions. We can restore capacity under the GE facility
from time to time by securitizing portfolios of finance receivables. Our ability
to successfully complete securitizations in the future may be affected by
several factors, including:
o the condition of securities markets generally;
o conditions in the asset-backed securities markets specifically;
o the credit quality of our loan contract portfolio; and
o the performance of our servicing operations.
Our securitization subsidiaries are wholly-owned "bankruptcy remote"
entities. Their assets, including the line items "Residuals in Finance
Receivables Sold" and "Investments Held in Trust," within Dealership Operations
which are components of Finance Receivables on our balance sheet, are not
available to satisfy the claims of our creditors.
On November 17, 1998, we announced that we were changing the way that we
structure transactions under our securitization program. In the past, we
structured these transactions as sales for accounting purposes. In the fourth
quarter of 1998, however, we began to structure securitizations for accounting
purposes to retain the financed receivables and related debt on our balance
sheet and recognize the income over the life of the contracts. In the past, gain
on sales of loans in securitization transactions has been material to our
results of operation. This change has caused and will continue to cause a
material adverse effect on our reported earnings until the net interest earnings
from new contracts added to our balance sheet approximates those net revenues
that we historically recognized on our securitization sales.
Contractual Restrictions. The revolving facility, the securitization
program, and our other credit facilities contain various restrictive covenants.
Under these credit facilities, we must also meet certain financial tests. As of
March 31, 1999, we did not satisfy the interest coverage ratio under the GE
facility. GE Capital waived the default for this period. We believe that we are
in compliance with the other terms and conditions of the revolving facility and
our other credit facilities. Failure to satisfy the covenants in our credit
facilities and/or our securitization program, could preclude us from further
borrowing under the defaulted facility and could prevent us from securing
alternate sources of funds necessary to operate our business.
6
<PAGE>
We have a high risk of credit losses because of the poor creditworthiness of our
borrowers.
Substantially all of the sales financing that we extend and the contracts
that we service are with sub-prime borrowers. Sub-prime borrowers generally
cannot obtain credit from traditional financial institutions, such as banks,
savings and loans, credit unions, or captive finance companies owned by
automobile manufacturers, because of their poor credit histories and/or low
incomes. Loans to sub-prime borrowers are difficult to collect and are subject
to a high risk of loss. We have established an allowance for credit losses to
cover our anticipated credit losses. However, we cannot assure you that we have
adequately provided for such credit risks or that we will continue to do so in
the future. A significant variation in the timing of or increase in credit
losses in our portfolio would have a material adverse effect on our net
earnings.
We also operate our Cygnet dealer program, under which we provide third
party dealers who finance the sale of used cars to sub-prime borrowers with
financing primarily secured by those dealers' retail installment contract
portfolios and/or inventory. While we require third party dealers to meet
certain minimum net worth and operating history criteria before we loan money to
them, these dealers may not otherwise be able to obtain debt financing from
traditional lending institutions. We have established an allowance for credit
losses to cover our anticipated credit losses. However, we cannot assure you
that we have adequately provided for such credit risks or that we will continue
to do so in the future. Like our other financing activities, these loans subject
us to a high risk of credit losses that could have a material adverse effect on
our net earnings and ability to meet our other financing obligations.
We are affected by various industry considerations and legal contingencies.
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation, and other events. Companies in the used vehicle
sales and financing market have also been named as defendants in an increasing
number of class action lawsuits brought by customers claiming violations of
various federal and state consumer credit and similar laws and regulations. In
addition, certain of these companies have filed for bankruptcy protection. These
events:
o have lowered the value of securities of sub-prime automobile finance
companies;
o have made it more difficult for sub-prime lenders to borrow money; and
o could cause more restrictive regulation of this industry.
Compliance with additional regulatory requirements may also increase our
operating expenses and reduce our profitability.
Interest rates affect our profitability.
A substantial portion of our financing income results from the difference
between the rate of interest we pay on the funds we borrow and the rate of
interest we earn on the contracts in our portfolio. While we earn interest on
the contracts we own at a fixed rate, we pay interest on our borrowings under
our GE facility at a floating rate. When interest rates increase, our interest
expense increases and our net interest margins decrease. Increases in our
interest expense that we cannot offset by increases in interest income will
lower our profitability.
Laws that limit the interest rates we can charge can adversely affect our
profitability.
Historically, a significant portion of the contracts we service were
originated in states that did not impose limits on the interest rate that a
lender may charge. However, we have expanded, and will continue to expand, into
states that impose interest rate limitations. When a state limits the amount of
interest we can charge on our installment sales contracts, we may not be able to
offset any increased interest expense caused by rising interest rates or greater
levels of borrowings under our credit facilities. Therefore, these interest rate
limitations can adversely affect our profitability.
7
<PAGE>
Government regulation may limit our ability to recover and enforce receivables
or to repossess and sell collateral.
We are subject to ongoing regulation, supervision, and licensing under
various federal, state, and local statutes, ordinances, and regulations. If we
do not comply with these laws, we could be fined or certain of our operations
could be interrupted or shut down. Failure to comply could, therefore, have a
material adverse effect on our operations. Among other things, these laws:
o require that we obtain and maintain certain licenses and
qualifications;
o limit or prescribe terms of the contracts that we originate and/or
purchase;
o require specified disclosures to customers;
o limit our right to repossess and sell collateral; and
o prohibit us from discriminating against certain customers.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. We may not,
however, be able to remain in compliance with such laws. In addition, the
adoption of additional statutes and regulations, changes in the interpretation
of existing statutes and regulations, or our entry into jurisdictions with more
stringent regulatory requirements could also have a material adverse effect on
our operations.
We could experience problems with the recent conversion of our loan servicing
and data processing operations to a single computer system.
We recently converted our chain of dealerships and related loan servicing
data processing operations to a single computer system. These conversions can
cause various problems that can affect our servicing operations and result in
increases in contract delinquencies and charge-offs and decreases in our
servicing income. Failure to successfully complete our conversions could
materially affect our business and profitability.
Our computer systems may be subject to a Year 2000 date failure.
We could be affected by failures of our business systems, as well as those
of our suppliers and vendors, due to Year 2000 issues. Any failure could result
in a disruption of our collection efforts, which would impair our operations. We
have evaluated and remediated our mission critical computer systems to determine
our exposure to Year 2000 issues. We have made modifications to our computer
systems that we believe will allow them to properly process transactions
relating to the Year 2000 and beyond. We estimate that we will spend between
$2.2 million to $2.7 million for Year 2000 evaluation, remediation, testing, and
replacement. We have spent approximately $2.2 million through May 31, 1999. We
can also be adversely affected by Year 2000 issues in the business systems of
our suppliers, vendors, and business partners, such as utility suppliers,
banking partners and telecommunication service providers. We can also be
adversely affected if Year 2000 issues result in business disruptions or
failures that impact our customers' ability to make their loan payments. Failure
to fully address and resolve these Year 2000 issues could have a material
adverse effect on our operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Year 2000 Readiness Disclosure."
We could have a system failure if our current contingency plan is not adequate.
We depend on our loan servicing and collection facilities and on
long-distance and local telecommunications access to transmit and process
information among our various facilities. We use a standard program to prepare
and store off-site backup tapes of our main system applications and data files
on a routine basis. However, we believe that we need to revise our current
contingency plan because of our recent system conversions and significant
growth. Although we intend to update our contingency plan during 1999, there
could be a failure in the interim. In addition, the plan as revised may not
prevent a systems failure or allow us to timely resolve any systems failure.
Also, a natural disaster, calamity, or other significant event that causes
long-term damage to any of these facilities or that interrupts our
telecommunications networks could have a material adverse effect on our
operations.
8
<PAGE>
We have certain risks relating to the FMAC transaction.
We have entered into several transactions in the bankruptcy proceedings of
FMAC. We purchased 78% of FMAC's senior bank debt at a 10% discount. We agreed
to pay the selling banks additional consideration up to the amount of this 10%
discount (or approximately $7.6 million) if FMAC makes cash payments or issues
notes at market rates to its unsecured creditors and equity holders in excess of
10% of their allowed claims against FMAC. FMAC may make future cash payments to
its unsecured creditors and equity holders from recoveries on the contracts
which originally secured the senior bank debt and from certain residual
interests in FMAC's securitized loan pools, after FMAC pays certain other
amounts ("Excess Collections"). Under FMAC's plan of reorganization, we will
split these Excess Collections with FMAC.
If we satisfy certain requirements, we may be able to issue shares of our
common stock in exchange for all or part of FMAC's share of the Excess
Collections. This would reduce the cash distributions that could be made to
FMAC's unsecured creditors and/or equity holders. We would then be entitled to
receive FMAC's share of the Excess Collections up to the price of the shares we
issue. The shares would be priced at 98% of the average closing price of our
common stock for the 10 trading days prior to the date of issuance. This market
price must be at least $8.00 per share or we cannot exercise this option.
Even if we are able to issue common stock for this purpose:
o the number of shares that we issue may not be sufficient to prevent
FMAC from paying unsecured creditors and equity holders more than 10%
of their claims against FMAC. Should this happen, we would be required
to pay the selling banks additional consideration (up to approximately
$7.6 million) for our purchase of 78% of FMAC's senior bank debt; and
o the issuance of shares would cause dilution to our common stock.
We also have other risks in the FMAC bankruptcy case:
o we sold the contracts securing the bank claims at a profit to a third
party purchaser (the "Contract Purchaser"). We guaranteed the Contract
Purchaser a specified return on the contracts with a current maximum of
$8 million. Although we obtained a related guarantee from FMAC secured
by certain assets, there is no assurance that the FMAC guarantee will
cover all of our obligations under our guarantee to the Contract
Purchaser;
o we have made debtor-in-possession loans to FMAC, secured by certain
assets. We have continuing obligations under our debtor-in-possession
credit facility. We assert that FMAC is currently in default on the DIP
Facility. We have negotiated a settlement with them that will cure the
asserted default and increase our funding obligation by $2.0 million, in
exchange for other concessions; and
o we entered into various agreements to service the contracts in the
securitized pools of FMAC and the contracts sold to the Contract
Purchaser. If we lose our right to service these contracts, our 17 1/2%
share of the Excess Collections can be reduced or eliminated.
Each of the FMAC risks described in this section could have a material
adverse effect on our operations.
We may make acquisitions that are unsuccessful or strain or divert our
resources.
In 1997, we completed three significant acquisitions (Seminole, E-Z Plan,
and Kars). We intend to consider additional acquisitions, alliances, and
transactions involving other companies that could complement our existing
business. We may not, however, be able to identify suitable acquisition parties,
joint venture candidates, or transaction counterparties. Additionally, even if
we can identify suitable parties, we may not be able to consummate these
transactions on terms that we find favorable.
9
<PAGE>
Furthermore, we may not be able to successfully integrate any businesses
that we acquire into our existing operations. If we cannot successfully
integrate acquisitions, our operating expenses may increase in the short-term.
This increase would affect our net earnings, which could adversely affect the
value of our outstanding securities. Moreover, these types of transactions may
result in potentially dilutive issuances of equity securities, the incurrence of
additional debt, and amortization of expenses related to goodwill and intangible
assets, all of which could adversely affect our profitability. In addition to
the risks already mentioned, these transactions involve numerous other risks,
including the diversion of management attention from other business concerns,
entry into markets in which we have had no or only limited experience, and the
potential loss of key employees of acquired companies. Occurrence of any of
these risks could have a material adverse effect on us.
Increased competition could adversely affect our operations and profitability.
Although a large number of smaller companies have historically operated in
the used car sales industry, this industry has attracted significant attention
from a number of large companies. These large companies include AutoNation,
U.S.A., CarMax, and Driver's Mart. These companies have either entered the used
car sales business or announced plans to develop large used car sales
operations. Many franchised new car dealerships have also increased their focus
on the used car market. We believe that these companies are attracted by the
relatively high gross margins that can be achieved in this market and the
industry's lack of consolidation. Many of these companies and franchised dealers
have significantly greater financial, marketing, and other resources than we do.
Increased competition in our dealership operations could result in increased
wholesale costs for used cars, decreased retail sales prices, and lower margins.
Like the sale of used cars, the business of purchasing and servicing
contracts originated from the sale of used cars to sub-prime borrowers is highly
fragmented and very competitive. In recent years, several consumer finance
companies have completed public offerings. Through these public offerings, these
companies have been able to raise the capital necessary to fund expansion and
support increased purchases of contracts. These companies have increased the
competition for the purchase of contracts, in many cases purchasing contracts at
higher prices than we would be willing to pay.
There are numerous financial services companies serving, or capable of
serving, our market. These companies include traditional financial institutions
such as banks, savings and loans, credit unions, and captive finance companies
owned by automobile manufacturers, as well as other non-traditional consumer
finance companies, many of which have significantly greater financial and other
resources than our own. Increased competition may cause downward pressure on the
interest rates that we charge. This pressure could affect the interest rates we
charge on contracts originated by our dealerships or cause us to reduce or
eliminate the acquisition discount on the contracts we purchase from third party
dealers. Either change could have a material adverse effect on the value of our
securities.
The success of our operations depends on certain key personnel.
We believe that our ability to successfully implement our business strategy
and to operate profitably depends on the continued employment of our senior
management team. The unexpected loss of the services of any of our key
management personnel or our inability to attract new management when necessary
could have a material adverse effect on our operations. Other than Mr. Sullivan,
our President and Chief Executive Officer, we do not currently maintain any key
person life insurance on any of our executive officers.
We may be required to issue stock in the future that will dilute the value of
our existing stock.
Issuance of any or all of the following securities may dilute the value of
the securities that our existing stockholders now hold:
o we have granted warrants to purchase a total of approximately 1.6
million shares of our common stock to various parties with exercise
prices ranging from $6.75 to $20.00 per share;
o we may be required to issue additional warrants in the future in
connection with future transactions;
o we may issue common stock under our various stock option plans, and
o we may issue common stock in the FMAC transaction in exchange for
FMAC's portion of the Excess Collections.
10
<PAGE>
The voting power of our principal stockholder may limit your voting rights.
Mr. Ernest C. Garcia II, our Chairman and principal stockholder, or his
affiliates held approximately 32% of our outstanding common stock as of May 31,
1999. As a result, Mr. Garcia has a significant influence upon our activities as
well as on all matters requiring approval of our stockholders. These matters
include electing or removing members of our board of directors, engaging in
transactions with affiliated entities, causing or restricting our sale or
merger, and changing our dividend policy. The interests of Mr. Garcia may
conflict with the interests of our other stockholders.
There is a potential anti-takeover or dilutive effect if we issue preferred
stock.
Our Certificate of Incorporation authorizes us to issue "blank check"
preferred stock. Our Board of Directors may fix or change from time to time the
designation, number, voting powers, preferences, and rights of this stock. Such
issuances could make it more difficult for a third party to acquire us by
reducing the voting power or other rights of the holders of our common stock.
Preferred stock can also reduce the market value of the common stock.
FORWARD LOOKING STATEMENTS
This prospectus contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The words "believe," "expect," "anticipate," "estimate,"
"project," and similar expressions identify forward looking statements. These
statements may include, but are not limited to, projections of revenues, income
or loss, liquidity, estimates of capital expenditures, plans for future
operations, products or services, Year 2000 readiness, and financing needs or
plans, as well as assumptions relating to these matters. Forward looking
statements speak only as of the date the statement was made. They are inherently
subject to risks and uncertainties, some of which we cannot predict or quantify.
Future events and actual results could differ materially from the forward
looking statements. When considering each forward looking statement, you should
keep in mind the risk factors and cautionary statements found throughout this
prospectus and specifically those found above. We are not obligated to publicly
update or revise any forward looking statements, whether as a result of new
information, future events, or for any other reason.
USE OF PROCEEDS
We may elect to issue up to 5,000,000 shares of common stock in lieu of
making distributions in cash to FMAC from the Excess Collections on the
contracts sold to a third party purchaser in the FMAC transaction and from the
interests that FMAC retained in its securitization transactions. The shares
would be priced at 98% of the closing price of our common stock for the 10
trading days prior to the date of issuance (the "Share Value"). Our ability to
issue these shares is subject to certain conditions. If we choose and are able
to issue these shares, we would retain the cash distributions otherwise payable
to FMAC from the contracts and interests up to the Share Value. These proceeds
will be used for general corporate purposes. See "Business - Non-Dealership
Operations - Bulk Purchasing and Loan Servicing Operations" and "Risk Factors -
We have certain risks relating to the FMAC transaction" for a more detailed
description of our transactions with FMAC.
The FMAC warrants, the bank group warrants and related warrant shares may be
offered from time to time in the future by FMAC and the selling securityholders.
Except for proceeds from the exercise of such warrants, if any, we will not
receive any of the proceeds from the sale of the warrants or related warrant
shares offered in this prospectus. See "Plan of Distribution." Payments made to
us upon the exercise of the warrants will be used for general corporate
purposes.
11
<PAGE>
PRICE RANGE OF COMMON STOCK
Our common stock trades on the Nasdaq Stock Market under the symbol "UGLY."
The high and low closing sales prices of the common stock, as reported by Nasdaq
for the two most recent fiscal years and the first quarter of 1999 are reported
below.
Market Price
------------
High Low
---- ---
Fiscal Year 1997:
First Quarter...........................................$... 25.75 $ 16.25
Second Quarter..........................................$... 18.06 $ 13.13
Third Quarter...........................................$... 17.00 $ 12.50
Fourth Quarter..........................................$... 16.75 $ 7.69
Fiscal Year 1998:
First Quarter...........................................$... 10.88 $ 6.31
Second Quarter..........................................$... 12.69 $ 8.00
Third Quarter...........................................$... 9.13 $ 4.63
Fourth Quarter..........................................$... 6.00 $ 4.25
Fiscal Year 1999:
First Quarter...........................................$... 6.50 $ 4.25
On July 6, 1999, the last reported sale price of the common stock on Nasdaq
was $7.25 per share. On July 6, 1999 there were approximately 89 record owners
of our common stock. We estimate that, as of such date, there were approximately
2,000 beneficial owners of our common stock.
DIVIDEND POLICY
We have never paid dividends on our common stock and do not anticipate doing
so in the foreseeable future. It is our current policy to retain any earnings to
finance the operation and expansion of our business or to repurchase our common
stock pursuant to an existing stock buy back program. In addition, the terms of
our primary revolving credit facility prevent us from declaring or paying
dividends in excess of 15.0% of each year's net earnings available for
distribution. Our future financings may also include such restrictions. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Financing Resources --
Revolving Facility."
12
<PAGE>
CAPITALIZATION
The following table sets forth our actual capitalization as of March 31,
1999, and our pro forma capitalization giving effect to the issuance of the
5,000,000 shares offered in this prospectus at an assumed issuance price of
$8.00 per share (the floor price) plus the issuance of 666,190 shares of common
stock upon exercise of the FMAC warrants and bank group warrants being offered
in this prospectus at the stated exercise price of $20.00 per share, and the
initial application of such proceeds. The table should be read in conjunction
with our Consolidated Financial Statements and the related notes included
elsewhere in this prospectus.
March 31, 1999
--------------
Actual Pro Forma
------ ---------
(In Thousands)
Debt:
Notes Payable................................ $ 171,904 $ 171,904
Subordinated Notes Payable................... 40,815 40,815
------ ------
Total Debt........................... 212,719 212,719
------- -------
Stockholders' Equity:
Common Stock................................. 19 25
Additional Paid in Capital................... 173,819 226,737
Retained Earnings............................ 3,869 3,869
Treasury Stock............................... (19,817) (19,817)
------- -------
Total Stockholders' Equity(1)........ 157,890 210,814
-- ------- -------
Total Capitalization............ $ 370,609 $ 423,533
========= =========
- ----------
(1) Excludes (i) 1,128,732 shares of common stock issuable upon exercise of
stock options outstanding at May 31, 1999 under our Long-Term Incentive Plan
with a weighted average price of $6.32 per share; (ii) 800,000 shares of
common stock issuable upon exercise of stock options outstanding at May 31,
1999 under our 1998 Executive Incentive Plan with a weighted average price
of $7.24 per share; (iii) 22,220 shares of common stock issuable upon
exercise of stock options under our Directors Stock Option Plan with a
weighted average price of $6.75; (iv) 291,023 shares of common stock
issuable upon exercise of warrants issued in connection with our initial
public offering of common stock with a weighted average exercise price of
$8.33 per share; (v) 325,000 shares of common stock issuable upon exercise
of warrants issued to FMAC which have an exercise price of $20.00 per share;
(vi) 50,000 shares of common stock issuable upon exercise of warrants issued
in connection with the bankruptcy of Reliance Acceptance Group which have an
exercise price of $12.50 per share; (vii) 500,000 shares of common stock
issuable upon exercise of warrants issued in connection with the sale of
subordinated notes payable which have an exercise price of $10.00 per share;
and (viii) 389,800 shares of common stock issuable upon exercise of warrants
issued in connection with our purchase of FMAC's senior bank debt which have
an exercise price of $20.00 per share.
13
<PAGE>
SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share and operating data)
The following table sets forth selected historical consolidated financial
data for Ugly Duckling for each of the years in the five-year period ended
December 31, 1998, and for the three month periods ending March 31, 1999 and
1998. The selected annual historical consolidated financial data is derived from
our Consolidated Financial Statements audited by KPMG LLP, independent auditors.
Information for the three month periods ended March 31, 1999 and 1998 is derived
from unaudited interim condensed consolidated financial statements which
reflect, in our opinion, all adjustments, which include only normal recurring
adjustments, necessary for a fair presentation of the data for such periods. For
additional information, see our Consolidated Financial Statements included
elsewhere in this prospectus. The following table should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
Three Months Ended
March 31, Years Ended December 31,
--------- ------------------------
1999 1998 1998 1997 1996 1995 1994
---- ---- ---- ---- ---- ---- ----
(unaudited) (unaudited)
Statement of Operations
Data:
<S> <C> <C> <C> <C> <C> <C> <C>
Sales of Used Cars......... $106,443 $ 72,973 $287,618 $123,814 $ 53,768 $ 47,824 $ 27,768
Less:
Cost of Used Cars Sold... 60,097 39,731 167,014 72,358 31,879 27,964 12,577
Provision for Credit
Losses................ 28,561 15,362 67,634 23,045 9,657 8,359 8,140
------ ------ ------ ------ ----- ----- -----
17,785 17,880 52,970 28,411 12,232 11,501 7,051
------ ------ ------ ------ ------ ------ -----
Other Income:
Interest Income............ 14,003 6,205 27,828 18,736 8,597 10,071 5,449
Gain on Sale of Loans...... -- 4,614 12,093 14,852 3,925 -- --
Servicing and Other Income. 9,672 3,912 38,631 12,681 2,537 308 556
----- ----- ------ ------ ----- --- ---
23,675 14,731 78,552 46,269 15,059 10,379 6,005
------ ------ ------ ------ ------ ------ -----
Income before Operating
Expenses................. 41,460 32,611 131,522 74,680 27,291 21,880 13,056
Operating Expenses:
Selling and Marketing...... 6,416 4,921 20,565 10,538 3,585 3,856 2,402
General and Administrative. 28,553 18,786 92,402 41,902 13,118 14,726 9,141
Depreciation and
Amortization............. 2,135 1,173 5,732 3,301 1,382 1,314 777
----- ----- ----- ----- ----- ----- ---
37,104 24,880 118,702 55,741 18,085 19,896 12,320
------ ------ ------- ------ ------ ------ ------
Income before Interest
Expense.................. 4,356 7,731 12,820 18,939 9,206 1,984 736
Interest Expense........... 3,656 1,502 6,904 2,774 2,429 5,956 3,037
----- ----- ----- ----- ----- ----- -----
Earnings (Loss) before Income
Taxes.................... 700 6,229 5,916 16,165 6,777 (3,972) (2,301)
Income Taxes (Benefit)..... 280 2,500 2,396 6,637 100 -- (334)
--- ----- ----- ----- --- ----
Earnings (Loss) from
Continuing Operations... 420 3,729 3,520 9,528 6,677 (3,976) (1,967)
Discontinued Operations:
Loss from Operations of
Discontinued Operations. -- (768) (768) (83) (811) -- --
Loss from Disposal of
Discontinued Operations. -- (4,827) (8,455) -- -- -- --
----- ------ ------ ----- ----- ----- -----
Net Earnings (Loss) $ 420 $ (1,866) $ (5,703) $ 9,445 $ 5,866 $ (3,972) $ (1,967)
======== ======== ======== ======== ======== ======== ========
Diluted Earnings (Loss) per
Share................... $ 0.03 $ (0.10) $ (0.31) $ 0.52 $ 0.60 $ (0.67) $ (0.35)
========= ========= ======== ========= ======== ========= ========
Shares used in Computation. 15,785 19,093 18,405 18,234 8,283 5,892 5,584
====== ====== ====== ====== ===== ===== =====
Balance Sheet Data:
Cash and Cash Equivalents $ 4,387 $ 514 $ 2,751 $ 3,537 $ 18,455 $ 1,419 $ 168
Finance Receivables, Net. 237,928 91,213 163,209 90,573 51,063 40,726 15,858
Total Assets............. 406,616 288,041 345,975 276,426 118,083 60,790 29,711
Subordinated Notes Payable 40,815 27,000 43,741 12,000 14,000 14,553 18,291
Total Debt............... 212,719 90,304 161,035 76,821 26,904 49,754 28,233
Total Stockholders' Equity
(Deficit).............. 157,890 181,010 162,767 181,774 82,319 4,884 (1,194)
</TABLE>
14
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information regarding our
consolidated financial position as of March 31, 1999 and December 31, 1998 and
1997, and the results of operations for the three months ended March 31, 1999
and 1998 and for the years ended December 31, 1998, 1997, and 1996. This
discussion should be read in conjunction with the preceding "Selected
Consolidated Financial Data" and our Consolidated Financial Statements and
related Notes thereto and other consolidated financial data appearing elsewhere
in this prospectus. In the opinion of management, such unaudited and interim
data reflect all adjustments, consisting only of normal recurring adjustments,
necessary to fairly present our financial position and results of operations for
the periods presented. The results of operations for any interim period are not
necessarily indicative of the results to be expected for a full fiscal year. For
information relating to factors that could affect future operating results, see
"Risk Factors." Any forward looking statements included in this prospectus
should be considered in light of such factors, as well as the information set
forth below.
Overview
We generally view Ugly Duckling as operating in two areas. The first is
dealership operations, and the second is non-dealership operations. Below is an
organizational chart of our businesses and their related segments:
[ORGANIZATIONAL CHART OMITTED]
The chart above shows Ugly Duckling with two operating divisions. Dealership
operations is the first division. Dealership operations has three distinct
segments. Retail sales is its first segment. This is the segment that operates
our chain of Ugly Duckling Car Sales dealerships. Portfolio and loan servicing
is the second segment of dealership operations. This segment holds and services
the loan portfolios originated or acquired by our dealership operations.
Finally, dealership operations has an administration segment that provides
corporate administration to the division. Our non-dealership operations division
also contains three segments. The first non-dealership operations segment is the
bulk purchasing/loan servicing segment. In this segment, we acquire loan
portfolios from third parties and provide loan servicing for third parties. The
second segment of non-dealership operations is the Cygnet dealer program under
which we provide various credit facilities to independent used car dealers.
Finally, the non-dealership operations also have an administration segment that
provides corporate administration to the non-dealership operations. Lastly, the
chart shows our discontinued operations, which contains our branch office
network that we closed in February 1998 and the loans we acquired through that
network.
We have experienced a number of significant events during the past three
years. Some of the more important events follow:
o During 1996 we:
o completed our initial public offering and secondary offering of common
stock generating a total of $79.4 million in cash.
o During 1997 we:
o completed a private placement of common stock in February 1997
generating $88.7 million in cash,
o completed a conversion of one of our loan servicing systems. We
experienced various transitional problems with the conversion, which
resulted in a charge of $5.7 million (approximately $3.4 million net
of income taxes) to write down our residuals in finance receivables
sold,
15
<PAGE>
o completed three significant acquisitions and developed new stores to
increase our total number of dealerships in operation from seven to 41
at December 31, 1997, and
o expanded our dealership chain from two markets at the end of 1996 to
ten markets at the end of 1997.
o During 1998 we:
o closed our branch office network, resulting in two significant charges
to discontinued operations totaling $15.1 million (approximately $9.2
million, net of income taxes),
o completed the conversion of our dealerships to a single computer
system,
o attempted to split-up the company through a rights offering to our
stockholders. We terminated the rights offering due to a lack of
stockholder participation. Although the rights offering was
unsuccessful, the exercise of splitting the operations and management
teams has proven beneficial to each of our businesses,
o completed an exchange offer whereby we issued $17.5 million in
subordinated debentures and repurchased approximately 2.7 million
shares of our common stock, and
o changed the way we structure our securitization transactions for
accounting purposes from a sale to a financing. The change had a
significant effect on earnings in 1998.
In this discussion and analysis we explain the general financial condition
and the results of operations of Ugly Duckling and its subsidiaries. In
particular, we analyze and explain the changes in the results of operations of
our various business segments for the periods noted above. As you read this
discussion, you should refer to our Consolidated Financial Statements beginning
on page F-1, which contain the results of our operations for 1998, 1997, and
1996 and our Condensed Consolidated Financial Statements for the three month
periods ended March 31, 1999 and 1998 beginning on page F-27.
Results of Operations--Three Months Ended March 31, 1999 and 1998
Income items in our Statement of Operations consist of:
o Sales of Used Cars
less Cost of Used Cars Sold
less Provision for Credit Losses
o Interest Income
o Gain on Sale of Loans
o Servicing and Other Income
16
<PAGE>
Sales of Used Cars and Cost of Used Cars Sold
Three Months Ended March 31,
(dollars in thousands)
1999 1998
----------- ----------
Used Cars Sold (Units) 12,754 9,439
=========== ==========
Sales of Used Cars $ 106,443 $ 72,973
Cost of Used Cars Sold 60,097 39,731
----------- ----------
Gross Margin $ 46,346 $ 33,242
=========== ==========
Gross Margin % 43.5% 45.6%
=========== ==========
Per Unit Sold:
Sales of Used Cars $ 8,346 $ 7,731
Cost of Used Cars Sold 4,712 4,209
----------- ----------
Gross Margin $ 3,634 $ 3,522
=========== ==========
The number of cars we sold (units) increased by 35.1% for the three months
ended March 31, 1999 over the same period in 1998. Same store unit sales for the
three months ended March 31, 1999 increased 5.0 % compared to the three month
period ended March 31, 1998. The increase in our same store unit sales was
primarily a result of the maturation of stores purchased or opened in late 1997.
We anticipate future revenue growth will come from increasing the number of our
dealerships and not from higher sales volumes at existing dealerships.
Our Used Car Sales revenues increased by 45.9% for the three months ended
March 31, 1999 over the same period ended March 31, 1998. The growth for these
periods reflects increases in the number of dealerships in operation and the
average unit sales price. The Cost of Used Cars Sold increased by 51.3% for the
three months ended March 31, 1999 over the same period ended March 31, 1998. The
gross margin on used car sales (Sales of Used Cars less Cost of Used Cars Sold
excluding Provision for Credit Losses) increased by 39.4% for the three months
ended March 31, 1999 over the same period ended March 31, 1998. The gross margin
per car sold for the first quarter of 1999 is comparable to the first quarter of
1998.
Our average sales price per car increased by 8.0% for the three months ended
March 31, 1999 over the three months ended March 31, 1998. The increase in the
average sales price was necessary to offset the increase in the Cost of Used
Cars Sold. On a per unit basis, the Cost of Used Cars Sold increased by 12.0%
for the three months ended March 31, 1999 over the three months ended March 31,
1998. The increase in our average cost per used car sold is primarily due to an
increase in the direct cost of the cars we acquire and re-sell.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
17
<PAGE>
Three Months Ended
March 31,
-------------------------
1999 1998
------------- ------------
Provision for Credit Losses (in thousands) $27,764 $15,034
============= ============
Provision per contact originated $2,198 $1,610
============= ============
Provision as a percentage of
principal balances originated 27.0% 21.6%
============= ============
The Provision for Credit Losses in our dealership operations increased by
84.7% in the three months ended March 31, 1999 over the three months ended March
31, 1998. The Provision for Credit Losses per unit originated at our dealerships
increased by $588 or 36.5% in the three months ended March 31, 1999 over the
three months ended March 31, 1998. When we changed how we structure
securitizations for accounting purposes in the fourth quarter of 1998, we also
changed the timing of providing for credit losses. For periods prior to the
fourth quarter of 1998, we generally provided a Provision for Credit Losses of
approximately 21% of the loan principal balance at the time of origination to
record the loan at the lower of cost or market. However, as a consequence of our
revised securitization structure, we will now be retaining securitized loans on
our balance sheet for accounting purposes and recognizing income over the life
of the contracts. We record the provision for credit losses at 27% of the
principal balance at the time of origination.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 143.0% to $797,000 in the three months
ended March 31, 1999 from $328,000 in the three months ended March 31, 1998. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program.
See also "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our securitization transactions that were
structured as sale transactions for accounting purposes ("Securitized Contract
Sales"). Interest Income increased by 167.3% to $10.4 million for the three
months ended March 31, 1999 from $6.5 million for the three months ended March
31, 1998. The increase was primarily due to the increase in the average finance
receivables retained on our balance sheet. Because we structured most of our
securitizations to recognize income as sales for accounting purposes prior to
1999, there were fewer receivables retained on our balance sheet and Interest
Income was lower in these periods. See "Securitizations-Dealership Operations"
below for additional discussion of our securitization transactions and our on
balance sheet portfolio.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold and financed.
Three Months Ended March 31,
1999 1998
----------------- ----------
Percentage of sales revenue financed 96.0% 95.5%
Percentage of sales units financed 99.1% 98.9%
18
<PAGE>
As a result of our expansion into markets with interest rate limits, the
yield on our dealership receivable contracts has gone down. The average
effective yield on finance receivables from our dealerships was approximately
25.3% for the three months ended March 31, 1999 and 26.0% for the three months
ended March 31, 1998. Our policy is to charge 29.9% per year on our dealership
contracts. However, in those states that impose interest rate limits, such as
Texas and Florida, we charge the maximum interest rate permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from our Cygnet dealer program and from a loan we made
to FMAC as part of its bankruptcy proceedings. Interest Income from the FMAC
transaction decreased by 56.9% to $313,000 for the three months ended March 31,
1999 from $727,000 for the three months ended March 31, 1998. Interest Income
from the Cygnet dealer program increased by 107.6% to $3.3 million for the three
months ended March 31, 1999 from $1.6 million for the three months ended March
31, 1998. The increase in interest income in the Cygnet dealer program reflects
a significant increase in the amount of loans outstanding during the three
months ended March 31, 1999 compared to the three months ended March 31, 1998.
Gain on Sale of Loans
Dealership Operations. The gain on sale of finance receivables we recorded
prior to the fourth quarter of 1998 was generated from securitizations that were
structured as sale transactions. During the fourth quarter of 1998, we began
structuring our securitization transactions as financings for accounting
purposes ("Securitized Borrowings") instead of as sales transactions and,
therefore, we will not recognize gains on the sale of loans from securitization
transactions in the future. We recorded Gains on Sale of Loans related to
Securitized Contract Sales of zero for the three months ended March 31, 1999 and
$4.6 million during the three months ended March 31, 1998. See
"Securitizations-Dealership Operations" below for a summary of the structure of
our securitizations.
