<PAGE> 1
REGISTRATION NO. 333-
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------
CYGNET FINANCIAL CORPORATION
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C> <C>
DELAWARE 6141 86-0917503
(STATE OF INCORPORATION) (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.)
</TABLE>
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
(602) 852-6600
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)
------------------------
STEVEN P. JOHNSON, ESQ.
SENIOR VICE PRESIDENT AND GENERAL COUNSEL
CYGNET FINANCIAL CORPORATION
2525 EAST CAMELBACK ROAD, SUITE 1150
PHOENIX, ARIZONA 85016
(602) 852-6600
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)
------------------------
COPIES TO:
STEVEN D. PIDGEON, ESQ.
RICHARD B. STAGG, ESQ.
ROSARIO A. RODRIGUEZ, ESQ.
SNELL & WILMER L.L.P.
ONE ARIZONA CENTER
PHOENIX, ARIZONA 85004-0001
(602) 382-6000
------------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: From time
to time after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [X]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ] __________
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ] __________
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
------------------------
CALCULATION OF REGISTRATION FEE
<TABLE>
<CAPTION>
===========================================================================================================================
TITLE OF EACH CLASS OF PROPOSED MAXIMUM AMOUNT OF
SECURITIES TO BE REGISTERED AMOUNT AGGREGATE OFFERING PRICE REGISTRATION FEE
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Rights...................................... 4,650,000 $0.00(1) $0.00(1)
- ---------------------------------------------------------------------------------------------------------------------------
Common Stock, $.001 par value............... 5,578,572(2) $39,050,004 $11,520
- ---------------------------------------------------------------------------------------------------------------------------
Total............................. $39,050,004 $11,520
===========================================================================================================================
</TABLE>
(1) Pursuant to Rule 457(g), no registration fee is payable because a fee is
paid for registration of the shares of Common Stock offered pursuant to the
Rights.
(2) Includes 714,286 shares of Common Stock that may be purchased by Ernest C.
Garcia, II pursuant to the Additional Purchase Right (as defined herein) and
214,286 shares of Common Stock that may be purchased by certain directors
and officers of the registrant pursuant to the D&O Purchase Right (as
defined herein).
------------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE
ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY
DETERMINE.
================================================================================
<PAGE> 2
SUBJECT TO COMPLETION DATED JUNE 19, 1998
[CYGNET FINANCE LOGO]
CYGNET FINANCIAL CORPORATION
5,578,572 SHARES OF COMMON STOCK
AND
4,650,000 COMMON STOCK PURCHASE RIGHTS
This Prospectus relates to a rights offering (the "Rights Offering"), which
includes (a) a distribution of transferable rights ("Rights") to subscribe for
shares of Common Stock, $.001 par value (the "Common Stock") of Cygnet Financial
Corporation ("Cygnet") to holders of Common Stock, par value $.001 per share
("UDC Common Stock") of Ugly Duckling Corporation ("UDC"), (b) the sale of
shares of Common Stock upon exercise of the Rights (the "Offered Shares"), (c)
the sale of shares of Common Stock pursuant to the Over-Subscription Privilege
(as defined herein), (d) the sale of shares of Common Stock to the Standby
Purchaser (as defined herein) pursuant to the terms of the Standby Purchase
Agreement (as defined herein), and (e) the sale of shares of Common Stock
pursuant to the Additional Purchase Right (as defined herein) and the D&O
Purchase Right (as defined herein). The holders of UDC Common Stock receiving
Rights are referred to herein as "Rights Offering Participants."
The Rights Offering is being effected as part of a plan to separate UDC and
its existing subsidiaries into two publicly-held companies (the "Split-up").
Pursuant to the Split-up, Cygnet, a newly-formed Delaware corporation and
wholly-owned subsidiary of UDC, and its subsidiaries will acquire UDC's bulk
purchasing and certain servicing operations, its third party dealer financing
operations (excluding the branch office network operations that UDC closed in
the first quarter of 1998), and substantially all of the assets and liabilities
acquired pursuant to the transactions between UDC and First Merchants Acceptance
Corporation and Reliance Acceptance Corporation. In exchange for such assets,
Cygnet will issue $40 million of its Preferred Stock (as defined herein) and a
cash or equivalent payment as described herein. The sum of the Preferred Stock
and the cash payment will be equivalent to the greater of the appraised value or
book value of the assets transferred (in each case net of assumed liabilities).
The proceeds of the Rights Offering will be used primarily to provide funds to
Cygnet for capital expenditures and working capital and to fund the cash portion
of the consideration as described herein.
After consummation of the Split-up, Cygnet and UDC will be owned, operated,
and managed as separate public companies with separate management. Cygnet will
operate substantially all of the third party dealer finance operations currently
conducted by UDC, including its bulk purchasing and certain servicing operations
and its collateralized dealer finance program. UDC will retain and continue to
operate its "buy here-pay here" dealerships and to service the finance
receivables generated by those dealerships.
Pursuant to the Rights Offering, each holder of record of UDC Common Stock
on , 1998 (the "Record Date") will receive one (1) Right for every
four (4) shares of UDC Common Stock held on the Record Date. Each Right
represents the right to subscribe for one share of Common Stock at an exercise
price of $7.00 (the "Subscription Price"). The Rights will be exercisable for a
limited period (the "Rights Offering Period") beginning on the date of such
distribution (the "Commencement Date") and ending at 5:00 p.m. (New York City
time) on the date that is 30 days following the Commencement Date or such other
later date to which the Rights Offering is extended (the "Expiration Date"). The
Rights will trade only during the Rights Offering Period. Holders of Rights who
exercise any of their Rights may subscribe at the Subscription Price for
additional shares of Common Stock out of the pool of shares underlying
unexercised Rights on the Expiration Date, if any, equal to the number of shares
of Common Stock purchased through Rights exercised during the Rights Offering
Period (the "Over-Subscription Privilege"), subject to allocation as described
herein. See "The Rights Offering."
The issuance of Common Stock following the Rights Offering and the transfer
of assets from UDC to Cygnet are contingent upon, among other things, the
approval of the Split-up by the stockholders of UDC and the purchase of at least
75% of the Offered Shares (the "Required Purchase Amount"). Ernest C. Garcia,
II, Cygnet's Chairman of the Board, Chief Executive Officer, and President, and
the holder of approximately 25.2% of the outstanding shares of UDC Common Stock,
has agreed to purchase his full pro rata share of the Offered Shares. In
addition, as Standby Purchaser (as described herein), Mr. Garcia has agreed,
subject to certain conditions, to purchase, through the exercise of his
Over-Subscription Privilege and his Standby Purchase Obligation (as defined
herein), the number of shares of Common Stock required to meet the Required
Purchase Amount.
To provide additional capital, Mr. Garcia may, at his election, purchase up
to an additional 714,286 shares of Common Stock at the Subscription Price, for
an aggregate price of approximately $5 million, over and above the Required
Purchase Amount, and directors and officers of Cygnet (other than Mr. Garcia)
will have the opportunity to purchase up to 214,286 shares of Common Stock at
the Subscription Price, for an aggregate price of approximately $1.5 million,
over and above any shares of Common Stock that such directors and officers have
the right to acquire through the Rights Offering.
Prior to this Rights Offering, there has been no public market for the
Rights or the Common Stock. Cygnet will apply, however, to have the Rights and
the Common Stock listed for trading on an exchange. The Rights Offering is
contingent on the Rights and the Common Stock being approved for listing on an
exchange acceptable to Cygnet's Board of Directors.
SEE "RISK FACTORS" AT PAGE 10 OF THIS PROSPECTUS FOR A DISCUSSION OF CERTAIN
FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SECURITIES
OFFERED HEREBY.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
<TABLE>
<CAPTION>
=================================================================================================================================
PURCHASE PRICE COMMISSION PROCEEDS(1)
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share...................... $7.00 none $7.00
- ---------------------------------------------------------------------------------------------------------------------------------
Total................... $39,050,004(2) none $39,050,004(2)
=================================================================================================================================
</TABLE>
(1) Before deducting expenses payable by Cygnet estimated at $625,000 relating
to the Rights Offering.
(2) Assumes full exercise of all Rights, the Additional Purchase Right, and the
D&O Purchase Right and the corresponding sale of all 5,578,572 shares of
Common Stock offered hereby at the Subscription Price.
------------------------
THE DATE OF THIS PROSPECTUS IS JUNE , 1998
<PAGE> 3
THERE MAY BE CERTAIN TAX CONSEQUENCES TO YOU IF THE RIGHTS OFFERING DESCRIBED
HEREIN IS EFFECTED. TO AVOID THE POSSIBILITY OF THE RECOGNITION OF ORDINARY
INCOME AND THE CREATION OF A POTENTIALLY DEFERRED OR NONDEDUCTIBLE CAPITAL LOSS,
IT WILL, IN MANY INSTANCES, BE IN THE INTERESTS OF RIGHTS OFFERING PARTICIPANTS
TO EITHER EXERCISE OR SELL THE RIGHTS, RATHER THAN TO ALLOW THE RIGHTS TO LAPSE.
PLEASE READ THE ENCLOSED MATERIALS CONCERNING THE RIGHTS OFFERING CAREFULLY.
<PAGE> 4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the detailed
information and combined financial statements, including the notes thereto,
appearing elsewhere in this Prospectus. Investors should carefully consider the
information set forth under the heading "Risk Factors." Unless the context
otherwise requires, the term "Company" as used herein means Cygnet Financial
Corporation and all of its subsidiaries, including the assets and operations of
those entities both before and after the separation of such assets and
operations from UDC.
THE COMPANY
Assuming successful completion of the Rights Offering and consummation of
the Split-up, the Company will engage in the business of providing various
financial services primarily to the sub-prime segment of the automobile
financing industry, which focuses on selling and financing the sale of new and
used cars to persons who have limited credit histories, low incomes, or past
credit problems ("Sub-Prime Borrowers"). The Company will (i) engage in the bulk
purchase and servicing of pools of finance receivables generated from the sale
of new and used automobiles by independent third party dealers ("Third Party
Dealers"), including pools of charged-off receivables, deficient loans, or other
receivables; (ii) service pools of various types of finance receivables; (iii)
operate a collateralized dealer financing program (the "Cygnet Dealer Program"),
pursuant to which it will provide qualified independent used car dealers with
warehouse purchase facilities and revolving lines of credit primarily secured by
the dealers' finance receivable portfolios; and (iv) pursue other opportunities
in the financial services market.
In connection with the Split-up, the Company will acquire the bulk
purchasing and certain servicing operations and related assets from UDC and
substantially all of UDC's servicing and other rights and obligations pursuant
to transactions with First Merchants Acceptance Corporation ("FMAC") and
Reliance Acceptance Group, Inc. ("Reliance"). The Company intends to consider
the bulk purchase and servicing of other portfolios of finance receivables,
including instances in which the holders of the portfolios are experiencing
financial difficulties. For a description of the Company's bulk purchase and
servicing operations and the Company's rights and obligations with respect to
the FMAC and Reliance transactions, see "Business -- Bulk Purchasing and
Servicing Operations."
The Company also will acquire the operations and related assets associated
with the Cygnet Dealer Program, which provides qualified independent used car
dealers with warehouse purchase facilities and revolving lines of credit
primarily secured by the dealers' finance receivable portfolios. Unlike other
typical financing programs available to dealers, the Cygnet Dealer Program
permits participating dealers to retain servicing rights with respect to their
finance receivable portfolios, which enables dealers to generate servicing
income and maintain relationships with their customers, which dealers believe is
a key factor in generating referrals for additional sales and improving the
chances of repeat business. For a description of the Cygnet Dealer Program, see
"Business -- Cygnet Dealer Program."
In late 1997, UDC, which operates the largest publicly-held chain of "buy
here-pay here" used car dealerships in the United States, began a strategic
evaluation of its operations, determining to separate its dealership operations
from its non-dealership operations pursuant to the Split-up. Cygnet is a
Delaware corporation formed in June 1998 to acquire and operate the
non-dealership operations of UDC and will, upon successful completion of the
Rights Offering and consummation of the Split-up, be a separately-traded public
company. The Company's principal executive offices will be located at 2525 East
Camelback Road, Suite 1150, Phoenix, Arizona 85016 and its telephone number will
be (602) 852-6600.
THE RIGHTS OFFERING
General. The Rights Offering is being made as part of a plan pursuant to
which UDC and its existing subsidiaries will be separated into two publicly-held
companies (the "Split-up"). Pursuant to the Split-up, Cygnet, a newly-formed
Delaware corporation and wholly-owned subsidiary of UDC, and its subsidiaries,
will acquire UDC's bulk purchasing and certain servicing operations, its
third-party dealer financing operations
3
<PAGE> 5
(excluding the branch office network operations that UDC closed in the first
quarter of 1998), and substantially all of UDC's assets and liabilities acquired
pursuant to the FMAC and Reliance transactions. In exchange for such assets,
Cygnet will issue $40 million of its Preferred Stock (as defined below) and a
cash payment or equivalent as described herein. The sum of the Preferred Stock
and the cash or equivalent payment will be equal to the greater of the appraised
value or book value of the assets transferred, which the Company does not expect
to materially differ (in each case net of assumed liabilities).
Description of Rights. In connection with the Split-up, Cygnet will issue
transferable rights ("Rights") to subscribe for shares of its Common Stock, par
value $.001 per share (the "Common Stock"), to UDC's stockholders of record as
of the Record Date pro rata in accordance with the ownership of UDC Common Stock
as of the Record Date. Each holder of record of UDC Common Stock on the Record
Date will receive one (1) Right for every four (4) shares of UDC Common Stock.
Each Right entitles the holder to purchase one (1) share of Common Stock at an
exercise price of $7.00 (the "Subscription Price"). The Rights are exercisable
and transferable for a limited period (the "Rights Offering Period") beginning
on the date of such distribution (the "Commencement Date") and ending at 5:00
p.m., New York City time, on the date that is 30 days following the Commencement
Date or such other later date to which the Rights Offering is extended in the
Company's sole discretion (the "Expiration Date"). The proceeds of the Rights
Offering will be used primarily to provide funds to the Company for capital
expenditures and working capital and to fund the cash portion of the
consideration described herein.
Required Purchase Amount. The issuance of Common Stock following the
Rights Offering is contingent upon, among other things, approval of the Split-up
by the stockholders of UDC and the purchase of at least 75% of the Offered
Shares (the "Required Purchase Amount"). Mr. Garcia, Cygnet's Chairman of the
Board, Chief Executive Officer, and President, and the holder of approximately
25.2% of the outstanding shares of UDC Common Stock, has agreed to purchase his
full pro rata share of the Common Stock offered pursuant to the Rights Offering.
In addition, Mr. Garcia has agreed to purchase, subject to certain conditions,
through the exercise of his Over-Subscription Privilege (as described below),
and his Standby Purchase Obligation (as described below), the number of shares
of Common Stock required to meet the Required Purchase Amount.
Assets to be Transferred. If the Rights Offering is successfully
completed, on the effective date of the Split-up (the "Effective Date"), UDC and
its subsidiaries will transfer to subsidiaries of Cygnet certain assets and
liabilities, which will include (i) UDC's bulk purchase and certain servicing
operations with respect to finance receivables originated by Third Party
Dealers, (ii) the assets and related liabilities of Cygnet Dealer Finance, Inc.,
a wholly-owned subsidiary of UDC, through which the Company will provide
qualified Third Party Dealers with warehouse purchase facilities and revolving
lines of credit primarily secured by the dealers' finance receivable portfolios
under the Cygnet Dealer Program; (iii) substantially all of UDC's rights and
obligations pursuant to certain transactions with FMAC, including the servicing
platform and certain other rights and residual interests, and the assumption by
the Company of certain funding obligations and guarantees of UDC in connection
with the FMAC transaction, but excluding certain rights and liabilities retained
by UDC as described under "Business -- Bulk Purchasing and Servicing
Operations -- Transactions Regarding First Merchants Acceptance Corporation;"
and (iv) substantially all of UDC's rights and obligations pursuant to certain
transactions with Reliance, including certain servicing and transition servicing
agreements, as described under "Business -- Bulk Purchasing and Servicing
Operations -- Transactions Regarding Reliance Acceptance Group." These assets
and related liabilities are collectively referred to herein as the "Split-up
Businesses" or the "Transferred Assets." As of , 1998, the
Transferred Assets had a net book value of approximately $ million and
a net appraised value of approximately $ million. The Company
anticipates that the net book value of the Transferred Assets will increase
prior to the transfer contemplated herein as additional finance receivables are
acquired under warehouse purchase facilities or additional advances are made
under revolving lines of credit through the Cygnet Dealer Program.
Consideration for Transferred Assets. As consideration for the Transferred
Assets, Cygnet will issue to UDC 40,000 shares of Cumulative, Convertible
Preferred Stock, Series A, $.001 par value per share (the "Preferred Stock"),
with an aggregate liquidation preference of $40 million and make a cash or
equivalent
4
<PAGE> 6
payment equal to the difference between the greater of the appraised value or
book value (in each case net of assumed liabilities) of the Transferred Assets
and the $40 million of Preferred Stock (the "Cash Payment").
Holders of the Preferred Stock, in preference to the Common Stock, will be
entitled to receive cumulative cash dividends, from the Effective Date through
the first anniversary of such date, at the initial annual rate of seven percent
(7%) of the Base Liquidation Amount (as defined below), and escalating one
percent (1%) per annum on each anniversary thereafter to a maximum rate of
eleven percent (11%) per annum on the aggregate Base Liquidation Amount, in each
case payable quarterly in arrears on the first day of March, June, September,
and December of each year, beginning December 1, 1998, when and as declared by
the Board of Directors of Cygnet out of funds legally available for such
payment. Holders of the Preferred Stock, in preference to the holders of Common
Stock, will be entitled to receive, in the event of dissolution or liquidation
of Cygnet, $1,000 per share (the "Base Liquidation Amount") plus accrued and
unpaid dividends thereon (the "Liquidation Preference Amount").
The Preferred Stock will be redeemable at Cygnet's option in whole or in
part at a redemption price equal to the Liquidation Preference Amount as of the
redemption date. The Preferred Stock will be convertible in whole or in part at
any time after the third anniversary following issuance at the option of UDC
into that number of shares of Common Stock determined by dividing the
Liquidation Preference Amount of the shares of Preferred Stock to be converted
by the lower of (a) the Subscription Price (defined below) or (b) 80% of the
average Market Price (as defined below) of the Common Stock for the ten
consecutive trading days ending not more than 15 days prior to the date notice
of conversion is given. For purposes of the conversion of the Preferred Stock,
"Market Price" means (i) if the Common Stock is quoted on the Nasdaq National
Market or the Nasdaq SmallCap Market or on a national securities exchange, the
daily per share closing price of the Common Stock as quoted on the Nasdaq
National Market or the Nasdaq SmallCap Market or on the principal stock exchange
on which it is listed on the trading day in question, as the case may be,
whichever is the higher, or (ii) if the Common Stock is traded in the
over-the-counter market and not quoted on the Nasdaq National Market or the
Nasdaq SmallCap Market or on any national securities exchange, the closing bid
price of the Common Stock on the trading day in question, as reported by Nasdaq
or an equivalent generally accepted reporting service. The Preferred Stock will
not have any pre-emptive or other subscription rights.
Over-Subscription Privilege. Any Rights Offering Participant who exercises
any of his Rights may subscribe at the Subscription Price for additional shares
of Common Stock out of the pool of shares underlying unexercised Rights on the
Expiration Date, if any (the "Unexercised Pool"), equal to the number of shares
of Common Stock such Rights Offering Participant purchased during the Rights
Offering Period (the "Over-Subscription Privilege"), subject to allocation as
described herein. Mr. Garcia, as the Standby Purchaser, will exercise his
Over-Subscription Privilege to the extent required to satisfy his obligations
under the Standby Purchase Agreement as described below.
Subscription Price. The exercise price of the Rights ("Subscription
Price") is equal to $7.00 per share. Upon exercise of a Right and the payment of
the Subscription Price in cash, the holder thereof will receive one share of
Common Stock. The Subscription Price will not necessarily bear any relationship
to the trading price of the Common Stock after completion of the Rights
Offering.
Fractional Shares. Only Rights to purchase whole shares of Common Stock
will be issued in the Rights Offering. If the number of shares of UDC Common
Stock held by a Rights Offering Participant is not divisible by four, the number
of Rights to be issued to such stockholder will be rounded upward or downward to
the nearest whole Right.
Directors and Executive Officers. If the Split-up is successfully
concluded, Mr. Garcia will remain Chairman of the Board, Chief Executive
Officer, and President of Cygnet. In addition, certain existing UDC directors,
officers, and employees will become directors and officers of the Company. See
"Management."
Standby Purchaser Obligation. The Standby Purchaser is Ernest C. Garcia,
II, Cygnet's Chairman of the Board, Chief Executive Officer, and President, and
the holder of approximately 25.2% of the outstanding shares of UDC Common Stock.
The Standby Purchaser has agreed, in accordance with the Standby Purchase
5
<PAGE> 7
Agreement, subject to certain conditions, to purchase additional shares of
Common Stock up to the Required Purchase Amount (the "Standby Purchase
Obligation"). In consideration for the obligations incurred by Mr. Garcia under
the Standby Purchase Agreement, on the Effective Date, Cygnet will grant to Mr.
Garcia warrants (the "Standby Warrants") entitling Mr. Garcia to purchase up to
500,000 additional shares of Common Stock at an exercise price equal to 120% of
the Subscription Price, or $8.40 per share (the "Warrant Exercise Price") at any
time within five years following the Effective Date.
Additional Purchase Right. In addition to his Rights, the
Over-Subscription Privilege, and his Standby Purchase Obligation, Mr. Garcia
also will have the right (the "Additional Purchase Right"), at his election, to
purchase up to an additional 714,286 shares of Common Stock at the Subscription
Price, or an aggregate of approximately $5 million, over and above the Required
Purchase Amount. Such Additional Purchase Right will be contingent on a
successful Rights Offering and must be exercised prior to the Effective Date.
D&O Purchase Right. In addition, directors and officers of the Company
(excluding Mr. Garcia) will have the right (the "D&O Purchase Right"), at their
election, to purchase in the aggregate 214,286 shares of Common Stock at the
Subscription Price over and above the number of shares of Common Stock they
could acquire pursuant to any Rights they may have. Such D&O Purchase Right will
be contingent on a successful Rights Offering and must be exercised prior to the
Effective Date.
Additional Capital. The Company is negotiating with a third-party lender
to secure $5 million in subordinated debt. The Company anticipates that this
debt will bear interest at 12% per annum and be payable quarterly with the
principal to be paid in full on the third anniversary of the Effective Date. In
consideration for providing such financing, Cygnet has proposed issuing warrants
to purchase 100,000 shares of Common Stock with an exercise price equal to the
Subscription Price.
Trading Market. Application has been made to list the Rights and the
Common Stock on an exchange for trading upon their issuance. The Rights Offering
is contingent on the Rights and the Common Stock being approved for listing on
an exchange acceptable to Cygnet's Board of Directors. There is no assurance,
however, that the Rights and the Common Stock will be approved for trading on an
exchange or that, if approved for trading, a trading market in the Rights or the
Common Stock will develop or, if developed, can be maintained. Upon the
Expiration Date, any unexercised Rights will lapse, and become null and void.
Tax Consequences to Rights Offering Participants. Rights Offering
Participants will recognize dividend income (taxable as ordinary income) in an
amount equal to the fair market value of the Rights as of the date of their
distribution. UDC is in the process of obtaining an appraisal of the Rights. UDC
believes that the Rights should have some value but is unable at this time to
determine the precise value. The Internal Revenue Service may assert that the
price at which the Rights trade during the 30-day trading period of the Rights
is indicative of the fair market value of the Rights on the date of their
distribution. However, it is not possible to predict the trading price of the
Rights at any time during the trading period. Accordingly, there can be no
assurance as to the exact amount of dividend income a holder of UDC Common Stock
will recognize upon the receipt of the Rights. If the Rights are trading for
value on the date of their distribution, UDC will report to holders of UDC
Common Stock the receipt of dividend income in an amount not less than the
greater of the average of the high and low trading prices of the Rights on such
date or the appraised value (if any) of the Rights.
To avoid the possibility of the recognition of ordinary income and the
creation of a potentially deferred or nondeductible capital loss, it will, in
many instances, be in the interests of Rights Offering Participants to either
exercise or sell the Rights, rather than to allow the Rights to lapse. See
"Federal Income Tax Consequences."
Exercise. The Rights are exercisable and transferable from the
Commencement Date until 5:00 p.m., New York City time, on the Expiration Date.
6
<PAGE> 8
USE OF PROCEEDS FROM THE RIGHTS OFFERING
The Company intends to use a portion of the proceeds of the Rights Offering
to make the Cash Payment to UDC as part of the consideration for the Transferred
Assets. The remaining proceeds of the Rights Offering will be used by the
Company for capital expenditures and as working capital.
EFFECT OF RIGHTS OFFERING
Cygnet currently is a wholly-owned subsidiary of UDC. Following the
transactions described in this Prospectus, Cygnet and UDC will be owned,
operated, and managed as separate public companies. Assuming all holders of the
Rights elect to purchase shares of Common Stock pursuant to the Rights Offering,
and the Cygnet directors and officers exercise their D&O Purchase Right in full,
Mr. Garcia will own approximately 24.1% of the outstanding shares of Common
Stock (or 33.8% if he fully exercises his Rights and the Additional Purchase
Right) and UDC will own 100% of the outstanding Preferred Stock of Cygnet.
RISK FACTORS AND FORWARD LOOKING STATEMENTS
Prospective purchasers of Common Stock pursuant to the Rights Offering
should carefully consider all of the information contained in this Prospectus,
particularly each of the factors set forth under "Risk Factors" beginning on
page 10. Factors that may affect the Company's business, results of operations
and financial condition, and the price and market for its securities, include,
among others, the following:
- The Company's ability to maintain profitability is related to its ability
to successfully complete bulk purchases of finance receivable contracts
or enter into servicing arrangements with respect to such contracts. For
example, the Company believes that in the near future, a significant
portion of its revenues will be attributable to the FMAC transaction (as
described herein), unless other significant bulk purchase or servicing
transactions are consummated. There can be no assurance that the Company
will be able to successfully negotiate additional bulk purchase or
servicing arrangements, or, if it were able to do so, that such
transactions would be profitable. In addition, the Company's results of
operations may fluctuate dramatically based upon transactions entered
into in any given period.
- The operations of the Company are significantly dependent on its
personnel, in particular Mr. Garcia. Without Mr. Garcia's expertise in
attracting and obtaining bulk purchase and servicing opportunities, the
Company's operations could be materially adversely affected.
- The profitable realization of bulk purchase and servicing opportunities
requires management of significant transition activities, accomplished
within a very short time period. These transition activities include,
among others, converting the servicing platform and related computer
systems utilized by the existing holder/servicer to the loan servicing
platform and related computer systems utilized by the Company, rapidly
changing servicing capacity, arranging for transition of employees, and
arranging for facilities to facilitate servicing. There is no assurance
that the Company can successfully manage the transition of subsequent
transactions.
- The Company operates primarily in the sub-prime finance market, which is
characterized by borrowers that are generally unable to obtain financing
from traditional sources of credit and the companies that provide
financing to such borrowers. Accordingly, the Company's operations are
subject to increased credit risks and fraud.
- The Company is dependent upon its information systems to properly account
for and monitor its finance receivable portfolio, its loan servicing
operations, and the Cygnet Dealer Program loan portfolio. The Company is
in the process of converting its existing servicing platforms to systems
licensed from Affiliated Computer Services ("ACS"). There can be no
assurance that the conversions will be completed in a timely manner or
that such conversions will be successful. The Company's failure to
successfully migrate and convert its existing systems to the ACS systems
on a timely basis could have a material adverse effect on the Company.
7
<PAGE> 9
- There currently exists no public market for the Rights or shares of
Common Stock being offered pursuant to this Prospectus. While the Company
will apply to list the Rights and the Common Stock for trading on an
exchange, there is no assurance that the Rights and the Common Stock will
be approved for listing or that, if approved for listing, a trading
market in the Rights or the shares of Common Stock will develop, or, if
developed, can be sustained. Even if a trading market does develop, there
can be no assurance that the market price or shares of Common Stock will
remain at or above the Subscription Price.
This Prospectus contains forward looking statements. Additional written or
oral forward looking statements may be made by the Company from time to time in
filings with the Securities and Exchange Commission or otherwise. Such
statements may include, but not be limited to, projections of revenues, income,
loss, capital expenditures, plans for future operations, financing needs or
plans, and plans relating to products or services of the Company, as well as
assumptions relating to the foregoing. The words "believe," "expect,"
"anticipate," "estimate," "project," and similar expressions identify forward
looking statements. Forward looking statements are inherently subject to risks
and uncertainties, some of which cannot be predicted or quantified. Future
events and actual results could differ materially from those set forth in,
contemplated by, or underlying the forward looking statements. Statements in
this Prospectus, including those contained in the section entitled "Risk
Factors," in the section entitled "Management's Discussion and Analysis of
Financial Condition and Results of Operations," and in the Notes to the
Company's Combined Financial Statements, describe factors, among others, that
could contribute to or cause such differences. The Company undertakes no
obligation to update any forward looking statements.
8
<PAGE> 10
SUMMARY COMBINED FINANCIAL INFORMATION
The summary combined financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the combined financial statements of the Company
and the notes thereto included in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31, 1997
------------------ -----------------
1998 1997
------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues.......................................... $3,382 $ 5 $15,959
Interest Income...................................... 3,323 5 7,472
Gain on Sale of Notes Receivable..................... -- -- 8,132
Other Income......................................... 59 -- 355
Operating Expenses:
Provision for Credit Losses.......................... 287 -- 691
Selling and Marketing Expense........................ 7 3 18
General and Administrative........................... 2,180 477 3,766
Depreciation and Amortization........................ 52 29 153
------ ------ -------
Total Operating Expenses................................ 2,526 509 4,628
------ ------ -------
Earnings (Loss) Before Interest Expense................. 856 (504) 11,331
Interest Expense........................................ 854 8 2,067
------ ------ -------
Earnings (Loss) before Income Taxes..................... 2 (512) 9,264
Income Taxes (Benefit).................................. -- (206) 3,728
------ ------ -------
Net Earnings (Loss)..................................... $ 2 $ (306) $ 5,536
====== ====== =======
Basic Earnings (Loss) per Share......................... $ 2 $ (306) $ 5,536
====== ====== =======
Shares used in Computation.............................. 1 1 1
====== ====== =======
Proforma Basic/Diluted Earnings (Loss) per Share(2)..... $(0.13) $(0.05) $ 0.49
====== ====== =======
Proforma Shares used in Computation(2).................. 5,583 5,583 5,583
====== ====== =======
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1998 YEAR ENDED
--------------------------------------- DECEMBER 31, 1997
PRO FORMA -----------------
ACTUAL PRO FORMA(1) AS ADJUSTED(1) ACTUAL
------- ------------ -------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents................ $ 365 $15,692 $22,192 $ 1,225
Finance Receivables, Net................. 23,023 23,023 23,023 19,274
Notes Receivable, Net.................... 28,103 28,103 28,103 21,861
Total Assets............................. 57,400 72,727 79,227 50,330
Total Note Payable....................... 380 380 380 380
Total Stockholders' Equity............... 40,000 71,925 78,425 40,000
</TABLE>
- ---------------
(1) The table sets forth above (i) the combined capitalization of the Company as
of March 31, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,650,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company; and (iii) the pro forma as
adjusted capitalization of the Company to give effect to the sale of
4,650,000 shares of Common Stock offered hereby and the sale of 214,286
shares of Common Stock pursuant to the D&O Purchase Right and 714,286 shares
of Common Stock pursuant to the Additional Purchase Right, assuming these
rights are exercised in full, in each case at the Subscription Price of
$7.00 per share, after deducting estimated offering expenses allocable to
and payable by the Company.