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows for the three months ending March 31, 1999 and 1998 (in thousands):
Dealership Non-Dealership
Operations Operations Total
--------------- -------------- ------------
March 31, 1999 $ 2,834 $ 6,738 $ 9,572
=============== ============== ============
March 31, 1998 $ 3,912 $ 3,912 $ 7,824
=============== ============== ============
Dealership Operations. Servicing and Other Income decreased by 25.0% to $2.9
million in the three months ended March 31, 1999 compared to the $3.9 million
recognized in the three months ended March 31, 1998. We service the securitized
contracts that were included in the Securitized Contract Sales transactions for
monthly fees ranging from .25% to .33% of the beginning of month principal
balances (3.0% to 4.0% per year). We do not, however, recognize service fee
income on the contracts included in our Securitized Borrowings. The significant
decrease in Servicing and Other Income is primarily due to the decrease in the
principal balance of (1) contracts being serviced under the previous
securitization structure and (2) a portfolio we service on behalf of a third
party. We anticipate that our future Servicing and Other Income will decline as
the principal balance of the contracts serviced under the Securitized Contract
Sales agreements and the third party portfolio will continue to decrease.
Non-Dealership Operations. Our Servicing and Other Income in the first
quarter 1999 totaled $6.7 million. Our servicing fee is generally a percentage
of the portfolio balance (generally 3.25% to 4.0% per year) with a minimum fee
per loan serviced (generally $14 to $17 per month). Our service fee income is
tied to the contract principal balance of the contracts we service and the
number of units that we service, and will continue to decline, subject to the
incentive compensation discussed below, unless we increase the number and amount
19
<PAGE>
of contracts we are servicing. We have not entered into any loan servicing
agreements thus far in 1999 and expect that our service fee income will continue
to decline as the principal balances of the portfolios that we are currently
servicing decrease. We did not recognize any servicing income in the first
quarter 1998, as we did not begin servicing loans in our non-dealership
operations until April 1998.
Our non-dealership operations have entered into servicing agreements with
two companies that have filed and subsequently emerged from bankruptcy and
continue to operate under their approved plans of reorganization. Under the
terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, we are entitled to certain incentive compensation in excess of the
servicing fees that we have earned to date. Under the terms of the agreements
with FMAC, we are scheduled to receive 17.5% of all collections of the serviced
portfolio once the specified creditors have been paid in full. See
"Business--Non-Dealership Operations--Bulk Purchasing and Loan Servicing
Operations." Under the terms of the second agreement, we are scheduled to
receive the first $3.25 million in collections once the specified creditors have
been paid in full and 15.O% thereafter. We are required to issue warrants to
purchase up to 150,000 shares of our common stock to the extent we receive the
$3.25 million and, in addition, will be required to issue 75,000 warrants for
each $1.0 million in incentive fee income we receive after we collect the $3.25
million. As of March 31, 1999, we estimate that the total incentive compensation
from both agreements could range from $0 to $8.0 million. We have not accrued
any fee income from these incentives.
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 27.1% to $41.5 million for the three months ended March 31, 1999 from
$32.6 million for the three months ended March 31, 1998. Growth of Sales of Used
Cars, Interest Income, and Servicing and Other Income were the primary
contributors to the increase.
Operating Expenses
Operating Expenses consist of:
o Selling and Marketing Expenses,
o General and Administrative Expenses, and
o Depreciation and Amortization.
A summary of operating expenses for our business segments for the three
months ended March 31, 1999 and 1998 follows (in thousands).
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
------------------------------------ -----------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Receivables and Other Dealer Servicing and Other Total
Dealerships
----------------------------------------------------------------------------------------
1999:
<S> <C> <C> <C> <C> <C> <C> <C>
Selling and Marketing $ 6,378 $ - $ - $ 35 $ 3 $ - $ 6,416
General and Administrative 11,102 4,590 5,332 963 5,821 745 28,553
Depreciation and Amortization 791 283 521 78 321 141 2,135
------------ ----------- ---------- ---------- ------------ ---------- -----------
$ 18,271 $ 4,873 $5,853 $ 1,076 $ 6,145 $ 886 $ 37,104
============ =========== ========== ========== ============ ========== ===========
1998:
Selling and Marketing $ 4,878 $ - $ - $ 43 $ - $ - $ 4,921
General and Administrative 10,506 4,555 2,619 515 - 591 18,786
Depreciation and Amortization 613 337 201 22 - - 1,173
------------ ----------- ---------- ---------- ------------ ---------- -----------
$ 15,997 $ 4,892 $2,820 $ 580 $ - $ 591 $ 24,880
============ =========== ========== ========== ============ ========== ===========
</TABLE>
20
<PAGE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
as a percentage of Sales of Used Cars and Selling and Marketing Expense per car
sold from our dealership operations follows:
Three Months
ended March 31,
----------------------
1999 1998
---------- ----------
Selling and Marketing Expense as a
Percent of Sales of Used Cars 6.0% 6.7%
========== ==========
Selling and Marketing Expense
per Car Sold $ 500 $ 517
========== ==========
For the three months ended March 31, 1999 and 1998, Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Selling and Marketing Expenses increased by 30.8%
to $6.4 million for the three months ended March 31, 1999 from $4.9 million for
the three months ended March 31, 1998. The decrease in Selling and Marketing
Expense as a percentage of Sales of Used Cars and on a per unit basis from 1998
to 1999 is due to the significant increase in the number of cars sold in 1999
compared to 1998 and an increase in the selling price of units sold and
management's decision to reduce expenditures for advertising on a per car basis.
General and Administrative Expenses. General and Administrative Expenses
increased by 52.0% to $28.6 million for the three months ended March 31, 1999
from $18.8 million for the three months ended March 31, 1998. The increase in
General and Administrative Expenses was primarily a result of the addition of
our bulk purchasing and loan servicing operations, the expansion of
infrastructure to administer the increased number of used car dealerships in
operation, and the growth of the Cygnet dealer program.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 82.0% to
$2.1 million for the three months ended March 31, 1999 from $1.2 million for the
three months ended March 31, 1998. The increase in 1999 was primarily due to
depreciation from our non-dealership operations and an increase in software
amortization of our investment in our integrated car sales and loan servicing
system.
Interest Expense
Interest expense increased by 143.4% to $3.7 million for the three months
ended March 31, 1999 from $1.5 million for the three months ended March 31,
1998. The increase in the first quarter of 1999 was primarily due to increased
borrowings under our Securitization Note Payable, Notes Payable and Subordinated
Notes Payable. The increased borrowings were used primarily to fund the
increases in Finance Receivables in our dealership operations and our Cygnet
dealer finance receivables portfolio.
Income Taxes
Income taxes totaled $280,000 for the three months ended March 31, 1999, and
$2.5 million for the three months ended March 31, 1998. Our effective tax rate
was 40.0% for the three months ended March 31, 1999 and 40.1% for the three
months ended March 31, 1998.
Discontinued Operations
We recorded a pre-tax charge to discontinued operations totaling
approximately $9.1 million (approximately $5.6 million, net of income taxes)
during the first quarter of 1998 related to the closure of our branch office
network. In addition, we recorded a $6.0 million charge (approximately $3.6
million, net of income taxes) during the third quarter of 1998 due primarily to
higher than anticipated loan losses and servicing expenses. The charges we
recorded to discontinued operations represent the total estimated net loss we
expect to realize from the branch office network closure. As a result, there was
no income or loss from discontinued operations for the three months ended March
31, 1999.
21
<PAGE>
Results of Operations- Years Ended December 31, 1998, 1997 and 1996
Sales of Used Cars and Cost of Used Cars Sold
(dollars in thousands)
1998 1997 1996
Used Cars Sold (Units)....... 35,964 16,636 7,565
========== =========== ==========
Sales of Used Cars .......... $ 287,618 $ 123,814 $ 53,768
Cost of Used Cars Sold ...... 167,014 72,358 31,879
---------- ----------- -----------
Gross Margin ................ $ 120,604 $ 51,456 $ 21,889
========== =========== ==========
Gross Margin %............... 41.9% 41.6% 40.7%
========== =========== ===========
Per Unit Sold:
Sales ....................... $ 7,997 $ 7,443 $ 7,107
Cost of Used Cars Sold ...... 4,644 4,349 4,214
---------- ----------- ----------
Gross Margin ................ $ 3,353 $ 3,094 $ 2,893
========== =========== ==========
The number of cars sold (units) increased by 116.2% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to an increase
of 119.9% over the year ended December 31, 1996. Same store unit sales in the
year ended December 31, 1998 were comparable to the year ended December 31,
1997. We anticipate future revenue growth will come from increasing the number
of our dealerships and not from higher sales volumes at existing dealerships.
Same store unit sales declined by 11.6% in the year ended December 31, 1997
compared to the year ended December 31, 1996. We believe that this decline was
due primarily to the increased emphasis on underwriting at our 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.
Sales of Used Cars (revenues) increased by 132.3% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to a 130.3%
increase over the year ended December 31, 1996. The growth for these periods
reflects increases in the number of dealerships in operation and the average
unit sales price. The Cost of Used Cars Sold increased by 130.8% for the year
ended December 31, 1998 over the year ended December 31, 1997, compared to an
increase of 127.0% over the year ended December 31, 1996. The gross margin on
used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding
Provision for Credit Losses) increased by 134.4% for the year ended December 31,
1998 over the year ended December 31, 1997, compared to an increase of 135.1%
over the year ended December 31, 1996. The gross margin percentage has increased
over the past two years, as we have been successful in increasing our sales
prices by more than the increase in the Cost of Used Cars Sold.
Our average sales price per car increased by 7.4% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to a 4.7%
increase in the year ended December 31, 1997 from the year ended December 31,
1996. The increase in the average sales price was necessary to offset the
increase in the Cost of Used Cars Sold. On a per unit basis, the Cost of Used
Cars Sold increased by 6.8% for the year ended December 31, 1998 over the year
ended December 31, 1997, compared to an increase of 3.2% over the year ended
December 31, 1996.
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
22
<PAGE>
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
1998 1997 1996
Provision for Credit Losses (in thousands).. $ 65,318 $ 22,354 $ 9,657
========= ======== =========
Provision per contract originated........... $ 1,837 $ 1,397 $ 1,394
========= ======== =========
Provision as a percentage of
principal balances originated............. 23.6% 19.1% 19.7%
========= ======== =========
The Provision for Credit Losses in our dealership operations increased by
192.2% in the year ended December 31, 1998 over the year ended December 31,
1997, compared to an increase of 131.5% over the year ended December 31, 1996.
The Provision for Credit Losses per contract originated at our dealerships
increased by 31.5% in the year ended December 31, 1998 over the year ended
December 31, 1997, compared to an increase of 0.2% over the year ended December
31, 1996. The increase in 1998 was primarily due to an increase in the average
amount financed to $7,796 per unit in the year ended December 31, 1998 from
$7,301 per unit in the year ended December 31, 1997 and from the change in our
securitization structure beginning in the fourth quarter of 1998.
As a percentage of dealership contract principal balances originated, the
Provision for Credit Losses averaged 23.6% for the year ended December 31, 1998,
19.1% for the year ended December 31, 1997, and 19.7% for the year ended
December 31, 1996. When we changed how we structure securitizations for
accounting purposes in the fourth quarter of 1998, we also changed the timing of
providing for credit losses. For periods prior to the fourth quarter of 1998, we
generally provided a Provision for Credit Losses of approximately 20% of the
loan principal balance at the time of origination to record the loan at the
lower of cost or market. However, as a consequence of our revised securitization
structure, we will now be retaining securitized loans on our balance sheet and
recognizing income over the life of the contracts. Therefore, for loans
originated in the fourth quarter of 1998, we increased the provision for credit
losses to 27% of the principal balance at the time of origination. We also
increased the provision for credit losses to 27% on loans originated in prior
periods that had not been securitized prior to the fourth quarter.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 235.2% to $2.3 million in the year ended
December 31, 1998 from $691,000 in the year ended December 31, 1997. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program. There was no provision for credit losses in our non-dealership
operations in 1996, since there was no significant activity until 1997.
See "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our Securitized Contract Sales. Interest Income
increased by 37.6% to $17.3 million for the year ended December 31, 1998 from
$12.6 million for the year ended December 31, 1997, which increased by 46.1%
from $8.6 million in the year ended December 31, 1996. The increases were
primarily due to the increase in the average finance receivables retained on our
balance sheet during these periods. However, because we structured most of our
securitizations as sales for accounting purposes during 1998, 1997, and 1996,
Interest Income was lower than if we had structured the securitizations as
secured financings for accounting purposes.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold.
23
<PAGE>
1998 1997 1996
---- ---- ----
Percentage of sales revenue financed... 96.4% 94.4% 90.5%
===== ===== =====
Percentage of used cars sold financed.. 98.9% 96.2% 91.6%
===== ===== =====
As a result of our expansion into markets with interest rate limits, the
yield on our dealership receivable contracts has gone down. The average
effective yield on finance receivables from our dealerships was approximately
25.8% for the year ended December 31, 1998, 26.7% for the year ended December
31, 1997, and 29.2% for the year ended December 31, 1996. Our policy is to
charge 29.9% per year on our dealership contracts. However, in those states that
impose interest rate limits, we charge the maximum interest rate permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from a loan we made to FMAC as part of its bankruptcy
proceedings, and from our Cygnet dealer program. Interest Income from the FMAC
transaction decreased by 52.0% to $1.8 million in 1998 from $3.8 million in 1997
when we originated the FMAC loan. During a portion of 1997, in addition to our
debtor-in-possession loan to FMAC, we held other notes receivable from FMAC
totaling approximately $76.3 million. We sold receivables that secured the notes
for a gain at the end of 1997. Interest income from the Cygnet dealer program
increased by 269.2% to $8.7 million from $2.4 million in 1997, when the Cygnet
dealer program commenced significant operations. The increase in interest income
in the Cygnet dealer program reflects a significant increase in the amount of
loans outstanding during 1998 compared to 1997.
Gain on Sale of Loans
A summary of Gain on Sale of Loans follows:
(dollar amounts in thousands)
1998 1997 1996
---- ---- ----
Dealership Operations................... $ 12,093 $ 6,721 $ 3,925
Non-Dealership Operations............... -- 8,131 --
-------- --------- --------
$ 12,093 $ 14,852 $ 3,925
======== ========= ========
Gain on Sale of Loans as a percentage
of principal balances securitized -
dealership operations ................ 5.4% (1) 8.2% 6.7%
======== ========= =======
(1) Excluding a $5.7 million charge in 1997 described below
Dealership Operations. We recorded Gain on Sale of Loans related to
securitization transactions of $12.1 million during the year ended December 31,
1998, $6.7 million (net of a $5.7 million charge) during the year ended December
31, 1997, and $3.9 million during the year ended December 31, 1996. We recorded
a $5.7 million charge (approximately $3.4 million net of income taxes) in the
third quarter of 1997 in order to adjust our assumptions related to our
previously completed securitization transactions. The decrease in Gain on Sale
of Loans (excluding the $5.7 million charge in 1997) as a percentage of
principal balances securitized in 1998 compared to 1997 is primarily due to the
use of a higher cumulative charge off assumption in the 1998 securitizations and
the securitized portfolios in 1998 having a shorter weighted average life than
those in 1997. The increase in Gain on Sale of Loans (excluding the $5.7 million
charge in 1997) as a percentage of principal balances securitized in 1997
compared to 1996 is primarily due to a decrease in the weighted average
borrowing rate of the underlying Class A certificates. See
"Securitizations-Dealership Operations" below for a summary of the structure of
our securitizations.
Non-Dealership Operations. During 1997, our non-dealership operations
entered into a series of transactions with FMAC including transactions in which
we acquired 100% of FMAC's senior bank debt. When FMAC put the finance contracts
securing this debt up for bid, we purchased the contracts by releasing the debt.
We then sold the contracts to a third party purchaser. We recorded a one-time
gain of $8.1 million from this transaction. See "Business--Non-Dealership
Operations--Bulk Purchasing and Loan Servicing Operations."
24
<PAGE>
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows (in thousands):
Non-Dealership
Dealership Operations Operations
--------------------- --------------
Company
Company Dealership Corporate Cygnet
Dealerships Receivables and Other Loan Servicing Total
----------- ----------- --------- -------------- --------
1998...........$ 389 $ 15,453 $ 493 $ 22,296 $ 38,631
1997...........$ 1,498 $ 8,814 $ 2,013 $ 356 $ 12,681
1996...........$ 195 $ 1,887 $ 455 $ -- $ 2,537
Dealership Operations. Servicing and Other Income increased by 32.5% to
$16.3 million in the year ended December 31, 1998 over the $12.3 million
recognized in 1997, which was an increase of 385.8% over the $2.5 million in
1996. We service the contracts under our Securitized Contract Sales for monthly
fees ranging from .25% to .33% of the beginning of month principal balances
(3.0% to 4.0% per year). The significant increase in Servicing and Other Income
is primarily due to the increase in the principal balance of contracts being
serviced under the securitization program and the addition in 1997 of a
portfolio that we service for Kars Yes Holdings, Inc. (Kars). Although we
acquired several dealerships in the Kars transaction, the owners retained the
loan portfolio, which we service. In addition, the increase in 1997 was also due
to our investment income on the proceeds from our private placement that we
closed in February 1997. We recorded earnings on these investments of $1.2
million compared to no investment earnings in the year ended December 31, 1996.
We expect that our future Servicing and Other Income will decline as the
principal balance of the contracts serviced under the Securitized Contract Sales
agreements and the Kars portfolio continue to decrease.
Non-Dealership Operations. In April 1998, we began servicing loans on behalf
of FMAC. Shortly thereafter, we entered into additional agreements to service
loan portfolios on behalf of other third parties. Our servicing fee is generally
a percentage of the portfolio balance (generally 3.25% to 4.0% per year) with a
minimum fee per loan serviced (generally $14 to $17 per month). Servicing and
Other Income totaled $22.3 million in the year ended December 31, 1998, compared
to $356,000 in 1997 and $0 in 1996.
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 76.1% to $131.5 million for the year ended December 31, 1998 from $74.7
million for the year ended December 31, 1997, compared to an increase of 173.6%
from $27.3 million in 1996. Growth of Sales of Used Cars, Interest Income, Gain
on Sale of Loans, and Servicing and Other Income were the primary contributors
to the increase.
25
<PAGE>
Operating Expenses
A summary of operating expenses for our business segments for the years
ended December 31, 1998, 1997 and 1996 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non-Dealership Operations
--------------------- -------------------------
Company Cygnet Cygnet
Company Dealership Corporate Dealer Loan Corporate
Dealerships Receivables and Other Program Servicing and Other Total
----------- ----------- --------- ------- --------- --------- -----
1998:
<S> <C> <C> <C> <C> <C> <C> <C>
Selling and Marketing...... $ 20,285 $ -- $ -- $ 242 $ 31 $ 7 $ 20,565
General and Administrative. 32,383 18,491 16,103 2,721 18,664 4,040 92,402
Depreciation and Amortization 2,581 1,334 997 104 614 105 5,735
----- ----- --- --- --- --- -----
$ 55,249 $19,825 $17,100 $3,067 $19,309 $4,152 $118,702
======== ======= ======= ====== ======= ====== ========
1997:
Selling and Marketing...... $ 10,538 $ -- $ -- $ -- $ -- $ -- $ 10,538
General and Administrative. 17,214 12,303 9,896 917 -- 1,572 41,902
Depreciation and Amortization. 1,536 1,108 504 28 -- 125 3,301
----- ----- --- -- --- -----
$ 29,288 $13,411 $10,400 $ 945 $ -- $1,697 $ 55,741
======== ======= ======= ======= ======= ====== ========
1996:
Selling and Marketing...... $ 3,568 $ -- $ 17 $ -- $ -- $ -- $ 3,585
General and Administrative. 6,306 2,859 3,953 -- -- -- 13,118
Depreciation and Amortization 318 769 295 -- -- -- 1,382
--- --- --- -----
$ 10,192 $ 3,628 $4,265 $ -- $ -- $ -- $ 18,085
======== ======= ====== ===== ======= ======= ========
</TABLE>
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
as a percentage of Sales of Used Cars and Selling and Marketing Expense per car
sold from our dealership operations follows:
1998 1997 1996
---- ---- ----
Selling and Marketing Expense as a
Percent of Sales of Used Cars....... 7.1% 8.5% 6.6%
Selling and Marketing Expense
per Car Sold....................... $564 $633 $472
For the years ended December 31, 1998, 1997, and 1996, Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Total Selling and Marketing Expenses increased by
95.2% to $20.6 million for the year ended December 31, 1998 from $10.5 million
for the year ended December 31, 1997, which was an increase of 193.9% from $3.6
million in 1996. The decrease in total Selling and Marketing Expense as a
percentage of Sales of Used Cars and on a per unit basis from 1997 to 1998 is
due to the significant increase in the number of cars sold in 1998 compared to
1997, and to the fact that we did not enter any new markets in 1998. The
significant increase in per unit marketing in 1997 was primarily due to our
expansion into several new markets. We operated dealerships in ten markets
during 1997, compared to two markets in 1996. As a result of this expansion, we
incurred significant marketing costs in 1997 in new markets in an effort to
establish brand name recognition.
General and Administrative Expenses. General and Administrative Expenses
increased by 120.5% to $92.4 million for the year ended December 31, 1998 from
$41.9 million for the year ended December 31, 1997, which was an increase of
219.4% from $13.1 million for the year ended December 31, 1996. The increase in
General and Administrative Expenses was primarily a result of the increased
number of used car dealerships in operation, as well as the expansion of our
bulk purchasing and loan servicing operations, the Cygnet dealer program, and
continued expansion of infrastructure to administer growth. General and
Administrative expenses for the year ended 1998 includes a $2.0 million charge
($1.2 million, net of income taxes) to write off costs associated with the
rights offering.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 73.7% to
$5.7 million for the year ended December 31,1998 from $3.3 million for the year
ended December 31, 1997, which was an increase of 138.9% over the $1.4 million
incurred in the year ended December 31, 1996. The increase in 1998 was primarily
26
<PAGE>
due to increases in amortization of goodwill associated with our 1997
acquisitions, increased depreciation expense from the addition of used car
dealerships and the addition of four loan servicing facilities in 1998 to
support our bulk purchase and loan servicing operations.
Interest Expense
Interest expense increased by 148.9% to $6.9 million in 1998 from $2.8
million in 1997, which was an increase of 14.2% from $2.4 million in 1996. The
increase in 1998 was primarily due to increased borrowings of Notes Payable and
Subordinated Notes Payable. The relatively small increase in 1997, despite
significant growth in our total assets, was primarily the result of the private
placement of common stock that we completed in February 1997. Our private
placement generated $88.7 million in cash which we used to pay down debt.
Income Taxes
Income taxes totaled $2.4 million for the year ended December 31, 1998, $6.6
million for the year ended December 31, 1997, and $100,000 for the year ended
December 31, 1996. Our effective tax rate was 40.5% for the year ended December
31, 1998, 41.1% for the year ended December 31, 1997, and 1.6% for the year
ended December 31, 1996. In 1996, we reversed all of the valuation allowance
that existed against our deferred income tax assets as of December 31, 1995,
which significantly reduced our effective income tax rate.
Discontinued Operations
The loss from discontinued operations, net of income tax benefits, increased
by $9.1 million to $9.2 million in 1998 from $83,000 in 1997, which was an
improvement from the $811,000 loss we incurred in 1996. The significant increase
in the loss in 1998 was due to the charges we recorded totaling $15.1 million
($9.2 million, net of income taxes) to close our branch office network.
Financial Position
Total assets increased by 17.5% to $406.6 million at March 31, 1999 from
$346.0 million at December 31, 1998. The increase was due primarily to an
increase in Finance Receivables of $74.7 million to $237.9 million at March 31,
1999 from $163.2 million at December 31, 1998. Our dealership operations'
Finance Receivables increased approximately $63.9 million and our non-dealership
operations' Finance Receivables increased approximately $10.8 million primarily
as a result of growth of the Cygnet dealer program.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable. Notes Payable increased by $54.6
million to $171.9 million at March 31, 1999 from $117.3 million at December 31,
1998. We obtained a $30 million repurchase facility in the first quarter of
1999, which resulted in the increase in Collateralized Notes Payable. The
increase in our Notes Payable is attributable to an increase in the balance of
our revolving line of credit, which totaled approximately $75.6 million at March
31, 1999, compared to $51.8 million at December 31, 1998.
Total assets increased by 25.2% to $346.0 million at December 31, 1998 from
$276.4 million at December 31, 1997. The increase was due in part to an increase
in Finance Receivables of $72.6 million to $163.2 million at December 31, 1998
from $90.6 million at December 31, 1997. The increase in Finance Receivables was
primarily due to a significant increase in loans under the Cygnet dealer
program, and a change in the structure of our securitization transactions for
accounting purposes which resulted in us retaining on balance sheet the Finance
Receivables we securitized in the fourth quarter of 1998. We previously
structured securitizations as sales for accounting purposes and we removed the
related Finance Receivables from the balance sheet upon securitization.
Additionally, our dealership network increased from 41 dealerships at December
31, 1997 to 56 at December 31, 1998. The increase in the number of our
dealerships resulted in an increase in Inventory of $11.8 million to $44.2
million at December 31, 1998 from $32.4 million at December 31, 1997.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable, Collateralized Notes Payable, and
Subordinated Notes Payable. Notes Payable and Collateralized Notes Payable
increased by $52.5 million to $117.3 million at December 31, 1998 from $64.8
million at December 31, 1997. This increase was primarily due to the change in
our securitization structure. We retained the debt related to the securitization
27
<PAGE>
transaction we closed in the fourth quarter of 1998 on our balance sheet.
Subordinated Notes Payable increased by $31.7 million to $43.7 million at
December 31, 1998 from $12.0 million at December 31, 1997. The increase in
Subordinated Notes Payable was primarily due to the addition of $20.0 million in
subordinated notes used for working capital and other uses and approximately
$17.5 million used to repurchase our common stock in an exchange transaction.
Growth in Finance Receivables. As a result of our rapid expansion, contract
receivables managed by our dealership operations have increased significantly
during the past three years.
The following table reflects the growth in period end balances of our
dealership operations measured in terms of the principal amount and the number
of contracts outstanding.
<TABLE>
<CAPTION>
Total Contracts Outstanding-Dealership Operations
(In thousands, except number of contracts)
March 31, December 31,
-------------------------------------------- ---------------------------------------------
1999 1998 1998 1997
-------------------- --------------------- -------------------- ---------------------
Principal No. of Principal No. of Principal No. of Principal No. of
Amount Contracts Amount Contracts Amount Contracts Amount Contracts
--------- --------- --------- --------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Principal Amount...................$341,040 56,333 $ 218,505 39,734 $292,683 49,601 $ 183,321 35,762
Less: Portfolios Securitized
and Sold......................... 158,890 28,409 185,240 35,237 198,747 37,186 127,356 27,769
-------- ------ --------- ------ -------- ------ --------- ------
Dealership Operations Total......$182,150 27,924 $ 33,265 4,497 $ 93,936 12,415 $ 55,965 7,993
======== ====== ========= ===== ======== ====== ========= =====
</TABLE>
The following table reflects the growth in the principal amount and number
of contracts generated or acquired by our dealership operations.
<TABLE>
<CAPTION>
Total Contracts Generated or Acquired-Dealership Operations
Amounts (Principal In Thousands)
During the Three Months
Ended March 31, During the Years Ended December 31,
----------------------- -----------------------------------
1999 1998 1998 1997 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Principal Amount......... $102,733 $ 69,708 $277,226 $172,230 $ 48,996
Number of Contracts...... 12,634 9,339 35,560 29,251 6,929
Average Principal........ $ 8,131 $ 7,464 $ 7,796 $ 5,888 $ 7,071
</TABLE>
Finance Receivable principal balances generated or acquired by our
dealership operations during the three months ended March 31, 1999 increased by
47.4% to $102.7 million from $69.7 million in the three months ended March 31,
1998. Finance Receivable principal balances generated or acquired by our
dealership operations during the year ended December 31, 1998 increased by 61.0%
to $277.2 million from $172.2 million in the year ended December 31, 1997.
During the year ended December 31, 1997, Finance Receivable principal balances
generated or acquired by our dealership operations included the purchase of
approximately $55.4 million (13,250 contracts) in Finance Receivables principal
balances in conjunction with the E-Z Plan and Seminole acquisitions.
In addition to the loan portfolio summarized above, our dealership
operations also serviced loan portfolios totaling approximately $92.1 million
($36.1 million for Kars and $56.0 million from our branch office network) as of
March 31, 1999, $121.2 million ($47.9 million for Kars and $73.3 million from
our branch office network) as of December 31, 1998, and $267.9 million ($127.3
million for Kars and $140.6 million from our branch office network) as of
December 31, 1997.
Our non-dealership operations began servicing loans on behalf of FMAC on
April 1, 1998, and began servicing additional loan portfolios on behalf of other
third parties throughout 1998. As of March 31, 1999, our non-dealership bulk
purchasing/loan servicing operations were servicing a total of $480.4 million in
finance receivables (approximately 70,000 contracts) compared to a total of
$587.3 million in finance receivables (approximately 80,000 contracts) under
servicing at December 31, 1998.
28
<PAGE>
Allowance for Credit Losses
We have established an Allowance for Credit Losses ("Allowance") to cover
anticipated credit losses inherent in the contracts currently in our portfolio.
We established the Allowance by recording an expense through the Provision for
Credit Losses.
For Finance Receivables generated at our dealerships, our policy is to
charge off a contract the earlier of:
o when we believe it is uncollectible, or
o when it is delinquent for more than 90 days.
The following table reflects activity in the Allowance, as well as
information regarding charge off activity, for the three month periods ended
March 31, 1999 and 1998, and for the years ended December 31, 1998 and 1997, in
thousands.
<TABLE>
<CAPTION>
Dealership Operations
---------------------
Three Months Ended Years Ended
March 31, December 31,
-------------------- ----------------------
1999 1998 1998 1997
-------- ------- -------- ---------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Period..................... $ 24,777 $10,356 $ 10,356 $ 1,625
Provision for Credit Losses...................... 27,764 15,034 65,318 22,354
Allowance on Acquired Loans...................... -- -- -- 15,309
Reduction Attributable to Loans Sold............. -- (17,090) (44,539) (21,408)
Net Charge Offs.................................. (3,913) (2,147) (6,358) (7,524)
------ ------ ------ ------
Balance, End of Period........................... $ 48,628 $ 6,153 $ 24,777 $10,356
======== ======= ======== =======
Allowance as Percent of Period End Principal Balances 26.7% 18.5% 26.4% 18.5%
==== ==== ==== ====
Charge off Activity:
Principal Balances............................. $ (5,155) $ (3,197) $ (8,410) $(10,285)
Recoveries, Net................................ 1,242 1,050 2,052 2,761
----- ----- ----- -----
Net Charge Offs.................................. $ (3,913) $ (2,147) $ (6,358) $(7,524)
======== ======== ======== =======
</TABLE>
The Allowance on contracts from dealership operations was 26.7% of the
outstanding principal balances as of March 31, 1999 and 18.5% of outstanding
principal balances as of March 31, 1998, 26.4% of the outstanding principal
balances as of December 31, 1998 and 18.5% of outstanding principal balances as
of December 31, 1997.
The increase at March 31, 1999 and December 31, 1998 compared to March 31,
1998 and December 31, 1997 is due to the change in the structure of our
securitization transactions for accounting purposes in the fourth quarter of
1998. The change resulted in us retaining the securitized loans from our fourth
quarter securitization on balance sheet. As we intend to hold the balance sheet
portfolio for investment and not for sale, we increased the provision for credit
losses to 27% of the principal balance for loans originated in the fourth
quarter of 1998.
A Summary of the Allowance on contracts from non-dealership operations
follows.
Non-Dealership Operations
-------------------------
March 31, December 31,
--------- ------------
1999 1998 1998 1997
---- ---- ---- ----
As Percent of Period End Principal Balances:
Allowance...................................... 3.5% 2.9% 3.9% 3.8%
Non-refundable discount and security deposits.. 32.2% 27.6% 29.9% 26.0%
---- ---- ---- ----
Total Allowance, discount and security deposits 35.7% 30.5% 33.8% 29.8%
==== ==== ==== ====
Even though a contract is charged off, we continue to attempt to collect the
contract. Recoveries as a percentage of principal balances charged off from
dealership operations averaged 24.1% for the three months ended March 31, 1999
compared to 32.8% in the comparable period in 1998, and 24.4% for the year ended
December 31, 1998 compared to 26.8% for the year ended December 31, 1997.
Recoveries as a percentage of principal balances charged off from non-dealership
operations averaged 24.1% for the three months ended March 31, 1999 compared to
32.8% in the comparable period in 1998, and 30.1% for the year ended December
31, 1998 compared to 0% for the year ended December 31, 1997, when we recorded
only one charge off against the Allowance.
29
<PAGE>
For Finance Receivables acquired by our non-dealership operations with
recourse to the seller, our general policy is to exercise the recourse
provisions in our agreements under the Cygnet dealer program when a contract is
delinquent for 45 days. For contracts not purchased with recourse, our policy is
similar to that of our dealership operations.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for contracts we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge offs for each pool
separately. We calculate the cumulative net charge-offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge off. The table below
displays the cumulative net charge- offs of each pool as a percentage of
original contract cumulative balances, based on the quarter the loans were
originated. The table is further stratified by the number of payments made by
our customers prior to charge off. For periods denoted by "x", the pools have
not seasoned sufficiently to allow us to compute cumulative losses. For periods
denoted by "-", the pools have not yet reached the indicated cumulative age.
While we monitor static pools on a monthly basis, for presentation purposes, we
are presenting the information in the table below on a quarterly basis.
Currently reported cumulative losses may vary from those previously reported
for the reasons listed below, however, management believes that such variation
will not be material:
o ongoing collection efforts on charged off accounts, and
o the difference between final proceeds on the sale of repossessed
collateral versus our estimates of the sale proceeds.
The following table sets forth as of April 30, 1999, 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 customers before charge off. The table also shows the
percent of principal reduction for each pool since inception and cumulative
total net losses incurred (TLI).
<TABLE>
<CAPTION>
Pool's Cumulative Net Losses as Percentage of Pool's Original
Aggregate Principal Balance
(dollars in thousands)
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>
1994:
1st Quarter $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter $ 8,191 1.6% 9.1% 14.7% 20.4% 22.7% 23.6% 23.8% 100.0%
2nd Quarter $ 9,846 2.0% 8.5% 13.3% 18.1% 20.7% 22.1% 22.5% 99.9%
3rd Quarter $ 10,106 2.5% 7.9% 12.2% 18.8% 22.2% 23.6% 24.2% 99.5%
4th Quarter $ 8,426 1.5% 6.6% 11.7% 18.2% 22.6% 24.1% 24.7% 99.2%
1996:
1st Quarter $ 13,635 1.6% 8.0% 13.7% 20.7% 24.8% 26.2% 27.0% 97.8%
2nd Quarter $ 13,462 2.2% 9.2% 13.4% 22.1% 26.1% 27.7% 28.8% 95.4%
3rd Quarter $ 11,082 1.6% 6.9% 12.5% 21.5% 25.7% 28.0% 28.6% 91.8%
4th Quarter $ 10,817 0.6% 8.5% 16.0% 25.0% 29.3% 31.2% 31.3% 88.5%
1997:
1st Quarter $ 16,279 2.1% 10.6% 17.9% 24.6% 29.6% 30.9% 31.3% 83.8%
2nd Quarter $ 25,875 1.5% 9.9% 15.9% 22.8% 27.6% 27.5% 27.5% 75.9%
3rd Quarter $ 32,147 1.4% 8.4% 13.3% 22.6% 25.3% 26.4% 26.4% 68.7%
4th Quarter $ 42,529 1.5% 6.9% 12.7% 21.6% 23.4% x 23.4% 61.8%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.6% 20.0% x -- 20.1% 53.6%
2nd Quarter $ 66,908 1.1% 8.1% 14.3% x -- -- 16.9% 40.5%
3rd Quarter $ 71,027 1.0% 8.1% x -- -- -- 11.7% 27.7%
4th Quarter $ 69,583 1.0% x -- -- -- -- 4.7% 13.1%
1999
1st Quarter $102,733 x -- -- -- -- -- 0.3% 0.0%
</TABLE>
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<PAGE>
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
contract principal balances from dealership operations.