(2) For purposes of computing the proforma earnings per share for the periods
presented, the Company has assumed the maximum potential issuance of shares
of Common Stock totaling 5,578,572 shares pursuant to the planned Rights
Offering, the D&O Purchase Right and the Additional Purchase Right and for
dilutive stock options that will be granted on the effective date.
9
<PAGE> 11
RISK FACTORS
An investment in the Rights and the shares of Common Stock offered hereby
involves certain risks. In addition to the other information included elsewhere
in this Prospectus, prospective investors should give careful consideration to
the following factors before purchasing Rights or the shares of Common Stock
offered hereby upon exercise of the Rights.
RISKS RELATING TO THE BUSINESS
NO ASSURANCE OF PROFITABILITY
The Company's net earnings for the year ended December 31, 1997 were $5.5
million. For the quarter ended March 31, 1998, the Company's net earnings were
$2,000. The Company has experienced, and in the future is expected to continue
to experience, substantial variations in its results of operations as a result
of a number of factors, many of which are outside the Company's control.
Substantially all of the net earnings of the Company for the year ended
December 31, 1997 were attributable to the FMAC transaction. For a description
of the FMAC transaction and the profits generated therefrom, see
"Business -- Bulk Purchasing and Servicing Operations -- Transactions Regarding
First Merchants Acceptance Corporation." The profitability and cash flows of the
Company in the future, at least in the near term, will be highly dependent on
its ability to successfully conclude additional large bulk purchase and
servicing transactions similar to the FMAC and Reliance transactions. For a
description of the Reliance transaction, see "Business -- Bulk Purchasing and
Servicing Operations -- Transactions Regarding Reliance Acceptance Group." UDC's
ability to effect both the FMAC and Reliance transactions on favorable terms was
enhanced by recent industry conditions and by the fact that these companies were
in bankruptcy proceedings. See "Risk Factors -- Risks Relating to the
Business -- Industry Considerations and Legal Contingencies." In recent months,
UDC has experienced increased competition from other companies in its
consideration of transactions similar to FMAC and Reliance. There can be no
assurance that the Company will be able to effect similar transactions in the
future on terms as favorable to the Company as the FMAC and Reliance
transactions. Any inability of the Company to locate and conclude other
profitable bulk purchase or servicing opportunities in the future could have a
material adverse impact on the Company. See "Risk Factors -- Risks Relating to
the Business -- Avoidance of Excess Servicing Capacity."
In addition, the Company believes that a significant portion of its net
earnings in future periods may be attributable to the FMAC and Reliance
transactions. However, the ability of the Company to generate earnings from
these two transactions is subject to significant contingencies. See "Risk
Factors -- Risks Relating to the Business -- Risks Related to the FMAC
Transaction" and "Risk Factors -- Risks Relating to the Business -- Risks
Related to the Reliance Transaction."
The Company's ability to sustain profitability also will depend upon its
ability to meet its general objectives including: (i) expanding its revenue
generating operations while not proportionately increasing its administrative
overhead; (ii) purchasing portfolios of finance receivables with an acceptable
level of credit risk; (iii) effectively collecting payments due on the finance
receivables in its portfolios and in third party portfolios; (iv) locating
sufficient financing, with acceptable terms, to fund the expansion of the Cygnet
Dealer Program and the bulk purchase of additional finance receivables; and (v)
adapting to the increasingly competitive markets in which it operates. Outside
factors, such as the economic, regulatory, and judicial environments in which
the Company operates, also will have an effect on the Company's business.
Any of these factors could result in the periodic inefficient or
underutilization of the Company's resources and could cause the Company's
operating results to fluctuate significantly from period to period, including on
a quarterly basis. There can be no assurance that the Cygnet Dealer Program or
the FMAC or Reliance transactions or similar transactions effected in the future
will be profitable, or if they are, that such profitability can be sustained.
The Company's inability to achieve or maintain any or all of its objectives
could have a material adverse effect on the Company's business, financial
condition, or results of operations.
10
<PAGE> 12
DEPENDENCE ON UNIQUE TRANSACTIONS; QUARTERLY FLUCTUATIONS
As noted above, the Company's profitability will depend significantly on
its ability to effect large bulk purchase and servicing transactions, including,
among others, transactions similar to the FMAC and Reliance transactions.
Because each potential opportunity typically presents a unique set of risks and
circumstances, each transaction must be separately structured, evaluated, and
negotiated. This process typically consumes substantial amounts of executive
management time and attention with no assurance of a successful conclusion.
Accordingly, there can be no assurance that future opportunities of this type
can be identified and concluded on terms favorable to the Company. The failure
to identify and conclude such transactions on a continual basis could have a
material adverse effect on the Company. See "Risk Factors -- Risks Relating to
the Business -- No Assurance of Profitability" "-- Dependence on Key Personnel"
and "-- Avoidance of Excess Servicing Capacity." In addition, the timing of
effectuation of future transactions is likely to result in wide variation in
financial results on a quarterly basis. Moreover, the Company may evaluate
opportunities for favorable transactions in industries other than the sub-prime
automobile financing market. To the extent the Company purchases portfolios of
loan receivables in other industries, such transactions are likely to present a
different set of risks and challenges for which the Company may be less prepared
as a result of its relative lack of experience in that industry.
DEPENDENCE UPON KEY PERSONNEL
The Company's success will depend upon the continued services of the
Company's senior management, particularly its Chief Executive Officer, Mr.
Ernest C. Garcia, II, as well as the Company's ability to attract additional
members to its management team with experience in the bulk purchasing and
servicing industry and the used car dealer financing industry. The unexpected
loss of the services of any of the Company's key management personnel, or its
inability to attract new management when necessary, could have a material
adverse effect upon the Company. The Company does not currently plan to maintain
any key person life insurance on any of its executive officers.
The continued services of Mr. Garcia are critical to the future success of
the Company. In particular, in the bulk purchasing and servicing line of
business, the Company's success depends significantly on Mr. Garcia's ability to
(i) purchase portfolios of finance receivables at discounts sufficient to
generate profits and (ii) secure servicing of finance receivable portfolios with
sufficient volume and fees to generate profits. In particular, it is expected
that the Company will rely heavily on Mr. Garcia's expertise in identifying
opportunities to purchase or service large portfolios of finance receivables.
Losing the services of Mr. Garcia could adversely impact the Company's ability
to attract profitable bulk purchasing and servicing opportunities and in turn
could have a material adverse effect on the Company.
CONVERSION TO NEW SERVICING PLATFORMS
The Company is dependent upon its information systems to properly account
for and monitor its finance receivables portfolio, its loan servicing operations
and the Cygnet Dealer Program loan portfolio. The Cygnet Dealer Program
portfolio is currently tracked on an internally developed custom software
system. However, the Company recently signed a service bureau agreement (the
"ACS Agreement") with ACS to process the loan portfolios owned or serviced by
the Company. Due to the unique characteristics of the Cygnet Dealer Program, ACS
will be required to make a number of custom software enhancements to enable the
Cygnet Dealer Program to run on the ACS system. The Company anticipates that
implementation of the custom software changes and conversion from the Company's
in-house system to the ACS system will be completed by December 31, 1998. In
addition to the ACS system, the Company is developing a custom loan underwriting
and funding software module to interface between the Third Party Dealers'
systems and the ACS system. During 1999, the Company intends to migrate the
dealers from their separate stand alone loan systems to the ACS system for
purposes of loan servicing and collections. An extended delay in the conversion
to the ACS system, in the development of the custom loan underwriting and
funding software module, or in migrating the dealers to the ACS system for loan
servicing and collections, could have a negative impact on the Company's ability
to efficiently collect, account for and monitor the Cygnet Dealer Program loan
portfolio.
11
<PAGE> 13
The FMAC loan portfolio, aggregating approximately $378 million as of May
31, 1998, is currently being serviced on a loan servicing platform provided
under contract with Alltel Financial Information Services, Inc. ("Alltel"),
which is scheduled to expire in December 1998. If the Company continues to use
the Alltel platform after December 1998, the contract provides for a substantial
premium to be paid by the Company in exchange for the extension. The Company is
in the process of converting from the Alltel system to a system licensed from
ACS. This conversion is expected to be completed by the end of the third quarter
of 1998. There can be no assurance, however, that the conversion will be
completed in a timely manner. If the conversion is not completed in a timely
manner, the Company may be required to extend the contract with Alltel beyond
December 1998 and pay the required premium. Accordingly, failure to successfully
migrate and convert to the ACS system could have a material adverse effect on
the Company.
Similarly, upon confirmation and effectiveness of Reliance's proposed plan
of reorganization (which is expected to occur in July 1998), UDC will begin to
service the Reliance finance receivables portfolio, which totaled approximately
$157 million as of April 30, 1998. See "Business -- Bulk Purchasing and
Servicing Operations -- Transactions Regarding Reliance Acceptance Group." In
such event, the Company anticipates that UDC will be required to convert the
servicing of the Reliance finance receivables portfolio to its existing FMAC
servicing platform prior to the effective date of the Reliance plan of
reorganization in such a manner as to avoid disruption of servicing. There can
be no assurance that UDC will be able to perform all necessary actions to
effectively service the Reliance finance receivables portfolio in the limited
time available. Further, disruption of servicing of the Reliance portfolio could
result in the Company being removed as the servicer and could have other serious
adverse consequences to the Company. See "Risk Factors -- Risks Relating to the
Business -- Risks Related to the Reliance Transaction."
The conversion of both the Cygnet Dealer Program and the FMAC servicing
functions to ACS and the conversion of the Reliance portfolio to the FMAC
platform and then subsequently to the ACS platform may result in various
implementation and integration issues that could temporarily interrupt the
Company's ability to effectively collect, monitor and account for the Cygnet
Dealer Program and to service the FMAC and Reliance portfolios without serious
disruption. Any such issues or interruptions could result in an increase in
contract delinquencies and charge offs in the FMAC and/or Reliance portfolios
and in the Cygnet Dealer Program, which, depending on the severity of the
matter, could result in the Company being removed as the servicer for the FMAC
and Reliance transactions and have other material adverse consequences to the
Company. See "Risk Factors -- Risks Relating to the Business -- Risks Relating
to the FMAC Transaction" and "Risk Factors -- Risks Relating to the
Business -- Risks Relating to the Reliance Transaction."
DATA PROCESSING AND TECHNOLOGY AND YEAR 2000
The success of any participant that engages in the financing and servicing
of loan receivables, particularly those with a focus on the sub-prime industry,
including the Company, depends in large part on its ability to continue to adapt
its technology, on a timely and cost-effective basis, to meet changing customer
and industry standards and requirements.
As noted above, it is anticipated that the existing Cygnet Dealer Program
and FMAC and Reliance loan servicing functions will be converted to the ACS
system in the latter half of 1998. Pursuant to the ACS Agreement, the ACS
systems must be fully Year 2000 compliant by January 1, 1999. However, the
Company's sole remedy if ACS does not comply with this requirement is to
terminate the ACS Agreement and convert to another system, which would be costly
and disruptive and could have a material adverse effect on the Company's
business.
The Company has reviewed its internal computer systems in order to assess
its exposure to Year 2000 issues. The Company expects to make the necessary
modifications or changes to its computer information systems to enable proper
processing of transactions relating to the Year 2000 and beyond. The Company
estimates that it will not incur material costs to modify its existing systems.
The Company will continue to evaluate its Year 2000 exposure. However, failure
of the Company to fully address and resolve its Year 2000 issues, including
modification of its existing systems, replacement of such systems, or other
matters could have a material adverse effect on the Company.
12
<PAGE> 14
Pursuant to the ACS Agreement, ACS has agreed to provide enhancements and
modifications to the base system that is licensed to ACS. Some of the
enhancements and modifications will remain proprietary to ACS and will not be
licensed to the Company. If ACS or the Company breaches the ACS Agreement, and
ACS no longer provides processing services, the Company may incur significant
costs in securing a replacement processing company that will be able to process
the loans in the same manner as ACS. Further, the Company's remaining computer
applications would not be sufficient to effectively manage the Cygnet Dealer
Program or the loan servicing of finance receivables portfolios.
The Company will be dependent on its loan servicing and collection
facilities as well as long-distance and local telecommunications access in order
to transmit and process information among its various facilities. The Company
maintains a standard program whereby it prepares and stores off site back ups of
its main system applications and data files on a routine basis. Following the
Split-up, the Company believes that it will be necessary to adopt a disaster
response plan. There can be no assurance that a failure will not occur in the
interim or that any plan adopted will prevent or enable timely resolution of any
systems failure. Further, a natural disaster, calamity, or other significant
event that causes long-term damage to any of these facilities or that interrupts
its telecommunications networks could have a material adverse effect on the
Company. With respect to the Company's servicing operations following conversion
to the ACS system, the Company will be required to rely on the disaster response
plan developed and utilized by ACS. ACS believes that its disaster response plan
is proprietary information and has not allowed the Company to fully evaluate
such plan. Therefore, if the disaster response plan of ACS is inadequate, the
occurrence of a disaster could have a material adverse effect on the Company's
business.
AVOIDANCE OF EXCESS SERVICING CAPACITY
On the Effective Date of the Split-up, it is expected that the Company's
third party servicing operations will be limited to the FMAC and Reliance
portfolios. Moreover, because of the relatively short lives of automobile
finance receivables, these portfolios are expected to be reduced in the near
future to a point at which, if not replaced with additional finance receivables,
the Company's servicing platform and operations will have excess capacity. For
the Company's servicing operations to remain profitable, the Company must
continually service a sufficient number of finance receivables to generate
servicing income in excess of fixed overhead costs. For example, a significant
portion of servicing overhead is based on certain fixed costs for personnel
salaries and other expenses as well as lease or other facilities costs. If
portfolios being serviced are not continually replaced with new finance
receivables, the Company will be required to reduce the number of employees in
its servicing operations, and then rehire such employees as additional
portfolios are obtained. Such practices can lead to low employee morale and to
disruptions and loss of efficiency in servicing functions and can also result in
substantial severance and facilities closure costs. Therefore, in order to
maintain the profitability of the Company's servicing operations, it will be
necessary for the Company to continue to identify and secure servicing rights to
significant portfolios of finance receivables. To an extent, each bulk purchase
and servicing transaction is a unique opportunity. There can be no assurance
that the Company will be able to identify and successfully conclude sufficient
bulk purchasing and servicing transactions to maintain the profitability of
these operations. See "Risk Factors -- Risks Relating to the Business -- No
Assurance of Profitability."
Although the Company is evaluating the possibility of expanding its
servicing operations to include receivables other than auto receivables, such as
mortgages or credit card receivables, in order to mitigate its excess capacity
issues, the Company has no experience in servicing such types of receivables and
may encounter other unanticipated problems. Moreover, there can be no assurance
that such receivables could be serviced on the existing and anticipated
servicing systems of the Company without substantial modification.
MANAGEMENT OF TRANSITION ACTIVITIES
The profitable realization of bulk purchase and servicing opportunities
requires effective management of significant transition activities, which must
be accomplished within a very short time period. These transition activities
include, among others, converting acquired or serviced loan portfolios from the
seller's or owner's servicing systems to the loan servicing systems utilized by
the Company, managing rapidly changing servicing
13
<PAGE> 15
capacity, arranging for transition of employees, and arranging for facilities to
allow servicing. These issues are magnified as larger portfolios of the type the
Company will seek to purchase or service are transitioned into the Company's
systems, and the concurrent risks are greater if a transition is not smoothly
implemented. There can be no assurance that the Company can successfully manage
the transition of its current or subsequent transactions. See "Risk
Factors -- Risks Relating to the Business -- Conversion to New Servicing
Platforms."
RISKS RELATED TO THE FMAC TRANSACTION
Although UDC's involvement in the FMAC bankruptcy proceedings has been
profitable, there can be no assurance that this transaction will continue to be
profitable in the future. Unless otherwise defined in this section, capitalized
terms utilized in this description of the risks inherent in the FMAC transaction
will have the meanings given in the detailed description of the FMAC transaction
under the heading "Business -- Bulk Purchasing and Servicing
Operations -- Transactions Regarding First Merchants Acceptance Corporation."
On the Effective Date of the Split-up, UDC will transfer to the Company
substantially all of its rights and certain liabilities accruing on or after the
Effective Date in connection with the FMAC transaction. The Company will assume
UDC's guarantee to the Contract Purchaser of a stated return, based in part on a
10.35% per annum interest rate, on certain Owned Contracts acquired from FMAC
and sold to the Contract Purchaser, subject to a maximum guarantee of $10.0
million. Although FMAC has provided a similar guarantee to UDC, which will be
transferred to the Company, payable out of certain distributions from residual
interests held by FMAC in securitization transactions, the guarantee in some
circumstances may be less than the guarantee given by UDC to the Contract
Purchaser. There can be no assurance that there will be sufficient distributions
from the residual interests to support the guarantee. In addition, the Company
will assume the funding obligations of UDC with respect to the DIP Facility. The
DIP Facility and certain fees payable to UDC that will be assigned to the
Company are also payable out of certain expected tax refunds of FMAC and/or
distributions from the same residual interests in FMAC's securitization
transactions. Although the Company anticipates collecting such items, there can
be no assurance that these loans or fees will be paid. Payments pursuant to the
residual interests may not be made until the senior certificates in the
securitization transactions are paid in full. The liabilities to be assumed by
the Company relating to the FMAC transaction are not conditioned on the profit
ultimately achieved by the Company from that transaction and such liabilities
may exceed payments made to the Company.
In addition, although it is contemplated that all of UDC's servicing rights
with respect to the FMAC transaction will be transferred to the Company in
conjunction with the Split-up, the ability of the Company to take over such
servicing rights is subject to the consents of certain parties that have not yet
been obtained. Moreover, if consent is not obtained or the Company does not
satisfy the conditions to be an "Authorized Servicer," the Company would lose
the right to significant benefits expected in the FMAC transaction, including
ongoing servicing fees and its right to certain distributions from residual
interests in FMAC's securitized pools, which could have a material adverse
effect on the Company. The Company believes, however, that it will satisfy the
required conditions.
Moreover, the Company will be required to meet certain performance criteria
with respect to servicing of the FMAC and Owned Contract portfolios. The failure
to meet the required performance criteria could result from a number of factors,
including, among others, general economic conditions that cause increased
payment delinquencies by the obligors on the contracts in the pools being
serviced, and servicing interruptions and inefficiencies caused by the Company's
anticipated servicing platform conversions or any Year 2000 issues. See "Risk
Factors -- Risks Relating to the Business -- Conversion to New Servicing
Platforms" and "Risk Factors -- Risks Relating to the Business -- Data
Processing and Technology and Year 2000." The failure to meet such performance
criteria could result in "termination events" under the various servicing
agreements governing the FMAC and Owned Contract portfolios, and in such case
the Company could lose the right to service the receivables in such portfolios
and the related servicing fees. If for any reason the Company cannot continue to
service the FMAC portfolios, the Company would lose significant benefits
expected in the FMAC transaction, including ongoing servicing fees and its right
to certain distributions from residual interests in FMAC's securitized pools,
which could have a material adverse effect on the Company.
14
<PAGE> 16
RISKS RELATED TO THE RELIANCE TRANSACTION
On the Effective Date of the Split-up, UDC will transfer to the Company all
of its rights and substantially all of its obligations in connection with the
Reliance transaction. For a detailed description of the Reliance transaction,
see "Business -- Bulk Purchasing and Servicing Operations -- Transactions
Regarding Reliance Acceptance Group." There can be no assurance that the
proposed Reliance plan of reorganization as described herein will be confirmed
and effected or that, if confirmed, the servicing rights and interests to be
obtained by the Company in the Reliance transaction will prove valuable or
profitable. In addition, the Company's ability to assume the servicing rights in
the Reliance transaction on or after the Effective Date is subject to consents
of certain parties, including Reliance, that have not yet been obtained.
Substantially all of the benefits expected in the Reliance transaction are
contingent on the Company's acquiring and retaining servicing rights to the
Reliance portfolio.
Further, the Company's ability to profitably service the Reliance portfolio
is largely dependent on its ability to effectively manage the transition
activities associated with the assumption of such servicing. See "Risk
Factors -- Risks Relating to the Business -- Management of Transition
Activities."
Moreover, the Company will be required to meet certain performance criteria
with respect to servicing of the Reliance portfolio. A failure to meet the
required performance criteria could result from a number of factors, including,
among others, general economic conditions that cause increased payment
delinquencies by the obligors on the contracts in the pools being serviced, and
servicing interruptions and inefficiencies caused by the Company's anticipated
servicing platform conversions or any Year 2000 issues. See "Risk Factors --
Risks Relating to the Business -- Conversion to New Servicing Platforms" and
"Risk Factors -- Risks Relating to the Business -- Data Processing and
Technology and Year 2000." The failure to meet such performance criteria could
result in a "termination event" under the servicing agreement entered into by
the Company with Reliance and, in such case, the Company could lose the right to
service the Reliance portfolio.
CYGNET DEALER PROGRAM
The Cygnet Dealer Program provides qualified dealers with financing options
and revolving lines of credit primarily secured by such dealers' finance
receivable portfolios. While the Company will require dealers to meet certain
minimum net worth and operating history criteria to be considered for inclusion
in the Cygnet Dealer Program, it will, nevertheless, be extending credit to
dealers who may not otherwise be able to obtain debt financing from traditional
lending institutions such as banks, credit unions, and major finance companies.
Under the Cygnet Dealer Program, the dealer remains responsible for collection
of the contract payments and retains control of the customer relationship. All
cash collections, including regular monthly payments, payoffs, and repurchases
are deposited by the dealers into a bank account maintained by the Company.
Consequently, the Company will be subject to a high risk of credit losses due to
dealer defaults or fraudulent activities, specifically related to the
collection, depositing, and reporting of customer payments, which could have a
material adverse effect on the Company and on the Company's ability to meet its
own financing obligations.
SENSITIVITY TO INTEREST RATES
The Company anticipates that a substantial portion of its borrowing
facilities will be on a floating rate basis. Conversely, the contracts that the
Company purchases under its DCP program (as defined herein) and the contracts
that it purchases in bulk will bear interest at fixed rates. Therefore,
increases in interest rates would effectively reduce the interest rate spread
the Company earns on the retail installment contracts in its portfolios. The
Company can attempt to mitigate any such reduction by reducing the advance rate
under its DCP program (as defined herein), increasing the discount rate on bulk
purchases, or securitizing its portfolios in order to lock in a fixed cost of
funds. However, the Company may not be able to increase the interest rate spread
on future purchases of contracts due to market competition or restrictions
placed on interest rates by various states. Further, there can be no assurance
that the Company would be successful in the implementation of a securitization
program.
15
<PAGE> 17
DEPENDENCE ON EXTERNAL FINANCING
Because of the significant equity being invested in the Company, the
Company's capital structure will support substantial additional leverage, and
could become highly leveraged in the future. The Company has borrowed, and will
continue to borrow, substantial amounts required to fund its operations. In this
regard, the Company's operations are highly capital intensive. Although the
Company has had discussions with various lenders regarding a credit facility,
there can be no assurance that the Company will be able to secure financing when
and as needed in the future, or on terms acceptable to the Company. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations-Liquidity and Capital Resources."
Securitizations. The Company may finance its operations in part through
securitization transactions. The Company's ability to successfully complete
securitizations may be affected by several factors, including the condition of
securities markets generally, conditions in the asset-backed securities markets
specifically, and the credit quality of the Company's portfolio.
To the extent the Company were to record a gain on sale in connection with
securitizations, the gain would be based upon certain estimates and assumptions,
which may not subsequently be realized. To the extent that actual cash flows on
a securitization differ materially from the original securitization assumptions,
and in the opinion of management those differences appear to be other than
temporary in nature, the Company would be required to revalue its residual
interests in the finance receivable contracts that it has sold in the
securitization ("Residuals in Finance Receivables Sold"), and record a charge to
earnings based upon the reduction. In addition, the Company would record ongoing
income based upon the cash flows on Residuals in Finance Receivables Sold. The
income recorded on the Residuals in Finance Receivables Sold would vary from
quarter to quarter based upon cash flows received in a given period. To the
extent that cash flows were deficient, charge-offs of finance receivables exceed
estimates, or assumptions applied to the underlying portfolio were not realized,
and in the opinion of management those differences were to appear to be other
than temporary in nature, the Company would be required to revalue the Residuals
in Finance Receivables Sold, and record a charge to earnings.
COMPETITION
The markets in which the Company competes are highly competitive. With
respect to its Cygnet Dealer Program and bulk purchasing and servicing
operations, the Company competes with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater resources, including access to lower priced capital. In
addition, there are numerous financial services companies serving, or capable of
serving, these markets. While traditional financial institutions, such as
commercial banks, savings and loans, credit unions, and captive finance
companies of major automobile manufacturers, have not consistently served the
sub-prime markets, the relatively high yields that can be earned by companies
involved in sub-prime financing have encouraged certain of these traditional
institutions to enter, or contemplate entering, these markets. Increased
competition may adversely affect the Company under the DCP program (as defined
herein) by reducing the discount at which the Company purchases contracts, may
result in a decrease in the discounts at which the Company purchases portfolios
in bulk, or may result in downward pressure on the rates charged for loan
servicing, all of which could have an adverse effect on the Company.
NO ASSURANCE OF SUCCESSFUL ACQUISITIONS
The Company intends to consider additional acquisitions, alliances, and
transactions involving other companies that could complement the Company's
existing business. There can be no assurance that suitable acquisition parties,
joint venture candidates, or transaction counter parties can be identified, or
that, if identified, any such transactions will be consummated on terms
favorable to the Company, or at all. Furthermore, there can be no assurance that
the Company will be able to integrate successfully such acquired businesses into
its existing operations, which could increase the Company's operating expenses
in the short-term and materially adversely affect the Company. Moreover, these
types of transactions by the Company may result in potentially dilutive
issuances of equity securities, the incurrence of additional debt, and
amortization of expenses related to goodwill and intangible assets, all of which
could adversely affect the Company's
16
<PAGE> 18
profitability. These transactions involve numerous risks, such as the diversion
of the attention of the Company's management from other business concerns, the
entrance of the Company into markets in which it has had no or only limited
experience, and the potential loss of key employees of the acquired company, all
of which could have a material adverse effect on the Company.
GENERAL ECONOMIC CONDITIONS; RISKS ASSOCIATED WITH SUB-PRIME MARKET
The Company's business is directly related to the ability of the obligors
on the finance receivables that the Company services, expects to purchase in
bulk, and that secure its Cygnet Dealer Program to continue to make the required
payments on such contracts, which is affected by employment rates, prevailing
interest rates, and other general economic conditions. While the Company
believes that current economic conditions favor continued growth in the markets
it serves and those in which it seeks to expand, a future economic slowdown or
recession could lead to increased delinquencies, repossessions, and credit
losses on the finance receivables that the Company services, expects to purchase
in bulk, or that secure the Cygnet Dealer Program. Further, increased
competition for the bulk purchase and servicing transactions that the Company
must effect to remain profitable could have a material adverse effect on the
Company's business. Moreover, substantially all of the finance receivables that
the Company services, expects to purchase in bulk, or that secure the Cygnet
Dealer Program are with Sub-Prime Borrowers, who due to their poor credit
histories and/or low incomes are generally unable to obtain credit from
traditional financial institutions, such as banks, savings and loans, credit
unions, or captive finance companies owned by automobile manufacturers. Because
of the Company's primary focus on the sub-prime segment of the automobile
financing industry, the actual rate of delinquencies, repossessions, and credit
losses on the finance receivables that the Company services, expects to purchase
in bulk, or that secure the Cygnet Dealer Program could be higher under adverse
conditions than those experienced in the used car sales and finance industry in
general. Moreover, adverse economic conditions that result in decreased sales of
used cars could adversely affect the dealers that participate in the Cygnet
Dealer Program, which could have a material adverse effect on such program.
INDUSTRY CONSIDERATIONS AND LEGAL CONTINGENCIES
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation, and other events. In addition, certain of these
companies have filed for bankruptcy protection. These announcements have had a
disruptive effect on the market for securities of sub-prime automobile finance
companies, have resulted in a tightening of credit to the sub-prime markets, and
could lead to enhanced regulatory oversight. Furthermore, companies in the used
vehicle financing market have been named as defendants in an increasing number
of class action lawsuits brought by customers alleging violations of various
federal and state consumer credit and similar laws and regulations. Although the
Company is not currently a named defendant in any such lawsuits, no assurance
can be given that such claims will not be asserted against the Company in the
future or that the Company's operations will not be subject to enhanced
regulatory oversight.
RISKS RELATING TO THE RIGHTS OFFERING
NO PUBLIC MARKET; MARKET PERCEPTION ISSUES
There currently exists no public market for the Rights or shares of Common
Stock being offered pursuant to this Prospectus. While the Company will apply to
list the Rights and the Common Stock for trading on an exchange, there is no
assurance that a trading market in the Rights or the shares of Common Stock will
develop, or, if developed, can be sustained. Even if a trading market does
develop, there can be no assurance that the market price for shares of Common
Stock will remain at or above the Subscription Price. Prices at which the Common
Stock may trade, either prior to the Split-up, on a "when-issued" basis, or
subsequent thereto, cannot be predicted. Until the Common Stock is fully
distributed and an orderly market develops, the prices at which trading in such
stock occurs may fluctuate significantly. Further, the prices of common stock of
many participants in the sub-prime automobile financing industry have fluctuated
significantly in recent periods. The prices at which the Common Stock will trade
will be determined by the marketplace and may be influenced by many factors,
including, among others, the value of the Company's assets, its ability to
generate
17
<PAGE> 19
cash flow, its profitability or lack thereof or other measures of value, the
depth and liquidity of the market for such shares, investors' perceptions of the
Company and the industries in which its businesses participate, and general
economic and market conditions.
Rights distributed to UDC's stockholders in the Rights Offering and shares
of Common Stock distributed to holders who exercise the Rights will be freely
transferable, except for securities received by persons who may be deemed to be
"affiliates" of UDC or of the Company within the meaning of Rule 145 promulgated
under the Securities Act. Sales by persons who are affiliates of UDC or the
Company within the meaning of Rule 145 at the time of the Rights Offering may be
subject to certain restrictions.
Although one purpose of the Split-up is to allow investors, lenders, and
others to more easily evaluate the performance and investment characteristics of
the business of the Company as opposed to the business to be retained by UDC and
to enhance the likelihood that each business group will achieve appropriate
market recognition of its performance, there will, at least for a significant
period of time, continue to be material ties between the two companies that may
prove confusing to the market. There can be no assurance that the market will
regard the Split-up as a positive development. If the market perceives more
disadvantages than advantages resulting from the Split-up, the price of the
Common Stock is likely to suffer a decline.
OWNERSHIP OF COMMON STOCK BY MR. GARCIA
Ernest C. Garcia, II, will be Cygnet's Chairman of the Board, Chief
Executive Officer, and President. Mr. Garcia is also the holder of approximately
25.2% of UDC's outstanding Common Stock. Mr. Garcia will agree to exercise his
entire 25.2% pro rata share of the Rights. In addition, Mr. Garcia will agree
through his Over-Subscription Privilege and Standby Purchase Obligation to
purchase additional shares of Common Stock pursuant to the Rights Offering in an
amount sufficient to satisfy the Required Purchase Amount. See "The Rights
Offering" for a complete description of the Over-Subscription Privilege, the
Standby Purchase Obligation, and the Required Purchase Amount. Mr. Garcia also
has the right to purchase up to 714,286 additional shares of Common Stock at the
Subscription Price over and above the Required Purchase Amount and will be
issued warrants to purchase an additional 500,000 shares of Common Stock. These
transactions taken together will result in Mr. Garcia's ownership of a
significant percentage of the outstanding Common Stock following the Split-up.