Retained Securitized Managed
-------- ----------- -------
March 31, 1999:
31 to 60 days... 2.3% 4.9% 3.5%
61 to 90 days... 1.1% 2.8% 1.9%
December 31, 1998:
31 to 60 days... 2.3% 5.2% 4.6%
61 to 90 days... 0.5% 2.2% 1.9%
December 31,1997:
31 to 60 days... 2.2% 4.5% 3.6%
61 to 90 days... 0.6% 2.2% 1.5%
In accordance with our charge off policy, there are no accounts more than 90
days delinquent as of March 31, 1999, December 31, 1998 and December 31, 1997.
Securitizations-Dealership Operations
Structure of Securitizations. For the securitization transactions closed
prior to the fourth quarter of 1998, we recognized a Gain on Sale of Loans equal
to the difference between the sales proceeds for the Finance Receivables sold
and our recorded investment in the Finance Receivables sold. Our investment in
Finance Receivables consisted of the principal balance of the Finance
Receivables securitized net of the Allowance for Credit Losses related to the
securitized receivables. We then reduced our Allowance for Credit Losses by the
amount of Allowance for Credit Losses related to the loans securitized. We
allocated 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.
In the fourth quarter of 1998 we announced that we were changing the way we
structure transactions under our securitization program for accounting purposes.
Through September 30, 1998, we had structured these transactions as sales for
accounting purposes. However, beginning in the fourth quarter of 1998, we began
structuring securitizations for accounting purposes to retain the contracts and
the related Securitization Note Payable on our balance sheet and recognize the
income over the life of the contracts. This change will not affect our prior
securitizations. Historically, Gain on Sale of Loans has been material to our
reported revenues and net earnings. Altering the structure of these transactions
so that no gain is recognized at the time of a securitization transaction will
have a material effect on our reported revenues and net earnings until such time
as we accumulate Finance Receivables on our balance sheet sufficient to generate
interest income (net of interest, credit losses, and other expenses) equivalent
to the revenues that we had historically recognized on our securitization
transactions.
Under our securitization program, we sell the securitized Finance
Receivables to our securitization subsidiaries who then assign and transfer the
Finance Receivables to separate trusts. The trusts issue Class A certificates
and subordinated Class B certificates (Residuals in Finance Receivables Sold) to
the securitization subsidiaries. The securitization subsidiaries then sell the
Class A certificates to the investors and retain the Class B certificates. We
continue to service the securitized contracts.
The Class A certificates from our securitization transactions have
historically received investment grade ratings. To secure the payment of the
Class A certificates, the securitization subsidiaries have:
o obtained an insurance policy from MBIA Insurance Corporation which
guarantees payment of amounts to the holders of the Class A
certificates (for transactions closed after July 1, 1997), and
o established a cash "spread" account (essentially, a reserve account)
for the benefit of the certificate holders.
Spread Account Requirements. We maintain a spread account under our
securitization agreements. The spread account is a reserve account that would be
used to repay the Class A certificates in the event collections on a particular
pool of finance receivables was insufficient to make the required payments. At
the time a securitization transaction is entered into, our securitization
subsidiary makes an initial cash deposit into the spread account, generally
equivalent to 4% of the initial underlying Finance Receivables principal
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<PAGE>
balance, and pledges this cash to the spread account agent. The trustee then
makes additional deposits to the spread account out of collections on the
securitized receivables as necessary to fund the spread account to a specified
percentage, ranging from 6.0% to 10.5%, of the underlying Finance Receivables'
principal balance. The trustee will not make distributions to the securitization
subsidiaries on the Class B certificates unless:
o the spread account has the required balance,
o the required periodic payments to the Class A certificate holders are
current, and
o the trustee, servicer and other administrative costs are current.
We did not complete a securitization during the three-month period ended
March 31, 1999. We met the targeted spread account balances under our
securitization agreements of $19.8 million as of March 31, 1999. We also
maintain spread accounts for the securitization transactions that were
consummated by our discontinued operations. We had satisfied the spread account
obligation of $3.0 million as of March 31, 1999 with respect to these
securitization transactions. During the three month period ended March 31, 1998,
we made initial spread account deposits totaling approximately $3.5 million.
During 1998, we made initial spread account deposits totaling approximately
$13.1 million. The required spread account balance based upon the targeted
percentages was approximately $23.7 million at December 31, 1998 with balances
in the spread accounts totaling approximately $20.6 million. Therefore, the
amount remaining to be funded to meet the targeted balance was approximately
$3.1 million as of December 31, 1998.
In addition to the spread account balance of $20.6 million at December 31,
1998, we also had deposited a total of $1.6 million in trust accounts in
conjunction with certain other agreements. We also maintain spread accounts for
the securitization transactions that were consummated by our discontinued
operations. We had satisfied the spread account funding obligation of $3.7
million as of December 31, 1998 with respect to these securitization
transactions. In addition, as of March 31, 1999, we had satisfied the spread
account funding obligation of $3.0 million for our discontinued operations.
Residuals in Finance Receivables Sold, which are a component of Finance
Receivables, represent our retained portion (the Class B certificates) of the
loans we securitized prior to the fourth quarter of 1998. We utilize a number of
assumptions to determine the initial value of the Residuals in Finance
Receivables Sold. The Residuals in Finance Receivables Sold represent the
present value of the expected net cash flows of the securitization trusts using
the out of the trust method. The net cash flows out of the trusts are the
collections on the loans in the trust in excess of the Class A certificate
principal and interest payments and certain other trust expenses. The
assumptions used to compute the Residuals in Finance Receivables Sold include,
but are not limited to:
o charge off rates,
o repossession recovery rates,
o portfolio delinquency,
o prepayment rates, and
o trust expenses.
The Residuals in Finance Receivables Sold are adjusted monthly to
approximate the present value of the expected remaining net cash flows out of
the trust. To the extent that actual cash flows on a securitization are below
our original estimates, and those differences appear to be other than temporary
in nature, we are required to revalue Residuals in Finance Receivables Sold and
record a charge to earnings based upon the reduction. During the third quarter
of 1997, we recorded a $5.7 million charge (approximately $3.4 million, net of
income taxes) to dealership operations to write down the Residuals in Finance
Receivables Sold. We 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. The charge resulted in a reduction in the carrying
value of our Residuals in Finance Receivables Sold and had the effect of
increasing the cumulative net loss at loan origination assumption to
approximately 27.5% for the securitization transactions that took place prior to
September 30, 1997. The revised loss assumption approximates the assumption used
for the securitization transaction consummated during the third quarter of 1997.
For the securitizations that we completed during the nine month period ended
September 30, 1998, net losses were estimated using total expected cumulative
net losses at loan origination of approximately 29.0%, adjusted for actual
cumulative net losses prior to securitization.
One of the assumptions inherent in the valuation of the Residuals in Finance
Receivables Sold is the projected portfolio net charge offs. The remaining net
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<PAGE>
charge offs in the Residuals in Finance Receivables Sold as a percentage of the
remaining principal balances of securitized contracts was approximately 20.5% as
of March 31, 1999, and 22.0% as of December 31, 1998 compared to 17.9 % as of
December 31, 1997. There can be no assurance that the charge we recorded in the
third quarter of 1997 was sufficient and that we will not need to record
additional charges in the future in order to write down the Residuals in Finance
Receivables Sold.
We classify the residuals as "held-to-maturity" securities in accordance
with SFAS No. 115.
Certain Financial Information Regarding Our Securitizations. We did not
complete a securitization during the three month period ended March 31, 1999
compared to the comparable period in 1998, when we securitized a total of $86.6
million in contracts, issuing $62.6 million in Class A certificates and $24.0
million in Class B certificates. During the first three quarters of 1998, we
securitized an aggregate of $222.8 million in contracts, issuing $161.1 million
in Class A certificates, and $61.7 million in Class B certificates. During the
fourth quarter of 1998, we securitized $69.3 million in contracts, issuing $50.6
million of Class A certificates. Due to the revised securitization structure,
the $69.3 million of loans remained classified as Finance Receivables, and the
$50.6 million in Class A certificates were classified as Notes Payable in our
Consolidated Balance Sheet. During the year ended December 31, 1997, we
securitized an aggregate of $151.7 million in contracts, issuing $121.4 million
in Class A certificates, and $30.3 million in Class B certificates. In 1996, we
securitized an aggregate of $58.2 million in contracts, issuing $44.7 million in
Class A certificates, and $13.5 million in Class B certificates.
We recorded the carrying value of the Residuals in Finance Receivables sold
at $13.9 million for the securitization transaction closed in the first quarter
of 1998, and $36.5 million in the year ended December 31, 1998, and $17.7
million in the year ended December 31, 1997. The balance of the Residuals in
Finance Receivables sold from our dealership operations was $28.5 million as of
March 31, 1999, $33.3 million as of December 31, 1998 and $13.3 million as of
December 31, 1997.
The table below summarizes certain attributes of our securitizations:
<TABLE>
<CAPTION>
Years Ended December 31,
-------------------------------------------------------------
1998 1997 1996
----------------- ------------------ ------------------
<S> <C> <C> <C>
Weighted Average Yield of Certificates Issued.......... 5.9% 6.7% 8.4%
Range of Yields for Certificates Issued................ 5.6% - 6.1% 6.3% - 8.1% 8.2% - 8.6%
Average Net Spreads (after fees and expenses).......... 17.6% 15.8% 17.1%
Range of Net Spreads (after fees and expenses)......... 17.0% - 18.1% 13.7% - 17.8% 16.8% - 17.4%
</TABLE>
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 our expansion into markets
with interest rate limits.
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have increased
in connection with the growth of our business. We require capital for:
o increases in our contract portfolio,
o expansion of our dealership network,
o our commitments under the FMAC transaction,
o expansion of the Cygnet dealer program,
o common stock repurchases,
o the purchase of inventories,
o the purchase of property and equipment, and
o working capital and general corporate purposes.
We fund our capital requirements primarily through:
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<PAGE>
o operating cash flow,
o our revolving facility with General Electric Capital Corporation,
o securitization transactions,
o supplemental borrowings, and
o in the past, equity offerings.
While to date we have met our liquidity requirements as needed, there can be
no assurance that we will be able to continue to do so in the future.
Operating Cash Flow
Net Cash Provided by Operating Activities increased by $23.6 million in the
three months ended March 31, 1999 to $47.0 million compared to the three months
ended March 31, 1998 of $23.4 million. The change in inventory and accounts
payable and accrued expenses contributed to the increase in operating cash flow
for the quarter.
Net Cash Used in Investing Activities increased by $79.5 million to $99.9
million in the three months ended March 31, 1999 compared to $20.4 million in
the three months ended March 31, 1998. The increase is primarily due to
increases in Cash Used in Investing Activities from purchases of Finance
Receivables, net decreases in Cash advanced under our Notes Receivable, which
were offset by increased collections of Finance Receivables and Notes
Receivable.
Net Cash Provided by Financing Activities increased by $32.7 million to
$46.3 million in the three months ended March 31, 1999 compared to $13.6 million
in the three months ended March 31, 1998. The increase is due to increases in
Notes Payable, net of increases in repayments of Notes Payable and the
acquisition of Treasury Stock.
Net Cash Provided by Operating Activities increased by $29.9 million in the
year ended December 31, 1998 to $22.1 million from cash used in the year ended
December 31, 1997 of $7.8 million. The increase in 1998 was due primarily to
increases in the Loss from Discontinued Operations, the Provision for Credit
Losses, and Proceeds from the Sale of Finance Receivables, net of decreases in
Net Earnings and purchases of Finance Receivables. Net Cash Used by Operating
Activities totaled $7.8 million in the year ended December 31, 1997 compared to
Cash Provided by Operating Activities of $23.8 million in 1996. This increase in
cash used in 1997 over cash provided in 1996 was primarily due to increases in
the purchases of Finance Receivables and Inventory, and a reduction in
collections of Finance Receivables, net of increases in the Provision for Credit
Losses and Proceeds from the Sale of Finance Receivables.
Net Cash Used in Investing Activities decreased by $12.2 million to $98.7
million in the year ended December 31, 1998 compared to $110.9 million in 1997.
The decrease is primarily due to increases in Cash Used in Investing Activities
from purchases of Finance Receivables, net decreases in Cash advanced under our
Notes Receivable, increased collections of Notes Receivable, and a reduction in
payment for Acquisition of Assets. Net Cash Used in Investing Activities
increased by $100.3 million to $110.9 million in the year ended December 31,
1997 compared to $10.5 million in 1996. The increase was due primarily to net
increases in Notes Receivable of $25.9 million and Payment for Acquisition of
Assets of $45.2 million.
Net Cash Provided by Financing Activities decreased by $40.5 million to
$69.0 million in the year ended December 31, 1998 compared to $109.5 million in
the comparable period in 1997. The decrease is due to increases in Notes
Payable, net of increases in repayments of Notes Payable and a decrease in
proceeds from the issuance of common stock. Net Cash Provided by Financing
Activities increased by $69.3 million to $109.5 million in the year ended
December 31, 1997 compared to $40.1 million in 1996. The increase was primarily
due to increases in the issuance of Notes Payable, reduction in repayments of
Notes Payable and a lack of any redemption of Preferred Stock.
Financing Resources
Revolving Facility. The maximum commitment under our revolving credit
facility with GE Capital is $125.0 million. Under the revolving facility, we may
borrow:
o up to 65.0% of the principal balance of eligible contracts originated
from the sale of used cars,
o up to 86.0% of the principal balance of eligible contracts previously
originated by our branch office network,
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<PAGE>
o the lesser of $20 million or 58% of the direct vehicle costs for
eligible vehicle inventory, and
o the lesser of $15 million or 50% of eligible contracts or loans
originated under the Cygnet dealer program.
However, an amount up to $8.0 million of the borrowing capacity under the
revolving facility is not available at any time while our guarantee to the
purchaser of contracts acquired from First Merchants is outstanding. The
revolving facility expires in June 2000 and contains a provision that requires
us to pay GE Capital a termination fee of $200,000 if we terminate the revolving
facility prior to the expiration date. We secure the facility with substantially
all of our assets.
As of March 31, 1999, our borrowing capacity under the revolving facility
was $97.1 million, the aggregate principal amount outstanding under the
revolving facility was approximately $75.6 million, and the amount available to
be borrowed under the facility was $21.5 million. The revolving facility bears
interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.09% as
of March 31, 1999).
The revolving facility contains covenants that, among other things, limit
our ability to do the following without GE Capital's consent:
o incur additional indebtedness,
o make any change in our capital structure,
o 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, and
o make certain investments and capital expenditures.
The revolving facility also provides that an event of default will occur if
Mr. Ernest C. Garcia II owns less than 15.0% of our voting stock. Mr. Garcia
owned approximately 32.0% of our common stock at March 31, 1999.
In addition, we are also required to:
o be Year 2000 compliant no later than June 30, 1999 (see discussion below
under the Year 2000 Readiness Disclosure), and
o maintain specified financial ratios, including a debt to equity ratio of
2.2 to 1 and a net worth of at least $110 million.
Under the terms of the revolving facility, we are required to maintain an
interest coverage ratio that we failed to satisfy during the three months ended
March 31, 1999. We failed to meet this covenant primarily due to the reduction
in earnings we recognized as a result of the change in our securitization
structure. GE Capital has waived the covenant violation as of March 31, 1999.
Securitizations. Our securitization program is a primary source of our
working capital. Since September 30, 1997, we have closed all of our
securitizations with private investors through Greenwich Capital Markets, Inc.
(Greenwich Capital). In March 1999, we executed a commitment letter with
Greenwich Capital to act as our exclusive agent in placing up to $300 million of
surety wrapped securities under our securitization program.
Securitizations generate cash flow for us from:
o the sale of Class A certificates,
o ongoing servicing fees, and
o excess cash flow distributions from collections on the contracts
securitized after:
o payments on the Class A certificates sold to third party investors,
o payment of fees, expenses, and insurance premiums, and
o required deposits to the spread account.
In April 1999, we closed a securitization transaction through Greenwich
Capital. Under this transaction, we securitized approximately $120 million of
contracts and issued approximately $87 million of Class A certificates with an
annual interest rate of 5.7%. We received approximately $87 million in cash that
we used to repay our repurchase facility and pay down our revolving line of
credit.
35
<PAGE>
Securitization also allows us to fix our cost of funds for a given contract
portfolio. Failure to regularly engage in securitization transactions will
adversely affect us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Securitizations--Dealership operations" for
a more complete description of our securitization program.
Supplemental Borrowings
Verde Debt. Prior to our public offering in September 1996, we historically
borrowed substantial amounts from Verde Investments, Inc. (Verde), which is
owned by our Chairman, Ernest C. Garcia II. The Subordinated Notes Payable
balances outstanding to Verde totaled $10.0 million as of March 31, 1999 and as
of December 31, 1998. Under the terms of this note, we are required to make
monthly payments of interest and annual payments of principal in the amount of
$2.0 million. These borrowings accrue interest at an annual rate of 10.0%.
Except for the debt incurred related to our exchange offer, this debt is junior
to all of our other indebtedness and we may suspend interest and principal
payments if we are in default on obligations to any other creditors. In July
1997, our Board of Directors approved the prepayment of the $10.0 million in
subordinated debt after the earlier of the following:
o the completion of a debt offering,
o the First Merchants transactions have been completed or the cash
requirements for completion of the transaction are known, or
o we either have cash in excess of our current needs or have funds
available under our financing sources in excess of our current needs.
No such prepayment has been made as of the date of filing of this
prospectus. Any prepayment would require the consent of certain of our lenders.
Exchange Offer. In the fourth quarter of 1998, we acquired approximately 2.7
million shares of our common stock in exchange for approximately $17.5 million
of subordinated debentures. The debentures are unsecured and are subordinate to
all of our existing and future indebtedness. We must pay interest on the
debentures twice a year at 12% per year. We are required to pay the principal
amount of the debentures on October 23, 2003.
We issued the debentures at a premium of approximately $3.9 million over the
market value of the shares of our common stock that were exchanged for the
debentures. Accordingly, the debt was recorded at $13.6 million on our balance
sheet. The premium will be amortized over the life of the debentures and results
in an effective annual interest rate of approximately 18.8%. We can redeem all
or part of the debentures at any time, subject to the subordination provision of
the debentures. The balance of the subordinated debentures was $13.8 million at
March 31, 1999.
Senior Subordinated Notes. In February 1998, we borrowed a total of $15.0
million of subordinated debt from unrelated third parties for a three year term.
We pay interest on this debt quarterly at 12% per annum. This debt is:
o senior to the Verde subordinated note (described above) and the
subordinated debentures issued in our exchange offer (also described
above), and
o subordinate to our other indebtedness.
We issued warrants to the lenders of this debt to purchase up to 500,000
shares of our common stock at an exercise price of $10.00 per share, exercisable
at any time until the later of February 2001, or when the debt is paid in full.
In July 1998, we borrowed a total of $5.0 million in subordinated debt from
unrelated third parties for a three-year term. Under the terms of the loan
agreement, we were required to issue warrants to purchase 115,000 shares of our
common stock by December 31, 1998 if the loan was not paid in full by that date.
The warrants were to have been issued at an exercise price of 120% of the
average trading price for our common stock for the 20 consecutive trading days
prior to the issuance of the warrants. In the first quarter of 1999, we prepaid
$3.0 million of the loans and the lenders waived their right to a proportionate
amount of the warrants. We repaid the remaining $2.0 million in June 1999 and
will not be required to issue the remaining warrants.
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<PAGE>
Sale-Leaseback of Real Property. In March 1998, we executed an agreement
with an investment company for the sale and leaseback of up to $37.0 million in
real property. We sold certain real property to the investment company for its
original cost and leased back the properties for an initial term of twenty
years. We have the right to extend the leases in certain cases. We pay monthly
rents of approximately one-twelfth of 10.75% of the purchase price plus all
occupancy costs and taxes. The agreement calls for annual increases in monthly
rent of not less than 2%. As of December 31, 1998, we had sold approximately
$27.4 million of property under this arrangement. However, we do not anticipate
closing any additional transactions under this agreement with the investment
company. We used substantially all of the proceeds from the sales to pay down
debt.
Additional Financing. On November 12, 1998, we borrowed $15.0 million for a
term of 364 days from Greenwich Capital. We pay interest on this loan at an
interest rate equal to LIBOR plus 400 basis points. We secured the loan with the
common stock of our securitization subsidiaries. In March 1999, we borrowed
$20.0 million for a term of 278 days from Greenwich Capital. $1.5 million was
used to repay the remaining balance of the $15 million Greenwich Capital loan.
The new loan was secured by the common stock of our securitization subsidiaries.
The interest rate is at LIBOR plus 500 basis points and we paid an origination
fee of 100 basis points. This loan was paid in full in June 1999.
On March 26, 1999, we borrowed approximately $28.9 million from Greenwich
Capital under a repurchase facility with a 62% advance rate, bearing interest at
8.5%, and maturing May 31, 1999. This repurchase facility was repaid subsequent
to March 31, 1999. In addition, in March 1999, we executed a commitment letter
with Greenwich Capital in which, subject to satisfaction of certain conditions,
Greenwich Capital agreed to provide us with a $100 million surety-wrapped
warehouse line of credit at a rate equal to LIBOR plus 110 basis points.
In May 1999, we borrowed approximately $38.0 million from an unrelated party
for a term of three years. We pay interest on this loan at a rate of LIBOR plus
550 basis points. The loan is secured by our residuals and finance receivables
sold.
Debt Shelf Registration. In 1997, we registered up to $200 million of our
debt securities under the Securities Act of 1933. There can be no assurance that
we will be able to use this registration statement to sell debt securities, or
successfully register and sell other debt securities in the future.
Capital Expenditures and Commitments
During the three months ended March 31, 1999, we opened two new dealerships.
We also have 6 more dealerships under development. The direct cost of opening a
dealership is primarily a function of whether we lease a facility or construct a
facility. A leased facility costs approximately $650,000 to develop, while a
facility we construct costs approximately $1.7 million. In addition, we require
capital to finance the portfolio that we carry on our balance sheet for each
store. It takes approximately $2.2 million in cash to support a typical
stabilized store portfolio with our existing 65% advance rate under our GE
facility. Additionally, it takes approximately 30 months for a store portfolio
to reach a stabilized level.
On July 11, 1997, we entered into an agreement to provide debtor in
possession financing to FMAC (DIP facility). As of March 31, 1999, the maximum
commitment on the DIP facility was $11.5 million and the outstanding balance on
the DIP facility totaled $11.1 million. We have obligations under our
debtor-in-possession credit facility. We assert that FMAC is currently in
default on the DIP facility. We have negotiated a settlement with them that will
cure the asserted default and increase our funding obligation by $2.0 million in
exchange for certain other considerations, subject to satisfaction of certain
conditions.
We intend to finance the construction of new dealerships and the DIP
facility financing through operating cash flows and supplemental borrowings,
including amounts available under the revolving facility and the securitization
program.
Common Stock Repurchase Program. During the first quarter of 1999 we
repurchased approximately 928,000 shares of our common stock for $5.2 million
under our stock repurchase program. We have repurchased a total of one million
shares of our common stock under the program, which is the total number of
shares the Board of Directors authorized. In April 1999, our Board of Directors
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authorized, subject to certain conditions, a second stock repurchase program
that would allow us to repurchase up to 2.5 million additional shares of our
common stock. Purchases may be made depending on market conditions, share price,
and other factors. We have not purchased any additional shares of common stock
under the second stock repurchase program.
In September 1997, our Board of Directors approved a director and senior
officer stock purchase loan program. We may make 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 common stock on the open market. These
unsecured loans bear interest at 10% per year. During 1997, senior officers
purchased 50,000 shares of common stock under this program and we loaned
$500,000 to the senior officers for these purchases. During 1998, we made
additional loans under similar terms and conditions to senior officers totaling
approximately $393,000 for the purchase of 40,000 shares of our common stock.
Year 2000 Readiness Disclosure
Many older computer programs refer to years only in terms of their final two
digits. Such programs may interpret the year 2000 to mean the year 1900 instead.
The problem affects not only computer software, but also computer hardware and
other systems containing processors and embedded chips. Business systems
affected by this problem may not be able to accurately process date related
information before, during or after January 1, 2000. This is commonly referred
to as the Year 2000 issue. Failures of our own business systems due to Year 2000
issues as well as those of our suppliers and business partners could materially
adversely affect our business. We are in the process of addressing these issues.
Our Year 2000 compliance program consists of:
o identification and assessment of critical computer programs, hardware
and other business equipment and systems,
o remediation and testing,
o assessment of the Year 2000 readiness of our critical suppliers, vendors
and business partners, and
o contingency planning.
Identification and Assessment
The first component of our Year 2000 compliance program is complete. We have
identified our critical computer programs, hardware, and other equipment to
determine which systems are compliant, or must be replaced or remediated.
Remediation and Testing
Dealership Operations. We have finished remediating the program code and
underlying data, testing the remediated code modifications, and have implemented
these changes into operation for our integrated Car Loan Accounting and
Servicing System (CLASS). We placed the modified program code into production in
April 1999 and have completed date testing on the modified code.
Non-Dealership Operations. Our non-dealership loan servicing operations
currently utilize several loan processing and collections programs provided
through third party service bureaus. Based upon certifications we have received
from the software vendors, and independent testing we have performed, we believe
that our loan processing and collections programs are Year 2000 compliant.
Our Cygnet dealer program utilizes one of the same loan processing and
collections programs used by our loan servicing operations. The service bureau
that provides the program has written a custom module for us and has stated the
custom module is Year 2000 compliant. In addition, we have performed independent
Year 2000 compliance testing on the Cygnet dealer program's custom module, and
believe it is year 2000 compliant.
The remediation of the critical business systems used by our dealership and
non-dealership operations was substantially completed during the second quarter
of 1999.
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Assessment of Business Partners
We have also identified critical suppliers, vendors, and other business
partners and have taken steps to determine their Year 2000 readiness. These
steps include interviews, questionnaires, and other types of inquiries. Because
of the large number of business systems that our business partners use and their
varying levels of Year 2000 readiness, it is difficult to determine how any Year
2000 issues of our business partners will affect us. We are not currently aware
of any business relationships with third parties that we believe will likely
result in a significant disruption of our businesses. We believe that our
greatest risk is with our utility suppliers, banking and financial institution
partners, and suppliers of telecommunications services, all of which are
operating within the United States. Potential consequences if we, or our
business partners, are not Year 2000 compliant include:
o failure to operate from a lack of power,
o shortage of cash flow,
o disruption or errors in loan collection and processing efforts, and
o delays in receiving inventory, supplies, and services.
If any of these events occurred, the results could have a material adverse
impact on us and our operations.
Contingency Plans
We are also developing contingency plans to mitigate the risks that could
occur in the event of a Year 2000 business disruption. Contingency plans may
include:
o increasing inventory levels,
o securing additional financing,
o relocating operations to unaffected sites,
o vendor/supplier replacement,
o utilizing temporary manual or spreadsheet-based processes, or
o other prudent actions,
We are currently working on updating our disaster recovery plan and
formulating our Year 2000 contingency plans. We will continue to develop our
contingency plans throughout the rest of the year and expect to complete them by
December 31, 1999.
Costs
We currently estimate that remediation and testing of our business systems
will cost between $2.2 million and $2.7 million. Most of these costs will be
expensed and funded by our operating line of credit. Costs through May 31, 1999
approximate $2.2 million, including approximately $140,000 of internal payroll
costs, substantially all of which have been charged to general and
administrative expense. We believe costs associated with developing and
implementing contingency measures will not be material to our operating results.
The scheduled completion dates and costs associated with the various components
of our Year 2000 compliance program described above are estimates and are
subject to change.
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use financial instruments for trading purposes or to
manage interest rate risk. Our earnings are substantially affected by our net
interest income, which is the difference between the income earned on
interest-bearing assets and the interest paid on interest bearing notes payable.
Increases in market interest rates could have an adverse effect on
profitability.
Our financial instruments consist primarily of fixed rate finance
receivables, residual interests in pools of fixed rate finance receivables,
short term variable rate revolving Notes Receivable, and variable and fixed rate
Notes Payable. Our finance receivables are classified as subprime loans and
generally bear interest at the lower of 29.9% or the maximum interest rate
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allowed in states that impose interest rate limits. At December 31, 1998, the
scheduled maturities on our finance receivables ranged from one to 52 months
with a weighted average maturity of 31.3 months. The interest rates we charge
our customers on finance receivables has not changed as a result of fluctuations
in market interest rates, although we may increase the interest rates we charge
in the future if market interest rates increase. A large component of our debt
at December 31, 1998 is the Collateralized Note Payable (Class A certificates)
issued under our securitization program. Issuing debt through our securitization
program allows us to mitigate our interest rate risk by reducing the balance of
the variable revolving line of credit and replacing it with a lower fixed rate
note payable. We are subject to interest rate risk on fixed rate Notes Payable
to the extent that future interest rates are higher than the interest rates on
our existing Notes Payable.
The table below as of December 31, 1998 illustrates the impact that
hypothetical changes in interest rates could have on our earnings before income
taxes over a twelve month period. We compute the impact on earnings for the
period by first computing the baseline net interest income on our financial
instruments with interest rate risk, which are the variable rate revolving
credit lines and the variable rate notes payable. We then determine the net
interest income based on each of the interest rate changes listed below and
compare the results to the baseline net interest income to determine the
estimated change in pretax earnings. The table does not give effect to our fixed
rate receivables and borrowings.
Change in Interest Rates Change in Pretax Earnings
(in thousands)
+ 2% $ (1,208)
+ 1% $ (604)
- 1% $ 627
- 2% $ 1,581
In computing the effect of hypothetical changes in interest rates, we have
assumed that:
o interest rates used for the baseline and hypothetical net interest
income amounts are in effect for the entire twelve month period,
o interest for the period is calculated on financial instruments held at
December 31, 1998 less contractually scheduled payments and maturities,
and
o there is no change in prepayment rates as a result of the interest rate
changes.
Our sensitivity to interest rate changes could be significantly different if
actual experience differs from the assumptions used to compute the estimates.
Seasonality
Historically, we have experienced higher revenues in the first two quarters
of the year than in the latter half of the year. We believe that these results
are due to seasonal buying patterns because many of our 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 our borrowings would decrease the profitability of our
existing portfolio. To date, inflation has not had a significant impact on our
operations. We seek to limit this risk:
o through our securitization program, which allows us to fix our borrowing
costs,
o by increasing the interest rate charged for contracts originated at our
dealerships (if allowed under applicable law), or
o by increasing the profit margin on the cars sold, and for contracts
acquired from third party dealers under our Cygnet dealer program,
either by acquiring contracts at a higher discount or with a higher APR.
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Accounting Matters
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132) which became
effective for us January 1, 1999. SFAS No. 132 establishes standards for the
information that public enterprises report in annual financial statements. The
adoption of SFAS No. 132 did not have a material impact on us.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133) which becomes effective for us June 15,
2000. We believe the adoption of SFAS No. 133 will not have a material impact on
us.
BUSINESS
General
We operate the largest chain of buy here-pay here used car dealerships in
the United States. We sell and finance our used vehicles to customers within the
sub-prime segment of the used car market. Our customers will typically have
limited credit histories, low incomes or past credit problems. At March 31,
1999, we operated 58 dealerships located in several large markets, including Los
Angeles, Phoenix, Dallas, San Antonio, Atlanta, and Tampa.
In addition to our own dealership and financing operations, we also
o provide financing to other independent used car dealers through our
Cygnet dealer program,
o service and collect large portfolios of finance receivables owned by
others, and
o manage selected financial assets that we acquire from financially
distressed third parties.
For a description of the general development of our business during the past
five years, and a description of our financial information over the past three
years, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
Overview of Used Car Sales and Finance Industry
Used Car Sales. Used car retail sales typically occur through either
manufacturer's franchised new car dealerships that sell used cars or through
independent used car dealerships. The market for used car sales in the United
States is significant and has steadily increased over the past five years. There
are over 23,000 franchised and 63,000 independent used car dealership locations
in the United States.
We participate in the sub-prime segment of the independent used car sales
and finance market. This segment is serviced primarily by 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, including:
o expanded credit opportunities;
o flexible payment terms, including prorating customer payments due within
one month into several smaller payments and scheduling payments to
coincide with a customer's paydays; and
o the ability to make payments in person. This is 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.
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. This industry is served by such traditional lending sources as
banks, savings and loans, and captive finance subsidiaries of automobile
manufacturers, as well as by independent finance companies and buy here-pay here
dealers. In general, the industry is categorized according to the type of car
sold (new versus used) and the credit characteristics of the borrower.
The industry statistical information presented in this section is derived
from information provided to the Company by CNW Marketing/Research of Bandon,
Oregon.
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Company Dealership Operations
We commenced dealership operations in 1992 with the acquisition of two
dealerships in Arizona, and have expanded aggressively since then through a
combination of acquisitions and development of new stores. Our most significant
growth occurred in 1997, when
o we acquired from Seminole Finance, Inc. and related companies
(Seminole), four dealerships in Tampa/St. Petersburg and a contract
portfolio of approximately $31.1 million;
o we purchased from E-Z Plan, Inc. (E-Z Plan), seven dealerships in San
Antonio and a contract portfolio of approximately $24.3 million;
o we purchased from Kars-Yes Holdings, Inc. and related companies (Kars),
six dealerships in the Los Angeles market, two in the Miami market, two
in the Atlanta market, and two in the Dallas market; and
o we opened our first used car dealership in the Las Vegas market, opened
two additional dealerships in the Albuquerque market and opened one
additional dealership in the Phoenix market. We also closed a dealership
in Arizona.
We continued our aggressive growth in 1998 and the first quarter of 1999,
adding 17 new dealerships in our existing markets in 1998 and 2 new dealerships
in our existing markets in the first quarter of 1999. We opened one dealership
in the Albuquerque market, four dealerships in the Atlanta market, four
dealerships in the Dallas market, two dealerships in the Los Angeles market, two
dealerships in the Phoenix market, two dealerships in the San Antonio market,
and four dealerships in the Tampa market. We also closed two dealerships in
Miami and exited that market.
The following table summarizes the number of stores we had in operation by
major market for the three years ended December 31, 1998 and the three month
period ended March 31, 1999:
Number of Stores By Market
---------------------------------------------------------
March 31, December 31,
------------ ----------------------------------------
1999 1998 1997 1996
----------- ---------- ---------- ------------
Phoenix........... 9 9 7 5
San Antonio....... 9 9 7 --
Atlanta........... 9 9 5 --
Los Angeles....... 8 8 6 --
Tampa............. 9 8 5 --
Dallas............ 7 6 3 --
Tucson............ 3 3 3 3
Albuquerque....... 3 3 2 --
Las Vegas......... 1 1 1 --
Miami............. -- -- 2 --
=========== ========== ========== ============
58 56 41 8
=========== ========== ========== ============
Retail Car Sales. We distinguish our dealership operations from those of
typical buy here-pay here dealers through our:
o network of multiple locations,
o upgraded facilities,
o larger inventories of used cars,
o centralized purchasing,
o advertising and marketing programs, and
o dedication to customer service.
Our dealerships are generally located in high visibility, high traffic
commercial areas, and tend to be newer and cleaner in appearance than other buy
here-pay here dealerships. This helps promote our image as a friendly and
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reputable business. We believe this, coupled with our widespread brand name
recognition, enables us to attract customers who might otherwise visit another
buy here-pay here dealer.