In certain circumstances, Mr. Garcia could acquire a majority of the Company's
Common Stock, in which case Mr. Garcia would be in a position to control the
voting with respect to virtually all matters that affect the Company. As a
result, Mr. Garcia will have significant influence over the Company's
activities, as well as on all matters requiring approval of the Company's
stockholders, including electing or removing members of its Board of Directors,
causing the Company to engage in transactions with affiliated entities, causing
or restricting the sale or merger of the Company with other entities, and
changing its dividend or other policies.
POTENTIAL FEDERAL INCOME TAX CONSEQUENCES OF THE RIGHTS OFFERING
Holders of UDC Common Stock will recognize dividend income (taxable as
ordinary income) in an amount equal to the fair market value of the Rights as of
the date of their distribution. UDC is in the process of obtaining an appraisal
of the Rights. The Company believes that the Rights should have some value but
is unable at this time to determine the precise value. The Internal Revenue
Service may assert that the price at which the Rights trade during the 30-day
trading period of the Rights is indicative of the fair market value of the
Rights on the date of their distribution. It is not possible, however, to
predict the trading price of the Rights at any time during the trading period.
Accordingly, there can be no assurance as to the exact amount of dividend income
a Rights Offering Participant will recognize upon the receipt of Rights. If the
Rights are trading for value on the date of their distribution, UDC will report
to Rights Offering Participants the receipt of dividend income in an amount not
less than the greater of the average of the high and low trading prices of the
Rights on such date or the appraised value (if any) of the Rights. See "Certain
Federal Income Tax Consequences."
RISKS RELATING TO THE PREFERRED STOCK
The dividend rate for the Preferred Stock to be issued to UDC on the
Effective Date of the Split-up will be 7% per annum of the Base Liquidation
Amount for the period from the Effective Date to the first
18
<PAGE> 20
anniversary thereof. Thereafter, the annual dividend rate will increase 1% per
annum to a maximum rate of 11% per annum of the Base Liquidation Amount.
Although dividends on the Preferred Stock are payable only out of funds legally
available therefor when and as declared by the Board of Directors, if dividends
are not paid when due for a period of six quarters, UDC will have the right to
elect two members to the Company's Board of Directors at the next meeting of
stockholders and thereafter until all accrued dividends are paid in full. In
addition, the Preferred Stock is convertible into Common Stock and accrued but
unpaid dividends on the Preferred Stock may adversely affect the market price
for the Common Stock. During the first three years following the Effective Date
of the Split-up, the Preferred Stock will not be convertible. Thereafter, the
Preferred Stock will be convertible into Common Stock at the lower of the
Subscription Price or a discount to market of approximately 20%. Thus, the
Company will be motivated to redeem the Preferred Stock during the first three
years following the Effective Date. If the Company is unable to redeem the
Preferred Stock during such three year period, either because of financial
circumstances or contractual restrictions, a conversion of the Preferred Stock
into Common Stock could have the effect of significantly diluting the Company's
Common Stock.
The Company's Certificate of Incorporation authorizes the Company to issue
"blank check" preferred stock, the designation, number, voting powers,
preferences, and rights of which may be fixed or altered from time to time by
the Company's Board of Directors. Accordingly, the Board of Directors will have
the authority, without stockholder approval, to issue additional series or
classes of preferred stock with dividend, conversion, redemption, liquidation,
sinking fund, voting, and other rights that could adversely affect the voting
power or other rights of the holders of the Common Stock. The preferred stock
could be utilized, under certain circumstances, to discourage, delay, or prevent
a merger, tender offer, or change in control of the Company that a stockholder
might consider to be in its best interests.
Although the Company has no present intention of issuing additional shares
of its authorized preferred stock, there can be no assurance that the Company
will not do so in the future.
19
<PAGE> 21
THE RIGHTS OFFERING
PURPOSE OF THE RIGHTS OFFERING
The Company has agreed to make a Rights Offering to holders of UDC Common
Stock in connection with the Split-up. This Rights Offering represents the
Company's initial public offering of its securities, although unlike a
traditional public offering, the securities will be offered first to UDC's
stockholders before they are available to the general public. The Company
believes that this Rights Offering will provide several advantages over a
traditional initial public offering. This type of offering provides the Company
with the opportunity to offer the Company's Common Stock to investors who, as
UDC stockholders, already have some knowledge of the Split-up Businesses, which
have been operated by UDC. The Company's securities also will be distributed to
a broader, more stable shareholder base than might otherwise be the case in an
underwritten initial public offering.
DISTRIBUTION OF RIGHTS
In the event that UDC's stockholders approve the Split-up and all other
conditions thereto are satisfied, subject to UDC's Board of Directors exercising
its right, in its sole discretion without stockholder approval, to abandon,
defer (to a date certain or indefinitely), or modify the Rights Offering, the
Rights Offering will be made to UDC's stockholders of record as of ,
1998 (the "Record Date"). On the Commencement Date (as defined below) of the
Rights Offering, the Company will distribute the Rights to UDC's stockholders as
of the Record Date pro rata in accordance with the ownership of UDC Common Stock
on the Record Date. Each holder of record of UDC Common Stock as of the Record
Date will receive one (1) Right for every four (4) shares of UDC Common Stock.
Each Right will entitle the holder to acquire one (1) share of the Company's
Common Stock at $7.00 per share (the "Subscription Price"). The Subscription
Price must be paid to , as distribution agent for the Company
(the "Distribution Agent"), and will be deposited by the Distribution Agent into
an escrow account (the "Escrow Account") established by the Company with
, as escrow agent (the "Escrow Agent"). Except as provided in the
next sentence below, in order to exercise the Rights, the full Subscription
Price for all exercised Rights must be paid into the Escrow Account on or prior
to the Expiration Date. Notwithstanding the above, Mr. Garcia and his affiliates
may exercise their Rights by payment of the Subscription Price on or prior to
the Effective Date.
NO FRACTIONAL SHARES
If the number of shares of UDC Common Stock owned by a Rights Offering
Participant is not evenly divisible by four, the Company will round up or down
to the nearest whole number in calculating the number of Rights that such Rights
Offering Participant is entitled to receive (if the fraction is one-half, the
Company will round up to the next highest whole number). For example, if a
Rights Offering Participant holds ten (10) shares of UDC Common Stock, such
Rights Offering Participant will receive three (3) Rights. If such Rights
Offering Participant is a nominee for beneficial holders of shares of UDC Common
Stock, the Company will round the number of Rights received based upon the
amount held by each beneficial holder individually.
EXERCISING OR SELLING THE RIGHTS
Until the Expiration Date (as defined below) of the Rights Offering, Rights
Offering Participants may purchase one share of Common Stock for each Right
received, or may sell the Rights in the market. Rights Offering Participants
should consult with their regular investment and tax advisors and carefully
consider their alternatives. See "Certain Federal Income Tax Consequences."
THE RIGHTS OFFERING PERIOD
Rights may be exercised at any time during the period beginning on
, 1998 (the "Commencement Date") and ending at 5:00 p.m., New York
City time, on , 1998, which is 30 days after the Commencement Date
(the "Expiration Date"). After that date, Rights Offering Participants will not
be able
20
<PAGE> 22
to exercise or transfer their Rights and such Rights will be worthless. The
Company does not intend to honor any Rights received for exercise by the
Distribution Agent after , 1998, regardless of when such Rights were
sent to the Distribution Agent for exercise.
TRANSFERRING RIGHTS
Each Rights Offering Participant may transfer all or a portion of his or
her Rights by endorsing and delivering to the Distribution Agent (at the
addresses set forth below) his or her Rights Certificate. The Rights Offering
Participant must properly endorse the certificate for transfer, his or her
signature must be guaranteed by a bank or securities broker, and his or her
certificate must be accompanied by instructions to reissue the Rights to be
transferred in the name of the person purchasing the rights. The Distribution
Agent will reissue certificates for the transferred Rights to the purchaser, and
will reissue a certificate for the balance, if any, to the transferor if it is
able to do so before the Expiration Date. The transferor will be responsible for
the payment of any commissions, fees, and other expenses (including brokerage
commissions and any transfer taxes) incurred in connection with the purchase or
sale of the transferor's Rights. The Company believes that a market for the
Rights may develop during the Rights Offering Period. To facilitate the market,
the Company has applied to have the Rights listed for trading on an exchange
during the Rights Offering Period. Any questions regarding the transfer of
Rights should be directed to the Distribution Agent at .
Rights may be exercised by completing and signing the election to purchase
form that appears on the back of each Rights Certificate. To exercise Rights, a
Rights Offering Participant must send the completed and signed form, along with
payment in full of the Subscription Price for all shares of Common Stock to be
purchased to the Distribution Agent. The Distribution Agent must receive these
documents and the payment by 5:00 p.m., New York City time, not later than the
Expiration Date. The Company does not intend to honor any exercise of Rights
received by the Distribution Agent after that date, except that Mr. Garcia and
his affiliates may exercise their Rights by payment of the Subscription Price on
or prior to the Effective Date.
The Company will, however, accept an exercise if the Distribution Agent has
received full payment of the Subscription Price for shares of Common Stock to be
purchased through the exercise of Rights, and has received a letter or
telegraphic notice from a bank, trust company or member firm of the New York
Stock Exchange or the American Stock Exchange setting forth the Rights Offering
Participant's name, address and taxpayer identification number, the number of
shares to be purchased, and guaranteeing that a properly completed and signed
election to purchase form will be delivered to the Distribution Agent by 5:00
p.m., New York City time, on the Expiration Date. If the properly executed
documents are not received by 5:00 p.m. on the Expiration Date, the Company does
not intend to accept such a subscription.
The Company suggests, for the protection of the Rights Offering
Participants, that Rights be delivered to the Distribution Agent by overnight or
express mail courier. If Rights are mailed, the Company suggests that Rights
Offering Participants use registered mail. In any event, mail or delivery of
Rights and payment for the Subscription Price must be made to the Distribution
Agent as follows:
<TABLE>
<CAPTION>
BY OVERNIGHT/EXPRESS MAIL
BY MAIL: BY HAND: COURIER:
<S> <C> <C>
</TABLE>
The Subscription Price must be paid in U.S. dollars by check or money order
payable to the " Escrow Account." Until this Rights Offering is
closed, all payments will be held in escrow by the Escrow Agent.
Until the Expiration Date, the Escrow Agent will hold all funds received in
payment of the Subscription Price in escrow and will not deliver any funds to
the Company until the Rights Offering has been successfully completed and the
shares of Common Stock have been issued to the Rights Offering Participants. If
for any
21
<PAGE> 23
reason the Rights Offering is not successfully completed by the Expiration Date,
the Escrow Agent will return all funds held in escrow as promptly as practicable
to the Rights Offering Participants.
If a Rights Offering Participant is a broker or depository that holds
shares of UDC Common Stock for the account of others and it receives Rights
Certificates for the account of more than one beneficial owner, it should
provide copies of this Prospectus to the beneficial owners. It should also carry
out such owners' intentions as to the exercise or transfer of their Rights.
The Company will decide all questions as to the validity, form and
eligibility (including times of receipt, beneficial ownership and compliance
with other procedural matters). The acceptance of subscription forms and the
Subscription Price also will be determined by the Company. Alternative,
conditional or contingent subscriptions will not be accepted. The Company
reserves the absolute right to reject any subscriptions not properly submitted.
In addition, the Company may reject any subscription if the acceptance of the
subscription would be unlawful. The Company also may waive any irregularities
(or conditions) in the subscription of shares of Common Stock, and its
interpretation of the terms (and conditions) of the Rights Offering shall be
final and binding.
If a Rights Offering Participant is given notice of a defect in his or her
subscription, he or she will have five business days after the giving of notice
to correct it. Such Rights Offering Participant will not, however, be allowed to
cure any defect later than the Expiration Date. The Company is not obligated to
give notification of defects in any subscription. The Company will not consider
an exercise to be made until all defects have been cured or waived. If an
exercise is rejected, the related payment of the Subscription Price will be
promptly returned by the Escrow Agent.
THE OVER-SUBSCRIPTION PRIVILEGE
Each Rights Offering Participant who elects to exercise his or her Rights
may also subscribe for additional shares of Common Stock out of the pool of
shares underlying unexercised Rights on the Expiration Date, if any (the
"Unexercised Pool"), equal to the number of shares purchased upon exercise of
such Participant's Rights (the "Over-Subscription Privilege"), subject to
allocation as described below. Shares purchased through the Over-Subscription
Privilege must be purchased at the Subscription Price. For example, if a Rights
Offering Participant holds and validly exercises 1,000 Rights, such Participant
may also subscribe for an additional 1,000 shares of Common Stock out of the
Unexercised Pool at the Subscription Price of $7.00 per share. If there are more
shares subscribed for pursuant to the Over-Subscription Privilege than are
available in the Unexercised Pool, the available shares will be allocated pro
rata among all Rights Offering Participants exercising the Over-Subscription
Privilege, in proportion to the number of shares of Common Stock they have
purchased pursuant to the exercise of their Rights. The Escrow Agent will refund
to holders of Rights without interest, all amounts paid for shares of Common
Stock subscribed for pursuant to the Over-Subscription Privilege and not issued
or sold to such holders due to the allocation described above. Except as
described in the next sentence below, the full amount of the Subscription Price
for all exercised Rights and shares subscribed for pursuant to the
Over-Subscription Privilege must be paid into the Escrow Account on or prior to
the Expiration Date in order to validly exercise the Over-Subscription
Privilege. Notwithstanding the above, because of his obligations as Standby
Purchaser, Mr. Garcia and his affiliates may deposit funds necessary to exercise
the Over-Subscription Privilege with respect to their Rights at the same time
that they deposit monies to fulfill Mr. Garcia's Standby Purchase Obligation
(described below).
THE STANDBY PURCHASE OBLIGATION
Ernest C. Garcia, II, the Company's Chairman of the Board, Chief Executive
Officer, and President, and the holder of approximately 25.2% of the outstanding
shares of UDC Common Stock, will act as standby purchaser for the Rights
Offering (the "Standby Purchaser"). The successful conclusion of the Rights
Offering is contingent on the purchase of at least 75% of the Offered Shares
(the "Required Purchase Amount"). Mr. Garcia has agreed to purchase his full
25.2% pro rata share of the Offered Shares pursuant to the Rights Offering. In
addition, pursuant to that certain Standby Purchase Agreement dated
, 1998 among (the "Standby Purchase
Agreement"), through the Over-
22
<PAGE> 24
Subscription Privilege associated with his Rights or pursuant to his Standby
Purchase Obligation, Mr. Garcia will purchase additional shares of Common Stock
from the Unexercised Pool to the extent necessary to satisfy the Required
Purchase Amount. If, following the Expiration Date, validly exercised Rights and
the Over-Subscription Privilege do not result in proper and valid subscriptions
for the Required Purchase Amount, then Mr. Garcia will be required to purchase
additional shares of Common Stock pursuant to the Standby Purchase Obligation in
an amount necessary to achieve the Required Purchase Amount. Mr. Garcia will
deposit any additional subscription funds required pursuant to the Standby
Purchase Obligation into the Escrow Account on or prior to the Effective Date.
In addition, Mr. Garcia's Standby Purchase Obligation may be satisfied by any
company or entity wholly-owned by Mr. Garcia. As a result, Mr. Garcia (or his
affiliates) are expected to acquire at least 25.2% of Cygnet's Common Stock
through the Rights Offering. UDC intends to utilize a portion of the Cash
Payment to repay in full its $10 million subordinated note to Verde Investments,
Inc. ("Verde"), an affiliate of UDC, wholly-owned by Mr. Garcia (the "Verde
Note"), subject to the receipt of certain required consents. Alternatively,
Verde may deposit the Verde Note or any part thereof with the Company in payment
of all or any portion of the Subscription Price for exercise of Rights acquired
by Verde from Mr. Garcia or otherwise, the related Over-Subscription Privilege,
and the Standby Purchase Obligation. In such case, the Company would transfer
the Verde Note to UDC for cancellation in lieu of the payment of a portion of
the Cash Payment.
FAILURE BY THE STANDBY PURCHASER TO MEET HIS OBLIGATIONS
If the Standby Purchaser fails to meet his obligations under the Standby
Purchase Agreement, the Rights Offering may be canceled. If the Rights Offering
is canceled, the Escrow Agent will promptly return to all Rights Offering
Participants who elected to exercise Rights, without interest, any payment
received in respect of the Subscription Price and no shares of Common Stock will
be distributed.
THE STANDBY WARRANTS
In consideration for the obligations incurred by Mr. Garcia under the
Standby Purchase Agreement, on the Effective Date, Cygnet will grant to Mr.
Garcia warrants (the "Standby Warrants") entitling Mr. Garcia to purchase up to
500,000 additional shares of Common Stock at an exercise price equal to 120% of
the Subscription Price, or $8.40 per share (the "Warrant Price"), at any time
within five years following the Effective Date.
ADDITIONAL PURCHASE RIGHT AND D&O PURCHASE RIGHT
In addition to the shares of Common Stock that Mr. Garcia will purchase
through exercise of his Rights, the Over-Subscription Privilege associated with
his Rights, and the Standby Purchase Obligation, on the Effective Date, Mr.
Garcia and his affiliates will have the right at his election to purchase up to
an additional 714,286 shares of Common Stock at the Subscription Price (the
"Additional Purchase Right"). In addition, on the Effective Date, certain
individuals who are or will become directors and officers of the Company will
have the right to purchase 214,286 additional shares of Common Stock for $7.00
per share (the "D&O Purchase Right").
THE LENDER WARRANTS
Cygnet anticipates issuing warrants to a third party lender (the "Lender
Warrants") to purchase 100,000 shares of Common Stock at an exercise price of
$7.00 per share in connection with an anticipated $5 million loan being made to
the Company immediately following the Effective Date. The Lender Warrants are
expected to have a term of three years from the date of issuance.
See "Management's Discussion and Analysis of Financial Condition and
Results of Operations -- Liquidity and Capital Resources."
23
<PAGE> 25
CERTAIN FEDERAL INCOME TAX CONSEQUENCES
The following is a summary of certain federal income tax consequences,
based upon current law, which is subject to prospective or retroactive change at
any time, of the distribution and ownership of Rights, the exercise of Rights,
the acquisition of Common Stock incident to the exercise of Rights, and the
transfer and lapse of Rights without exercise or transfer. These tax
consequences may vary depending upon a Rights Offering Participant's particular
situation. Certain Rights Offering Participants (including the Standby
Purchaser, insurance companies, tax-exempt organizations, financial
institutions, broker-dealers, foreign corporations and persons who are not
citizens or residents of the United States) may be subject to special rules not
discussed below. No rulings will be sought from the Internal Revenue Service
with respect to transactions relating to the Rights. THIS SUMMARY IS FOR GENERAL
INFORMATION PURPOSES ONLY. ACCORDINGLY, EACH RIGHTS OFFERING PARTICIPANT SHOULD
CONSULT HIS OWN TAX ADVISOR AS TO THE PARTICULAR TAX CONSEQUENCES TO HIM OF
THESE TRANSACTIONS, INCLUDING THE APPLICABILITY AND EFFECT OF ALL FEDERAL,
STATE, LOCAL, AND FOREIGN TAX LAWS.
Distribution of Rights to Holders of UDC Common Stock. The transfer from
Cygnet to the holders of UDC Common Stock of the Rights, representing the right
to acquire shares of Common Stock, will be treated, for federal income tax
purposes, as (1) a distribution of the Rights by Cygnet to UDC, followed by (2)
a distribution of the Rights from UDC to the holders of UDC Common Stock.
Holders of UDC Common Stock will recognize dividend income (taxable as ordinary
income) on the date of the distribution in an amount equal to the fair market
value of the Rights as of the date of distribution, but only to the extent that
the amount of the distribution is properly sourced in UDC's accumulated or
current earnings and profits in its taxable year of the distribution. That
portion, if any, by which the fair market value of the Rights exceeded UDC's
accumulated and current earnings would be treated as a return of capital to the
extent of the holder's tax basis in his UDC Common Stock and, then, as gain from
the sale of such stock to the extent of any remaining excess. Corporate holders
of UDC Common Stock (other than S corporations) receiving Rights and recognizing
dividend income would be entitled to the dividends-received deduction for
corporations (generally 70%, but 80% under certain circumstances) with respect
to such dividends, to the extent applicable, taking into consideration all
limitations on the claiming of the dividends-received deduction.
UDC is in the process of obtaining an appraisal of the Rights. The Company
believes that the Rights should have some value for federal income tax purposes
but is unable at this time to determine the precise value. The Internal Revenue
Service may assert that the price at which the Rights trade during the 30-day
period following the distribution of the Rights is indicative of the fair market
value of the Rights as of the date of the distribution of the Rights. However,
it is not possible to predict the trading price of the Rights at any time during
the trading period. Accordingly, there can be no assurance as to the exact
amount of dividend income a Rights Offering Participant will recognize upon the
receipt of Rights. If the Rights are trading for value on the date of their
distribution, UDC will report to holders of UDC Common Stock the receipt of
dividend income in an amount not less than the greater of the average high and
low trading price of the Rights on such date or the appraised value (if any) of
the Rights.
Ownership of Rights. Each Rights Offering Participant who receives Rights
will have a tax basis in the Rights equal to the fair market value thereof.
Further, each Rights Offering Participant will have a holding period for his
Rights that begins on the date of receipt of the Rights.
Exercise of Rights. Rights Offering Participants, whether corporate or
noncorporate, will recognize neither gain nor loss upon the exercise of Rights.
A Rights Offering Participant who receives shares of Common Stock upon exercise
of the Rights will acquire a tax basis in such shares equal to the sum of the
Subscription Price paid under the Rights Offering and the tax basis (if any) of
the Rights Offering Participant in the Rights.
Transfer of Rights. The transferable nature of the Rights will permit a
Rights Offering Participant to sell Rights prior to exercise. Pursuant to Code
Section 1234, a Rights Offering Participant who sells Rights prior to exercise
will be entitled to treat the difference between the amount received for the
Rights and the adjusted tax basis (if any) of the Rights Offering Participant in
the Rights as a short-term capital gain or
24
<PAGE> 26
capital loss, provided that the shares of Common Stock subject to the Rights
would have been a capital asset in the hands of the Participant had it been
acquired by him. The gain or loss so recognized will be short-term since the
Rights will have been held for less than twelve months.
Non-Exercise of Rights. The federal income tax treatment applicable to
Rights Offering Participants who fail to exercise or transfer their Rights prior
to the Expiration Date also is set forth in Code Section 1234. Rights Offering
Participants who allow their Rights to lapse will be deemed under the Code to
have sold their Rights on the date on which the Rights expire. Since no
consideration will be received by Rights Offering Participants upon such lapse
and since the Rights will have been held for less than twelve months, a short-
term capital loss equal to the tax basis (if any) in the Rights will be
sustained by the holder on such lapse, provided that the shares of Common Stock
subject to the Rights would have been a capital asset in the hands of the
Participant had it been acquired by him.
Short-term capital losses incurred by non-corporate taxpayers may be used
to offset short-term or long-term capital gains realized, plus up to $3,000
($1,500 in the case of a married individual filing a separate return).
Non-corporate taxpayers may carry forward indefinitely, but may not carry back,
unused net capital losses. When carried forward by non-corporate taxpayers,
short-term capital losses retain their short-term character and are treated as
sustained in the taxable year to which they are carried forward. Short-term
capital losses incurred by corporations may be used only to offset short-term or
long-term capital gains. Unused capital losses, however, generally may be
carried back by corporate taxpayers to the three taxable years preceding the
loss year and carried forward to the five succeeding taxable years. When carried
back or carried forward, short-term capital losses retain their character as
short-term and are treated as sustained in the taxable year to which they are
carried. Accordingly, certain Rights Offering Participants who allow their
Rights to lapse may recognize ordinary income upon receipt of the Rights and a
potentially deferred or nondeductible capital loss upon the lapse of such
Rights. FOR THIS REASON, IN MOST INSTANCES, IT WILL BE IN A RIGHTS OFFERING
PARTICIPANT'S INTEREST TO EITHER EXERCISE OR SELL RIGHTS RATHER THAN TO ALLOW
RIGHTS TO LAPSE.
BECAUSE OF THE INDIVIDUAL NATURE OF TAX CONSEQUENCES, EACH RIGHTS OFFERING
PARTICIPANT IS ADVISED TO CONSULT HIS OWN TAX ADVISOR WITH RESPECT TO THESE AND
OTHER FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE DISTRIBUTION,
OWNERSHIP, EXERCISE, TRANSFER, AND LAPSE OF RIGHTS.
25
<PAGE> 27
USE OF PROCEEDS
The minimum net proceeds to the Company, assuming the sale of 75% of the
Offered Shares, the minimum necessary to satisfy the Required Purchase Amount
and complete the Rights Offering, are estimated to be approximately $23,787,500,
after deducting estimated offering expenses allocable to and payable by the
Company. If all of the Offered Shares (including shares available pursuant to
the Additional Purchase Right and D&O Purchase Right) are purchased pursuant to
the Rights Offering, the net proceeds to the Company, after deducting estimated
offering expenses allocable to and payable by the Company, are estimated to be
approximately $38,425,000.
The Company intends to use a portion of the net proceeds of this Rights
Offering to make the Cash Payment to UDC as partial consideration for the
transfer of the Transferred Assets from UDC to the Company. The Cash Payment
will be equal to the difference between the greater of the appraised value or
the book value, which the Company does not expect to materially differ (in each
case net of assumed liabilities) of the Transferred Assets and the $40 million
of Preferred Stock. UDC intends to utilize a portion of the Cash Payment to
repay in full its $10 million subordinated note to Verde Investments, Inc.
("Verde"), an affiliate of UDC, wholly-owned by Mr. Garcia (the "Verde Note"),
subject to the receipt of certain required consents. Alternatively, Verde may
deposit the Verde Note or any part thereof with the Company in payment of all or
any portion of the Subscription Price for exercise of Rights acquired by Verde
from Mr. Garcia or otherwise, the related Over-Subscription Privilege, and the
Standby Purchase Obligation. In such case, the Company would transfer the Verde
Note to UDC for cancellation in lieu of the payment of a portion of the Cash
Payment. The remainder of the net proceeds will be used for capital expenditures
and working capital. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
DIVIDEND POLICY
The Company does not anticipate paying cash dividends on the Common Stock
in the foreseeable future. Instead, the Company intends to retain any future
earnings to finance the operation and expansion of the Company's business. In
addition, the Company currently is negotiating with a third party lender to
secure $5 million of subordinated debt, the terms of which are expected to
require the Company to maintain a debt to tangible equity ratio not greater than
3 to 1, calculated as of the end of each quarterly period in each fiscal year.
Accordingly, if the Company secures subordinated debt on the terms anticipated,
and a proposed payment of dividends would cause the Company to exceed this
ratio, the Company would be unable to pay such dividends even if it were
otherwise in a position to do so. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
26
<PAGE> 28
CAPITALIZATION
The table sets forth below (i) the combined capitalization of the Company
as of March 31, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,650,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company; and (iii) the pro forma as
adjusted capitalization of the Company to give effect to the sale of 4,650,000
shares of Common Stock offered hereby and the sale of 214,286 shares of Common
Stock pursuant to the D&O Purchase Right and 714,286 shares of Common Stock
pursuant to the Additional Purchase Right, in each case at the Subscription
Price of $7.00 per share, after deducting estimated offering expenses allocable
to and payable by the Company.
<TABLE>
<CAPTION>
AS OF MARCH 31, 1998
-----------------------------------------
ACTUAL PRO FORMA AS ADJUSTED
----------- ----------- -----------
<S> <C> <C> <C>
Debt................................................ $ 380,000 $ 380,000 $ 380,000
Stockholders' equity
Preferred Stock, $.001 par value, 1,000,000 shares
authorized; none issued; 40,000 shares issued,
pro forma; 40,000 shares issued pro forma, as
adjusted....................................... -- 40,000,000 40,000,000
Common Stock, $.001 par value, 14,000,000 shares
authorized; 1 issued; 4,650,000 shares issued
pro forma; 5,578,572 shares issue pro forma, as
adjusted....................................... -- 4,650 5,579
Additional paid-in capital........................ 40,000,000 31,920,350 38,419,425
Retained earnings................................. -- -- --
----------- ----------- -----------
Total stockholders' equity................ 40,000,000 71,925,000 78,425,004
----------- ----------- -----------
Total capitalization...................... $40,380,000 $72,305,000 $78,805,004
=========== =========== ===========
</TABLE>
- ---------------
Excludes (i) approximately 284,000 shares of Common Stock issuable upon
exercise of stock options to be granted on the Effective Date, (ii) 100,000
shares of Common Stock issuable upon exercise of warrants anticipated to be
issued to the Company's subordinated debt lender, (iii) 500,000 shares of
Common Stock issuable upon exercise of the Standby Warrants, and (iv) 36,429
shares of Common Stock issuable upon the issuance of restricted stock grants to
be granted on the Effective Date.
27
<PAGE> 29
SELECTED COMBINED FINANCIAL DATA
The selected data presented below under the captions "Statement of
Operations Data" and "Balance Sheet Data" for, and as of the end of the year
ended December 31, 1997, are derived from the combined financial statements of
Cygnet Financial Corporation, which combined financial statements have been
audited by KPMG Peat Marwick LLP, independent certified public accountants. The
combined financial statements as of December 31, 1997 and for the year then
ended, and the report thereon, are included elsewhere in this prospectus. The
selected data presented below for the three-month periods ended March 31, 1998
and 1997, and as of March 31, 1998, are derived from the unaudited combined
financial statements of Cygnet Financial Corporation included elsewhere in this
prospectus. The results of operations of any interim period are not necessarily
indicative of results to be expected for a full fiscal year. For additional
information, see the combined financial statements and notes thereto of the
Company included elsewhere in this prospectus. The following table should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
MARCH 31, DECEMBER 31, 1997
------------------ -----------------
1998 1997
------- -------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Total Revenues.......................................... $3,382 $ 5 $15,959
Interest Income...................................... 3,323 5 7,472
Gain on Sale of Notes Receivable..................... -- -- 8,132
Other Income......................................... 59 -- 355
Operating Expenses:
Provision for Credit Losses.......................... 287 -- 691
Selling and Marketing Expense........................ 7 3 18
General and Administrative........................... 2,180 477 3,766
Depreciation and Amortization........................ 52 29 153
------ ------ -------
Total Operating Expenses................................ 2,526 509 4,628
------ ------ -------
Earnings (Loss) Before Interest Expense................. 856 (504) 11,331
Interest Expense........................................ 854 8 2,067
------ ------ -------
Earnings (Loss) before Income Taxes..................... 2 (512) 9,264
Income Taxes (Benefit).................................. -- (206) 3,728
------ ------ -------
Net Earnings (Loss)..................................... $ 2 $ (306) $ 5,536
====== ====== =======
Proforma Basic Diluted Earnings (Loss) per Share(2)..... $(0.13) $(0.05) $ 0.49
====== ====== =======
Shares used in Computation(2)........................... 5,583 5,583 5,583
====== ====== =======
</TABLE>
28
<PAGE> 30
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31, 1998 YEAR ENDED
----------------------------------------- DECEMBER 31, 1997
PRO FORMA -----------------
ACTUAL PRO FORMA(1) AS ADJUSTED(1) ACTUAL
------- ------------ -------------- -----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and Cash Equivalents.......... $ 365 $15,692 $22,192 $ 1,225
Finance Receivables, Net........... 23,023 23,023 23,023 19,274
Notes Receivable, Net.............. 28,103 28,103 28,103 21,861
Total Assets....................... 57,400 72,727 79,227 50,330
Total Note Payable................. 380 380 380 380
Total Stockholder's Equity......... 40,000 71,925 78,425 40,000
</TABLE>
- ---------------
(1) The table sets forth above (i) the combined capitalization of the Company as
of March 31, 1998; (ii) the pro forma capitalization of the Company to give
effect to the sale of 4,650,000 shares of Common Stock offered hereby at the
Subscription Price of $7.00 per share, after deducting estimated offering
expenses allocable to and payable by the Company; and (iii) the pro forma as
adjusted capitalization of the Company to give effect to the sale of
4,650,000 shares of Common Stock offered hereby and the sale of 214,286
shares of Common Stock pursuant to the D&O Purchase Right and 714,286 shares
of Common Stock pursuant to the Additional Purchase Right, assuming these
rights are exercised in full, in each case at the Subscription Price of
$7.00 per share, after deducting estimated offering expenses allocable to
and payable by the Company.