Our dealerships generally maintain an average inventory of 50 to 150 used
cars and feature a wide selection of makes and models (with ages generally
ranging from 3 to 7 years) and a range of sale prices. This allows us to meet
the tastes and budgets of a broad range of potential customers. We acquire our
inventory from new or late-model used car dealers, used car wholesalers, used
car auctions, and customer trade-ins. In making purchases, we take into account
each car's retail value and the costs of buying, reconditioning, and delivering
the car for resale. After purchase, cars are generally delivered to one of our
nearby inspection centers, where they are inspected and reconditioned for sale.
Upon inspection, certain used cars do not meet our criteria for reconditioning
either because it will cost too much to recondition the car, or because the car
is in a condition too poor for us to recondition and sell. In these instances,
we promptly sell the car in the wholesale market. Although the supply and prices
of used cars are subject to market variance, we do not believe that we will
encounter significant difficulty in maintaining the necessary inventory levels.
Our average sales price per car was $7,997 for the year ended December 31,
1998 compared to $7,443 for the year ended December 31, 1997 and $7,107 in the
year ended December 31, 1996. We typically require down payments of
approximately 5.0% to 15.0% of the purchase price with the balance of the
purchase price financed at fixed interest rates ranging from 21.0% to 29.9% over
periods ranging from 12 to 48 months. We sell cars on an "as is" basis, and
require our customers to sign an agreement at the date of sale releasing us from
any obligation with respect to vehicle-related problems that subsequently occur.
See " Legal Proceedings."
Used Car Financing. We finance substantially all of the used cars that we
sell at our dealerships through retail installment contracts, under which we
provide the financing and service the collection of loan payments. Subject to
the discretion of our sales managers, potential customers must meet our
underwriting guidelines before we will agree to finance the purchase of a car.
In connection with each sale, customers are required to complete a credit
application. Our employees then analyze and verify the customer application
information, which contains employment and residence histories, income
information, references, and other information regarding the customer's credit
history.
Our credit underwriting process takes into account the ability of our
managers 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, we may schedule contract payments to coincide with the
customer's paydays, whether weekly, biweekly, semi-monthly, or monthly.
Dealership Operations Computer Systems. We recently completed converting our
chain of dealerships and dealership portfolio loan service centers to a single
integrated computer system. The system allows us to make the sale, service the
loan, and track the vehicle and related loan. Once the final sales contract is
generated, the system automatically adds the loan to our loan servicing and
collections database and records the sale and related loan in our accounting
system. We use communication networks that allow us to service large volumes of
contracts from our centralized servicing facilities, while enabling the customer
the flexibility to make payments at any of our dealership locations. In
addition, we have developed comprehensive databases and sophisticated management
tools, including static pool analysis, to analyze customer payment history and
contract performance, and to monitor underwriting effectiveness.
Advertising and Marketing. We have a large advertising budget. In general,
our advertising campaigns emphasize our multiple locations, wide selection of
quality used cars, and ability to provide financing to most sub-prime borrowers.
We believe that our marketing approach creates brand name recognition and
promotes our image as a professional, yet approachable, business. We use
television, radio, billboard, and print advertising to market our dealerships.
A primary focus of our marketing strategy is our ability to finance
consumers with poor credit histories. Consequently, we have initiated innovative
marketing programs designed to attract sub-prime borrowers, assist these
customers in establishing good credit, reward those customers who pay on time,
develop customer loyalty, and increase referral and repeat business. Among these
programs are:
o The Down Payment Back Program. This program encourages customers to make
timely payments on their contracts by allowing them to receive a refund
of their initial down payment at the end of the contract term, if all
payments have been made by the scheduled due date.
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o The Income Tax Refund Program. During the first quarter of each year, we
offer assistance to customers in the preparation of their income tax
returns, including forwarding the customers' tax information to a
designated preparer, paying the preparation fee (in most states), and,
if they get a tax refund, crediting the refund toward the required down
payment. This program enables customers to purchase cars without having
to wait to receive their income tax refund.
o $250 Visa Card Program. This program encourages customers to make timely
payments on their contracts by allowing them to receive a Visa credit
card with an initial credit limit of $250. This program offers otherwise
unqualified customers the chance to obtain the convenience of a credit
card and rebuild their credit records.
We also operate a loan-by-phone program using our toll-free telephone number
of 1-800-THE-DUCK, and accept credit inquiries on our web site at
www.uglyduckling.com. Credit inquiries received over the web are reviewed by our
employees, who then contact and schedule an appointment for the customers.
Sales Personnel and Compensation. Each dealership is run by a general
manager who has responsibility for the operations of the dealership facility,
including:
o profitability of the dealership,
o final approval of sales and contract originations,
o inventory maintenance,
o the appearance and condition of the facility, and
o the hiring, training, and performance of dealership employees.
We also typically staff each dealership with a sales manager, an assistant
sales manager, three customer service representatives, five to twelve
salespersons, and two lot attendants.
We train our managers to be contract underwriters. They are paid a base
salary and may earn bonuses based upon the overall performance of the contract
portfolio originated at their dealership, as well as the dealership's
profitability. Sales persons are paid on a commission basis. However, each sale
must be underwritten and approved by a manager.
Monitoring and Collections
One of our goals is to minimize credit losses through close monitoring of
contracts in our portfolio. When a car sale is completed, the contract is
automatically added to our loan servicing database. Our monitoring and
collections staff then use our collections software to monitor the performance
of the contracts.
The collections software provides us with, among other things, up-to-date
activity reports, allowing prompt identification of customers whose accounts
have become past due. In accordance with our policy, collections personnel
contact a customer with a past due account within three days of delinquency to
inquire as to the reasons for the delinquency and to suggest ways in which the
customer can resolve the underlying problem. Our early detection of a customer's
delinquent status, as well as our commitment to working with our customers,
allows us to identify and address payment problems quickly, and reduce the
chance of credit loss. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Allowance for Credit Losses."
If our efforts to work with a customer are unsuccessful and the customer
becomes seriously delinquent, we will take the necessary steps to minimize our
loan loss and protect our collateral. Frequently, delinquent customers will
recognize their inability to honor their contractual obligations and will work
with us to coordinate "voluntary repossessions" of their cars. In other cases,
we hire independent firms to repossess the vehicles. After repossession and a
statutorily mandated waiting period, we typically sell the repossessed car in
the wholesale market. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Allowance for Credit Losses."
Unlike most other used car dealership chains or automobile finance
companies, we permit our customers to make payments on their contracts in person
at any of our dealerships or at any of our collection facilities. Payments
received at our dealerships account for a significant portion of monthly
contract receipts on the dealership portfolio.
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Non-Dealership Operations
Cygnet Dealer Program. Many independent used car dealers have difficulty
obtaining working capital from traditional financing sources. As a result, they
are forced to sell the finance receivables that they originate from the sale of
used cars at significant discounts in order to obtain the working capital
necessary to operate their businesses. Most financing programs available to
independent used car dealers do not allow the dealer to service the loans sold.
Yet, we believe that dealers prefer to service the loans they originate so they
can maintain contact with the customer to more effectively collect payments and
generate referrals or repeat business.
To capitalize on this opportunity, we developed the Cygnet dealer program,
which provides qualified dealers with warehouse purchase facilities and
revolving lines of credit primarily secured by the dealers' finance receivable
portfolios. The dealer remains responsible for collection of finance receivable
payments and retains control of the customer relationship. The credit facilities
are for specified amounts and are subject to various collateral coverage ratios,
maximum advance rates, and performance measurements, depending on the financial
condition of the dealer and the quality of the finance receivables originated.
As a condition to providing financing, each dealer is required to satisfy
certain criteria to qualify for the program, report collection activities to us
on a daily basis and provide us with periodic financial statements. In addition,
dealers are "audited" by our audit department on a periodic basis. As of March
31, 1999, we had lending relationships with a total of 65 independent dealers in
37 states, with principal balances totaling approximately $55.0 million.
The dealer collection program is the primary product offered to independent
dealers under the Cygnet dealer program. Under this program, we purchase finance
receivables at a discount from qualified dealers. The dealer remains responsible
for the collection of the contract payments and retains control of the customer
relationship. We typically purchase finance receivable contracts at 65% to 75%
of the principal balance subject to a maximum of 170% of the Kelly Blue Book
wholesale price of the underlying collateral. All cash collections, including
regular monthly payments, payoffs and repurchases, are deposited directly by the
dealer into a bank account that we maintain and control. We keep all regular
monthly cash payments and payoffs, and generally pay the dealer a servicing fee
equal to 20% to 25% of the regular monthly cash payments collected. Generally,
each dealer pays a nonrefundable initial audit fee plus a processing fee per
contract or provides a security deposit. The dealer is required to repurchase
all finance receivable contracts that are 45 days past due. The dealer
collection program is full recourse to the dealer and typically includes
personal guarantees by the principal owners of the dealership.
We also offer a secured revolving line of credit to qualified dealers under
the asset based loan version of the Cygnet dealer program. We generally advance
up to 65% of the principal amount of eligible finance receivables subject to a
maximum of 170% of the Kelly Blue Book wholesale price of the underlying
collateral. We also charge an annual commitment fee of 1% to 2% of the available
line and interest on any amounts outstanding at the rate of prime plus 5% to 9%.
In addition, each dealer generally pays a nonrefundable initial audit fee plus a
processing fee per contract. The dealer is responsible for collection of
contract payments and maintaining the customer relationship. All cash
collections are deposited directly into a bank account that we maintain and
control. Finance receivables that are 45 days delinquent are excluded from the
calculation of the amount available under the line of credit. If the exclusion
of delinquent contracts causes the line to become over funded, then the dealer
must either pay down the line or assign additional qualifying finance
receivables to us. Each line of credit is full recourse to the dealer, typically
with full guarantees by the principal owners of the dealership.
Cygnet dealer's net investment in finance receivables purchased from two
third party dealers totaled approximately $16.3 million representing
approximately 30% of Cygnet dealer's net finance receivables portfolio as of
March 31, 1999. There were no other third party dealer loans that exceeded 10%
of Cygnet dealer's finance receivable portfolio as of March 31, 1999.
Bulk Purchasing and Loan Servicing Operations. In 1997 and 1998, we entered
into several large servicing and/or bulk purchasing transactions involving third
party dealer contract portfolios. The most significant of these transactions is
our involvement in the bankruptcy proceedings of First Merchants Acceptance
Corporation ("FMAC") described below. Our non-dealership operations service
loans from facilities in Aurora, Colorado and Plano, Texas. As of March 31,
1999, our loan servicing segment employed approximately 470 employees and
serviced approximately 70,000 loans with an aggregate principal balance of
approximately $475 million.
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Our non-dealership operations use separate computer systems from our
dealership operations. However, our collection policies and procedures for
non-dealership operations are generally the same as those used by our dealership
operations.
See "Monitoring and Collections" above.
The following describes certain aspects of our involvement in the bankruptcy
case of FMAC and in FMAC's approved plan of reorganization which were undertaken
through our bulk purchasing and loan servicing operations. FMAC emerged from
bankruptcy on April 1, 1998.
Senior Bank Debt Claim. On August 21, 1997, we purchased 78% of the senior
bank debt of FMAC for approximately $69 million, which represented a discount of
10% of the outstanding principal amount of such debt. In addition, we agreed to
pay the selling banks additional consideration up to the amount of this 10%
discount (or approximately $7.6 million) if FMAC makes cash payments or issues
notes at market rates to its unsecured creditors and equity holders in excess of
10% of their allowed claims against FMAC. In connection with the purchase, we
also issued to the selling banks warrants to purchase up to 389,800 shares of
our common stock at an exercise price of $20.00 per share at any time through
February 20, 2000. We subsequently purchased the remaining senior bank debt at a
5% discount.
The contracts securing the senior bank debt were then sold in the fourth
quarter to a third party (the "Contract Purchaser") at a gain of approximately
$8.1 million ($5.0 million, net of income taxes). We guaranteed to the Contract
Purchaser a specified return on the contracts that it purchased. Our maximum
exposure on this guarantee was approximately $8.0 million at March 31, 1999.
However, we do not believe that we will be required to make any payments under
this guarantee. Consequently, we have not accrued any liability related to this
guarantee as of March 31, 1999.
Once the Contract Purchaser has received its guaranteed return on the
contracts, we are entitled to additional recoveries from the contracts up to a
specified amount. FMAC has guaranteed to us on a non-recourse basis our recovery
of this amount, secured by the residual interests and certain equity
certificates in FMAC's securitization transactions (collectively, the "B
Pieces"). However, with certain exceptions, if we do not continue to service the
contracts sold to the Contract Purchaser, the guaranteed amount will be limited
to $10 million.
DIP Facility. We have agreed to provide debtor-in-possession financing to
FMAC (the "DIP Facility"). As of March 31, 1999, our maximum commitment under
the DIP Facility was reduced to $11.5 million, of which $11.1 million was
outstanding. FMAC pays interest on the DIP Facility at 10% per year. The DIP
Facility is scheduled to be repaid with certain income tax refunds and, after
payment of FMAC's guarantee to us, distributions from FMAC's B pieces. Under the
terms of the agreement, FMAC must apply the first $10 million of income tax
refunds to pay down the DIP Facility. These payments will permanently reduce the
maximum that FMAC can borrow under the DIP Facility. Payments from B Pieces will
also pay down and permanently reduce the maximum amount FMAC can borrow under
the DIP Facility. Payments made on the DIP Facility from sources other than
income tax refunds and B Pieces will not permanently reduce the maximum amount
and FMAC is allowed to reborrow such amounts under the DIP Facility. As of March
31, 1999, FMAC had applied approximately $10.0 million in income tax refunds to
pay down and reduce the maximum availability under this facility. Although we
have declared FMAC in default under the DIP Facility, we have negotiated a
resolution of this matter with FMAC, which will include an increase in the DIP
Facility by approximately $2.0 million in exchange for other concessions.
Excess Collections Split. We will split with FMAC any excess recovery on the
contracts sold to the Contract Purchaser and on the B Pieces, after FMAC pays
its guaranteed amount to us, the DIP Facility and our fees. We are entitled to
receive 17 1/2% of the excess with the remaining 82 1/2% being distributed to
FMAC (the "Excess Collections Split"). The Excess Collections Split allocation
may be reduced or eliminated if certain events occur. As of March 31, 1999, we
had not recognized any revenue from the Excess Collections Split. We anticipate
recognizing revenue on this transaction at the time collections under the
arrangement are probable and reasonably estimable. If several conditions are
met, including that our common stock is trading at $8 or more, we have the right
to issue shares of common stock to FMAC or its unsecured creditors or equity
holders in exchange for all or part of FMAC's portion of the Excess Collection
Split.
Servicing. We service the contracts sold to the Contract Purchaser and the
contracts in all but one of FMAC's securitized pools, and receive servicing
fees.
46
<PAGE>
Other Matters. On the effective date of FMAC's plan of reorganization, in
addition to the warrants described above, we issued warrants to FMAC to purchase
up to 325,000 shares of our common stock at $20.00 per share. These warrants are
exercisable through April 1, 2001. See "Risk Factors - We Have Certain Risks
Relating to the FMAC Transaction."
Discontinued Operations/Split-Up of the Company
Contract Purchasing. In 1994, we acquired Champion Financial Services, Inc.,
an independent automobile finance company. In April 1995, we initiated an
aggressive plan to expand Champion's branch office network and, by December 31,
1997, we operated 83 branch offices across the country. In February 1998, we
announced our intention to close the branch office network and exit this line of
business in the first quarter of 1998. We recorded a pre-tax charge to
discontinued operations totaling approximately $9.1 million (approximately $5.6
million, net of income taxes) during the first quarter of 1998. In addition, a
$6.0 million charge (approximately $3.6 million, net of income taxes) was taken
during the third quarter of 1998 due primarily to higher than anticipated loan
losses and servicing expenses. The branch office closure was substantially
complete by the end of the first quarter of 1998.
In the third quarter of 1997, we announced a strategic evaluation of our
non-dealership operations, including the possible sale or spin-off of these
operations. In February 1998, in addition to closing our branch offices, we
announced our intent to evaluate alternatives for our remaining non-dealership
operations. On April 28, 1998, we announced that our Board of Directors had
directed management to proceed with separating the existing operations into two
companies and subsequently formed a new wholly owned subsidiary, Cygnet
Financial Corporation ("Cygnet"), to operate the Cygnet dealer program and the
bulk purchase and third party loan servicing operations. These businesses were
then classified as discontinued operations in our consolidated financial
statements. A proposal to split-up the two companies through a rights offering
was approved by our stockholders at the annual stockholders meeting held in
August 1998. We subsequently issued rights to our stockholders to purchase
Cygnet common stock. Due to a lack of stockholder participation, however, the
rights offering was canceled. We recorded a $2.0 million charge ($1.2 million,
net of income tax) in the third quarter of 1998 to write off the costs
associated with the rights offering. In the first quarter of 1999, we
reclassified the Cygnet dealer program and bulk purchasing and loan servicing
operations into continuing operations for all years presented in the
accompanying consolidated financial statements and this prospectus.
Accordingly, while the branch office network continues to be reported as
discontinued operations, the Cygnet dealer program and bulk purchasing and loan
servicing operations (including the FMAC transaction) have been reclassified
into continuing operations for the years ended December 31, 1998, 1997, and 1996
in our accompanying Consolidated Financial Statements.
Competition
Although the used car industry has historically been highly fragmented, it
has attracted significant attention from a number of large companies, including
AutoNation, U.S.A, and Car Max, all of whom have entered the used car sales
business or announced plans to develop large used car sales operations. Many
franchised automobile dealers have increased their focus on the used car market
as well. We believe 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 we have.
However, none of these companies currently represent significant direct
competition in the sub-prime market. Currently, our major competition for our
dealership operations is the numerous independent buy here-pay here dealers that
sell and finance sales of used cars to sub-prime borrowers. See
"Business--Company Dealership Operations" for a description of how we
distinguish our operations from those of typical buy here-pay here dealers.
Our non-dealership operations are also highly competitive. In these
operations, we compete with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater resources, including access to lower priced capital. In
addition, there are numerous financial services companies serving, or capable of
serving these markets. While traditional financial institutions, such as
commercial banks, saving and loans, credit unions, and captive finance companies
of major automobile manufacturers, have not consistently served the sub-prime
markets, the yields earned by companies involved in sub-prime financing have
encouraged certain of these traditional institutions to enter, or contemplate
entering, these markets.
47
<PAGE>
Increased competition may cause downward pressure on sales prices and/or on
the interest rate we charge on contracts originated at our dealerships, or cause
us to reduce or eliminate acquisition discounts on the contracts we purchase in
our non-dealership operations. Such events would have a material adverse affect
on us.
Regulation, Supervision, and Licensing
Our operations are subject to ongoing regulation, supervision, and licensing
under various federal, state, and local laws related to the sale of cars, the
extension of credit, and the collections of loans. Among other things, these
laws:
o require that we obtain and maintain certain licenses and qualifications,
o limit or prescribe terms of the contracts that we originate and/or
purchase,
o require specific disclosures to customers,
o limit our right to repossess and sell collateral, and
o prohibit us from discriminating against certain customers.
We typically charge fixed interest rates significantly in excess of
traditional finance companies on the contracts originated at our dealerships.
Currently, a significant portion of our used car sales activities are conducted
in, and a significant portion of the contracts we service were originated in,
states which do not impose limits on the interest rate that a lender may charge.
However, we have expanded, and will continue to expand our operations into
states that impose interest rate limits, such as Florida and Texas.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. However, if
we do not remain in compliance with such laws, this failure could have a
material adverse effect on our operations. In addition, the adoption of
additional laws, changes in the interpretation of existing laws, or our entrance
into jurisdictions with more stringent regulatory requirements could have a
material adverse effect on our business.
Trademarks and Proprietary Rights
We have an ongoing program under which we evaluate our intellectual property
and consider appropriate Federal and State intellectual property related
filings. We believe that the value of our trademarks is increasing with the
development of our business. We believe we have taken appropriate measures to
protect our proprietary rights. However, there can be no assurance that such
efforts have been successful.
Employees
At March 31, 1999, we employed approximately 2,100 persons. None of our
employees are covered by a collective bargaining agreement.
Properties
As of March 31, 1999, we leased substantially all of our facilities,
including 58 dealerships, 4 collection facilities that service our dealership
portfolios, 3 non-dealership collection facilities, 11 inspection centers, and
our corporate offices. We are continuing to negotiate lease settlements and
terminations with respect to our branch office network closure. Our corporate
and divisional administrative offices are located in approximately 40,000 square
feet of leased space in Phoenix, Arizona.
Legal Proceedings
We sell our cars on an "as is" basis. We require all customers to
acknowledge in writing on the date of sale that we disclaim any obligation for
vehicle-related problems that subsequently occur. Although we believe that these
disclaimers are enforceable under applicable laws, there can be no assurance
48
<PAGE>
that they will be upheld in every instance. Despite obtaining these disclaimers,
in the ordinary course of business, we receive complaints from customers
relating to vehicle condition problems as well as alleged violations of federal
and state consumer lending or other similar laws and regulations. Most of these
complaints are made directly to us or to various consumer protection
organizations and are subsequently resolved. However, customers occasionally
name us as a defendant in civil suits filed in state, local, or small claims
courts. Additionally, in the ordinary course of business, we are a defendant in
various other types of legal proceedings. Although we cannot determine at this
time the amount of the ultimate exposure from these lawsuits, if any, based on
the advice of counsel, we do not expect the final outcome to have a material
adverse effect on our financial position.
MANAGEMENT
Directors and Executive Officers
Information concerning our directors and executive officers as of June 21,
1999 is below. The table gives the name, age, positions and offices with Ugly
Duckling, principal occupation and business experience of the individual, family
relationships, other directorships and certain other biographical information
for our directors and executive officers. The table also includes for our
directors the year in which he first became a director for us:
<TABLE>
<CAPTION>
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Name Age Position with Ugly Duckling & Business Experience Director
Since
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
<S> <C> <C>
Ernest C. Garcia II 42 Chairman of the Board of Ugly Duckling since its founding in 1992 1992
and Chief Executive Officer of Ugly Duckling since its founding to
July 1999. Mr. Garcia also served as President from 1992 to 1996.
Since 1991, Mr. Garcia has served as President of Verde Investments,
Inc. (Verde), a real estate investment corporation that is an
affiliate of Ugly Duckling. Mr. Garcia's sister is married to Mr.
Johnson, our General Counsel and Secretary. See "Involvement in
Certain Legal Proceedings" and "Certain Relationships and Related
Transactions."
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Christopher D. Jennings 45 Director of Ugly Duckling. Also, a Managing Director of Friedman, 1996
Billings, Ramsey & Co., Inc., an investment banking firm, since
April 1998. Mr. Jennings served as a managing director of Cruttenden
Roth Incorporated (Cruttenden Roth), also an investment banking
firm, from 1995 to April 1998. From 1992 to 1994, Mr. Jennings
served as a Managing Director at the investment banking firm, Sutro
& Co. 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 is also a
director of GlobalNet Financial.com, an international multimedia
provider of online news and information services to the investment
community. Mr. Jennings is a member of both the Compensation
Committee and the Audit Committee of our board. See "Certain
Relationships and Related Transactions" and "Security Ownership of
Certain Beneficial Owners and Management."
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
49
<PAGE>
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
John N. MacDonough 55 Director of Ugly Duckling. Also, the former Chairman and Chief 1996
Executive Officer of Miller Brewing Company, a brewer and marketer
of beer, from 1993 until April 1999. Mr. MacDonough previously
served from 1992 to 1993 as Miller Brewing's President and Chief
Operating Officer. Prior to 1992, he 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
and Wisconsin Energy Corporation, a utility engaged in the
generation, transmission, distribution and sale of electric energy.
He is married to the sister of Mr. Sullivan.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Gregory B. Sullivan 41 Director, President and Chief Executive Officer of Ugly Duckling 1998
Corporation, since 1998 as Director, since March 1996 as President
and since July 1999 as CEO. From March 1996 to July 1999, Mr.
Sullivan served as Chief Operating Officer of Ugly Duckling. 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 for us. He 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.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Frank P. Willey 45 Director of Ugly Duckling. Also, President of Fidelity National 1996
Financial, Inc., a title insurance underwriter, since 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. and CKE Restaurants,
Inc., an operator of various quick-service restaurant chains. He is
a member of both the Compensation Committee and the Audit Committee
of our board.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Jon D. Ehlinger 42 Vice President, General Counsel and Secretary of Ugly Duckling --
Corporation, since July 1999. Beginning in July 1998, Mr.Ehlinger began
serving as General Counsel and Secretary for Ugly Duckling's Car Sales
subsidiaries and related dealership operations. From 1997 to July 1998,
Mr. Ehlinger worked as a corporate attorney in the law firm of Bonn,
Luscher, Padden & Wilkins. From April of 1996 to April of 1997 Mr.
Ehlinger was self-employed as an attorney in the state of Arizona. Mr.
Ehlinger served as corporate counsel for First Interstate Bank in
Phoenix, Arizona from 1984 to 1996.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Steven T. Darak 51 Senior Vice President and Chief Financial Officer of Ugly Duckling, --
since February 1994, having joined us 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 we acquired in early 1994. Prior to 1989, Mr. Darak served
in various positions in the banking industry and in public
accounting.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
50
<PAGE>
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
Donald L. Addink 49 Treasurer and Senior Vice President - Senior Analyst of Ugly --
Duckling, since June 1999 as Treasurer and since November 1998 as
Senior Vice President - Senior Analyst. From 1995 to November 1998,
he served as our Vice President - Senior Analyst. 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.
- ------------------------------- --------- ---------------------------------------------------------------------- -----------
</TABLE>
Directors of Ugly Duckling are elected for 1 year terms. Each of our
directors serve until the following annual meeting of Ugly Duckling or until his
successor is duly elected and qualified. Our executive officers serve at the
discretion our Board of Directors. The term of office for the officers named
above will expire in July 2000 or on their earlier retirement, resignation, or
removal. Except as summarized above, there is no family relationship among any
of our directors or executive officers.
Involvement in Certain Legal Proceedings
Prior to 1992, when he founded Ugly Duckling, Ernest C. Garcia II 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, which ultimately took over Lincoln, asserted that Lincoln
improperly accounted for the transactions and that Mr. Garcia's participation in
the transactions facilitated the improper accounting. Facing severe financial
pressures, Mr. Garcia agreed to plead guilty to one count of bank fraud, but in
light of his cooperation with authorities both before and after he was charged,
was sentenced to only three years probation, which has expired, was fined $50
(the minimum fine the court could assess), and during the period of his
probation, which ended in 1996, was banned from becoming an officer, director or
employee of any federally-insured financial institution or a securities firm
without governmental approval. In separate actions arising out of this matter,
Mr. Garcia agreed not to violate the securities laws, and filed for bankruptcy
both personally and with respect to certain entities he controlled. The
bankruptcies were discharged by 1993.
COMPENSATION OF EXECUTIVE OFFICERS, BENEFITS AND RELATED MATTERS
Summary Compensation Table
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities for us during the three
fiscal years ended December 31, 1998 of our Named Executive Officers. "Named
Executive Officers" consist of (1) our Chairman of the Board and Chief Executive
Officer, (2) our 4 next most highly compensated executive officers serving as
executive officers at December 31, 1998, and (3) 2 additional individuals who
would have been reported under (2) above but for the fact that the individuals
were not serving as executive officers for Ugly Duckling at December 31, 1998.
51
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------- -------- ----------------------------------- -------------------------- ----------
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------- --------------------------
AWARDS
------------- ------------
OTHER SECURITIES
ANNUAL RESTRICTED UNDER- ALL OTHER
NAME AND PRINCIPAL COMPEN- STOCK LYING COMPEN-
POSITION YEAR SALARY BONUS SATION AWARD(S) OPTIONS SATION
($) ($) ($) (#)(1) ($)(2)
<S> <C> <C> <C> <C> <C> <C> <C>
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Ernest C. Garcia II(10) 1998 $150,462 -- $ 3,228(3) -- -- $ 1,000
Chairman of the Board and -------- ----------- ----------- ----------- ------------- ------------ ----------
Chief Executive Officer 1997 131,677 -- 2,985(3) -- -- 950
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 121,538 -- 2,950(3) -- -- 923
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Gregory B. Sullivan(10) 1998 $208,308 -- $ 1,156(4) -- 500,000 $ 833
President and Chief -------- ----------- ----------- ----------- ------------- ------------ ----------
Operating Officer 1997 197,846 -- -- -- -- 554
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 97,385(4) --(4) --(4) -- 125,000 --
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Steven T. Darak 1998 $180,961 -- $ 1,750(5) -- 65,001(6) --
Senior Vice President and -------- ----------- ----------- ----------- ------------- ------------ ----------
Chief Financial Officer 1997 148,654 $ 25,000 1,750(5) -- -- --
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 100,000 100,000 9,250(5) -- 40,000 --
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Steven P. Johnson(10) 1998 $179,023 -- -- -- 42,500(7) $ 1,252
Senior Vice President, -------- ----------- ----------- ----------- ------------- ------------ ----------
General Counsel and Secretary 1997 131,677 -- -- -- 20,000 820
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 121,538 -- -- -- 25,000 566
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Donald L. Addink 1998 $171,346 $ 40,000 -- -- 33,500(8) $ 1,000
Treasurer and Senior Vice -------- ----------- ----------- ----------- ------------- ------------ ----------
President -- Senior Analyst 1997 139,671 10,000 -- -- -- 950
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 122,142 10,000 -- -- 42,000 985
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Walter T. Vonsh(10) 1998 $155,869 $ 81,000 $ 1,125(3) -- -- $ 1,000
Former Senior Vice President -------- ----------- ----------- ----------- ------------- ------------ ----------
--- Credit 1997 150,000 -- 2,550(3) -- -- 889
-------- ----------- ----------- ----------- ------------- ------------ ----------
1996 126,923 30,000 5,000(3) -- 50,000 277
-------- ----------- ----------- ----------- ------------- ------------ ----------
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
Steven A. Tesdahl(10) 1998 $187,115 -- -- -- 75,000(9) $ 1,000
Senior Vice President -------- ----------- ----------- ----------- ------------- ------------ ----------
and Chief Information Officer 1997 53,846 -- -- $100,000(11) 100,000 --
of Ugly Duckling Car Sales -------- ----------- ----------- ----------- ------------- ------------ ----------
1996 -- -- -- -- -- --
- ----------------------------------------- -------- ----------- ----------- ----------- ------------- ------------ ----------
<FN>
(1) The amounts shown in this column represent stock options granted either pursuant to the Incentive Plan or the Executive
Plan. For the Incentive Plan, options generally vest over a 5-year period, with 20.0% of the options becoming exercisable
on each successive anniversary of the date of grant. For the Executive Plan, options vest over a 5-year period, with 20.0%
becoming exercisable on each successive anniversary of the date of grant, but subject to additional vesting hurdles based
on the market price of our common stock as traded on Nasdaq. Regardless of the preceding vesting schedule being met for
the Executive Plan options, such options fully vest on January 15, 2005 (i.e., "cliff vest"). See "Compensation of
Executive Officers, Benefits and Related Matters - Long Term Incentive Plan" and " --- 1998 Executive Incentive Plan" for
a discussion of the Incentive Plan and Executive Plan, respectively.
(2) The amounts shown in this column include the dollar value of 401(k) plan contributions made by Ugly Duckling for the
benefit of our Named Executive Officers.
(3) These amounts include car allowances as follows: (a) Mr. Garcia -- a $3,228 car allowance during 1998, a $2,985 car
allowance during 1997 and a $2,950 car allowance during 1996; and (b) Mr. Vonsh - a $1,125 car allowance during 1998, a
$2,550 car allowance during 1997, and a $5,000 car allowance during 1996.
(4) Mr. Sullivan became an executive officer of Ugly Duckling during March 1996. Prior to that, he was an independent
contractor for us. Therefore, the above table does not reflect the Annual Compensation paid to Mr. Sullivan while he was
an independent contractor in 1996. Other Annual Compensation includes $1,156 for Mr. Sullivan's personal use of a company
car for a portion of 1998.
(5) These amounts include $7,500 that we paid for a Phoenix apartment for Mr. Darak during 1996, while his full time residence
was in Tucson, Arizona, and a $1,750 car allowance during each of 1998, 1997 and 1996.
(6) Includes 15,001 options that were cancelled and reissued on November 17, 1998. See "Report on Repricing of Options."
(7) Includes 17,500 options that were cancelled and reissued on November 17, 1998. See "Report on Repricing of Options."
(8) Includes 8,500 options that were cancelled and reissued on November 17, 1998. See "Report on Repricing of Options."
(9) Includes 50,000 options that were cancelled and reissued on November 17, 1998. See "Report on Repricing of Options."
(10) Employment changes occurred for these officers as follows: (a) effective July 26, 1999, Mr. Garcia ceased to be the Chief
Executive Officer of Ugly Duckling, but continues to serve as Chairman of the Board; (b) effective July 26, 1999, Mr.
Sullivan was elected President and Chief Executive Officer of the Company; (c) effective July 26, 1999, Mr. Johnson no
longer holds any executive office with Ugly Duckling, although he continues to hold offices with Cygnet Financial
Corporation, a subsidiary of Ugly Duckling, and certain subsidiaries of Cygnet;(d) effective March 1998, Mr. Vonsh
resigned his officer position of Senior Vice President -- Credit for Ugly Duckling, but he continues to be employed by us
in other positions and capacities; and (e) effective November 1998, we revised our officer structure and as part of that
process, Mr. Tesdahl stopped being an executive officer for Ugly Duckling. He continues to be employed by us as a Senior
Vice President and Chief Information Officer of Ugly Duckling Car Sales. Mr. Tesdahl began his employment and became an
executive officer of Ugly Duckling in September 1997.
(11) The dollar amount shown represents the market value as of the grant date of restricted stock awarded to Mr. Tesdahl upon
his initial hiring in September 1997. The grant was pursuant to his employment agreement with us and was made outside of
the Incentive Plan and the Executive Plan. The award was for approximately 7,692 shares at $13.00 per share (based on the
closing price of our stock on the grant date as reported by Nasdaq). Under Mr. Tesdahl's employment agreement, these
shares vested 100% in January 1998. At December 31, 1998, Mr. Tesdahl retained 4,565 shares from the restricted stock
award, valued at $21,136 (based on the December 31, 1998 closing price of our stock of $4.63 per share as reported by
Nasdaq).