(2) For purposes of computing the proforma earnings per share for the periods
presented, the Company has assumed the maximum potential issuance of shares
of Common Stock totaling 5,578,572 shares pursuant to the planned Rights
Offering, the D&O Purchase Right and the Additional Purchase Right and for
dilutive stock options that will be granted on the effective date.
29
<PAGE> 31
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
General. Cygnet Financial Corporation (the Company), a wholly-owned
subsidiary of Ugly Duckling Corporation (Ugly Duckling), was formed on June 1,
1998 for the purpose of consummating a transaction whereby Ugly Duckling would
split-up its operations into two publicly-held companies (the split-up). The
Company will purchase from Ugly Duckling, substantially all of Ugly Duckling's
non-dealership operations including, the bulk purchasing and certain servicing
operations (excluding the branch office network), it's third party dealer
financing operations, and substantially all other non-dealership assets and
contract rights including those acquired in the First Merchants Acceptance
Corporation Transaction and assume the liabilities related thereto (collectively
referred to as the acquired assets). In exchange for the acquired assets, the
Company will issue $40.0 million of its cumulative, convertible preferred stock
and a cash payment equivalent to the greater of the appraised value or the book
value of the acquired assets, which the Company does not expect to materially
differ. These combined financial statements reflect the results of operations,
financial position, changes in stockholder's equity and cash flows of the
Company, as if the Company were a separate entity operating the acquired assets
for all periods presented. The combined financial statements have been prepared
using the historical basis in the assets and liabilities and historical results
of operations of the Company. In connection with the split-up, the Company
intends, through a rights offering to Ugly Duckling stockholders, to issue up to
5.6 million shares of common stock at an offering price of $7.00 per share.
The Company provides qualified independent used car dealers with warehouse
purchase facilities and operating credit lines pursuant to its Cygnet Dealer
Program. In addition, the Company purchases loan portfolios in bulk and services
loan portfolios on behalf of third parties. The Company targets its products and
services primarily to the sub-prime segment of the automobile financing
industry, which focuses on selling and financing the sale of used cars to
Sub-Prime Borrowers.
Bulk Purchasing and Loan Servicing. The Company believes bulk purchase and
large servicing transactions are efficient methods of purchasing or obtaining
servicing rights to sub-prime automobile finance receivables. In this regard,
the Company has effected certain transactions with FMAC, pursuant to which the
Company has acquired significant servicing and other rights from FMAC, and
Reliance, pursuant to which the Company has entered into a servicing agreement
related to the Reliance bankruptcy case that, subject to bankruptcy court
approval, will entitle the Company to service Reliance's finance receivable
portfolio. See "-- Transactions Regarding First Merchants Acceptance
Corporation" and "-- Transactions Regarding Reliance Acceptance Corporation."
Cygnet Dealer Program. Through the Cygnet Dealer Program, the Company
either purchases finance receivables under its Dealer Collection Program ("DCP")
or provides traditional revolving lines of credit under its Asset-Based Loan
Program ("ABL"). Under the DCP, the Company generally purchases finance
receivables on a full recourse basis from Third Party Dealers for 60% to 75% of
the principal amount of the respective contract. The Company's ABL is similar to
traditional asset-based lending relationships. The Company generally advances
65% of the principal amount of the contract. Under both programs, the Third
Party Dealer retains responsibility for servicing the contracts. The Third Party
Dealer is generally entitled to a fee of 20% to 25% of gross collections for
servicing the contracts purchased under the DCP; however, the Company does not
pay a servicing fee to Third Party Dealers for servicing contracts under the
ABL.
Acquisition. In August 1997, the Company acquired substantially all of the
assets of American National Acceptance Corporation ("ANAC") in exchange for
approximately $9.3 million in cash. The acquisition was recorded in accordance
with the "purchase method" of accounting, and, accordingly, the purchase price
has been allocated to the assets purchased and the liabilities assumed based
upon the estimated fair values at the date of acquisition. The excess of the
purchase price over the fair values of the net assets acquired was approximately
$1.2 million and has been recorded as goodwill, which is being amortized over a
period of 15 years. The results of operations of ANAC have been included in the
Company's combined statement of operations from the acquisition date.
30
<PAGE> 32
The following discussion and analysis provides information regarding the
Company's combined financial position as of December 31, 1997 and March 31,
1998, and its results of operations for the year ended December 31, 1997, and
the three month periods ended March 31, 1998 and 1997.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997
Interest Income. Interest income consists of income recognized from the
Cygnet Dealer Program and interest income recognized from advances related to
the FMAC transaction.
Cygnet Dealer Program. Interest income from this category increased
by $2.6 million in the three month period ended March 31, 1998, from $5,000
in the three month period ended March 31, 1997. This increase is due to the
increase in finance receivables and advances under the DCP and ABL
programs, respectively, from the comparable period in 1997.
FMAC Transaction. Interest income for this category totaled $727,000
in the three month period ended March 31, 1998 related to advances to FMAC
pursuant to various lending facilities. No such income was recognized
during the comparable period in 1997, as the Company did not begin
conducting business with FMAC until the third fiscal quarter of 1997.
Other Income. Other income generally represent revenues from services such
as periodic audits of borrowers and collateral monitoring and maintenance fees,
and loan commitment and processing fees. Other income increased from $0 in the
three month period ended March 31, 1997 to $59,000 in the three month period
ended March 31, 1998. This increase was due to the increase in finance
receivables and advances under the DCP and ABL programs, respectively, from the
comparable period in 1997.
Operating Expenses. Operating expenses consist of the provision for credit
losses, selling and marketing expenses, general and administrative expenses, and
depreciation and amortization.
Provision for Credit Losses. The provision for credit losses
increased from $0 in the three month period ended March 31, 1997 to
$287,000 in the three month period ended March 31, 1998. This increase was
due to the increase in finance receivables and advances under the DCP and
ABL programs, respectively, from the comparable period in 1997.
General and Administrative Expenses. General and administrative
expenses increased by 357.0% during the three month period ended March 31,
1998 to $2.2 million from $477,000 in the comparable period in 1997. This
increase was primarily due to overhead required to manage expansion of the
Cygnet Dealer Program and the expansion of the Company's management team
and infrastructure dedicated to the bulk purchasing and loan servicing
businesses. In addition, pursuant to the Cygnet Dealer Program, the Company
paid participating Third Party Dealers loan servicing fees totaling $1.0
million.
Depreciation and Amortization. Depreciation and amortization expense
increased by 79.3% in the three month period ended March 31, 1998 to
$52,000 from $29,000 for the comparable period in the prior year, due
primarily to an increase in amortization of goodwill related to the
Company's acquisition of ANAC in August 1997.
Interest Expense. Interest expense increased from $8,000 in the three
month period ended March 31, 1997 to $854,000 in the three month period
ended March 31, 1998. This increase was due to the increase in the carrying
costs of the assets under the Cygnet Dealer Program, as well as the
carrying cost of the Company's investment in the notes receivable and other
assets related to the FMAC transaction.
YEAR ENDED DECEMBER 31, 1997
Interest Income. Interest income consists of income recognized from the
Cygnet Dealer Program and FMAC transaction.
Cygnet Dealer Program. Interest income for this category during the
year ended December 31, 1997 totaled $3.7 million. This consisted of $3.2
million in interest income from finance receivables under DCP and $521,000
in interest income from notes receivable under ABL. The effective average
yield
31
<PAGE> 33
during 1997, net of loan servicing fees paid to Third Party Dealers, was
22.9% and 15.6% on the finance receivables and notes receivable portfolios,
respectively.
FMAC Transaction. Interest income from this category during the year
ended December 31, 1997 totaled $3.8 million. The Company recognized a
total of $3.6 million in interest income on the senior bank debt (the
"Senior Bank Debt") acquired from the FMAC bank group and $261,000 in
interest income on the "debtor-in-possession" financing made available to
FMAC (the "DIP Facility".) No future interest income will be realized on
the Senior Bank Debt, which was sold in the fourth quarter of 1997. See
"-- Transactions Regarding First Merchants Acceptance Corporation" below.
Gain on Sale of Notes Receivable. During the year ended December 31, 1997,
the Company acquired directly and indirectly 100% of FMAC's Senior Bank Debt. On
December 15, 1997, the bankruptcy court in the FMAC bankruptcy entered an order
approving a transfer, whereby the agent for the holders (at such time, the
Company) of the Senior Bank Debt credit bid this debt and purchased the
contracts which secured the debt (the "Owned Contracts"), and immediately sold
the Owned Contracts to a third party purchaser (the "Contract Purchaser"). The
Company recorded a one-time gain of approximately $8.1 million from this
transaction. See "-- Transactions Regarding First Merchants Acceptance
Corporation" below.
Other Income. Other income generally represent revenues from services such
as periodic audits of borrowers and collateral monitoring and maintenance fees,
and loan commitment and processing fees. Fee and other income totaled $355,000
during the year ended December 31, 1997.
Operating Expenses. Operating expenses consist of the provision for credit
losses, selling and marketing expenses, general and administrative expenses, and
depreciation and amortization.
Provision for Credit Losses. The provision for credit losses totaled
$691,000 for the year ended December 31, 1997. Of this amount, $200,000 was
allocated to the allowance for credit losses for notes receivable, with the
balance allocated to the allowance for credit losses for finance
receivables under DCP.
General and Administrative Expenses. General and administrative
expenses for the year ended December 31, 1997 totaled $3.8 million. The
largest component of general and administrative expenses was payroll and
benefits, which totaled $1.4 million, reflecting establishment of the
Company's management team and infrastructure to purchase finance
receivables and originate loans under its Cygnet Dealer Program as well as
the hiring of personnel to manage the bulk purchasing and loan servicing
business. In addition, pursuant to the Cygnet Dealer Program, the Company
paid participating Third Party Dealers loan servicing fees totaling $1.3
million.
Depreciation and Amortization. Depreciation and amortization consists
of depreciation and amortization on the Company's property and equipment
and amortization of the Company's goodwill. Depreciation and amortization
expense totaled $153,000 during 1997.
Interest Expense. Interest expense totaled $2.1 million in the year ended
December 31, 1997. Substantially all of the interest expense was incurred on the
loan that was carried back by the members of the FMAC senior bank group, which
financed 80% of the Company's purchase price related to the acquisition of the
Senior Bank Debt. Interest expense on this loan totaled $1.4 million during the
year ended December 31, 1997. This loan was paid in full in conjunction with the
sale of the Senior Bank Debt in December 1997.
Income Taxes. Income taxes totaled $3.7 million in 1997, which is an
effective corporate tax rate of approximately 40.2%.
FINANCE RECEIVABLES AND NOTES RECEIVABLE
During the three months ended March 31, 1998 and the year ended December
31, 1997, the Company purchased finance receivable contracts with a total
principal balance of approximately $12.6 million and $36.8 million,
respectively.
32
<PAGE> 34
A summary of the Company's finance receivables follows (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS
ENDED YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
<S> <C> <C>
Balance, Beginning of Period.................. $27,481 $ --
Purchases................................... 12,624 36,819
Principal Payments.......................... (3,622) (4,357)
Chargeoffs.................................. (521) (8)
Recourse to Seller.......................... (3,119) (4,973)
------- -------
Balance, End of Period........................ $32,843 $27,481
======= =======
</TABLE>
Finance receivables were comprised of the following as of March 31, 1998
and December 31, 1997 (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
--------- ------------
<S> <C> <C>
Finance Receivable Contract Principal Balances....... $32,843 $27,481
Add: Accrued Interest Receivable..................... 179 147
------- -------
Principal Balances, Net.............................. 33,022 27,628
Allowance for Credit Losses........................ (937) (485)
Acquired Allowance................................. (8,817) (7,706)
Refundable Security Deposits....................... (245) (163)
------- -------
Finance Receivables, net............................. $23,023 $19,274
======= =======
</TABLE>
As of March 31, 1998 and December 31, 1997, the Company maintained notes
receivable with 8 and 12 Third Party Dealers, respectively. The total balance of
notes receivables with Third Party Dealers totaled $6.5 million and $5.8 million
as of March 31, 1998 and December 31, 1997, respectively.
The Company has established an allowance for credit losses ("Allowance") to
cover anticipated credit losses on the finance receivables and notes receivable
currently in its portfolio. The Allowance has been established through
nonrefundable acquisition discounts ("Acquired Allowance") and a provision for
credit losses. The Allowance as a percentage of the principal amounts
outstanding on the finance receivables was 29.7% and 29.8% at March 31, 1998 and
December 31, 1997, respectively.
The following table reflects activity in the Allowance for the three months
ended March 31, 1998 and the year ended December 31, 1997 (dollar amounts in
thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997
-------------------------- -------------------------
FINANCE NOTES FINANCE NOTES
RECEIVABLES RECEIVABLES RECEIVABLES RECEIVABLE
----------- ----------- ----------- ----------
<S> <C> <C> <C> <C>
Allowance Activity:
Balance, Beginning of Year... $8,191 $200 $ -- $ --
Provision for Credit
Losses.................... 287 -- 491 200
Acquired Allowance........... 1,662 -- 7,706 --
Net Charge Offs.............. (386) -- (6) --
------ ---- ------ ----
Balance, End of Year........... $9,754 $200 $8,191 $200
====== ==== ====== ====
Allowance as % of Year Ended
Principal Balance............ 29.7% 0.7% 29.8% 0.9%
====== ==== ====== ====
</TABLE>
The Company's policy is to charge off contracts when they are deemed
uncollectible. Generally, contracts delinquent for 90 days are considered
uncollectible and are charged-off. There is no allowance related to the FMAC
transactions as, in the opinion of management, all amounts due under advances to
FMAC are believed to be collectible.
33
<PAGE> 35
The following table sets forth the percentage of the principal amount
outstanding of finance receivables in the Company's portfolio that were 30 to 44
days delinquent and over 44 days delinquent, as of March 31, 1998 and December
31, 1997, respectively:
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
DAYS DELINQUENT 1998 1997
- --------------- --------- ------------
<S> <C> <C>
30 to 44 days................................ 4.0% 8.0%
Over 44 days................................. 5.3% 5.3%
</TABLE>
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support lending activities under its Cygnet
Dealer Program, the purchase of bulk finance receivable portfolios, the purchase
of property and equipment, and for working capital and general corporate
purposes. The Company historically has funded its capital requirements through
equity contributions and advances by UDC and operating cash flow.
Cash Flows. The Company's Net Cash Provided by Operating Activities
totaled $6.4 million in the year ended 1997. Earnings of $5.5 million plus the
effect of the provision for credit losses and an increase in accrued expenses
and other liabilities offset deferred income taxes and cash used to purchase
other assets.
The Company's Net Cash Provided by Operating Activities increased by 945.0%
or $2.4 million to $2.2 million for the three month period ended March 31, 1998
from ($258,000) Used in Operating Activities for the three month period ended
March 31, 1997. The increase was primarily due to a significant net loss for the
three month period ended March 31, 1997, and a decrease in Other Assets.
Net Cash Used in Investing Activities totaled $26.7 million in the year
ended 1997. The Company used cash to purchase finance receivables totaling $20.9
million, to make notes receivable advances aggregating $12.7 million, and to
fund the purchase of assets of $9.1 million. These uses were offset by the
collection of $9.3 million in finance receivables and the collection of $6.9
million in notes receivable.