</FN>
</TABLE>
52
<PAGE>
Option Grants In Last Fiscal Year
The following table provides information on option grants for the fiscal
year ended December 31, 1998 to each of our Named Executive Officers.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------ --------------------------------
POTENTIAL REALIZABLE VALUE AT
INDIVIDUAL GRANTS ASSUMED ANNUAL RATES OF STOCK
PRICE APPRECIATION FOR OPTION
TERM(1)
- --------------------------- --------------- ----------------- ----------- ---------------- --------------- ----------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS GRANTED
UNDERLYING TO EMPLOYEES EXERCISE
OPTIONS IN FISCAL YEAR PRICE EXPIRATION
NAME GRANTED (#) ($/SH) DATE 5%($) 10%($)
<S> <C> <C> <C> <C> <C> <C>
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Ernest C. Garcia II -- -- -- -- -- --
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Gregory B. Sullivan 250,000(2) 17.2% $ 8.25 1/15/2008 $1,297,095 $3,287,094
250,000(3) 17.2% 8.25 1/15/2008 1,297,095 3,287,094
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Steven T. Darak 50,000(2) 3.5% $ 8.25 1/15/2008 $ 259,419 $ 657,419
15,001(4) 1.0% 5.13 11/17/2004(4) 26,172 59,376
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Steven P. Johnson 25,000(2) 1.7% $ 8.25 1/15/2008 $ 129,710 $ 328,709
17,500(4) 1.2% 5.13 11/17/2004(4) 30,532 69,267
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Donald L. Addink 25,000(2) 1.7% $ 8.25 1/15/2008 $ 129,710 $ 328,709
8,500(4) 0.6% 5.13 11/17/2004(4) 14,830 33,644
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Walter T. Vonsh -- -- -- -- -- --
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
Steven A. Tesdahl 25,000(2) 1.7% $ 8.25 1/15/2008 $ 129,710 $ 328,709
50,000(4) 3.5% 5.13 11/17/2004(4) 87,235 197,905
- --------------------------- --------- ----- ----------- ---------------- ---------- ----------
<FN>
(1) Potential Realized Values are net of the exercise price, but before
taxes associated with the exercise. Amounts represent hypothetical
gains that could be achieved for the respective options if exercised at
the end of the option term. The assumed 5% and 10% rates of stock price
appreciation are provided in accordance with the rules of the
Securities and Exchange Commission and do not represent our estimate or
projection of the future price of our common stock. Actual gains, if
any, on stock option exercises will depend upon the future market
prices of our common stock on the date of exercise. Accordingly, there
can be no assurance that the values shown in the last 2 columns will be
realized. The closing price of our common stock on June 21, 1999 was
$7.50 per share.
(2) On January 15, 1998, these Named Executive Officers of Ugly Duckling
were granted these performance-based stock option awards under the
Executive Plan. They are part of the initial grants that were approved
by our board, the Compensation Committee and ultimately our
stockholders at the 1998 annual meeting. The initial grants have
exercise prices equal to the fair value of our common stock on the date
of grant. They vest over a 5-year period, with 20.0% becoming
exercisable on each successive anniversary of the date of grant, but
subject to additional vesting hurdles based on the market price of our
common stock as traded on Nasdaq. However, even if the market price
hurdles are not met, these options fully vest on January 15, 2005
(i.e., "cliff vest"). The options have 10-year terms. See "Compensation
of Executive Officers, Benefits and Related Matters - 1998 Executive
Incentive Plan" for additional information on these initial grants and
our Executive Plan.
(3) These options were granted to Mr. Sullivan under the Incentive Plan at
an exercise price equal to the fair value of the shares on the date of
grant. The options have a 10-year term. The options vest over a 5-year
period, with 20.0% becoming exercisable on each successive anniversary
of the date of grant. See "Compensation of Executive Officers, Benefits
and Related Matters - Long Term Incentive Plan" for additional
information on this grant and our Incentive Plan.
(4) In November 1998, we repriced certain outstanding options. As a
condition to the repricing, the optionee was required to reduce the
number of shares underlying the repriced grant by 50%. The number in
the table represents the repriced options remaining after the
reduction. See "Report on Repricing of Options."
</FN>
</TABLE>
Recent Option Grants In 1999
On March 2, 1999, the Compensation Committee reviewed and approved grants of
stock options to Ugly Duckling employees. These grants include the right to
acquire an aggregate of approximately 452,400 shares of our common stock. The
options include awards to the following Named Executive Officers to acquire our
common stock at an exercise price of $5.56 per share: (1) a 100,000 share option
to Ernest C. Garcia II; (2) a 125,000 share option to Gregory B. Sullivan; (3) a
35,000 share option to Steven T. Darak; (4) a 20,000 share option to Steven P.
Johnson; and (5) a 35,000 share option to Donald L. Addink. The grants to
Messrs. Sullivan and Darak are performance-based stock options with cliff
vesting. The exercise price for these grants equaled the fair value of the
shares on the date of grant.
53
<PAGE>
Aggregated Option Exercises in Last Fiscal Year and Option Values as of
December 31, 1998
The table below sets forth information with respect to option exercises and
the number and value of options outstanding at December 31, 1998 held by our
Named Executive Officers. Generally, we have not issued any other forms of stock
based awards.
<TABLE>
<CAPTION>
- --------------------------- ---------------- ----------------- ---------------------------------- ----------------------------------
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
FISCAL YEAR END (#)(1) FISCAL YEAR END ($)(2)
----------------- ---------------- ----------------- ----------------
SHARES
ACQUIRED ON VALUE
NAME EXERCISE (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
<S> <C> <C> <C> <C> <C> <C>
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Ernest C. Garcia II -- -- -- -- -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Gregory B. Sullivan -- -- 79,600 561,400 $141,984 $94,656
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Steven T. Darak -- -- 4,000 71,001 -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Steven P. Johnson 4,000 $13,820(4) -- 48,500 -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Donald L. Addink 20,000(3) $30,000(4) -- 33,500 -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Walter T. Vonsh -- -- 20,000 30,000 -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
Steven A. Tesdahl -- -- -- 75,000 -- --
- --------------------------- ---------------- ----------------- ----------------- ---------------- ----------------- ----------------
<FN>
(1) For the Incentive Plan, generally, options vest over a 5-year period,
with 20% of the options becoming exercisable on each successive
anniversary of the date of grant. For the Executive Plan, options vest
over a 5-year period, with 20% of the options becoming exercisable on
each successive anniversary of the date of grant, but subject to
additional vesting hurdles based on the market price of our common
stock as traded on Nasdaq. In any event, such options fully vest on
January 15, 2005 (i.e., "cliff vest"). See "Compensation of Executive
Officers, Benefits and Related Matters- Long Term Incentive Plan" and "
--- 1998 Executive Incentive Plan" for additional information on the
Incentive Plan and Executive Plan, respectively.
(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 our common stock on December 31, 1998. The market price of our
common stock on December 31, 1998 was $4.63 per share based on the
closing price of our 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 2 columns will be realized. The closing price of our
common stock on June 21, 1999 was $7.50 per share.
(3) In January 1998, Mr. Addink exercised 20,000 stock options at an
exercise price of $6.75 per share. As discussed in this prospectus,
these options were subject to accelerated vesting pursuant to Mr.
Addink's restated employment agreement with us. See " -- Contracts with
Directors and Executive Officers and Severance Arrangements - Donald L.
Addink."
(4) The value realized represents the value of stock options exercised
during the last fiscal year. The value realized was calculated by
subtracting the exercise price of each relevant option from the fair
market value of the common stock underlying the options as of the
exercise date. The fair market value of our common stock was based on
the closing price of Ugly Duckling stock on the date of exercise as
reported by Nasdaq. Under Ugly Duckling's plans, the exercise date is
the date the participant provides notice to us of his/her exercise and
method of payment.
</FN>
</TABLE>
Long-Term Incentive Plan
In June 1995, our stockholders approved the Long Term Incentive Plan
(Incentive Plan). We believe that our Incentive Plan promotes the success and
enhances the value of Ugly Duckling by (1) linking the personal interests of
participants to those of our stockholders, and (2) providing participants with
an incentive for outstanding performance. Under the Incentive Plan, we may grant
various types of awards to our employees, consultants and advisors, including:
o incentive stock options (ISOs),
o nonqualified stock options (NQSOs),
o performance shares,
o restricted stock, and
o performance-based awards.
54
<PAGE>
The Incentive Plan is administered by our board or a board committee (i.e.,
Compensation Committee), whose membership qualifies as non-employee directors
and outside directors. The Compensation Committee has the authority to
administer the plan, including the power to determine -
o eligibility,
o type and number of awards to be granted, and
o 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).
Thus far, we have only granted ISOs and NQSOs under this plan. Generally,
these stock options have been subject to vesting over a 5-year period, with
20.0% of the options becoming exercisable by the holder on each successive
anniversary date of the grant. The options generally expire 10 years after the
grant date. The total number of shares of our common stock initially available
for awards under the Incentive Plan was 1,800,000. The exercise price of all
options granted under the plan in the past has equaled or exceeded the fair
market value of our common stock on the date of grant. The plan has a "change of
control" provision that is summarized below in this prospectus. See
"Compensation of Executive Officers, Benefits and Related Matters -- Change of
Control Arrangements."
In January 1998, the Compensation Committee granted, subject to certain
conditions, approximately 775,000 options to purchase common stock to several of
our officers, 250,000 of which were granted under the Incentive Plan and the
remaining 525,000 of which were granted under the 1998 Executive Incentive Plan.
In March 1999, the Compensation Committee granted, subject to certain
conditions, approximately 152,400 options under the Incentive Plan. Also in
January 1998 and later in November 1998, we repriced certain options under the
Incentive Plan after the Compensation Committee approved the repricings.
At June 28, 1999, we had granted options under the plan to purchase
approximately 1,396,000 shares of our common stock (net of canceled and lapsed
grants) to various of our employees, of which approximately 1,125,000 were
outstanding. Also at June 28, 1999, there were approximately 404,000 of our
shares that remained available for grant under the plan.
1998 Executive Incentive Plan
The 1998 Executive Incentive Plan (Executive Plan) was approved by our
stockholders at our 1998 annual meeting. The plan became effective as of January
1998. Under the Executive Plan, Ugly Duckling may grant ISOs, NQSOs, SARs,
performance shares, restricted stock, and performance-based awards to its
employees, consultants and advisors. Although the Executive Plan allows broad
based awards to be granted and thus is similar to the Incentive Plan, we
currently intend to utilize the Executive Plan primarily for performance-based
awards to our executives and key employees. The total number of shares of our
common stock initially available for awards under the Executive Plan was
800,000. The exercise price of all options granted under the Executive Plan in
the past has been equal to the fair market value of our common stock on the date
of grant. The plan is administered by the Compensation Committee and has a
"change of control" provision that is summarized below in this prospectus. See
"-- Change of Control Arrangements."
In January 1998, the Compensation Committee granted, subject to certain
conditions, approximately 775,000 options to purchase our common stock to
several of our officers, 525,000 of which were granted under the Executive Plan
and the remaining 250,000 of which were granted under the Incentive Plan. In
March 1999, the Compensation Committee granted, subject to certain conditions,
approximately 300,000 options under the Executive Plan.
At June 28, 1999, we had granted options under the plan to purchase 760,000
shares of our common stock (net of canceled and lapsed grants) to various
officers of Ugly Duckling, all of which are outstanding. Also at June 28, 1999,
there were 40,000 shares that remained available for grant under the plan.
Other than as summarized and noted above, the Executive Plan is similar to
the Incentive Plan as described in this Prospectus.
55
<PAGE>
401(k) Plans
Under both of our 401(k) plans, eligible employees may direct that we
withhold a portion of their compensation, up to a legally established maximum,
and contribute this amount to their accounts. We place all 401(k) plan
contributions in trust funds within our 401(k) plans. Participants may direct
the investment of their account balances among mutual or investment funds
available under the plans. The 401(k) plans provide a matching contribution of
25.0% of a participant's pretax contributions up to 6% of the participant's
compensation. Under one of our 401(k) plans, Ugly Duckling's matching
contributions are generally made in the form of Ugly Duckling common stock.
Under both plans, discretionary additional contributions may be made by us, if
we authorize them. Amounts contributed to participant accounts under the 401(k)
plans and any earnings or interest accrued on the participant accounts are
generally not subject to federal income tax until distributed to the participant
and, except in limited cases, the participant may not withdraw such amounts
until death, retirement or termination of employment.
Report on Repricing of Options
During 1998, the Compensation Committee of our board approved 2 separate
plans to reprice certain outstanding stock options under the Incentive Plan. The
first repricing occurred on January 15, 1998 and excluded Ugly Duckling's
executive officers from the repricing program (January Repricing). In connection
with the January Repricing the Compensation Committee retained a compensation
consultant who advised the members on the reasonableness and appropriateness of
the repricing. The second repricing occurred on November 17, 1998 and included
certain executive officers in the program (November Repricing). During 1997 and
1998, Ugly Duckling's stock declined leaving many key employees with options
that had exercise prices significantly above the trading range of our stock
(i.e., the options were "underwater"). Both the January Repricing and November
Repricing were offered to a broad base of Ugly Duckling's non-executive officers
and other employees holding options under the Incentive Plan. As part of both
repricings, the exercise price of the options was reduced to equal or exceed the
then fair market value of Ugly Duckling's stock on the date of the repricings,
as measured by the closing price of its stock on such date per Nasdaq. Other
than the 2 repricings that occurred in 1998, Ugly Duckling has not repriced any
options held by any of its employees.
For the January Repricing, eligible options were repriced to $9.75 per
share. The repriced exercise price was at a premium over the market price of
Ugly Duckling's stock on the date of the reprice. On the date of the repricing,
Ugly Duckling's stock closed at $8.25 per share. The repricing did not change
any other term of the eligible options, including vesting.
For the November Repricing, the Compensation Committee decided to give
certain optionees (including executive officers) a new opportunity to cancel and
reprice certain underwater options. Generally, this repricing allowed optionees
with grants at exercise prices of $9.75 and above the choice of repricing
specific grants to an exercise price of $5.13, the closing price of Ugly
Duckling's stock on the date of the repricing. The term of each repriced option
began anew on the date of repricing. In exchange for the lower exercise price
and extended term, the optionees were required to (1) reduce their number of
eligible shares under each grant by 50%, and (2) start the original vesting
schedule over again.
Contracts with Directors and Executive Officers and Severance Arrangements
Ernest C. Garcia II. On January 1, 1996, we entered into a 3-year
employment agreement with Mr. Garcia, our Chairman and former Chief Executive
Officer. This agreement was extended for another 3-year term effective December
31, 1998. The agreement established Mr. Garcia's base salary for 1996 at
$120,000 per year and provided a minimum 10.0% increase in the base salary each
year throughout the term of the agreement. In addition, the agreement provided
for the continuation of Mr. Garcia's base salary and certain benefits for a
period of 1 year in the event Mr. Garcia is terminated by us without cause prior
to the expiration of the agreement. It also contains confidentiality and
non-compete covenants.
In July 1999, Mr. Garcia stepped down from his position as Chief Executive
Officer of Ugly Duckling. He remains as our Chairman of the Board. Gregory B.
Sullivan was appointed as the new Chief Executive Officer of Ugly Duckling.
56
<PAGE>
Donald L. Addink. On June 1, 1995, we entered into a 5-year employment
agreement with Mr. Addink, our Treasurer and Senior 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 agreement, a $10,000 bonus payment
upon execution of the restated agreement, certain benefits, and the continuation
of Mr. Addink's base salary and certain benefits for a period of 1 year in the
event Mr. Addink is terminated by us without cause prior to expiration of the
restated agreement. It also contains confidentiality and non-compete covenants.
Further, it accelerated the vesting of Mr. Addink's 100,000 stock options
previously granted under the Incentive Plan, as set forth in the table below.
These options were originally granted pursuant to the Incentive Plan's general
5-year vesting schedule with 20% vesting each year.
ORIGINAL GRANT DATE NUMBER EXERCISE PRICE ACCELERATED
OF SHARES(#) PER SHARE($) VESTING DATE
- --------------------- ----------------- ---------------- ----------------------
June 1995 58,000 $ 1.72 August 1, 1997
- --------------------- ----------------- ---------------- ----------------------
June 1996 25,000 6.75 January 15, 1998
- --------------------- ----------------- ---------------- ----------------------
December 1996 17,000 17.69 August 1, 1997
- --------------------- ----------------- ---------------- ----------------------
Walter T. Vonsh. On April 1, 1995, we entered into a 3-year employment
agreement with Mr. Vonsh, our former Senior Vice President -- Credit, that was
modified on or about April 1, 1996, August 6, 1997 and May 26, 1998. Mr. Vonsh
is no longer our Senior Vice President -- Credit, but continues to be employed
by us in other capacities. 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 us without cause prior to that time. It also contains
confidentiality and non-compete covenants.
Steven A. Tesdahl. On August 16, 1997, we entered into an employment
agreement with Mr. Tesdahl that was amended as of May 21, 1998. Mr. Tesdahl is
Senior Vice President and Chief Information Officer of our Ugly Duckling Car
Sales subsidiary and the former Senior Vice President and Chief Information
Officer of Ugly Duckling. The agreement provides for no minimum or maximum term
of employment. But it does provide for: (1) his annual base salary at $175,000
per year with a minimum 10% increase on each anniversary of the hire date; (2)
an initial stock option grant to acquire 100,000 shares of our common stock
under the Incentive Plan, with terms and conditions consistent with the plan's
general terms; (3) a grant of restricted stock valued at $100,000 on the
approximate effective date of Mr. Tesdahl's employment with us, which fully
vested as of January 15, 1998; and (4) certain other benefits. The agreement
provides for the continuation of Mr. Tesdahl's base salary for a limited period
in the event he is terminated by us without cause. The potential severance
benefit decreases over time, and goes to zero after September 1, 2000. The
agreement has a "change of control" provision that provides for certain rights
and benefits to Mr. Tesdahl upon such an event occurring and either:
o he terminates his employment with us within 12 months after the change
of control; or
o we terminate him without cause within 90 days prior to the change of
control or within 12 months after the event.
If these events occur, Mr. Tesdahl will receive a termination fee equal to
200% of his then current salary, and at the time of the change of control, his
initial option will fully vest. 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 Ugly Duckling. See " -- Change of Control Arrangements."
Generally. For additional information on option grants to our executive
officers under the Incentive Plan and Executive Plan, see " - Long Term
Incentive Plan" and " - 1998 Executive Incentive Plan." For information on stock
repricings that occurred during 1998, see "Report on Repricing of Options."
57
<PAGE>
Change of Control Arrangements
Long Term Incentive Plan. The term "change of control" is defined in the
Incentive Plan and is summarized in the next paragraph of this prospectus. Upon
a change of control of Ugly Duckling, the Compensation Committee, in its
discretion, will either --
o cause all outstanding options and awards to be fully vested and
exercisable and all restrictions to lapse, allowing participants the
right to exercise options and awards before the change of control occurs
(which event would otherwise terminate participants' options and
awards); or
o cause all outstanding options and awards to terminate, if the surviving
or resulting corporation agrees to assume the options and awards on
terms that substantially preserve the rights and benefits of outstanding
options and awards.
Under the Incentive Plan, a "change of control" occurs upon any of the
following events:
o a merger or consolidation of Ugly Duckling with another corporation
where we are not the surviving entity or where our stock would be
converted into cash, securities or other property, other than a merger
in which our stockholders before the merger have the same proportionate
ownership after the merger;
o with certain exceptions, any sale, lease, or other transfer of more than
40% of our assets or our earning power;
o our stockholders approve a plan of complete liquidation or dissolution;
o any person (other than a current stockholder or any employee benefit
plan) becoming the beneficial owner of 20% or more of our common stock;
or
o during any 2-year period, the persons who are on our board at the
beginning of such period and any new person whose election or nomination
was approved by two-thirds of such directors cease to constitute a
majority of the persons serving on our board.
1998 Executive Incentive Plan. The Executive Plan provides that in the event
of a "change of control" of Ugly Duckling, all outstanding options and awards
will be fully vested and exercisable and all restrictions will lapse unless the
surviving or resulting corporation agrees to assume the options and awards on
terms that substantially preserve the rights and benefits of outstanding options
and awards. The Executive Plan and the Incentive Plan have the same definition
for the term "change of control."
Generally. For additional information on change of control and severance
arrangements, see " -- Contracts with Directors and Executive Officers and
Severance Arrangements."
Compensation Committee Interlocks and Insider Participation
There are no compensation committee interlocks and no officer or former
officer of ours has ever been a member of our board's Compensation Committee.
See "Certain Relationships and Related Transactions."
Compensation of Our Directors and the Director Incentive Plan
We pay our independent directors $1,000 for physical attendance at meetings
of the board and at meetings of committees of the board on which they serve, and
we reimburse them for reasonable travel expenses for such meetings. We do not
compensate board and committee members for their attendance at telephonic
meetings. If a board and committee meeting are held on the same day, a member
who attends both meetings will receive a combined total compensation of $1,000.
In addition, under Ugly Duckling's Director Incentive Plan (Director Plan), upon
initial appointment or initial election to the board, each of our independent
directors receives Ugly Duckling common stock valued at $30,000 (Director
Stock). Director Stock generally vests in increments of 1/3 over a three-year
period. Arturo Moreno stepped down from our board in June 1998 due to time
constraints relating to his family and other business interests. In
consideration for Mr. Moreno's invaluable services as a director over the past
two years, we accelerated the vesting of the final one-third of Mr. Moreno's
Director Stock. Similarly, when Robert Abrahams resigned from the board in April
of 1999, we accelerated the vesting of the final one-third of Mr. Abrahams'
Director Stock in recognition of his services to us as a director. On April 20,
1999, our board and the Compensation Committee approved additional compensation
58
<PAGE>
for each of our independent directors. On that date it was determined that each
independent director would receive a stock option to purchase 5,000 shares of
Ugly Duckling common stock under the Incentive Plan. The options were granted
effective June 21, 1999 at an exercise price of $6.28 per share (the closing
price per Nasdaq and the fair market value of our stock on April 20, 1999), and
fully vested as of June 21, 1999. We do not compensate directors who are also
officers of Ugly Duckling for their service as directors and such directors are
not eligible to participate in our Director Plan.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table gives information as of June 21, 1999, unless another date
is indicated, concerning:
o each beneficial owner of more than 5% of our common stock: Ernest C.
Garcia II, Harris Associates L.P., FMR Corp., Merrill Lynch & Co., Inc.
and Wellington Management Company, LLP;
o beneficial ownership by all our directors and all our other executive
officers named in the Summary Compensation Table found earlier in this
prospectus (Named Executive Officers); and
o beneficial ownership by all our directors and executive officers as a
group.
The number of shares beneficially owned by each entity, person, director or
executive officer is determined under rules of the Securities and Exchange
Commission, and the information does not necessarily indicate beneficial
ownership for any other purpose. Under these rules, beneficial ownership
includes any shares as to which the individual has the sole or shared voting
power or investment power and also any shares which the individual has the right
to acquire as of August 20, 1999 (60 days after June 21, 1999) through the
exercise of any stock option, warrant or other right. Unless otherwise
indicated, each person has sole investment and voting power (or shares these
powers with his spouse) with respect to the shares set forth in the following
table. Other than as set forth below, we know of no other 5% owner of our common
stock as of June 21, 1999.
59
<PAGE>
<TABLE>
<CAPTION>
BENEFICIAL OWNERSHIP TABLE
Amount and Nature of Percent of
Title of Class Name of Beneficial Owner, Address and Other Information(1) Beneficial Class(2)(3)(4)
Ownership(#)(2)(3)(4)
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
<S> <C> <C> <C>
Common Stock Ernest C. Garcia II, Chairman of the Board and 5% 4,500,000 Direct
Owner, indirect ownership consists of 136,500 shares held 294,500 Indirect 32.1%
by the Garcia Family Foundation, Inc., an Arizona nonprofit 0 Vested Options
corporation, and 158,000 shares held by Verde, an affiliate ---------
of ours and Mr. Garcia. 4,794,500 Total
=========
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Harris Associates L.P.,(4) 5% Owner, based on Schedule 13G 1,825,000 Direct 11.4%
filings as of December 31, 1998, by Harris Associates L.P. 0 Indirect
(Harris) and an affiliate of Harris, Harris Associates 0 Vested Options
Investment Trust and related funds (Harris Trust). ---------
According to these Schedule 13Gs, each of Harris and Harris 1,825,000 Total
Trust has shared voting and dispositive power over 1,750,000 =========
shares of our common stock and Harris has shared voting and
sole dispositive power over an additional 75,000 shares of
our common stock.
Two North LaSalle Street, Suite 500
Chicago, Illinois 60602
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock FMR Corp.,(4) 5% Owner, based on a Schedule 13G filing as 1,172,800 Direct 7.3%
of December 31, 1998, by FMR Corp., along with certain of 0 Indirect
its affiliates (FMR). According to the Schedule 13G, FMR 0 Vested Options
has no voting power over shares and has sole dispositive ---------
power over 1,172,800 shares of our common stock. 1,172,800 Total
82 Devonshire Street =========
Boston, Massachusetts 02019
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Merrill Lynch & Co., Inc.,(4) 5% Owner, based on a Schedule 1,055,000 Direct 6.6%
13G filing as of December 31, 1998, by Merrill Lynch & Co., 0 Indirect
Inc. on behalf of Merrill Lynch Asset Management Group 0 Vested Options
(Merrill Parent) and Merrill Lynch Global Allocation Fund, ---------
Inc. (Merrill Global). Merrill Parent is located at 250 1,055,000 Total
Vesey Street, New York, New York 10281. Merrill Global is =========
located at the below address. According to the Schedule
13G, Merrill Global has shared voting and dispositive power
over 1,000,000 shares of our common stock and Merrill
Parent has shared voting and dispositive power over
1,055,000 shares of our common stock.
800 Scudders Mill Rd.
Plainsboro, New Jersey 08536
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Wellington Management Company, LLP,(4) 5% Owner, based on a 1,041,000 Direct 6.5%
Schedule 13G filing as of December 31, 1998, by Wellington 0 Indirect
Management Company, LLP. According to the filing, 0 Vested Options
Wellington Management Company, LLP has shared voting power ---------
over 403,200 shares of our common stock and shared 1,041,000 Total
dispositive power over 1,041,000 shares of our common stock. =========
75 State Street
Boston, Massachusetts 02109
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Gregory B. Sullivan, Director, President and Chief 50,800 Direct 1.6%
Executive Officer 0 Indirect
184,600 Vested Options
-------
235,400 Total
=======
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Steven P. Johnson, Vice President and General Counsel of 313,000 Direct 2.1%
Cygnet Financial Corporation 0 Indirect
7,000 Vested Options
320,000 Total
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
Common Stock Steven T. Darak, Senior Vice President, Chief Financial 140,000 Direct 1.0%
Officer 0 Indirect
16,000 Vested Options
------
156,000 Total
=======
- ------------------ ------------------------------------------------------------- -------------------------------- -------------
</TABLE>
60
<PAGE>
<TABLE>
<CAPTION>
Title of Class Amount and Nature of Percent of
Name of Beneficial Owner, Address and Other Information(1) Beneficial Class(2)(3)(4)
Ownership(#)(2)(3)(4)
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
<S> <C> <C> <C>
Common Stock Donald L. Addink, Treasurer and Senior Vice President - 98,000 Direct *
Senior Analyst 0 Indirect
5,000 Vested Options
-----
103,000 Total
=======
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock Walter T. Vonsh, Former Senior Vice President - Credit 14,000 Direct *
0 Indirect
25,000 Vested Options
------
39,000 Total
======
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock Steven A. Tesdahl, Senior Vice President and Chief 14,565 Direct *
Information Officer of Ugly Duckling Car Sales and Finance 0 Indirect
Corporation (Ugly Duckling Car Sales) 5,000 Vested Options
-----
19,565 Total
======
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock Robert J. Abrahams, (5) Former Director (6), indirect 8,244 Direct *
ownership consists of shares of our common stock acquired 700 Indirect
by Mr. Abrahams' spouse. 0 Vested Options
-----
8,944 Total
=====
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock Christopher D. Jennings, (5)(7) Director, indirect ownership 6,444 Direct *
of a warrant to purchase 19,833 shares of our common stock 19,833 Indirect
held on behalf of Mr. Jennings by Cruttenden Roth, an 5,000 Vested Options
investment banking firm and previous employer of Mr. ------
Jennings. The warrants are convertible into our common 31,277 Total
stock at any time through June 21, 2001 at an exercise ======
price of $9.45 per share and are fully vested
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock John N. MacDonough, (5)(7) Director, indirect ownership 4,444 Direct *
consists of shares of our common stock acquired by Mr. 100 Indirect
MacDonough's son. 5,000 Vested Options
-----
9,544 Total
=====
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
Common Stock Frank P. Willey, (5)(7) Director 27,144 Direct *
0 Indirect
5,000 Vested Options
-----
32,144 Total
======
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
All directors and executive officers as a group 5,753,374 37.8%
(12 persons)
- ------------------ ------------------------------------------------------------ -------------------------------- --------------
<FN>
* Represents less than one percent of the outstanding common stock.
(1) Unless otherwise noted, the address of each of the listed beneficial owners of our common stock is 2525 East Camelback
Road, Suite 500, Phoenix, Arizona 85016.
(2) "Vested Options" are options that the holder can exercise as of August 20, 1999. These options were issued under either
the Incentive Plan or Executive Plan and their related terms and conditions, including vesting schedules. See
"Compensation of Executive Officers, Benefits and Related Matters - Long Term Incentive Plan" and " - 1998 Executive
Incentive Plan."
(3) Shares of our common stock that are subject to options, warrants or other rights which are currently exercisable or
exercisable within 60 days (i.e., as of August 20, 1999) are treated as outstanding for purposes of computing the
percentage of the person holding the option, warrant or other right, but are not treated as outstanding for computing the
percentage of any other person. Except as indicated in footnote (4) below, the amounts and percentages are based upon
14,942,557 shares of our common stock outstanding as of June 21, 1999, net of shares we hold in our treasury.
(4) Information in the table that is described as based on Schedule 13G and/or amendment filings was provided to us by the
beneficial owner as of December 31, 1998, including the amount of securities beneficially owned and the percentage of
class. We make no representation as to the accuracy or completeness of the information provided in these Schedule 13Gs
and/or amendments or the information in the beneficial ownership table which is based solely on the filings.
(5) The total and direct ownership for each independent board member includes 4,444 shares of our common stock that we granted
under the Director Plan. We granted and issued shares having a value of $30,000 on or about the date of grant (i.e., 4,444
shares of our common stock) to each independent board member upon his appointment or election to our board in June 1996.
Under the Director Plan, these shares generally vest over a 3-year period at an annual rate of 33%, beginning on the first
anniversary date after the grant date (June 1996).
(6) Mr. Abrahams resigned from the board effective on or around April 16, 1999 because of personal reasons, other business
commitments and related matters.
(7) These stock options were granted under the Incentive Plan effective June 21, 1999 at an exercise price of $6.28 per share
to each of our independent directors. The options fully vested as of June 21, 1999.
</FN>
</TABLE>
61
<PAGE>
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
In the most recent fiscal year, we have maintained business relationships
and engaged in certain transactions with the affiliated companies and parties
described below. Our plan is that any significant future transactions between us
and our affiliated entities, executive officers, directors, or significant
stockholders will receive approval of a majority of our independent directors,
will be fair and generally will be on terms no less favorable to us than we
could obtain from non-affiliated parties.
Verde has been and continues to be one of our lenders. As mentioned above
in this prospectus, Mr. Garcia, our Chairman and former Chief Executive Officer,
is also the President and sole stockholder of Verde. Generally, we have used the
Verde loan proceeds to fund working capital and other corporate needs. The loan
is represented by a $14 million unsecured note with interest payable monthly at
a rate of 10% per year and annual principal payments of $2 million. The Verde
debt matures in June 2003. At January 1, 1998, the balance of the debt was $12.0
million. At December 31, 1998 and at June 30, 1999, the balance of the debt was
$10.0 million and $8.0 million, respectively. For the year ended 1998, we paid
Verde $2.0 million of principal and approximately $1.1 million of interest in
connection with the debt. During 1999, through June 30, 1999, we paid Verde $2.0
million of principal and approximately $475,000 of interest in connection with
the debt. The Verde loan is subordinate to all of our other indebtedness except
our 12% Subordinated Debentures due 2003 issued in the fourth quarter of 1998.
In addition, pursuant to a Modification Agreement effective June 21, 1996
between us and Verde, on December 31, 1996, we purchased from Verde six car
lots, a vehicle reconditioning center, and two office buildings at the lower of
$7.45 million or the appraised value. We had previously leased these properties
from Verde. Rents paid to Verde under these leases totaled approximately $1.5
million in 1996. In addition, Verde assigned to us Verde's leasehold interest in
two properties it had previously sub-leased to us.
We believe that it is important for our directors and officers to be
stakeholders in Ugly Duckling. With this in mind, in September 1997, our board
approved a directors' and officers' stock repurchase program (D&O Stock Purchase
Program). The program provides loans of up to $1.0 million in total to our
directors and senior officers to assist them in purchasing our common stock on
the open market from time-to-time. The D&O Stock Purchase Program provides for
unsecured loans, with interest at 10% per year, interest and principal payments
due at the end of each loan term, and maturity dates of either December 31, 1999
or May 31, 2000. During 1997, senior officers purchased 50,000 shares of common
stock under the program and we advanced $500,000 for these purchases. During
1998, senior officers purchased an additional 40,000 shares of common stock
under the program and we advanced approximately $400,000 for these purchases.
Through June 21, 1999, there were no additional purchases of common stock under
the program. In addition, there have been no principal payments and minimal
interest payments made to Ugly Duckling since the program began. The table that
follows provides additional information on the D&O Stock Purchase Program for
each of our executive officers.
During September 1998 and October 1998, we loaned a total of $285,500 to
Mr. Darak, our Senior Vice President and Chief Financial Officer. The loan is an
employee advance to Mr. Darak. The indebtedness is unsecured, with interest at
10% per year, and principal and interest due upon demand. There have been no
interest or principal payments made by Mr. Darak to Ugly Duckling since the
inception of the loan. The table that follows provides additional information on
this loan.
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<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Name & title of executive officer Nature of debt Date debt Principal Balance Of Debt Number of
incurred At 12/31/98 & 6/30/99 Shares
(unless otherwise Purchased (#)
indicated) ($)
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
<S> <C> <C> <C> <C>
Gregory B. Sullivan, President, CEO & D&O Stock Purchase 11/97 & 5/98 $198,126 20,000
Director Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Steven T. Darak, Sr. VP & CFO D&O Stock Purchase 11/97 $100,000 10,000
Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Steven P. Johnson, VP and Genl Counsel of D&O Stock Purchase 11/97 $100,000 10,000
Cygnet Financial Corporation Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Donald L. Addink, Treasurer and Sr. VP D&O Stock Purchase 11/97 $100,000 10,000
Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Steven A. Tesdahl, Sr. VP & CIO of Ugly D&O Stock Purchase 5/98 $98,126 10,000
Duckling Program
Car Sales
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Russell J. Grisanti, former Ex VP - D&O Stock Purchase 5/98 $98,126(1) 10,000
Operations(1) Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Other Senior Officers D&O Stock Purchase 11/97 & 5/98 $198,126 20,000
Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
TOTAL for D&O Stock Purchase Program D&O Stock Purchase 11/97 & 5/98 $892,504 90,000
Program
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
Steven T. Darak, Sr. VP & CFO Employee Advance 9/98 & 10/98 $285,500
- ----------------------------------------------- -------------------- ------------- --------------------------- --------------
<FN>
(1) In October 1998, Mr. Grisanti and Ugly Duckling mutually agreed to
terminate their employment relationship. In connection with this
termination, the principal balance of the debt was reduced to zero during
March 1999 in exchange for the company receiving the Ugly Duckling stock
initially purchased by Mr. Grisanti under the D&O Stock Purchase Program.
</FN>
</TABLE>
Since April 1998, Mr. Jennings, one of our directors, has been a managing
director of Friedman, Billings, Ramsey & Co., Inc., which makes a market in our
common stock and from time to time may provide investment banking and other
services to us.
DESCRIPTION OF CAPITAL STOCK
We are a Delaware corporation and our affairs are governed by our
certificate of incorporation and bylaws and the Delaware General Corporation
Law. The following description of our capital stock is qualified in its entirety
by reference to the provisions of the our Certificate of Incorporation and
Bylaws, as amended.
The authorized capital stock of Ugly Duckling consists of 100,000,000 shares
of common stock, par value $.001 per share, and 10,000,000 shares of preferred
stock, par value $.001 per share. At March 31, 1999, there were approximately
14,939,000 shares of common stock issued and outstanding. As of March 31,1999,
there were no issued and outstanding shares of preferred stock.
Common Stock
Holders of common stock are entitled to one vote for each share held of
record on all matters on which stockholders are entitled to vote. Holders of
common stock do not have cumulative voting rights, and therefore holders of a
majority of the shares voting for the election of directors can elect all of the
directors. In such event, the holders of the remaining shares will not be able
to elect any directors.
Holders of common stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. We do not anticipate paying cash dividends in the
foreseeable future. See "Dividend Policy." In the event of liquidation,
dissolution, or winding up of Ugly Duckling, the holders of common stock are
entitled to share ratably in any corporate assets remaining after payment of all
debts, subject to any preferential rights of any outstanding preferred stock.
Holders of common stock have no preemptive, conversion, or redemption rights
and are not subject to further calls or assessments by us. All of the
outstanding shares of common stock are validly issued, fully paid, and
nonassessable.
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<PAGE>
Preferred Stock
The Board of Directors of Ugly Duckling has the authority, without further
action by our stockholders, to issue from time to time up to 10,000,000 shares
of preferred stock in one or more series and to fix the number of shares,
designations, voting powers, preferences, optional and other special rights, and
the restrictions or qualifications thereof. The rights, preferences, privileges,
and restrictions or qualifications of different series of preferred stock may
differ with respect to dividend rates, amounts payable on liquidation, voting
rights, conversion rights, redemption provisions, sinking fund provisions, and
other matters. The issuance of preferred stock could: (i) decrease the amount of
earnings and assets available for distribution to holders of common stock; (ii)
adversely affect the rights and powers, including voting rights, of holders of
common stock; and (iii) have the effect of delaying, deferring, or preventing a
change in control of Ugly Duckling.
Warrants
The warrants that may be offered and sold by FMAC under this prospectus
("FMAC warrants") will be governed by the Warrant Agreement dated as of April 1,
1999 (the "Warrant Agreement") between us and Harris Trust Company of
California, as warrant agent (the "Warrant Agent"). Holders of warrants are
referred to the Warrant Agreement which is included as an exhibit to the
Registration Statement of which this prospectus is a part for a complete
statement of the terms of the FMAC warrants. The following summary does not
purport to be complete and is qualified in its entirety by reference to all of
the provisions of the Warrant Agreement. Capitalized terms used in this
description of the FMAC warrants and not defined herein have the meanings given
to them in the Warrant Agreement.
Each FMAC warrant entitles the holder to purchase one share of our common
stock for $20.00 per share, subject to adjustment as described herein (the
"Warrant Price"). The FMAC warrants can be exericed at any time through April
1, 2001.
We can redeem the then outstanding FMAC warrants, at our option, at $.10 per
share of common stock purchasable upon exercise of such warrants, at any time
after the average daily market price (defined below) per share of our common
stock for a period of at least 10 consecutive trading days ending not more than
fifteen days prior to the date of the redemption notice described below has
equaled or exceeded $28.50. We must redeem all outstanding FMAC warrants if any
are redeemed, and any right to exercise an outstanding warrant shall terminate
at 5:00 p.m. (New York City time) on the date fixed for redemption. Trading day
means a day in which trading of securities occurred on Nasdaq. Appropriate
adjustment shall be made to the redemption price and to the minimum daily market
price required for redemption, in each case on the same basis as provided with
respect to adjustment of the Warrant Price as described below.
If we exercise our right to redeem, we will give notice to the Warrant Agent
and the registered holders of the outstanding warrants by mailing or causing the
Warrant Agent to mail to such registered holders a notice of redemption, first
class, postage prepaid, at their addresses as they appear on the records of the
Warrant Agent. The notice of redemption must specify the redemption price, the
date fixed for redemption (which must be at least 30 days after the date such
notice is mailed), the place where the warrant certificates must be delivered
and the redemption price paid, and that the right to exercise the warrants will
terminate at 5:00 P.M. (New York City time) on the date fixed for redemption.
The term "daily market price" means either:
(i) if our common stock is quoted on Nasdaq or the Nasdaq Small Cap Market
or on a national securities exchange, the daily per share closing
price of the common stock as quoted on Nasdaq or the Nasdaq Small Cap
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.
The closing price shall be the last reported sale price or, in case no
such reported sale takes place on such day, the average of the
reported closing bid and asked prices, in either case on Nasdaq or the
Nasdaq Small Cap Market or on the national securities exchange on
which our common stock is then listed.
(ii) if our common stock is traded in the over-the-counter market and not
quoted on Nasdaq or the Nasdaq Small Cap Market nor on any national
securities exchange, the closing bid price of the common stock on the
trading day in question, as reported by Nasdaq or an equivalent
generally accepted reporting service. If trading in our common stock
is not reported by Nasdaq, the bid price referred to shall be the
lowest bid price as quoted on the OTC Bulletin Board or reported in
the "pink sheets" published by National Quotation Bureau,
Incorporated.
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<PAGE>
The warrants may be exercised in whole or in part by surrendering at the
office of the Warrant Agent in Los Angeles, California, or at the office of any
successor to the Warrant Agent, the warrant certificate evidencing such
warrants, together with the subscription form set forth on the reverse of the
warrant certificate, duly executed and endorsed, with signatures properly
guaranteed, and accompanied by payment of the Warrant Price in cash or by
certified or bank draft, payable in U.S. dollars to the order of the Warrant
Agent. As soon as practicable after such exercise, we will cause to be issued
and delivered to the holder or upon his order, in such name or names as may be
directed by him, a certificate or certificates for the number of full shares of
common stock to which he is entitled.
If fewer than all of the warrants evidenced by a warrant certificate are
exercised, the Warrant Agent will deliver to you a new warrant certificate
representing the unexercised portion of the warrant certificate. We will not
issue fractional shares upon exercise of a warrant, and instead, we will pay to
the holder an amount in cash equal to such fraction multiplied by the then
Current Market Price per share, determined in accordance with the Warrant
Agreement.
We will consider the person in whose name the stock certificate is to be
issued to have become the holder of record of the stock represented by a warrant
on the date when you exercise a warrant certificate and the Warrant Price is
paid, or if our stock transfer books are closed on such date, on the next date
on which such books shall be opened.
We will not make a service charge for registration of transfer or exchange
of any warrant certificate. We may require payment of a sum sufficient to cover
any stamp or other tax or governmental charge that may be imposed in connection
with any registration of transfer of warrant certificates or the issuance of a
warrant certificate in a name other than that of the registered holder of the
warrants.
We will adjust the number of shares of common stock issuable upon the
exercise of the warrants and/or the Warrant Price if we pay a dividend or make a
distribution in common stock, subdivide our outstanding common stock into a
greater number of shares, combine our common stock into a smaller number of
shares or issue by reclassification of our common stock, other securities of
Ugly Duckling. For purposes of these adjustment mechanisms, "common stock" means
our common stock as of the date of execution and delivery of the Warrant
Agreement or any other class of stock or securities resulting from successive
changes or reclassifications of such common stock consisting solely of changes
in par value, or from par value to no par value, or from no par value to par
value. Upon any adjustment of the number of shares issuable upon exercise of the
warrants, the Warrant Price will also be adjusted proportionately.
In the event that we consolidate with, merge into, or sell or convey our
property, assets, or business as an entirety or substantially as an entirety to,
another corporation, we and such successor or purchasing corporation will
execute with the Warrant Agent an agreement that the registered holders of the
warrants will have the right thereafter, upon payment of the Warrant Price in
effect immediately prior to the action, to purchase, upon exercise of a warrant,
the kind and amount of shares and other securities and property which the holder
would have owned or been entitled to receive after the happening of such action
had the warrants been exercised immediately prior to the consolidation, merger,
or sale of assets.
In the event a bankruptcy or reorganization is commenced by or against us, a
bankruptcy court may hold that unexercised warrants are executory contracts
which may be subject to rejection by us with approval of the bankruptcy court.
As a result, holders of the warrants may not be entitled to receive any
consideration or may receive an amount less than they would be entitled to if
they had exercised their warrants prior to the commencement of any such
bankruptcy or reorganization.
The holders of unexercised warrants are not entitled, by virtue of being
holders, to exercise any rights as stockholders of Ugly Duckling.
Subject to certain requirements, from time to time we and the Warrant Agent,
without the consent of the holders of the warrants, may amend or supplement the
Warrant Agreement for certain purposes, including curing ambiguities, defects,
or inconsistencies, or to make other provisions in regard to matters or
questions arising under the Warrant Agreement which shall not be inconsistent
with the provisions of the warrants, or which shall not adversely affect the
interests of holders of the warrants (including reducing the Warrant Price or
extending the redemption or exercise date). In any situation where the Warrant
65
<PAGE>
Agreement cannot be amended by us and the Warrant Agent as described above, the
Warrant Agreement can be amended by us, the Warrant Agent, and the holders of a
majority of the outstanding warrants representing a majority of the shares of
common stock underlying such warrants, provided that, among other exceptions,
without the consent of each holder of a warrant, except pursuant to the
adjustment mechanisms of the Warrant Agreement, there can be no increase of the
Warrant Price, reduction of the number of shares of common stock purchasable on
exercise of the warrants, or reduction of the exercise period for the warrants.
Bank Group Warrants
The warrants that may be offered and sold by the selling securityholers
under this prospectus ("bank group warrants") are governed by a Warrant
Agreement dated as of August 20, 1997 (the "Bank Group Warrant Agreement")
between us and Harris Trust Company of California, as Warrant Agent. Holders of
bank group warrants are referred to the Bank Group Warrant Agreement which is
included as an exhibit to the Registration Statement of which this prospectus is
a part for a complete statement of the terms of the bank group warrants. The
summary contained herein does not purport to be complete and is qualified in its
entirety by reference to all of the provisions of the Bank Group Warrant
Agreement.
Except as described below, the bank group warrants and the Bank Group
Warrant Agreement are substantially similar to the FMAC warrants and the Warrant
Agreement relating to the FMAC Warrants described above under "Description of
Capital Stock -- FMAC warrants." The bank group warrants differ substantially
from the FMAC warrants as follows:
o The bank group warrants are exerciseable only through February 20,
2000.
o The outstanding bank group warrants are redeemable at our option at
$.10 per share of common stock purchaseable upon exercise of such bank
group warrants, at any time after the average daily market price per
share of the common stock for a period of at least five consecutive
trading days ending not more than fifteen days prior to the date of
the required redemption notice has equaled or exceeded $27.00. The
method of determining the daily market price per share of the common
stock and for giving the required redemption notice are as described
with respect to the FMAC warrants under the heading "Description of
Capital Stock -- FMAC Warrants."
Other Securities and Registration Rights
In connection with our initial public offering, we issued warrants to
SunAmerica to purchase 121,023 shares, as adjusted, of common stock at an
exercise price per share of $6.75 and to Cruttenden Roth to purchase 170,000
shares of common stock at an exercise price per share of $9.45. The agreements
with respect to the issuance of such warrants provide for certain registration
rights. We are required to use our best efforts to effect such registrations,
subject to certain conditions and limitations, and are required to pay all
expenses of SunAmerica and Cruttenden Roth in connection with any registration
of such securities, except for any underwriting discounts and commissions.
In connection with our initial public offering, we registered the warrants
issued to Cruttenden Roth and the shares underlying such warrants. Under the
terms of such warrants, however, Cruttenden Roth could not exercise such
warrants and sell the underlying common stock until June 21, 1997, and only
pursuant to a currently effective registration statement.
In connection with the FMAC senior bank debt purchase, we issued warrants
(including the bank group warrants) to the bank group members to purchase a
total of 500,000 shares of common stock at an exercise price of $20.00 per
share, through February 20, 2000, subject to a call provision by us and
containing certain registration rights. 110,200 of these warrants were
subsequently returned to us and cancelled in connection with the settlement of a
disputed issue with certain of the bank group members.
In connection with a $15.0 million loan, we issued warrants to the lenders to
purchase a total of 500,000 shares of our common stock at an exercise price of
$10.00 per share, through February 12, 2001, subject to a call provision by us
and containing certain registration rights.
In connection with our involvement in the Reliance Acceptance Group bankruptcy
proceedings, we issued warrants to Reliance to purchase 50,000 shares of common
stock at an exercise price of $12.50 per share, with certain registration
rights. For additional information
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<PAGE>
concerning the warrants that we may issue to Reliance, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Results of Operations -- Three Months Ended March 31, 1999 -- Servicing and
Other Income -- Non-Dealership Operations.
We have authorized for issuance the following:
o 1,800,000 shares of common stock under our Incentive Plan, as amended.
See "Management -- Compensation of Executive Officers, Benefits and
Related Matters -- Long-Term Incentive Plan."
o 50,000 shares of common stock under our Director Incentive Plan. See
"Management -- Compensation of Executive Officers, Benefits and
Related Matters -- and the Director's Incentive Plan."
o 800,000 shares of common stock under our 1998 Executive Incentive
Plan. See "Management -- Compensation of Executive Officers, Benefits
and Related Matters -- 1998 Executive Incentive Plan."
Limitation of Liability and Indemnification of Directors and Officers
Our Certificate of Incorporation provides that to the fullest extent
permitted by Delaware law, a director of Ugly Duckling shall not be personally
liable to us or our stockholders for monetary damages for breach of such
director's fiduciary duty, except for liability:
o for any breach of the director's duty of loyalty to us or our stockholders;
o for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
o in respect of certain unlawful dividend payments or stock redemptions or
repurchases; and
o for any transaction from which the director derives an improper benefit.
The effect of this provision is to eliminate our rights and the rights of
our stockholders (through stockholders' derivative suits on our behalf) to
recover monetary damages against a director for breach of the fiduciary duty of
care as a director (including breaches resulting from negligent or grossly
negligent behavior), except in the situations described above. This provision
does not limit or eliminate our rights or the rights of any stockholder to seek
non-monetary relief such as an injunction or recision in the event of a breach
of a director's duty of care. In addition, our Certificate of Incorporation
provides that we will indemnify any person who is or was a director, officer,
employee, or agent of Ugly Duckling, or who is or was serving at our request as
a director, officer, employee, or agent of another corporation or entity,
against expenses, liabilities, and losses incurred by any such person by reason
of the fact that such person is or was acting in such capacity. We have also
obtained insurance on behalf of our directors and officers for any liability
arising out of such person's actions in such capacity.
We have entered into agreements to indemnify our directors and certain
officers. These agreements, among other things, require us to indemnify our
directors and officers for certain expenses (including attorneys' fees),
judgments, fines, and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of Ugly Duckling,
arising out of such person's services as a director or officer of Ugly Duckling,
any of our subsidiaries, or any other company or enterprise to which such person
provides services at our request. To the extent that our Board of Directors or
stockholders may in the future wish to limit or repeal our ability to provide
indemnification as set forth in our Certificate of Incorporation, such repeal or
limitation may not be effective as to directors or officers who are parties to
the indemnification agreements because their rights to full protection would be
contractually assured by such agreements. It is anticipated that similar
contracts may be entered into, from time to time, with our future directors. We
believe that the indemnification provisions in our Certificate of Incorporation
and in the indemnification agreements are necessary to attract and retain
qualified persons as directors and officers.
Certain Bylaw Provisions
Our Bylaws, as amended, contain several provisions that regulate the
nomination of directors and the submission of proposals in connection with
stockholder meetings. Our Bylaws require that, subject to certain exceptions,
any stockholder desiring to propose business or nominate a person to the Board
of Directors at a stockholders meeting must give notice of any proposals not
less than 60 days nor more than 90 days prior to the meeting. Such notice is
required to contain certain information as set forth in the Bylaws. No business
matter shall be transacted nor shall any person be eligible for election as a
director unless proposed or nominated, as the case may be, in strict accordance
with this procedure set forth in our Bylaws.
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<PAGE>
Although the Bylaws do not give the Board of Directors any power to approve
or disapprove of stockholder nominations for the election of directors or of any
other business desired by stockholders to be conducted at an annual or any other
meeting, the Bylaws may have the effect of precluding a nomination for the
election of directors or the conduct of business at a particular annual meeting
if the proper procedures are not followed or may discourage or deter a third
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of Ugly Duckling, even if
the conduct of such solicitation or such attempt might be beneficial to us and
our stockholders. Our procedures with respect to all stockholder proposals and
the nomination of directors will be conducted in accordance with Section 14 of
the Security Exchange Act of 1934 and the rules promulgated thereunder.
Transfer Agent and Registrar
The Transfer Agent and Registrar for our common stock is Harris Trust
Company of California, 601 S. Figueroa, Los Angeles, California 90017.
SELLING SECURITY HOLDERS
The following table sets forth the name of each selling securityholder, the
aggregate number of shares of common stock beneficially owned by each selling
securityholder as of July 1, 1999, the aggregate number of bank group warrants
and related warrant shares registered hereby that each selling securityholder
may offer and sell pursuant to this prospectus, and the aggregate number of
shares of common stock that will be beneficially owned by each selling
securityholder after completion of the offering. However, because the selling
securityholders may offer all or a portion of the bank group warrants and
related warrant shares at any time and from time to time after the date hereof,
the exact number of shares of common stock that each selling securityholder may
retain upon completion of the offering cannot be determined at this time. All of
the bank group warrants are issued and outstanding as of the date of this
prospectus. To our knowledge, none of the selling securityholders has had any
material relationship with us or any of our predecessors or affiliates within
the past three years, except as set forth in the footnotes to the following
table.
<TABLE>
<CAPTION>
Bank Group Warrants
and related
Warrant Shares
to be Offered
Shares Beneficially for the Selling Shares Beneficially
Owned Prior to Securityholder's Owned after the
Selling Securityholder the Offering Account Offering
------------------------------- ------------------- ------------------- ------------------
<S> <C> <C> <C>
First Merchants Acceptance
Corporation.................. 325,000 325,000 0
LaSalle National Bank........... 72,916 72,916 0
Fleet Bank, National Association 60,763 60,763 0
Bank One, Michigan
(formerly NBD Bank)........... 61,680 61,680 0
Bank of America National Association
(formerly known as Nations Bank, N.A) 36,458 36,458 0
U.S. Bank National Association
(successor by merger to First Bank
National Association)......... 60,763 60,763 0
Mellon Bank, N.A. (or its
assignee APT Holdings
Corporation).................. 99,918 48,610 51,308
------- ------ ------
717,498 666,190 51,308
======= ======= ======
<FN>
- ----------
Note: Other than the short-term loan to us arising out of the FMAC transaction, we are unaware of any borrowings by us from any of
the selling securityholders listed above.
</FN>
</TABLE>
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<PAGE>
PLAN OF DISTRIBUTION
FMAC Warrants, related Warrant Shares, and Stock Option Shares
The FMAC Warrants were issued to FMAC on the effective date of FMAC's plan
of reorganization. The term "equity holders," when used in this prospectus, will
mean the equity holders of FMAC on the effective date of the plan of
reorganization. Under FMAC's plan of reorganization, equity holders received the
benefit of 32,500 warrants. FMAC may:
o distribute that portion of the warrants allocable to its equity holders
(the "Equity Warrants") directly to such holders,
o hold the Equity Warrants until exercise and either distribute the warrant
shares to its equity holders or sell the warrant shares and distribute the
proceeds to such holders, or
o sell the Equity Warrants and distribute the proceeds to its equity holders.
With respect to any remaining FMAC warrants not allocated to the equity
holders of FMAC, FMAC may:
o distribute such warrants to its unsecured creditors,
o hold such warrants until exercise and either distribute the warrant shares
to its unsecured creditors or sell the warrant shares and distribute the
proceeds thereof to its unsecured creditors, or
o sell such warrants and distribute the proceeds to its unsecured creditors,
or if necessary, use the proceeds of the sale of warrants or warrant shares
to pay ongoing administrative and operating expenses.
The warrant shares relating to the FMAC warrants will be issued from time
to time upon exercise of the warrants by the holders thereof in accordance with
the Warrant Agreement. See "Description of Capital Stock -- FMAC Warrants."
At our option, we have the right to issue up to 5,000,000 shares of our
common stock to FMAC or its unsecured creditors or equity holders in exchange
for all or part of FMAC's portion of the Excess Collection Split (the "Stock
Option"). If we decide to exercise the Stock Option, we must give FMAC at least
15 days advance notice of the date on which we will exercise the Stock Option
and the number of shares of our common stock that we will issue on the exercise
date ("Stock Option Shares"). We may only exercise the Stock Option one time. On
the exercise date, the aggregate value of the Stock Option Shares will be
determined by multiplying the Stock Option Shares by 98% of the average of the
closing prices for the previous 10 trading days of our common stock on the
Nasdaq (the "Stock Option Value".) After issuance and delivery of the Stock
Option Shares, we will be entitled to receive FMAC's share of cash distributions
under the Excess Collections Split until we have received cash distributions
equal to the Stock Option Value. This would be in addition to our right to
receive our 17.5% share under the Excess Collections Split. In order to exercise
the Stock Option,
o the value of our common stock on the exercise date and the closing price
for our common stock on each day during the previous 10 trading days must
be at least $8.00 per share,
o we must have registered the Stock Option Shares under the Securities Act of
1933 and the Stock Options Shares must be unrestricted and transferable,
o we must have taken all steps necessary to allow FMAC to distribute the
Stock Option Shares to its unsecured creditors, and
o we cannot have purchased any of our common stock (except upon the exercise
of previously issued and outstanding options, warrants or other rights) or
announced any stock repurchase programs from the delivery of the notice of
our intent to exercise this option through the exercise date.
If we issue the Stock Option Shares directly to FMAC, FMAC may either
distribute such shares to its unsecured creditors or sell such Stock Option
Shares and distribute the proceeds to its unsecured creditors, or if necessary,
use the proceeds of the sale of the Stock Option Shares to pay ongoing
administrative and operating expenses.
FMAC or its nominees or pledgees may sell or distribute some or all of the
FMAC warrants and/or related warrant shares and/or Stock Option Shares from time
to time through dealers, brokers or other agents or directly to one or more
purchasers, including pledgees, in transactions (which may involve crosses and
block transactions) on Nasdaq (as to the warrant shares and/or Stock Option
Shares only), in privately negotiated transactions (including sales pursuant to
pledges), in the over-the-counter market, in brokerage transactions, in a
combination of such transactions or by any other legally available means. Such
transactions may be effected by FMAC or its nominees or pledgees at market
prices prevailing at the time of sale, at prices related to such prevailing
market prices, at negotiated prices, or at fixed prices, which may be changed.
Brokers, dealers, or agents participating in such transactions may receive
compensation in the form of discounts, concessions or commissions from FMAC or
its nominees or pledgees (and, if they act as agent for the purchaser of such
shares, from such purchaser). Such discounts, concessions or commissions as to a
particular broker, dealer, or agent might be in excess of those customary in the
type of transaction involved. To the extent required, we will file, during any
period in which offers or sales are being made, one or more supplements to this
prospectus to set forth any other material information with respect to the plan
of distribution not previously disclosed.
69
<PAGE>
FMAC will be deemed to be an underwriter, as such term is defined in Section
2(11) of the Securities Act, of the FMAC warrants, warrant shares, and Stock
Option Shares to the extent that it participates, directly or indirectly, in the
distribution of such securities. Both Ugly Duckling and FMAC have agreed to
indemnify the other against certain liabilities including certain liabilities
under the Securities Act.
Bank Group Warrants and Related Warrant Shares
The selling securityholders or their nominees or pledgees, other than FMAC,
may sell or distribute some or all of the bank group warrants and/or related
warrant shares from time to time through dealers, brokers or other agents or
directly to one or more purchasers, including pledgees, in transactions (which
may involve crosses and block transactions) on Nasdaq (as to the warrant shares
only), in privately negotiated transactions (including sales pursuant to
pledges), in the over-the-counter market, in brokerage transactions, in a
combination of such transactions or by any other legally available means. Such
transactions may be effected by the selling securityholders at market prices
prevailing at the time of sale, at prices related to such prevailing market
prices, at negotiated prices, or at fixed prices, which may be changed. Brokers,
dealers or agents participating in such transactions may receive compensation in
the form of discounts, concessions or commissions from the selling
securityholders (and, if they act as agent for the purchaser of such shares,
from such purchaser). Such discounts, concessions or commissions as to a
particular broker, dealer or agent might be in excess of those customary in the
type of transaction involved. This prospectus also may be used, with our
consent, by donees of the selling securityholders or by other persons acquiring
bank group warrants and related warrant shares and who wish to offer and sell
such shares under circumstances requiring or making desirable its use. To the
extent required, we will file, during any period in which offers or sales are
being made, one or more supplements to this prospectus to set forth the names of
donees of selling securityholders and any other material information with
respect to the plan of distribution not previously disclosed. In addition, any
bank group warrants and related warrant shares which qualify for sale pursuant
to Section 4 of, or Rule 144 under, the Securities Act may be sold under such
provisions rather than pursuant to this prospectus.
The selling securityholders and any such brokers, dealers or agents that
participate in such distribution may be deemed to be "underwriters" within the
meaning of the Securities Act with regard to the bank group warrants and related
warrant shares, and any discounts, commissions or concessions received by any
such brokers, dealers or agents might be deemed to be underwriting discounts and
commissions under the Securities Act. Neither Ugly Duckling nor the selling
securityholders can presently estimate the amount of such compensation. We know
of no existing arrangements between any selling securityholder and any other
selling securityholder, broker, dealer or other agent relating to the sale or
distribution of the bank group warrants and related warrant shares.
The selling securityholders will be subject to applicable provisions of the
Exchange Act and the rules and regulations thereunder, including without
limitation Regulation M, which provisions may limit the timing of purchases and
sales of any of the bank group warrants and related warrant shares by the
selling securityholders. All of the foregoing may affect the marketability of
the bank group warrants and related warrant shares.
We will pay substantially all of the expenses incident to this offering of
the bank group warrants and related warrant shares by the selling
securityholders to the public other than commissions and discounts of brokers,
dealers or agents. Each selling securityholder may indemnify any broker, dealer,
or agent that participates in transactions involving sales of the bank group
warrants and related warrant shares against certain liabilities, including
liabilities arising under the Securities Act. We have agreed to indemnify the
selling securityholders against certain liabilities including certain
liabilities under the Securities Act. Insofar as indemnification for liabilities
arising under the Securities Act may be permitted to our directors, officers or
persons controlling us, we have been informed that in the opinion of the
Securities and Exchange Commission such indemnification is against public policy
as expressed in the Securities Act and is therefore unenforceable.
General
Our common stock is traded on Nasdaq under the symbol "UGLY." Neither the
FMAC Warrants nor the bank group warrants will be listed on any national
securities exchange or admitted for trading on Nasdaq.
We are bearing the expenses of registration of the FMAC warrants, bank group
warrants, warrant shares, and Stock Option Shares offered hereby, which we
estimate will be approximately $400,000.
70
<PAGE>
LEGAL MATTERS
The validity of the securities offered hereby is being passed upon for us by
Snell & Wilmer L.L.P., Phoenix, Arizona.
EXPERTS
The consolidated financial statements of Ugly Duckling Corporation as of
December 31, 1998 and 1997 and for each of the years in the three-year period
ended December 31, 1998, have been included herein and in the Registration
Statement in reliance upon the report of KPMG LLP, independent auditors,
appearing elsewhere herein, and upon the authority of said firm as experts in
accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We have filed a registration statement on Form S-1 with the Securities and
Exchange Commission (the "Commission") with respect to the FMAC warrants, bank
group warrants, warrant shares, and Stock Option Shares offered hereby. Please
see the registration statement and the exhibits and schedules filed as part of
the registration statement for further information about us and our stock. You
may examine the registration statement, including the exhibits thereto, at the
Commission's public reference facility at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549. In addition, you can obtain copies of all
or any part of the registration statement, including such exhibits, from the
Commission at its principal office in Washington, D.C., upon payment of the
required fees.
We are subject to the reporting and informational requirements of the
Exchange Act and file reports, proxy statements, and other information with the
Commission. You may inspect and copy such reports, proxy statements, and other
information filed by us at the principal office of the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington D.C. 20549, and at the
following regional offices of the Commission: 7 World Trade Center, New York, NY
10048, and Northwestern Atrium Center, 500 West Madison Street, Suite 1400,
Chicago, IL 60601. You may obtain copies of such material from the Public
Reference Section of the Commission at its principal office at 450 Fifth Street,
N.W., Washington D.C. 20549, upon payment of the required fees. The Commission
maintains a World Wide Web site (http://www.sec.gov) that contains reports,
proxy statements, and other information regarding registrants, such as us, that
file electronically with the Commission.
Our common stock is traded on Nasdaq. Reports, proxy statements, and other
information filed by us may be inspected and copied at the National Association
of Securities Dealers, 1735 K Street, N.W., Washington, D.C. 20007.
71
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report............................................. F-2
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997............. F-3
Consolidated Statements of Operations for the years ended December 31,
1998,1997 and 1996......................................................... F-4
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997 and 1996........................................... F-5
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996......................................................... F-6
Notes to Consolidated Financial Statements................................. F-7
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Condensed Consolidated Financial Statements:
Condensed Consolidated Balance Sheets as of March 31, 1999 and December
31, 1998............................................................... F-27
Condensed Consolidated Statements of Operations for the three months ended
March 31, 1999 and 1998................................................... F-28
Consolidated Statements of Cash Flows for the three months ended March 31,
1999 and 1998......................................................... F-29
Notes to Consolidated Financial Statements................................. F-30
F-1
<PAGE>
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, 1998 and 1997, 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, 1998.
These consolidated financial statements are the responsibility of our
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, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally accepted
accounting principles.
/S/ KPMG LLP
Phoenix, Arizona
February 18, 1999
F-2
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
1998 1997
(In thousands, except
share amounts)
ASSETS
Cash and Cash Equivalents............................ $ 2,751 $ 3,537
Finance Receivables, Net............................. 163,209 90,573
Notes Receivable, Net................................ 28,257 26,745
Inventory............................................ 44,167 32,372
Property and Equipment, Net.......................... 32,970 39,827
Intangible Assets, Net............................... 15,530 17,543
Other Assets......................................... 20,575 11,246
Net Assets of Discontinued Operations................ 38,516 54,583
------ ------
$ 345,975 $ 276,426
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable................................... $ 2,479 $ 2,867
Accrued Expenses and Other Liabilities............. 19,694 14,964
Notes Payable...................................... 55,093 64,821
Collateralized Notes Payable....................... 62,201 --
Subordinated Notes Payable......................... 43,741 12,000
------ ------
Total Liabilities.......................... 183,208 94,652
======= ======
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, 18,605,000 and 18,521,000 issued,
respectively, and 15,841,000 and 18,521,000 outstanding,
respectively 19 19
Additional Paid in Capital 173,809 172,603
Retained Earnings................................... 3,449 9,152
Treasury Stock, 2,761 ,000 shares at cost.......... (14,510) --
Total Stockholders' Equity.................. 162,767 181,774
Commitments and Contingencies ........................ -- --
-------- -------
$ 345,975 $ 276,426
========= =========
See accompanying notes to Consolidated Financial Statements.
F-3
<PAGE>
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31,
------------------------
1998 1997 1996
------- ------ ------
(In thousands, except earnings
per share amounts)
<S> <C> <C> <C>
Sales of Used Cars...................................... $287,618 $ 123,814 $ 53,768
Less:
Cost of Used Cars Sold................................ 167,014 72,358 31,879
Provision for Credit Losses........................... 67,634 23,045 9,657
------ ------ -----
52,970 28,411 12,232
------ ------ ------
Other Income:
Interest Income....................................... 27,828 18,736 8,597
Gain on Sale of Loans................................. 12,093 14,852 3,925
Servicing and Other Income............................ 38,631 12,681 2,537
------ ------ -----
78,552 46,269 15,059
------ ------ ------
Income before Operating Expenses........................ 131,522 74,680 27,291
------- ------ ------
Operating Expenses:
Selling and Marketing................................. 20,565 10,538 3,585
General and Administrative............................ 92,402 41,902 13,118
Depreciation and Amortization......................... 5,735 3,301 1,382
----- ----- -----
118,702 55,741 18,085
------- ------ ------
Income before Interest Expense.......................... 12,820 18,939 9,206
Interest Expense........................................ 6,904 2,774 2,429
----- ----- -----
Earnings before Income Taxes............................ 5,916 16,165 6,777
Income Taxes............................................ 2,396 6,637 100
----- ----- ---
Earnings from Continuing Operations..................... 3,520 9,528 6,677
Discontinued Operations:
Loss from Operations of Discontinued Operations,
net of income tax benefit of $489, $58, and $0..... (768) (83) (811)
Loss from Disposal of Discontinued Operations,
net of income tax benefit of $5,393, $0, and $0.... (8,455) -- --
-------- -------- ---------
Net Earnings (Loss)..................................... $(5,703) $ 9,445 $ 5,866
======= ========= =========
Earnings per Common Share from Continuing Operations:
Basic................................................. $ 0.19 $ 0.53 $ 0.73
======== ========= =========
Diluted............................................... $ 0.19 $ 0.52 $ 0.69
======== ========= =========
Net Earnings (Loss) per Common Share:
Basic................................................. $ (0.32) $ 0.53 $ 0.63
======== ========= =========
Diluted............................................... $ (0.31) $ 0.52 $ 0.60
======== ========= =========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-4
<PAGE>
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1998, 1997, and 1996
(in thousands)
Retained
Earnings Total
Number of Shares Amount ($'s) (Accumulated Stockholders'
---------------- ---------------------- ------------ -------------
Preferred Common Treasury Preferred Common Treasury Deficit) Equity
--------- ------ -------- --------- ------ -------- -------- ------
<S> <C> <C> <C> <C> <C> <C> <C>
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 (1,000) -- -- (10,000) -- -- -- (10,000)
Stock......................
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
Issuance of Common Stock
for Cash.................. -- 84 -- -- 306 -- -- 306
Issuance of Common Stock
Warrants.................... -- -- -- -- 900 -- -- 900
Purchase of Treasury Stock
for Cash................... -- -- (72) -- -- (535) -- (535)
Acquisition of Treasury
Stock for Subordinated
Debentures.................... -- -- (2,689) -- -- (13,975) -- (13,975)
Net Loss for the Year......... -- -- -- -- -- -- (5,703) (5,703)
Balances at December 31, ----- ------ ------ ------- --------- --------- -------- ----------
1998........................ -- 18,605 (2,761) $ -- $ 173,828 $ (14,510) $ 3,449 $ 162,767
===== ====== ====== ======= ========= ========= ======== =========
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-5
<PAGE>
<TABLE>
<CAPTION>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31,
------------------------
1998 1997 1996
---- ---- ----
(In thousands)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss).......................................... $ (5,703) $ 9,445 $ 5,866
Adjustments to Reconcile Net Earnings (Loss) to Net Cash
Provided by
(Used in) Operating Activities from Continuing Operations:
Loss from Discontinued Operations............................ 9,223 83 811
Provision for Credit Losses.................................. 67,634 23,045 9,657
Gain on Sale of Loans........................................ (12,093) (6,721) (3,925)
Deferred Income Taxes........................................ (3,344) 1,094 498
Depreciation and Amortization................................ 5,735 3,301 1,382
Purchase of Finance Receivables for Sale..................... (207,085) (116,830) (48,996)
Proceeds from Sale of Finance Receivables.................... 159,498 81,098 30,259
Collections of Finance Receivables........................... 22,000 15,554 26,552
Decrease (Increase) in Inventory............................. (11,795) (20,592) 778
Increase in Other Assets..................................... (6,020) (2,779) (2,155)
Increase in Accounts Payable, Accrued Expenses, and Other
Liabilities.................................................... 5,425 6,905 2,571
Increase (Decrease) in Income Taxes Receivable/Payable....... (1,233) (1,378) 535
Other, Net................................................... (156) -- --
Net Cash Provided by (Used in) Operating Activities ------- ------- -------
of Continuing Operations................................. 22,086 (7,775) 23,833
------ ------ ------
Cash Flows from Investing Activities:
Increase in Finance Receivables.............................. (111,467) (20,941) --
Collections of Finance Receivables........................... 22,779 9,160 --
Increase in Investments Held in Trust........................ (13,802) (8,475) (3,162)
Advances under Notes Receivable.............................. (13,669) (32,782) --
Repayments of Notes Receivable............................... 11,857 6,900 137
Proceeds from disposal of Property and Equipment............. 27,413 -- --
Purchase of Property and Equipment........................... (21,786) (19,509) (5,549)
Payment for Acquisition of Assets............................ -- (45,220) --
Other, Net................................................... -- -- (1,944)
Net Cash Used in Investing Activities of Continuing ------- -------- --------
Operations..................................................... (98,675) (110,867) (10,518)
------- -------- --------
Cash Flows from Financing Activities:
Additions to Notes Payable................................... 95,191 22,228 1,000
Repayments of Notes Payable.................................. (43,169) -- (28,610)
Issuance of Subordinated Notes Payable....................... 19,630 -- --
Repayment of Subordinated Notes Payable...................... (2,000) (2,000) (553)
Redemption of Preferred Stock................................ -- -- (10,000)
Proceeds from Issuance of Common Stock....................... 306 89,398 79,435
Acquisition of Treasury Stock................................ (535) -- --
Other, Net................................................... (464) (178) (1,158)
Net Cash Provided by Financing Activities of Continuing ------ ------- ------
Operations..................................................... 68,959 109,448 40,114
------ ------- ------
Net Cash Provided by (Used in) Discontinued Operations......... 6,844 (5,724) (36,393)
----- ------ -------
Net Increase (Decrease) in Cash and Cash Equivalents........... (786) (14,918) 17,036
Cash and Cash Equivalents at Beginning of Year................. 3,537 18,455 1,419
----- ------ -----
Cash and Cash Equivalents at End of Year....................... $ 2,751 $ 3,537 $ 18,455
========== ========== ========
Supplemental Statement of Cash Flows Information:
Interest Paid................................................ $ 10,483 $ 5,382 $ 5,144
Income Taxes Paid............................................ 1,633 6,570 450
Assumption of Debt in Connection with Acquisition of Assets.. -- 29,900 --
Conversion of Note Payable to Common Stock................... -- -- 3,000
Purchase of Property and Equipment with Notes Payable........ 825 -- 8,313
Purchase of Property and Equipment with Capital Leases....... -- 357 57
Purchase of Treasury Stock with Subordinated Notes Payable... 13,835 -- --
Issuance of Warrants for Subordinated Note Payable........... 900 -- --
</TABLE>
See accompanying notes to Consolidated Financial Statements.
F-6
<PAGE>
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 16.
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 $16.0 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.
(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 $15.1
million (approximately $9.2 million, net of income taxes) in 1998. The closure
was substantially complete as of March 31, 1998 and included the termination of
approximately 400 employees, substantially all of whom were employed at the
Company's 76 branches that were in place on the date of the announcement.
Approximately $1.7 million of the discontinued operations charge was for
termination benefits, $6.7 million for portfolio allowance and collection costs,
$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. The Company has reclassified the
accompanying consolidated balance sheets and consolidated statements of
operations of the Branch Offices to Discontinued Operations.
In April 1998, the Company announced that its Board of Directors directed
management to proceed with separating the Company's operations into two
companies. The Company formed a new subsidiary to operate the Cygnet Dealer
Program and Cygnet Financial Services ("Non Dealership Operations"). A proposal
to split-up the Company through a rights offering was approved by stockholders
at the annual meeting held in August 1998 and rights were subsequently issued to
Company stockholders. The Company had previously reported the net assets,
results of operations, and cash flows of the Non Dealership Operations in
Discontinued Operations. However, the rights offering failed due to a lack of
shareholder participation. The Board of Directors has directed management to
F-7
<PAGE>
cease its efforts, for the time being, to separate the Non Dealership Operations
of the Company. As a result of the aforementioned, the assets, liabilities,
results of operations, and cash flows of the Non Dealership Operations have been
reclassified into continuing operations for the periods presented in these
consolidated financial statements. Total assets and liabilities for Non
Dealership Operations were $77.2 million and $8.7 million, and $49.9 million and
$559,000 at December 31, 1998 and 1997, respectively. Revenues and Earnings
(Loss) before Interest Expense were $32,837,000 and $3,993,000, $14,664,000 and
$11,331,000, and zero and zero, respectively, for the years ended December 31,
1998, 1997, and 1996. The Company did not record any charges to record the net
assets of the Non Dealership Operations at net realizable value at the time the
separation was announced, and, consequently, did not reverse any loss accruals
during 1998.
The components of Net Assets of Discontinued Operations as of December 31,
1998 and December 31, 1997 follow (in thousands):
December 31,
------------
1998 1997
---- ----
Finance Receivables, net..................... $ 30,649 $ 26,780
Residuals in Finance Receivables Sold........ 7,875 16,099
Investments Held in Trust.................... 3,665 7,277
Property and Equipment....................... 1,198 1,424
Capitalized Start-up Costs................... -- 2,453
Other Assets, net of Accounts Payable and
Accrued 1,153 550
Liabilities................................
Disposal Liability........................... (6,024) --
------ ------
$ 38,516 $ 54,583
======== ========
Following is a summary of the operating results of the Discontinued
Operations for the years ended December 31, 1998, 1997, and 1996 (in thousands):
December 31,
------------
1998 1997 1996
---- ---- ----
Revenues................................. $ 3,095 $ 21,213 $ 7,768
Expenses................................. (18,200) (21,354) (8,579)
------- ------- ------
Loss before Income Tax (Benefit)......... (15,105) (141) (811)
Income Tax Benefit....................... (5,882) (58) --
------- ---- --
Loss from Discontinued Operations........ $ (9,223) $ (83) $ (811)
======== ======== =======
(3) Summary of Significant Accounting Policies
Operations
The Company, through its subsidiaries, owns and operates used car sales
dealerships, a collateralized dealer finance program, and a third party bulk
purchasing and loan servicing operation. Additionally, Ugly Duckling Receivables
Corporation (UDRC) and Ugly Duckling Receivables Corporation II (UDRC 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 $7,875,000 and $3,665,000,
respectively, at December 31, 1998 and in the amounts of $16,099,000 and
$7,277,000, respectively, at December 31, 1997. These amounts would not be
available to satisfy claims of creditors of the Company.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-8
<PAGE>
Concentration of Credit Risk
The Company provides sales finance services in connection with the sales of
used cars to individuals residing in numerous metropolitan areas. The Company
operated a total of 56, 41, and 8 used car dealerships (company dealerships) in
nine, ten and two metropolitan markets at December 31, 1998, 1997, and 1996,
respectively.
As of December 31, 1998, the Company's Cygnet Dealer Program had warehouse
purchase facilities and revolving lines of credit with a total of approximately
63 third party dealers. Cygnet Dealer's net investment in finance receivables
purchased from 2 third party dealers totaled approximately $15.1 million,
representing approximately 34% of Cygnet Dealer's net finance receivables
portfolio as of December 31, 1998. There were no other third party dealer loans
that exceeded 10% of the Company's finance receivables portfolio as of December
31, 1998.
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 sold
(securitized), on a non-recourse basis, finance receivables to a trust which
used the finance receivables to create asset backed securities which were
remitted to the Company in consideration for the sale. The Company then sold
senior certificates (A certificates) to third party investors and retained
subordinated certificates (B certificates). In consideration of such sale, the
Company received 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 were 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 allocated 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, 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.
F-9
<PAGE>
The structure of the Company's securitization transaction consummated in the
fourth quarter of 1998 was changed from the structure of the transactions
previously effected under its Securitization Program and has been accounted for
as a secured financing in accordance with SFAS 125, Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities (SFAS No. 125).
The loan contracts included in the transaction remain in Finance Receivables and
the A Certificates are reflected in Collateralized Notes Payable.
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 Finance Receivables.
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, investments held in trust, and an
allowance for credit losses, including nonaccretable discounts.
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. For
contracts generated by the Company dealerships, the allowance is established by
charging the provision for credit losses. Contracts purchased from third party
dealers are generally purchased with an acquisition discount (discount). The
discount is negotiated with third party dealers pursuant to a financing program
that bases the discount on, among other things, the credit risk of the borrower
and the amount to be financed in relation to the car's wholesale value. The
discount is allocated between nonaccretable discount and discount available for
accretion to interest income. The portion of discount allocated to the allowance
is based upon historical performance and write-offs of contracts acquired from
third party dealers, as well as the general credit worthiness of the borrowers
and the wholesale value of the vehicle. The remaining discount, if any, is
deferred and accreted to income using the interest method.
To the extent that the allowance is considered insufficient to absorb
anticipated credit losses, additions to the allowance are established through a
charge to the provision for credit losses. The evaluation of the allowance
considers such factors as the performance of each dealerships loan portfolio,
the Company's historical credit losses, the overall portfolio quality and
delinquency status, the review of specific problem loans, the value of
underlying collateral, and current economic conditions that may affect the
borrower's ability to pay.
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 amounts due according
to the contractual terms of the note agreement. When a loan is considered to be
F-10
<PAGE>
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 or
the fair value of the collateral if the loan is collateral dependent. Impairment
losses are included in the allowance for credit losses through a charge to the
provision for credit losses. Cash receipts on impaired notes receivable are
applied to reduce the principal amount of such notes until the principal has
been received and are recognized as interest income, thereafter.
Inventory
Inventory consists of used vehicles held for sale which is valued at the
lower of cost or market, and repossessed vehicles which are valued at market
value. Vehicle reconditioning costs are capitalized as a component of inventory
cost.The cost of used vehicles sold is determined on a specific identification
basis.
Property and Equipment
Property and Equipment are stated at cost. Depreciation is computed using
straight-line and accelerated methods over the estimated useful lives of the
assets which range from three to ten years for equipment and thirty years for
buildings. Leasehold and land improvements are amortized using straight-line and
accelerated methods over the shorter of the lease term or the estimated useful
lives of the related improvements.
The Company has capitalized costs related to the development of software
products for internal use. Capitalization of costs begins when technological
feasibility has been established and ends when the software is available for
general use. Amortization is computed using the straight-line method over the
estimated economic life of five years.
Goodwill
Goodwill, which represents the excess of purchase price over fair value of
net assets acquired, is amortized on a straight-line basis over the expected
periods to be benefited, generally fifteen to twenty years.
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.
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. The Company has adopted the
disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
which permits entities to provide pro forma net earnings and pro forma earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method as defined in SFAS No. 123 had been
applied.
The Company uses one of the most widely used option pricing models, the
Black-Scholes model (Model), for purposes of valuing its stock option grants.
The Model was developed for use in estimating the fair value of traded options
that have no vesting restrictions and are fully transferable. In addition, it
requires the input of highly subjective assumptions, including the expected
F-11
<PAGE>
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
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 on January 1, 1997. This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. Adoption of SFAS No. 125 did not have a
material impact on the Company.
Reclassifications
Certain reclassifications have been made to the prior years' consolidated
financial statement amounts to conform to the current year presentation.
(4) Finance Receivables and Allowance for Credit Losses
A summary of finance receivables as of December 31, 1998 and 1997 follows
(in thousands):
<TABLE>
<CAPTION>
December 31,
----------------------------------------------------------------------
1998 1997
------------------------------- ----------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
---------- ---------- ----- ---------- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Installment Sales Contract Principal $ 93,936 $ 51,282 $145,218 $ 55,965 $ 27,480 $ 83,445
Balances...............................
Add: Accrued Interest Receivable....... 877 473 1,350 462 147 609
Loan Origination Costs, Net............ 2,237 -- 2,237 1,431 -- 1,431
----- ------ ----- ----- ------ -----
Principal Balances, Net................ 97,050 51,755 148,805 57,858 27,627 85,485
Residuals in Finance Receivables Sold.. 33,331 2,625 35,956 13,277 -- 13,277
Investments Held in Trust.............. 20,564 -- 20,564 10,357 -- 10,357
------ ------ ------ ------ ------ ------
150,945 54,380 205,325 81,492 27,627 109,119
Allowance for Credit Losses............ (24,777) (2,024) (26,801) (10,356) (1,035) (11,391)
Discount on Acquired Loans............. -- (15,315) (15,315) -- (7,155) (7,155)
------- ------- ------- ------- ------ ------
Finance Receivables, net............... $126,168 $ 37,041 $163,209 $ 71,136 $ 19,437 $ 90,573
======== ======== ======== ======== ======== ========
Classification:
Finance Receivables Held for Sale $ -- $ -- $ -- $ 52,000 $ -- $ 52,000
Finance Receivables Held for Investment 97,050 51,755 148,805 5,858 27,627 33,485
------ ------ ------- ----- ------ ------
$ 97,050 $ 51,755 $148,805 $ 57,858 $ 27,627 $ 85,485
======== ======== ======== ======== ======== ========
</TABLE>
F-12
<PAGE>
A summary of the allowance for credit losses on finance receivables for the
years ended December 31, 1998, 1997 and 1996 follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------- -------------------------------- ----------
Non Non
Dealership Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total Operations
---------- ---------- ----- ---------- ---------- ----- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances, Beginning of Year $ 10,356 $ 1,035 $ 11,391 $ 1,625 $ -- $ 1,625 $ 7,500
Provision for Credit Losses 65,318 2,016 67,334 22,354 491 22,845 9,657
Allowance on Acquired Loans -- 801 801 15,309 550 15,859 --
Net Charge Offs............ (6,358) (1,828) (8,186) (7,524) (6) (7,530) (6,202)
Sale of Finance Receivables (44,539) -- (44,539) (21,408) -- (21,408) (9,330)
------- -------- ------- ------- ------ ------- ------
Balances, End of Year...... $ 24,777 $ 2,024 $ 26,801 $ 10,356 $ 1,035 $ 11,391 $ 1,625
========= ========= ========= ========= ========= ========= =========
</TABLE>
The valuation of the Residual in Finance Receivables Sold as of December 31,
1998, which totaled $33.3 million, represents the present value of the
Dealership Operations' interests in the distributions of future cash flows from
the underlying portfolio out of the securitization trusts and Investments Held
in Trust (see note 5) which totaled $20.6 million at December 31, 1998. The
Company's securitization transactions were discounted with a rate of 12% using
the "cash out method". For securitizations 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 transaction that took place in September 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 securitization transactions completed during the
nine month period ended September 30, 1998, net losses were estimated using
total expected cumulative net losses at loan origination of approximately 29.0%,
adjusted for actual cumulative net losses prior to securitization. Prepayment
rates were estimated to be 1% per month of the beginning of month balance.
As of December 31, 1998 and 1997, the Residuals in Finance Receivables Sold
for the Company's Dealership Operations were comprised of the following (in
thousands):
December 31,
------------
1998 1997
---- ----
Retained interest in subordinated securities (B $ 51,243 $ 25,483
Certificates)........................................
Net interest spreads, less present value discount.. 25,838 10,622
Reduction for estimated credit loss................ (43,750) (22,828)
------- -------
Residuals in finance receivables sold.............. $ 33,331 $ 13,277
========= =========
Securitized principal balances outstanding......... $ 198,747 $ 127,356
========= =========
Estimated credit losses and allowances as a % of
securitized principal balances outstanding...... 22.0% 17.9%
==== ====
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the Company's Dealership Operations for the years
ended December 31, 1998 and 1997, respectively (in thousands):
December 31,
------------
1998 1997
---- ----
Balance, Beginning of Year....................... $ 13,277 $ 8,512
Additions........................................ 35,435 17,734
Amortization..................................... (15,381) (7,242)
Write-down of Residual in Finance Receivables Sold -- (5,727)
-------- --------
Balance, End of Year............................. $ 33,331 $ 13,277
======== ========
The Company also has an investment in subordinate certificates originated by
a third party approximating $2.6 million at December 31, 1998 held by its Non
Dealership Operations classified as Residuals in Finance Receivables Sold.
F-13
<PAGE>
(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 4% to 6% 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. Additional deposits from the residual cash flow (through
the trustee) are made to the spread account as necessary to attain and maintain
the spread account at a specified percentage, ranging from 6.0% to 10.5%, of the
underlying finance receivables principal balance.
In the event that the cash flows generated by the finance receivables 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 1998, the company made initial spread account deposits totaling $13.1
million and additional net deposits through the trustee totaling $4.8 million.
The total balance in the spread accounts was $20.6 million as of December 31,
1998. In connection therewith, the specified spread account balance based upon
the aforementioned specified percentages of the balances of the underlying
portfolios was $23.7 million, resulting in additional funding requirements from
future cash flows of $3.1 million as of December 31, 1998. 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 1997, the Company made initial spread account deposits totaling $6.1
million and additional net deposits through the trustee totaling $1.8 million.
The total balance in the spread accounts was $10.4 million 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 $10.5 million, resulting in additional
funding requirements of $101,000 as of December 31, 1997.
(6) Notes Receivable
The Company's Cygnet Dealer Program has various notes receivable from
used car dealers. Under its Asset Based Loan program, the Company had
commitments for revolving notes receivable totaling $13.8 million at December
31, 1998. These notes have various maturity dates through June 2001 with
interest rates ranging from prime plus 5.00% to prime plus 9.75% per annum
(12.75% to 17.50% at December 31, 1998) payable monthly. The revolving notes
subject the borrower to borrowing base requirements with advances on eligible
collateral (retail installment contracts) ranging from forty-five percent to
sixty-five percent of the par value of the underlying collateral. The balance
outstanding on notes receivable totaled $8.8 million, and $5.6 million at
December 31, 1998 and 1997, respectively. The allowance for credit losses for
notes receivable totaled $500,000 and $200,000 at December 31, 1998 and 1997,
respectively.
In July 1997, First Merchants Acceptance Corporation (FMAC) filed for
bankruptcy. Immediately subsequent to the bankruptcy filing, the Company
executed a loan agreement to provide FMAC with up to $10.0 million in debtor in
possession (the DIP facility) financing. The DIP facility accrued interest at
12.0%, was initially scheduled to mature on February 28, 1998, and was secured
by substantially all of FMAC's assets. The Company and FMAC subsequently amended
the DIP facility to increase the maximum commitment to $21.5 million, decrease
the interest rate to 10.0% per annum, and extend the maturity date indefinitely.
In connection with the amendment, FMAC pledged the first $10.0 million of income
tax refunds receivable, the balance of which FMAC anticipates collecting in
1999, to the Company. The maximum commitment under the DIP facility had been
reduced to $12.4 million at December 31, 1998. Once the proceeds from the income
tax refunds are remitted to the Company, such amounts permanently reduce the
maximum commitment under the DIP facility. Thereafter, the Company anticipates
collecting the balance of the DIP facility from distributions to FMAC from
FMAC's residual interests in certain securitization transactions. The
outstanding balance on the DIP facility totaled $12.2 million and $11.0 million
at December 31, 1998 and 1997, respectively.
F-14
<PAGE>
During the third and fourth fiscal quarters of 1997, the Company acquired
the senior bank debt of FMAC from the bank group members holding such debt. In
December 1997, a credit bid for the outstanding balance of the senior bank debt
plus certain fees and expenses (the "credit bid purchase price") was entered and
approved in the bankruptcy court resulting in the transfer of the senior bank
debt for the loan portfolio which secured the senior bank debt (the "owned
loans"). Simultaneous with the transfer to the Company, a finance company
purchased the owned loans for 86% of the principal balance of the loan
portfolio, and the Company retained a 14% participation in the loan portfolio.
FMAC has guaranteed that the Company will receive an 11.0% return on the credit
bid purchase price from the cash flows generated by the owned loans, and further
collateralized by FMAC's residual interests in certain securitization
transactions. The balance of the participation totaled $6.9 million and $9.2
million at December 31, 1998 and 1997, respectively.
A summary of notes receivable as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
------------
1998 1997
---- ----
Notes Receivable under the Asset Based Loan Program,
net of allowance for doubtful accounts of $500,
and $200, respectively.......... .................... $ 8,311 $ 5,594
FMAC Debtor in Possession Note Receivable............... 12,228 10,994
FMAC Bank Group Participation........................... 6,856 9,244
Other Notes Receivable.................................. 862 913
--- ---
Notes Receivable, net................................... $ 28,257 $ 26,745
======== ========
(7) Property and Equipment
A summary of Property and Equipment as of December 31, 1998 and 1997 follows
(in thousands):
December 31,
------------
1998 1997
---- ----
Land.................................................. $ 3,721 $ 13,813
Buildings and Leasehold Improvements.................. 9,984 16,274
Furniture and Equipment............................... 24,373 11,668
Vehicles.............................................. 219 306
Construction in Process............................... 2,872 2,817
----- -----
41,169 44,878
Less Accumulated Depreciation and Amortization........ (8,199) (5,051)
------ ------
Property and Equipment, Net........................... $ 32,970 $ 39,827
======== ========
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 agreement, the Company would sell certain real property to
the investment company at its cost and leaseback the properties for an initial
term of twenty years. During 1998, the Company sold approximately $27.4 million
of property under this agreement and recognized no gain or loss on the
sale-leaseback transactions.
Interest expense capitalized in 1998, 1997 and 1996 totaled $135,000,
$229,000, and zero, respectively.
(8) Intangible Assets
A summary of intangible assets as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
------------
1998 1997
---- ----
Original Cost:
Goodwill.................... $ 17,037 $17,945
Trademarks.................. 581 581
Covenants not to Compete.... 250 250
--- ---
17,868 18,776
Accumulated Amortization.... (2,338) (1,233)
------ ------
Intangibles, Net............ $ 15,530 $17,543
======== =======
F-15
<PAGE>
Amortization expense relating to intangible assets totaled $1,105,000,
$857,000, and $63,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
(9) Other Assets
A summary of Other Assets as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
------------
1998 1997
---- ----
Prepaid Expenses.............. $2,484 $1,957
Income Taxes Receivable....... 2,926 1,693
Servicing Receivables......... 4,266 1,389
Restricted Cash............... 1,565 1,280
Deposits...................... 1,286 829
Employee Advances............. 1,431 821
Deferred Income Taxes......... 2,626 --
Other......................... 3,991 3,277
----- -----
$20,575 $11,246
======= =======
(10) Accrued Expenses and Other Liabilities
A summary of Accrued Expenses and Other Liabilities as of December 31, 1998
and 1997 follows (in thousands):
December 31,
------------
1998 1997
---- ----
Sales Taxes.................... $ 3,033 $ 3,909
Accrued Payroll, Benefits & Taxes 2,192 2,366
Collections Liability.......... 3,121 1,503
Accrued Advertising............ 1,234 850
Accrued Post Sale Support...... 1,809 771
Deferred Income Taxes.......... -- 718
Others......................... 8,305 4,847
----- -----
$19,694 $14,964
======= =======
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.
(11) Notes Payable
A summary of Notes Payable at December 31, 1998 and 1997 follows (in
thousands):
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
$125,000,000 revolving loan with a finance company, interest
payable daily at 30 day LIBOR (5.24% at December 31,
1998) plus 3.15% through June 2000, secured by substantially
all assets of the Company..................................... $ 51,765 $ 56,950
Two notes payable to a finance company totaling $7,450,000, monthly
interest payable at the prime rate plus 1.50% (9.25% at December
31, 1998) through January 1998; thereafter, monthly payments of
$89,000 plus interest through April 1999 when the remaining
unpaid principal is due, secured by first deeds of trust and
assignments of rents on certain real property................ 3,386 7,450
Others bearing interest at rates ranging from 9% to 11% due through
August 2001, secured by certain real property and certain property
and equipment................................................. 967 771
--- ---
Subtotal............................................... 56,118 65,171
Less: Unamortized Loan Fees........................... 1,025 350
----- ---
Total.................................................. $55,093 $ 64,821
======= =========
</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,
1998 and 1997 except for interest coverage ratios at December 31, 1998, for
which the Company obtained a waiver.
F-16
<PAGE>
(12) Collateralized Notes Payable
The Company has Collateralized Notes Payable consisting of a note payable
under a securitization and a note payable secured by the common stock of the
Company's securitization subsidiaries. These notes do not have contractually
scheduled principal payments but require the Company to remit all collections on
the collateral to the note holders. A summary of Collateralized Notes Payable at
December 31, 1998 and 1997, respectively, follows (in thousands):
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
<S> <C> <C>
$50,607,000 of A Certificates issued pursuant to the Company's
Securitization Program, interest payable monthly at 5.90%,
secured by the underlying pool of finance receivable contracts
and spread account ($5.7 million at December 31, 1998), monthly
principal payments are 73% of principal reductions of the
underlying pool of finance receivable contracts................ 50,607 --
$15 million note payable to a finance company, bearing interest at
LIBOR plus 4% (9.54% at December 31, 1998), secured by the
capital stock of UDRC and UDRC II, Lender will receive all
distributions for Residuals in Finance Receivables Sold until note
is paid in full................................................ 12,234 --
------ -------
Subtotal................................................ 62,841 --
Less: Unamortized Loan Fees............................ 640 --
------ -------
Total................................................... $62,201 $ --
======= =======
</TABLE>
(13) Subordinated Notes Payable
A summary of Subordinated Notes Payable at December 31, 1998 and 1997
follows:
<TABLE>
<CAPTION>
December 31,
------------
1998 1997
---- ----
(In thousands)
<S> <C> <C>
$17.5million Subordinated debentures, interest at 12% per annum
(approximately 18.8% effective rate) payable semi-annually with
the entire principal balance due October 23, 2003; the debentures
are subordinate to all other Company indebtedness except the
Verde note and contain certain call provisions at the option of
the Company....................................................... $ 17,479 $ --
$15 million notes payable to unrelated parties, bearing interest at
12% per annum payable quarterly, principal due February 2001
senior to the Verde subordinated note payable and the
subordinated debentures........................................... 15,000 --
$5 million notes payable to unrelated parties, bearing interest 12%
per annum payable quarterly, principal due July 2001 senior to
the Verde subordinated note payable and the subordinated
debentures....................................................... 5,000 --
$14 million unsecured note payable with Verde, interest payable
monthly at 10% per annum with annual principal payments of $2
million maturing June 2003....................................... 10,000 12,000
------ ------
Subtotal................................................... 47,479 12,000
Less: Unamortized Premium................................. 3,738 --
----- -------
Total...................................................... $ 43,741 $ 12,000
======== ========
</TABLE>
During the year the Company issued $17.5 million of subordinated debentures
in exchange for 2.7 million shares of Company common stock valued at $14.0
million ("Exchange Offer"), including $370,000 of costs incurred for the
Exchange Offer. The debentures are unsecured and subordinate to all existing and
future indebtedness of the Company and bear interest at 12% per annum payable
semi-annually each April and October, approximately $2.9 million per year, until
they are paid in full on October 23, 2003. The debentures were issued at a
premium of approximately $3,874,000 in excess of the market value of the shares
tendered, which will be amortized over the life of the debentures and results in
an effective interest rate of approximately 18.8%. The Company is required to
pay the principal amount of debentures on the fifth anniversary of their
issuance date.
F-17
<PAGE>
In connection with the issuance of the $15 million senior subordinated notes
payable, the Company issued warrants, which were valued 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.
Interest expense related to the subordinated note payable with Verde
totaled $1,073,000, $1,232,000, and $1,933,000, during the years ended December
31, 1998, 1997 and 1996, respectively.
A summary of the future minimum principal payments required under the
aforementioned notes payable and subordinated notes payable after December 31,
1998 follows (in thousands):
Subordinated
December 31, Notes Payable Notes Payable Total
------------ ------------- ------------- -----
1999.......... $ 3,634 $ 2,000 $ 5,634
2000.......... 51,903 2,000 53,903
2001.......... 581 22,000 22,581
2002.......... -- 2,000 2,000
2003.......... -- 19,479 19,479
----------- ----------- ---------
$ 56,118 $ 47,479 $ 103,597
=========== =========== =========
(14) Income Taxes
Income taxes amounted to $2,396,000, $6,637,000, and $100,000 for the years
ended December 31, 1998, 1997 and 1996, respectively (an effective tax rate of
40.5%, 41.1%, and 1.6%, respectively). A reconciliation between taxes computed
at the federal statutory rate of 35% in 1998 and 1997 and 34% in 1996 at the
effective tax rate on earnings before income taxes follows (in thousands):
December 31,
------------
1998 1997 1996
---- ---- ----
Computed "Expected" Income Taxes ....... $2,071 $5,658 $ 2,142
State Income Taxes, Net of Federal Effect 96 962 41
Change in Valuation Allowance........... 735 -- (2,315)
Other, Net.............................. (506) 17 232
----- ----- ------
$2,396 $6,637 $ 100
====== ====== ========
Components of income taxes (benefit) for the years ended December 31, 1998,
1997 and 1996 follow (in thousands):
Current Deferred Total
------- -------- -----
1998:
Federal.............. $ 91 $ 2,158 $ 2,249
State................ 6 141 147
- --- ---
97 2,299 2,396
Discontinued operations (239) (5,643) (5,882)
---- ------ ------
$ (142) $(3,344) $(3,486)
======= ======= =======
1997:
Federal.............. $ 3,743 $ 1,414 $ 5,157
State................ 1,197 283 1,480
----- --- -----
4,940 1,697 6,637
Discontinued operations (40) (18) (58)
--- --- ---
$ 4,900 $ 1,679 $ 6,579
======= ======= =======
1996:
Federal.............. $ (149) $ 187 $ 38
State................ -- 62 62
----- ----- -----
$ (149) $ 249 $ 100
======= ======= =======
F-18
<PAGE>
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, 1998 and 1997 are presented below (in thousands):
December 31,
------------
1998 1997
---- ----
Deferred Tax Assets:
Finance Receivables, Principally Due to the
Allowance for Credit Losses......................... $2,282 $ 473
Inventory......................................... -- 246
Federal and State Income Tax Net Operating Loss
Carryforwards.................................. 1,224 28
Discontinued Operations Liability................. 2,410 --
Accrued Post Sale Support......................... 717 357
Other............................................. 934 395
--- ---
Total Gross Deferred Tax Assets................... 7,567 1,499
Less: Valuation Allowance......................... (735) --
----
Net Deferred Tax Assets................... 6,832 1,499
----- -----
Deferred Tax Liabilities:
Software Development Costs........................ (2,191) (237)
Inventory......................................... (1,176) --
Pre-Opening and Start Up Costs.................... -- (1,236)
Loan Origination Fees............................. (255) (586)
Other............................................. (584) (158)
---- ----
Total Gross Deferred Tax Liabilities........... (4,206) (2,217)
------ ------
Net Deferred Tax Asset (Liability)........ $2,626 $ (718)
------ ------
The valuation allowance for deferred tax assets as of December 31, 1998 and
1997 was $735,000 and zero, respectively. The net change in the total valuation
allowance for the year ended December 31, 1998 was an increase of $735,000. The
allowance is attributable primarily to future deductions and net operating loss
carryforwards in certain states where the Branch Offices operated and
realization of a tax benefit is unlikely. There was no change in the Valuation
Allowance for the year ended December 31, 1997. 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, net of the
established valuation allowance at December 31, 1998.
At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $1,822,000, which, subject to
annual limitations, are available to offset future taxable income, if any,
through 2011.
(15) Servicing
Pursuant to the Company's securitization program that 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%
(generally, 3.0% to 4.0% per annum) of the beginning of month principal balance
of the serviced portfolios. The Company has retained the servicing rights on the
contracts it has sold in connection with its securitization transactions. The
Company has not established any servicing assets or liabilities in connection
with its securitizations as the revenues from contractually specified servicing
fees and other ancillary sources have been just adequate to compensate the
Company for its servicing responsibilities.
In 1998 the Company's Non Dealership Operations entered into several
agreements with third parties to service loan portfolios on their behalf. The
service fees are generally a percentage of the outstanding principal balance
ranging from generally, 3.25% to 4.0% per annum, subject to a minimum dollar
amount per contract, and are paid monthly.
F-19
<PAGE>
The Company recognized servicing income of $33.3 million, $8.8 million, and
$1.9 million in the years ended December 31, 1998, 1997 and 1996, respectively.
A summary of portfolios serviced by the Company's respective segments as of
December 31, 1998 and 1997 follows (in thousands):
Dealership Operations: 1998 1997
---- ----
Finance Receivables from continuing operations.. $ 93,936 $ 55,965
Finance Receivables from discontinued operations 30,219 29,965
Securitized with servicing retained............. 242,297 238,025
Servicing on behalf of others................... 47,947 127,322
------ -------
Total serviced portfolios Dealership Operations. 414,399 451,277
======= =======
Non Dealership Operations:
Finance Receivables ............................ 1,237 --
Servicing on behalf of others................... 586,081 --
------- -------
Total serviced portfolios Non Dealership
Operations.................................. 587,318 --
------- -------
Total serviced portfolios................... $ 1,001,717 $ 451,277
=========== ==========
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.
(16) Lease Commitments
The Company leases used car sales facilities, loan servicing centers,
offices, and certain office equipment from unrelated entities under various
operating leases that expire through March 2019. The leases require monthly
rental payments aggregating approximately $871,000 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 totaled $11,419,000, $5,398,000 and
$2,394,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
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
that 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.
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, 1998 follows (in thousands):
Continuing Discontinued
December 31, Operations Operations Total
------------ ---------- ---------- -----
1999.......... $11,320 $ 567 $ 11,887
2000.......... 10,216 178 10,394
2001.......... 8,263 -- 8,263
2002.......... 5,849 -- 5,849
2003.......... 3,874 -- 3,874
Thereafter.... 45,181 -- 45,181
------ ------ ------
Total $84,703 $ 745 $ 85,448
======= ====== ========
F-20
<PAGE>
(17) Stockholders' Equity
During 1998 the company acquired approximately 2.7 million shares of Ugly
Duckling common stock with a value of approximately $14.0 million in the
Exchange Offer. We also acquired 72,000 shares of Treasury Stock for
approximately $535,000 under its Stock Repurchase Program.
During 1997, the company completed a private placement of 5,075,500 shares
of common stock for a total of approximately $88.7 million 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
$79.4 million cash, net of stock issuance costs.
During 1998, the company issued 50,000 warrants to a third party to purchase
Company common stock. The warrants are exercisable through February 2001 at an
exercise price of $12.50 per share of common stock.
During 1998, the company issued warrants, valued at approximately $900,000,
to purchase 500,000 shares of Company common stock at $10 per share in
connection with senior subordinated note payable agreements. The warrants are
exercisable at any time until (1) February 2001, or (2) the notes are paid in
full.
During the year the company issued 325,000 warrants to a third party to
purchase Company common stock at $20.00 per share. The warrants expire on April
1, 2001 and are subject to a call feature by we.
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 exercisable through
February 2000. The warrants were valued at approximately $612,000. These
warrants remained outstanding at December 31, 1998. 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 April 24, 1996, the company effectuated a 1.16-to-1 stock split. The
effect of this stock split has been reflected for all periods presented in the
Consolidated Financial Statements.
The Company'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.
(18) 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, 1998, 1997,
and 1996 follows (in thousands, except for per share amounts):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Earnings From Continuing Operations.............. $ 3,520 $ 9,528 $ 6,677
Less: Preferred Stock Dividends.................. -- -- (916)
------ ------- -------
Earnings available to Common Stockholders........ $ 3,520 $ 9,528 $ 5,761
========= ========= =========
Net Earnings (Loss).............................. $ (5,703) $ 9,445 $ 5,866
Less: Preferred Stock Dividends.................. -- -- (916)
------ ----- ----
Earnings (Loss) available to Common Stockholders. $ (5,703) $ 9,445 $ 4,950
========= ========= =========
Basic Earnings Per Share From Continuing
Operations..................................... $ 0.19 $ 0.53 $ 0.73
========= ========== ==========
Diluted Earnings Per Share From Continuing
Operations..................................... $ 0.19 $ 0.52 $ 0.69
========== ========== ==========
Basic Earnings (Loss) Per Share.................. $ (0.32) $ 0.53 $ 0.63
========== ========== ==========
Diluted Earnings (Loss) Per Share................ $ (0.31) $ 0.52 $ 0.60
========== ========== ==========
Basic EPS-Weighted Average Shares Outstanding.... 18,082 17,832 7,887
Effect of Diluted Securities:
Warrants....................................... 41 98 71
Stock Options.................................. 282 304 340
--- --- ---
Dilutive EPS-Weighted Average Shares Outstanding. 18,405 18,234 8,298
====== ======== =======
Warrants Not Included in Diluted EPS Since 1,044 390 --
====== ======== ========
Antidilutive.....................................
Stock Options Not Included in Diluted EPS Since
Antidilutive................................... 1,044 828 --
====== ======== =======
</TABLE>
F-21
<PAGE>
(19) Stock Option Plan
In June, 1995, the company adopted a long-term incentive plan (Stock Option
Plan) under which it has set aside 1,800,000 shares of common stock to be
granted to employees. Options are to vest over a period to be determined by the
Board of Directors upon grant and will generally expire 6 to 10 years after the
date of grant. The options generally vest over a period of 5 years.
In August 1998, the Company's stockholders approved an executive incentive
stock option plan (Executive Plan). The Company has reserved 800,000 shares of
its common stock for issuance. Options granted under the plan expire ten years
after the grant date and vest 20% per year upon completion of each year of
service after the date of grant (beginning 1 year after the grant date) subject
to meeting additional vesting hurdles that are based on the trading price of the
Company's stock. Even if these additional vesting hurdles are not met, the
options will fully vest 7 years after the date of grant.
A summary of the aforementioned stock plan activity follows:
Stock Option Plan Executive Plan
----------------- --------------
Weighted Weighted
Average Average
Price Per Price Per
Number Share Number Share
------ ----- ------ -----
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 -- --
Granted................. 925,000 7.68 525,000 8.25
Forfeited............... (995,000) 13.64 (25,000) 8.25
Exercised............... (76,000) 3.61 -- --
------- -------
Balance, December 31, 1998 1,152,000 7.43 500,000 8.25
========= =======
At December 31, 1998, there were 409,000 and 300,000 additional shares
available for grant under the Stock Option Plan and Executive Plan,
respectively. The per share weighted-average fair value of stock options granted
during 1998, 1997 and 1996 was $3.22, $6.54 and $8.39, respectively, on the date
of grant using the Black-Scholes option-pricing model. The following are the
weighted-average assumptions: 1998 -- expected dividend yield 0%, risk-free
interest rate of 5.25%, expected volatility of 50.0%, and an expected life of 5
years; 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.
During 1998 the Board of Directors approved separate plans to reprice the
Company's outstanding stock options under the Stock Option Plan, one in January
1998 and a second in November 1998. The forfeited options had exercise prices
ranging from $9.75 to $20.75 and were repriced at $9.75 or $5.13 per share, the
fair market value on the date of the respective repricings. Approximately
391,000 options were issued under the repricing program. The vesting period was
not affected for the options repriced under the January 1998 repricing plan.
However, the vesting period started over on the repricing date for the options
issued under the November 1998 repricing plan. Generally vesting occurs 20% per
year beginning one year after the grant date. The fair values of these options
were estimated at the date of grant using the criteria noted above. The
repricing resulted in additional pro forma compensation expense in 1998 of
$795,000, which is reflected in the pro forma table below. The repricing
activity has been reflected in table above and is included in the options
granted and forfeited in 1998.
The Company applies APB Opinion 25 in accounting for its Plan, and
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net earnings (loss) and earnings (loss) per share would
have been reduced to the pro forma amounts indicated below:
F-22
<PAGE>
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Pro Forma Earnings from Continuing Operations
Available to Common Stockholders............. $ 2,533 $ 8,650 $ 5,642
Pro forma Net Earnings (Loss) Available to
Common Stockholders........................... $ (6,690) $ 8,567 $ 4,831
Earnings (Loss) per Share -- Basic:
Continuing Operations Pro Forma.............. $ 0.14 $ 0.49 $ 0.72
Net Earnings (Loss) Pro Forma................ $ (0.37) $ 0.48 $ 0.61
Earnings (Loss) per Share -- Diluted:
Continuing Operations Pro Forma.............. $ 0.14 $ 0.48 $ 0.72
Net Earnings (Loss) Pro Forma................ $ (0.37) $ 0.48 $ 0.61
</TABLE>
A summary of stock options granted at December 31, 1998 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 12/31/98 Contractual Life Price at 12/31/98 Price
- --------------- ----------- ---------------- ----- ----------- -----
<S> <C> <C> <C> <C> <C>
$ .50 to $1.00. 65,000 5.4 years $ 0.86 -- $ --
$1.50 to $7.00. 543,000 5.9 years 4.68 117,000 3.78
$8.00 to $8.25. 816,000 7.8 years 8.2501 -- --
$8.30 to $18.63 228,000 5.4 years 14.71 86,000 15.76
------- ----- ------ -----
1,652,000 $ 7.68 203,000 $ 8.86
========= ======= ======= ========
</TABLE>
(20) Year 2000 Readiness Disclosure
In 1998, the Company developed a plan to deal with the Year 2000 problem and
began modifying and testing, or converting its computer systems to be Year 2000
compliant. The plan provides for the modification, testing, and conversion
efforts to be completed by June 30, 1999. The Year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. Management has also assessed the Year 2000 remediation efforts
of the Company's significant suppliers. Although management believes its efforts
minimize the potential adverse effects that a supplier's failure would have on
the Company, there can be no absolute assurance that all its suppliers will
become Year 2000 compliant on time. The Company will evaluate appropriate
courses of action, including replacement of certain systems whose associated
costs would be recorded as assets and subsequently amortized, or modification of
its existing systems which costs would be expensed as incurred. The Company
estimates it will cost between $2.2 million and $2.7 million to become Year 2000
compliant and had incurred $1.3 million of these costs during 1998. However,
there can be no assurance that the Company will be able to completely resolve
all Year 2000 issues or that the ultimate cost to identify and implement
solutions to all Year 2000 problems will not exceed the Company's estimate.
(21) Commitments and Contingencies
The Company's Non Dealership operations have entered into servicing
agreements with two companies that have filed and subsequently emerged from
bankruptcy and continue to operate under their approved plans of reorganization.
Under the terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, the Company is entitled to certain incentive compensation in excess of
the servicing fees earned to date. Under the terms of one of the agreements, the
Company is scheduled to receive 17.5% of all collections of the serviced
portfolio once the specified creditors have been paid in full. Under the terms
of the second agreement, the Company is scheduled to receive the first $3.25
million in collections once the specified creditors have been paid in full and
15% thereafter. The Company is required to issue up to 150,000 warrants to the
extent the Company receives the $3.25 million and in addition will be required
to issue 75,000 warrants for each $1.0 million in incentive fee income after
collection of the $3.25 million. As of December 31, 1998, management estimates
that the incentive compensation could range from $0 to $8.0 million under these
agreements. The Company has not accrued any fee income with regard to these
incentives.
F-23
<PAGE>
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 may be available for future debt offerings. There can be
no assurance, however, that the Company will be able to use this registration
statement to sell debt or other securities.
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.
(22) Retirement Plan
The Company has established qualified 401(k) retirement plans (defined
contribution plans) which became effective on October 1, 1995. The plans, as
amended, cover 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 from 10% to 25% 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 $121,000, $49,000, and $23,000
during the years ended December 31, 1998, 1997, and 1996, respectively.
(23) 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, 1998 and 1997, the
amounts that will actually be realized or paid in settlement of the instruments
could be significantly different.
Cash and Cash Equivalents
The carrying amount is estimated to be the fair value because of the
liquidity of these instruments.
Finance Receivables, Residuals in Finance Receivables Sold, Investments Held in
Trust, 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.
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.
F-24
<PAGE>
(24) Business Segments
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended December 31, 1998, 1997,
and 1996, respectively. The Company has 6 distinct business segments. Within the
Dealership Operations division, 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. Within
the Non Dealership Operations division, these consist of the Cygnet Dealer
program, bulk purchasing and loan servicing, 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>
Dealership Operations Non Dealership Operations
--------------------- -------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------------------- --------- ------ --------- --------- -----
(In thousands)
<S> <C> <C> <C> <C> <C> <C> <C>
December 31, 1998:
Sales of Used Cars............... $ 287,618 $ -- $ -- $ -- $ -- $ -- $ 287,618
Less: Cost of Cars Sold.......... 167,014 -- -- -- -- -- 167,014
Provision for Credit Losses...... 59,770 5,548 -- 2,316 -- -- 67,634
------ ----- ----- ----- ------ ----- ------
60,834 (5,548) -- (2,316) -- -- 52,970
Interest Income.................. -- 16,946 341 8,709 1,832 -- 27,828
Gain on Sale of Loans............ -- 12,093 -- -- -- -- 12,093
Service Fee and Other Income..... 389 15,453 493 -- 22,296 -- 38,631
--- ------ --- ----- ------ ----- ------
Income before Operating Expenses. 61,223 38,944 834 6,393 24,128 -- 131,522
------ ------ --- ----- ------ ----- -------
Operating Expenses:
Selling and Marketing............ 20,285 -- -- 242 31 7 20,565
General and Administrative....... 32,383 18,491 16,103 2,721 18,664 4,040 92,402
Depreciation and Amortization.... 2,581 1,334 997 104 614 105 5,735
----- ----- --- --- --- --- -----
55,249 19,825 17,100 3,067 19,309 4,152 118,702
------ ------ ------ ----- ------ ----- -------
Income (loss) before Interest $ 5,974 $ 19,119 $ (16,266) $ 3,326 $ 4,819 $ (4,152) $ 12,820
Expense.......................... ========= ========= ========= ========= ========== ========== =========
Capital Expenditures............. $ 14,265 $ 1,297 $ 2,352 $ 449 $ 2,260 $ 1,163 $ 21,786
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 75,366 $ 145,880 $ 47,543 $ 44,250 $ 31,589 $ 1,347 $ 345,975
========= ========= ========= ========= ========== ========== =========
December 31, 1997:
Sales of Used Cars............... $ 123,814 $ -- $ -- $ -- $ -- $ -- $ 123,814
Less: Cost of Cars Sold.......... 72,358 -- -- -- -- -- 72,358
Provision for Credit Losses...... 22,354 -- -- 691 -- -- 23,045
------ ------ ----- ---- ----- ----- ------
29,102 -- -- (691) -- -- 28,411
Interest Income.................. -- 12,559 -- 2,359 3,818 -- 18,736
Gain on Sale of Loans............ -- 6,721 -- -- 8,131 -- 14,852
Service Fee and Other Income..... 1,498 8,814 2,013 356 -- -- 12,681
----- ----- ----- --- ----- ----- ------
Income before Operating Expenses. 30,600 28,094 2,013 2,024 11,949 -- 74,680
------ ------ ----- ----- ------ ----- ------
Operating Expenses:
Selling and Marketing............ 10,538 -- -- -- -- -- 10,538
General and Administrative....... 17,214 12,303 9,896 917 -- 1,572 41,902
Depreciation and Amortization.... 1,536 1,108 504 28 -- 125 3,301
----- ----- --- -- ----- --- -----
29,288 13,411 10,400 945 -- 1,697 55,741
------ ------ ------ --- ----- ----- ------
Income (loss) before Interest $ 1,312 $ 14,683 $ (8,387) $ 1,079 $ 11,949 $ (1,697) $ 18,939
========= ========= ========= ========= ========== ========== =========
Expense..........................
Capital Expenditures............. $ 13,571 $ 3,791 $ 2,104 $ 19 $ -- $ 24 $ 19,509
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 74,287 $ 78,514 $ 72,799 $ 27,539 $ 22,318 $ 969 $ 276,426
========= ========= ========= ========= ========== ========== =========
December 31, 1996:
Sales of Used Cars............... $ 53,768 $ -- $ -- $ -- $ -- $ -- $ 53,768
Less: Cost of Cars Sold.......... 31,879 -- -- -- -- -- 31,879
Provision for Credit Losses...... 9,657 -- -- -- -- -- 9,657
----- ----- ---- ----- ----- ---- -----
12,232 -- -- -- -- -- 12,232
Interest Income.................. -- 8,426 171 -- -- -- 8,597
Gain on Sale of Loans............ -- 3,925 -- -- -- -- 3,925
Service Fee and Other Income..... 195 1,887 455 -- -- -- 2,537
--- ----- --- ----- ----- ---- -----
Income before Operating Expenses. 12,427 14,238 626 -- -- -- 27,291
------ ------ --- ----- ----- ---- ------
Operating Expenses:
Selling and Marketing............ 3,568 -- 17 -- -- -- 3,585
General and Administrative....... 6,306 2,859 3,953 -- -- -- 13,118
Depreciation and Amortization.... 318 769 295 -- -- -- 1,382
--- --- --- -----
10,192 3,628 4,265 -- -- -- 18,085
------ ----- ----- ------ ------ ------ ------
Income (loss) before Interest $ 2,235 $ 10,610 $ (3,639) $ -- $ -- $ -- $ 9,206
Expense.......................... ========= ========= ========= ========= ========== ========== =========
Capital Expenditures............. $ 4,530 $ 455 $ 564 $ -- $ -- $ -- $ 5,549
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 20,698 $ 12,775 $ 84,156 $ -- $ -- $ -- $ 117,629
========= ========= ========= ========= ========== ========== =========
</TABLE>
F-25
<PAGE>
(25) Quarterly Financial Data -- unaudited
A summary of the quarterly data for the years ended December 31, 1998, and
1997 follows:
<TABLE>
<CAPTION>
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
------- ------- ------- ------- -----
(In thousands, except per share amounts)
<S> <C> <C> <C> <C> <C>
1998:
Total Revenue..................... $ 87,777 $ 88,819 $ 96,714 $ 92,860 $ 366,170
======== ======== ======== ======== =========
Income before Operating Expenses.. 31,246 32,678 37,653 29,945 131,522
====== ====== ====== ====== =======
Operating Expenses................ 23,514 26,359 33,542 35,287 118,702
====== ====== ====== ====== =======
Income (Loss) before Interest
Expense........................ 7,732 6,319 4,111 (5,342) 12,820
===== ===== ===== ====== ======
Earnings (Loss) from Continuing
Operations..................... $ 3,729 $ 2,942 $ 1,527 $ (4,678) $ 3,520
======== ======== ======== ======== =========
(Loss) from Discontinued Operations (5,595) -- (3,628) -- (9,223)
====== ======== ====== ======== ========
Net Earnings (Loss)............... $ (1,866) $ 2,942 $ (2,101) $ (4,678) $ (5,703)
======== ======== ======== ======== =========
Basic Earnings (Loss) Per Share from
Continuing Operations.......... $ 0.20 $ 0.16 $ 0.08 $ (0.28) $ 0.19
========= ======== ======== ======== ==========
Diluted Earnings (Loss) Per Share
from Continuing Operations.......... $ 0.20 $ 0.16 $ 0.08 $ (0.28) $ 0.19
========= ======== ======== ======== ==========
Basic Earnings (Loss) Per Share... $ (0.10) $ 0.16 $ (0.11) $ (0.28) $ (0.32)
========= ======== ======== ======== ==========
Diluted Earnings (Loss) Per Share. $ (0.10) $ 0.16 $ (0.11) $ (0.28) $ (0.31)
========= ======== ======== ======== ==========
1997:
Total Revenue..................... $ 22,301 $ 36,279 $ 45,737 $ 65,766 $ 170,083
======== ======== ======== ======== =========
Income before Operating Expenses.. 9,101 15,480 19,415 30,684 74,680
===== ====== ====== ====== ======
Operating Expenses................ 8,133 11,988 14,780 20,840 55,741
===== ====== ====== ====== ======
Income before Interest Expense.... 968 3,492 4,635 9,844 18,939
=== ===== ===== ===== ======
Earnings from Continuing Operations $ 408 $ 1,896 $ 2,220 $ 5,004 $ 9,528
======== ======== ======== ======== =========
Earnings (Loss) from Discontinued
Operations..................... 2,854 2,415 (4,048) (1,304) (83)
===== ===== ====== ====== ===
Net Earnings (Loss)............... $ 3,262 $ 4,311 $ (1,828) $ 3,700 $ 9,445
======== ======== ======== ======== =========
Basic Earnings Per Share from
Continuing Operations.......... $ 0.03 $ 0.10 $ 0.12 $ 0.27 $ 0.53
========= ======== ======== ======== ==========
Diluted Earnings Per Share from
Continuing Operations.......... $ 0.02 $ 0.10 $ 0.12 $ 0.26 $ 0.52
========= ======== ======== ======== ==========
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
========= ======== ======== ======== ==========
</TABLE>
F-26
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
March 31, December 31,
1999 1998
-------------- --------------
ASSETS
Cash and Cash Equivalents $ 4,387 $ 2,751
Finance Recievables, net 237,928 163,209
Notes Receiveable, Net 21,670 28,257
Inventory 39,891 44,167
Property and Equipment, net 34,299 32,970
Intangible Assets, Net 15,256 15,530
Other Assets 22,880 20,575
Net Assets of Discontinued Operations 30,305 38,516
-------------- --------------
$ 406,616 $ 345,975
============== ==============
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Accounts Payable $ 5,678 $ 2,479
Accrued Expenses and Other Liabilities 30,329 19,694
Notes Payable 171,904 117,294
Subordinated Notes Payable 40,815 43,741
--------------- -------------
Total Liabilities: 248,726 183,208
--------------- -------------
Stockholder's Equity
Common Stock 19
19
Additional Paid in Capital 173,819 173,809
Retained Earnings 3,869 3,449
Treasury Stock (19,817) (14,510)
--------------- -------------
Total Stockholders' Equity 157,890 162,767
--------------- -------------
$ 406,616 $ 345,975
=============== =============
See accompanying notes to Condensed Consolidated Financial Statements.
F-27
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
Three Months Ended March 31, 1999 and
1998 (In thousands, except earnings per
share amounts)
1999 1998
------------- --------------
Sales of Used Cars $106,443 $72,973
Less:
Cost of Used Cars Sold 60,097 39,731
Provision for Credit Losses 28,561 15,362
------------- --------------
17,880
17,785
------------- --------------
Other Income:
Interest Income 14,003 6,205
Gain on Sale of Finance Receivables - 4,614
Servicing and Other Income 9,672 3,912
------------- --------------
14,731
23,675
------------- --------------
Income before Operating Expenses 41,460 32,611
Operating Expenses:
Selling and Marketing 6,416 4,921
General and Administrative 28,553 18,786
Depreciation and Amortization 2,135 1,173
------------- --------------
37,104 24,880
------------- --------------
Operating Income 4,356 7,731
Interest Expense 3,656 1,502
------------- --------------
Earnings before Income Taxes 700 6,229
Income Taxes 280 2,500
------------- --------------
Income from Continuing Operations 420 3,729
Discontinued Operations:
Loss from Operations of Discontinued Operations,
net of income tax benefit of $492 - (768)
Loss on Disposal of Discontinued Operations net
of income tax benefit of $3,024 - (4,827)
------------- --------------
Net Earnings (Loss) $ 420 $(1,866)
============= ==============
Earnings per Common Share from Continuing
Operations:
Basic $ 0.03 $ 0.20
============= ==============
Diluted $ 0.03 $ 0.20
============= ==============
Net Earnings (Loss) per Common Share:
Basic $ 0.03 $ (0.10)
============= ==============
Diluted $ 0.03 $ (0.10)
============= ==============
Shares Used in Computation:
Basic 15,650 18,557
============= ==============
Diluted 15,785 19,093
============= ==============
F-28
<PAGE>
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 1999 and 1998
(In thousands)
<TABLE>
<CAPTION>
1999 1998
------------- -------------
<S> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss) $ 420 $ (1,866)
Adjustments to Reconcile Net Earnings (Loss) to Net Cash
Provided
by Operating Activities:
Loss from Discontinued Operations - 5,595
Provision for Credit Losses 28,561 15,362
Purchase of Finance Receivables for Sale - (69,708)
Increase in Deferred Income Taxes (5,188) (2,205)
Depreciation and Amortization 2,135 1,173
Gain on Sale of Finance Receivables - (4,614)
Proceeds from Sale of Finance Receivables - 62,556
Collections of Finance Receivables - 5,935
Decrease in Inventory 4,276 6,914
Decrease in Other Assets 237 1,324
Increase in Accounts Payable, Accrued Expenses and Other 9,911 2,139
Increase in Income Taxes Receivable 6,689 793
------------- -------------
Net Cash Provided by Operating Activities 47,041 23,398
------------- -------------
Cash Flows Used in Investing Activities:
Increase in Finance Receivable (137,358) (8,735)
Collections of Finance Receivables 36,319 4,741
Increase in Investments Held in Trust (2,116) (3,543)
Advances under Notes Receivable (3,109) (11,131)
Repayments of Notes Receivable 9,571 4,926
Purchase of Property and Equipment (3,190) (6,640)
------------- -------------
Net Cash Used in Investing Activities (99,883) (20,382)
------------- -------------
Cash Flows from Financing Activities:
Additions to Notes Payable 72,717 45,000
Repayment of Notes Payable (21,538) (31,867)
Proceeds from Issuance of Common Stock 32 202
Acquisition of Treasury Stock (5,307) -
Other, Net 363 223
------------- -------------
Net Cash Provided by Financing Activities 46,267 13,558
------------- -------------
Cash Provided by (Used in) Discontinued Operations 8,211 (19,597)
------------- -------------
Net Increase (Decrease) in Cash and Cash Equivalents 1,636 (3,023)
Cash and Cash Equivalents and Beginning of Period 2,751 3,537
------------- -------------
Cash and Cash Equivalents and End of Period $ 4,387 $ 514
============= =============
Supplemental Statement of Cash Flows Information:
Interest Paid $ 5,934 $ 2,222
============= =============
Income Taxes Paid $ - $ 408
============= =============
</TABLE>
See accompanying notes to Condensed Consolidated Financial Statements.
F-29
<PAGE>
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Basis of Presentation
Our accompanying unaudited condensed consolidated financial statements 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 our opinion, such unaudited
interim information reflects all adjustments, consisting only of normal
recurring adjustments, necessary to present our financial position and results
of operations for the periods presented. Our results of operations for interim
periods are not necessarily indicative of the results to be expected for a full
fiscal year. Our Condensed Consolidated Balance Sheet as of December 31, 1998
was derived from our audited consolidated financial statements as of that date
but does not include all the information and footnotes required by generally
accepted accounting principles. We suggest that these condensed consolidated
financial statements be read in conjunction with the audited consolidated
financial statements included in our Annual Report on Form 10-K, for the year
ended December 31, 1998.
Note 2. Summary of Finance Receivables
Following is a summary of our Finance Receivables, net, as of March 31, 1999 and
December 31, 1998 (in thousands):
<TABLE>
<CAPTION>
March 31, 1999 December 31, 1998
---------------------------------------- ----------------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
------------- ------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Installment Sales Contract Principal Balances $182,150 $ 69,053 $251,203 $ 93,936 $ 51,282 $145,218
Add: Accrued Interest 1,798 765 2,563 877 473 1,350
Loan Origination Costs 3,583 - 3,583 2,237 - 2,237
------------- ------------ ------------ ------------ ------------ -------------
Principal Balances, net 187,531 69,818 257,349 97,050 51,755 148,805
Residuals in Finance Receivables Sold 28,480 2,625 31,105 33,331 2,625 35,956
Investments Held in Trust 22,680 - 22,680 20,564 - 20,564
------------- ------------ ------------ ------------ ------------ -------------
238,691 72,443 311,134 150,945 54,380 205,325
Allowance for Credit Losses (48,628) (2,326) (50,954) (24,777) (2,024) (26,801)
Discount on Acquired Loans - (22,252) (22,252) - (15,315) (15,315)
------------- ------------ ------------ ------------ ------------ -------------
Finance Receivables, net $190,063 $ 47,865 $237,928 $126,168 $ 37,041 $163,209
============= ============ ============ ============ ============ =============
Classification:
Finance Receivables Held for Investment $123,787 $ 69,053 $192,840 $ 26,852 $ 51,282 $ 78,134
Finance Receivables Held as Collateral for
Securitization Note Payable 58,363 - 58,363 67,084 - 67,084
============= ============ ============ ============ ============ =============
$182,150 $ 69,053 $251,203 $ 93,936 $ 51,282 $145,218
============= ============ ============ ============ ============ =============
</TABLE>
F-30
<PAGE>
As of March 31, 1999 and December 31, 1998, our Residuals in Finance
Receivables Sold from dealership operations were comprised of the following (in
thousands):
March 31, December 31,
1999 1998
--------------- -------------
Retained interest in subordinated securities (B $ $ 51,243
Certificates) 41,165
Net interest spreads, less present value discount 19,837 25,838
Reduction for estimated credit losses (32,522) (43,750)
--------------- -------------
Residuals in finance receivables sold $ 28,480 $ 33,331
=============== =============
Securitized principal balances outstanding $158,890 $ 198,747
=============== =============
Estimated credit losses as a % of securitized
principal balances outstanding 20.5% 22.0%
=============== =============
The following table reflects a summary of activity for our Residuals in
Finance Receivables Sold from dealership operations for the three month periods
ended March 31, 1999 and 1998 (in thousands):
March 31, March 31,
1999 1998
------------------- -------------------
Balance, Beginning of Period $ 33,331 $ 13,277
Additions - 13,858
Amortization (4,851) (2,394)
------------------- -------------------
Balance, End of Period $ 28,480 $ 24,741
=================== ===================
Note 3. Notes Receivable
Our Cygnet dealer program has various notes receivable from used car
dealers. Under Cygnet's asset based loan program, our commitments for revolving
notes receivable totaled $10.2 million at March 31, 1999.
In July 1997, First Merchants Acceptance Corporation (First Merchants) filed
for bankruptcy. Immediately subsequent to the bankruptcy filing, we executed a
loan agreement to provide First Merchants with debtor in possession financing
(DIP facility). The maximum commitment under the DIP facility is $11.5 million
at March 31, 1999. The outstanding balance on the DIP facility totaled $11.1
million and $12.2 million at March 31, 1999 and December 31, 1998.
Following is a summary of Notes Receivable at March 31, 1999 and December
31, 1998 (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
-------------- ----------------
<S> <C> <C>
Notes Receivable under the asset based loan program, net of
allowance for doubtful accounts of $167, and $500, respectively $ 7,230 $ 8,311
First Merchants Debtor in Possession Note Receivable 11,062 12,228
First Merchants Bank Group Participation 2,331 6,856
Other Notes Receivable 1,047 862
-------------- ----------------
Notes Receivable, net $ 21,670 $ 28,257
============== ================
</TABLE>
F-31
<PAGE>
Note 4. Notes Payable
The following is a summary of Notes Payable at March 31, 1999 and December
31, 1998 (in thousands):
<TABLE>
<CAPTION>
March 31, December 31,
1999 1998
----------------- ------------------
<S> <C> <C>
Revolving Facility with GE Capital $ 75,606 $ 51,765
Securitization Note Payable 44,596 49,967
Note Payable Collateralized by the Common Stock of our Securitization Subsidiaries 19,999 12,234
Note Payable Collateralized by Finance Receivables Contracts 28,876 -
Mortgage Loan with Finance Company 3,386 3,386
Others 897 967
----------------- ------------------
Subtotal 173,360 118,319
Less: Unamortized Loan Fees 1,456 1,025
----------------- ------------------
Notes Payable $ 171,904 $ 117,294
================= ==================
</TABLE>
Note 5. Common Stock Equivalents
Net Earnings (Loss) per common share amounts are based on the weighted
average number of common shares and common stock equivalents outstanding for the
three month periods ended March 31, 1999, and 1998 as follows (in thousands,
except for per share amounts):
<TABLE>
<CAPTION>
March 31, March 31,
1999 1998
---------------- -----------------
<S> <C> <C>
Income from Continuing Operations $ 420 $ 3,729
================ =================
Net Earnings (Loss) $ 420 $ (1,866)
================ =================
Basic EPS-Weighted Average Shares Outstanding 15,650 18,557
================ =================
Basic Earnings (Loss) Per Share from:
Continuing Operations $ 0.03 $ 0.20
================ =================
Net Earnings (Loss) $ 0.03 $ (0.10)
================ =================
Basic EPS-Weighted Average Shares Outstanding 15,650 18,557
Effect of Diluted Securities:
Warrants - 87
Stock Options 135 449
---------------- -----------------
Dilutive EPS-Weighted Average Shared Outstanding 15,785 19,093
================ =================
Diluted Earnings (Loss) Per Share from:
Continuing Operations $ 0.03 $ 0.20
================ =================
Net Earnings (Loss) $ 0.03 $ (0.10)
================ =================
Warrants Not Included in Diluted EPS Since Antidilutive 1,556 715
================ =================
Stock Options Not Included in Diluted EPS since Antidilutive 1,153 603
================ =================
</TABLE>
F-32
<PAGE>
Note 6. Business Segments
We have two divisions: dealership operations and non-dealership operations.
Within our divisions we have six distinct business segments. Within the
dealership operations division, the segments consist of retail car sales
operations (company dealerships), the income generated from the finance
receivables generated at the Ugly Duckling dealerships and corporate and other
operations. Under the non-dealership operations division, the segments consist
of the Cygnet dealer program, bulk purchasing and loan servicing, and corporate
and other operations.
A summary of operating activity by business segment for the three months
ended March 31, 1999 and 1998 follows (in thousands):
<TABLE>
<CAPTION>
Dealership Operations Non Dealership Operations
----------------------------------------- -----------------------------------------
Company
Company Dealership Corporate Cygnet Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
----------- ----------- --------- ------- ------------ -------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
1999:
Sales of Used Cars $ 106,443 $ - $ - $ - $ - $ - $ 106,443
Less: Cost of Used Cars Sold 60,097 - - - - - 60,097
Provision for Credit Losses 21,893 5,871 - 797 - - 28,561
----------- ----------- ------------- ------- -------------- ----------- ------------
24,453 (5,871) - (797) - - 17,785
----------- ----------- ------------- ------- -------------- ----------- ------------
Interest Income - 10,312 61 3,317 313 - 14,003
Servicing and Other Income 6 2,883 45 47 6,691 - 9,672
----------- ----------- ------------- ------- -------------- ----------- ------------
Income before Operating Expenses 24,459 7,324 106 2,567 7,004 - 41,460
----------- ----------- ------------- ------- -------------- ----------- ------------
Operating Expenses:
Selling and Marketing 6,378 35 3 - 6,416
General and Administrative 11,102 4,590 5,332 963 5,821 745 28,553
Depreciation and Amortization 791 283 521 78 321 141 2,135
----------- ----------- ------------- ------- -------------- ----------- ------------
18,271 4,873 5,853 1,076 6,145 886 37,104
----------- ----------- ------------- ------- -------------- ----------- ------------
Operating Income $ 6,188 $ 2,451 $(5,747) $ 1,491 $ 859 $ (886) $ 4,356
=========== =========== ============= ======= ============== =========== ============
1998:
Sales of Used Cars $ 72,973 $ - $ - $ - $ - $ - $ 72,973
Less: Cost of Used Cars Sold 39,731 - - - - - 39,731
Provision for Credit Losses 15,034 - - 328 - - 15,362
----------- ----------- ------------- ------- -------------- ----------- ------------
18,208 - - (328) - - 17,880
----------- ----------- ------------- ------- -------------- ----------- ------------
Interest Income - 3,816 64 1,598 727 - 6,205
Gain on Sale of Loans - 4,614 - - - - 4,614
Servicing and Other Income 41 3,825 46 - - - 3,912
----------- ----------- ------------- ------- -------------- ----------- ------------
Income before Operating Expenses 18,249 12,255 110 1,270 727 - 32,611
----------- ----------- ------------- ------- -------------- ----------- ------------
Operating Expenses:
Selling and Marketing 4,878 - - 43 - - 4,921
General and Administrative 10,506 4,555 2,619 515 - 591 18,786
Depreciation and Amortization 613 337 201 22 - - 1,173
----------- ----------- ------------- ------- -------------- ----------- ------------
15,997 4,892 2,820 580 - 591 24,880
----------- ----------- ------------- ------- -------------- ----------- ------------
Operating Income $ 2,252 $ 7,363 $(2,710) $ 690 $ 727 $ (591) $ 7,731
=========== =========== ============= ======= ============== =========== ============
</TABLE>
F-33
<PAGE>
Note 7. Discontinued Operations
In February 1998, we announced our intention to close our branch office
network, through which we purchased retail installment contracts from third
party dealers, and exit this line of business. We substantially completed the
branch office closure as of March 31, 1998. We are continuing to negotiate lease
settlements and terminations with respect to our branch office network closure.
As a result of the branch office network closure, we reclassified the results of
operations of the branch office network in the accompanying condensed
consolidated balance sheets and condensed consolidated statements of operations
to discontinued operations.
The components of Net Assets of Discontinued Operations as of March 31, 1999
and December 31, 1998 follow (in thousands):
March 31, December 31,
1999 1998
---------------- ----------------
Finance Receivables, net $ 24,282 $ 30,649
Residuals in Finance Receivables Sold 6,052 7,875
Investments Held in Trust 2,971 3,665
Disposal Liability (3,000) (3,673)
---------------- ----------------
Net Assets of Discontinued Operations $ 30,305 $ 38,516
================ ================
Note 8. Use of Estimates
The preparation of our consolidated financial statements requires us 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 our estimates.
Note 9. Certain Bankruptcy Remote Entities
Ugly Duckling Receivables Corporation ("UDRC") and Ugly Duckling Receivables
Corporation II ("UDRC II") (collectively referred to as "Securitization
Subsidiaries"), are our wholly-owned special purpose "bankruptcy remote
entities." Their assets, including assets classified as Discontinued Operations,
include Residuals in Finance Receivables Sold and Investments Held In Trust, in
the amounts of approximately $34.5 million and $25.6 million, respectively, at
March 31, 1999. These amounts would not be available to satisfy claims of our
creditors on a consolidated basis.
Note 10. Reclassifications
We have made certain reclassifications to previously reported information to
conform to the current presentation.
F-34
<PAGE>
You should rely only on the information contained in this prospectus. No
dealer, salesperson or other person is authorized to give information that is
not contained in this prospectus. This prospectus is not an offer to sell nor is
it seeking an offer to buy these securities in any jurisdiction where the offer
or sale is not permitted. The information contained in this prospectus is
correct only as of the date of this prospectus, regardless of the time of the
delibvery of this prospectus or any sale of these securities.
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TABLE OF CONTENTS
Page
Prospectus Summary.................. 3
Risk Factors........................ 5
Forward Looking Statements.......... 11
Use of Proceeds..................... 11
Dividend Policy..................... 12
Capitalization...................... 13
Selected Consolidated Financial and
Operating Data................... 14
Management's Discussion and Analysis
of Financial Condition and Results of
Operations........................ 15
Business............................ 41
Management.......................... 49
Description of Capital Stock........ 63
Selling Securityholders............. 68
Plan of Distribution................ 68
Legal Matters....................... 71
Experts............................. 71
Where You Can Find More Information 71
Index to Consolidated Financial
Statements and to Condensed Consolidated
Financial Statements................ F-1
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5,666,190 Shares
Common Stock
666,190
Common Stock Purchase Warrants
LOGO
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PROSPECTUS
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August 4, 1999
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