The Net Cash Used in Investing Activities increased by 722.2% or $9.0
million to $10.2 million for the three month period ended March 31, 1998 from
$1.2 million for the three month period ended March 31, 1997. The Company used
cash for the purchase of finance receivables totaling $8.7 million in the three
month period ended March 31, 1998, compared to the three month period ended
March 31, 1997, when no such purchases took place. Additionally, the Company
used cash for notes receivable advances aggregating $11.1 million in the three
month period ended March 31, 1998 compared to $1.3 million in the three month
period ended March 31, 1997. These uses were offset by the collections of
finance receivables of $4.7 million and collections of notes receivables of $4.9
million in the three month period ended March 31, 1998, as compared to $85,000
of collections in the three month period ended March 31, 1997.
Net Cash Provided by Financing Activities for 1997 was $21.5 million, all
of which was provided by UDC.
The Company's Net Cash Provided by Financing Activities increased by 411.1%
or $5.8 million to $7.2 million for the three month period ended March 31, 1998
from $1.4 million for the three month period ended March 31, 1997, due to a net
increase in financing provided by UDC.
Capital Expenditures and Commitments. The Company intends to pursue an
aggressive growth strategy. During 1997, the Company acquired substantially all
of the assets of ANAC for $9.3 million in cash. Further, the Company increased
its finance receivables and notes receivable portfolios by approximately $41.1
million during 1997.
On July 11, 1997, the Company entered into an agreement to provide a DIP
Facility to FMAC in an amount up to $10 million. On March 31, 1998, the
effective date of FMAC's plan of reorganization, the DIP Facility was amended to
increase the maximum commitment to $21.5 million, subject to future adjustment
downward by an amount not to exceed $10 million. The Company had advanced $15.7
million against this commitment as of March 31, 1998.
34
<PAGE> 36
The Company is negotiating a credit facility with certain third party
lenders affiliated with Kayne Anderson Investment Management pursuant to which
the Company anticipates that such lenders will provide $5 million to the Company
in the form of subordinated debt. If this credit facility is secured by the
Company, the principal amount is expected to be funded at the discretion of the
Company following the Effective Date of the Split-up, is expected to bear
interest at 12% per annum, payable quarterly in arrears, with the principal
balance and all accrued but unpaid interest payable in full on the third
anniversary of the initial funding date. The debt is anticipated to be
subordinated in right of payment to all existing and future debt of the Company.
The Company also anticipates that it will be required to maintain a debt to
tangible equity ratio not greater than 3 to 1, calculated as of the end of each
quarterly period. As additional consideration for the subordinated debt, the
Company expects to issue warrants to acquire 100,000 shares of Common Stock,
exercisable for a period of three years at an exercise price of $7.00 per share.
The lenders also will be granted certain registration rights with respect to the
shares of the Common Stock underlying the warrants.
The Company is in the process of negotiating the acquisition of or a
management arrangement with an insurance agency which offers insurance-related
products and services designed to reduce the risk of loss to holders of large
portfolios of vehicle and residential mortgage loans, including banks, savings
and loan associations, finance companies, credit unions, and automobile dealers,
among others. If the acquisition is completed, the Company believes that the
insurance-related products and services offered by this insurance agency will
complement the Company's existing business. There can be no assurance, however,
that this acquisition will be completed.
The Company intends to finance its future capital requirements through the
proceeds of the Rights Offering, operating cash flows and supplemental
borrowings. The Company believes that these sources will be adequate to support
its anticipated financial requirements at least through the end of 1998.
Industry Considerations. In recent periods, several major used car finance
companies have announced major downward adjustments to their financial
statements, violations of loan covenants, related litigation, and other events.
In addition, certain of these companies have filed for bankruptcy protection.
These announcements have had a disruptive effect on the market for securities of
sub-prime automobile finance companies, have resulted in a tightening of credit
to the sub-prime markets, and could lead to enhanced regulatory oversight. A
reduction in access to the capital markets or to credit sources could have a
material adverse affect on the Company.
Transactions Regarding First Merchants Acceptance Corporation. UDC has
been actively involved in the FMAC bankruptcy proceedings. FMAC was in the
business of purchasing and securitizing loans made primarily to sub-prime
borrowers by various Third Party Dealers. In various transactions relating to
the FMAC bankruptcy proceedings, UDC, among other things, (1) purchased the
beneficial interest in the Senior Bank Debt held by certain creditors of FMAC,
participated in the sale of the contracts securing such claims at a profit to a
third party purchaser, guaranteed the purchaser a specified return on the
contracts and obtained a related guarantee from FMAC secured by, among other
things, the stock of certain entities holding residual interests and certain
equity certificates in various securitized loan pools of FMAC, and entered into
servicing arrangements with respect to such contracts; (2) made loans under the
DIP Facility to FMAC, which at May 31, 1998 carried a remaining maximum
commitment of $12.6 million, of which $9.3 million was outstanding on such date,
and received interest income therefrom; (3) entered into various servicing
agreements with respect to receivables in the securitized pools of FMAC; (4)
obtained rights to receive certain payments with respect to distributions on
residual interests in such securitized pools and obtained certain interests in
charged off receivables in such pools; (5) obtained rights to certain fees; (6)
obtained the FMAC servicing platform; and (7) issued certain warrants to
purchase UDC Common Stock consisting of (a) warrants issued to FMAC's bank group
to purchase up to 389,800 shares of UDC's Common Stock at an exercise price of
$20.00 per share at any time through February 20, 2000, subject to a call
feature by UDC if the closing market price of UDC Common Stock equals or exceeds
$27.00 per share for a period of five consecutive trading days, and (b) warrants
issued to FMAC to purchase 325,000 shares of UDC Common Stock at any time
through April 1, 2001 at a price of $20.00 per share, subject to a call feature
by UDC if the closing market price of the UDC Common Stock equals or exceeds
$28.50 per share for a period of 10
35
<PAGE> 37
consecutive trading days. UDC also contributed to FMAC all of its shares of FMAC
common stock in exchange for the assets constituting FMAC's servicing platform.
In connection with the Split-up, UDC will transfer all of the rights and
substantially all of the liabilities related to the FMAC transaction accruing on
or after the Effective Date to the Company. However, UDC will remain liable with
respect to certain liabilities related to the FMAC transaction. For additional
information concerning the FMAC transaction and the rights and liabilities
assumed by the Company in connection with the Split-up, see "Business -- Bulk
Purchase and Servicing Operations -- Transactions Regarding First Merchants
Acceptance Corporation" and "Risk Factors -- Risks Relating to the
Business -- Risks Relating to the FMAC Transaction."
Transactions Regarding Reliance Acceptance Group. In February 1998, UDC
entered into servicing and transition servicing arrangements with Reliance,
after Reliance had filed for reorganization under the Bankruptcy Code the same
month. Pursuant to the servicing agreement entered into between UDC and Reliance
(the "Servicing Agreement"), following the effective date of Reliance's plan of
reorganization, UDC will service certain receivables of Reliance in exchange for
(i) a monthly servicing fee of the greater of four percent (4%) per annum of the
aggregate outstanding principal balance of all non-defaulted receivables
computed monthly on the basis of the declining balance of the receivables
portfolio (consisting of Reliance's portfolio of (A) prime receivables and (B)
sub-prime receivables), or fifteen dollars ($15.00) per receivable per month
plus reimbursement of certain costs and expenses; (ii) $1.3 million in proceeds
realized from the sale of a pool of charged-off receivables existing as of the
Reliance petition date ("Charged-Off Proceeds"); (iii) a total of (A) four
percent (4%) of the outstanding principal balance of each receivable (exclusive
of defaulted and certain other receivables) sold in any bulk sale to a person
other than UDC or an affiliate of UDC, and (B) $4.7 million in net collections,
recovery, and sale proceeds from the receivables portfolio and certain other
cash receipts of Reliance reduced by any amount previously paid under clause (A)
above, following payment of Reliance's primary bank debt and, if applicable,
repayment to Reliance of any proceeds of litigation, the Reliance Warrants (as
defined below), and equity proceeds used by Reliance to pay its primary bank
debt ("Post-Bank Debt Proceeds"); and (iv) following UDC's receipt of the
Post-Bank Debt Proceeds, twenty-five percent (25%) of the net collections,
recovery, and sale proceeds from the receivables portfolio and certain other
cash receipts of Reliance (the "Incentive Fee"). Reliance, in consideration for
entering into the Servicing Agreement, will receive privately issued warrants
("Reliance Warrants") to purchase shares of UDC Common Stock as follows: 50,000
Reliance Warrants will be granted to Reliance upon UDC's receipt of the
Charged-Off Proceeds; up to 100,000 Reliance Warrants will be granted to
Reliance based upon UDC's receipt of up to $4.7 million of Post-Bank Debt
Proceeds; and Reliance will be granted an additional 75,000 Reliance Warrants
for every $1 million actually received by UDC through the Incentive Fee. The
Reliance Warrants will have a strike price of $12.50 for the first 150,000
Reliance Warrants and a strike price for all other Reliance Warrants of the
greater of $12.50 or 120% of the market price of UDC Common Stock on the date of
issuance of the Reliance Warrants. The Reliance Warrants will be exercisable as
follows: (i) the first 50,000 Reliance Warrants will be exercisable for three
years from the Reliance Petition Date and (ii) all remaining Reliance Warrants
will be exercisable for three years from their date of issuance.
UDC will transfer all contract rights and substantially all liabilities
related to the Reliance transaction to the Company. However, UDC will remain
liable as to certain obligations in the Reliance transaction. See
"Business -- Bulk Purchase and Servicing Operations -- Transactions Regarding
Reliance Acceptance Group" and "Risk Factors -- Risks Relating to the
Business -- Risks Relating to the Reliance Transaction."
YEAR 2000
The Company has reviewed its internal computer systems in order to assess
its exposure to Year 2000 issues. The Company expects to make the necessary
modifications or changes to its computer information systems to enable proper
processing of transactions relating to the Year 2000 and beyond. The Company
estimates that the cost to modify its existing systems, should it choose to do
so, will not be material. 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
36
<PAGE> 38
systems, which costs would be expensed as incurred. Resolution of all Year 2000
issues is critical to the Company's business. There can be no assurance that the
Company will be able to completely resolve all Year 2000 issues in a timely
fashion or that the ultimate cost to identify and implement solutions to all
Year 2000 problems will not be material to the Company.
The Company is in the process of converting its loan processing and
collection systems to a new third party service bureau which will be responsible
for Year 2000 issues affecting that system. The Company's remedy for failure of
such system to be Year 2000 compliant is limited to termination of the
agreement. See "Risk Factors -- Risks Relating to the Business -- Data
Processing and Technology and Year 2000."
INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's expected borrowings would decrease the
profitability of the Company's existing portfolio. The Company has sought to
limit this risk by (i) maintaining a portion of its investment portfolio in the
floating rate ABL program and (ii) limiting the maturity of finance receivable
contracts. If the Company's borrowing rates increase, then the Company will seek
to further limit the negative impact on earnings by increasing the purchase
discount at which the Company purchases finance receivables and/or require
higher stated annual percentage rates on finances receivables which are
purchased. To date, inflation has not had a significant impact on the Company's
operations.
ACCOUNTING MATTERS
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130) which became effective for the Company on January 1, 1998. SFAS No. 130
establishes standards for reporting and displaying comprehensive income and its
components in a full set of general purpose financial statements. The Company
had no comprehensive income.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131), which became effective for
the Company on January 1, 1998. SFAS No. 131 establishes standards for the way
that public enterprises report information about operating segments in annual
financial statements and requires that those enterprises report selected
information about operating segments in interim reports issued to stockholders.
Management does not expect the adoption of SFAS No. 131 to have a material
impact on the Company's disclosures.
FORWARD LOOKING STATEMENTS
This Prospectus contains forward looking statements. Additional written or
oral forward looking statements may be made by the Company from time to time in
filings with the Securities and Exchange Commission or otherwise. Such forward
looking statements are within the meaning of that term in Section 27A of the
Securities Act, and Section 21E of the Securities Exchange Act of 1934, as
amended (the "Exchange Act"). Such statements may include, but not be limited
to, projections of revenues, income, or loss, estimates of capital expenditures,
plans for future operations, products or services, and financing needs or plans,
as well as assumptions relating to the foregoing. The words "believe," "expect,"
"anticipate," "estimate," "project," and similar expressions identify forward
looking statements, which speak only as of the date the statement was made.
Forward looking statements are inherently subject to risks and uncertainties,
some of which cannot be predicted or quantified. Future events and actual
results could differ materially from those set forth in, contemplated by, or
underlying the forward looking statements. The Company undertakes no obligation
to publicly update or revise any forward looking statements, whether as a result
of new information, future events, or otherwise. The following disclosures, as
well as other statements in this Prospectus, including those contained in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," and in the Notes to the Company's Combined Financial Statements,
describe factors, among others, that could contribute to or cause such
differences, or that could affect the Company's stock price.
37
<PAGE> 39
BUSINESS
GENERAL
Assuming successful completion of the Rights Offering and consummation of
the Split-up, the Company will engage in the business of providing various
financial services primarily to the sub-prime segment of the automobile
financing industry, which focuses on selling and financing the sale of new and
used cars to persons who have limited credit histories, low incomes, or past
credit problems ("Sub-Prime Borrowers"). The Company will (i) engage in the bulk
purchase and servicing of pools of finance receivables generated from the sale
of new and used automobiles by independent third party dealers ("Third Party
Dealers"), including pools of charged-off receivables, deficient loans, or other
receivables; (ii) service pools of various types of finance receivables; (iii)
operate a collateralized dealer financing program (the "Cygnet Dealer Program"),
pursuant to which it will provide qualified independent used car dealers with
warehouse purchase facilities and revolving lines of credit primarily secured by
the dealers' finance receivable portfolios; and (iv) pursue other opportunities
in the financial services market.
In connection with the Split-up, the Company will acquire the bulk
purchasing and certain servicing operations and related assets from UDC and
substantially all of UDC's servicing and other rights and obligations pursuant
to transactions with First Merchants Acceptance Corporation ("FMAC") and
Reliance Acceptance Corporation ("Reliance"). The Company intends to consider
the bulk purchase and servicing of other portfolios of finance receivables,
including instances in which the holders of the portfolios are experiencing
financial difficulties. For a description of the Company's bulk purchase and
servicing operations and the Company's rights and obligations with respect to
the FMAC and Reliance transactions, see "Business-Bulk Purchasing and Servicing
Operations."
The Company also will acquire the operations and related assets associated
with the Cygnet Dealer Program, which provides qualified independent used car
dealers with warehouse purchase facilities and revolving lines of credit
primarily secured by the dealers' finance receivable portfolios. Unlike other
typical financing programs available to dealers, the Cygnet Dealer Program
permits participating dealers to retain servicing rights with respect to their
finance receivable portfolios, which enables dealers to generate servicing
income and maintain relationships with their customers, which dealers believe is
a key factor in generating referrals for additional sales and improving the
chances of repeat business. For a description of the Cygnet Dealer Program, see
"Business -- Cygnet Dealer Program."
In addition, the Company is currently evaluating the acquisition of or a
management arrangement with an operating insurance agency, which offers
insurance-related products and services designed to reduce the risk of loss to
holders of portfolios of vehicle and residential mortgage loans, including
banks, savings and loan associations, finance companies, credit unions,
securitization participants and automobile dealers, among others. If the Company
decides to proceed with the transaction, a portion of the proceeds from the
Rights Offering may be utilized to repay indebtedness related thereto.
In late 1997, UDC, which operates the largest publicly-held chain of "buy
here-pay here" used car dealerships in the United States, began a strategic
evaluation of its operations, determining to separate its dealership operations
from its non-dealership operations pursuant to the Split-up. Cygnet is a
Delaware corporation formed in June 1998 to acquire and operate the
non-dealership operations of UDC and will, upon successful completion of the
Rights Offering and consummation of the Split-up, be a separately-traded public
company.
OVERVIEW OF USED CAR FINANCE INDUSTRY
The automobile financing industry is the third-largest consumer finance
market in the country, after mortgage debt and credit card revolving debt. The
industry is served by such traditional lending sources as banks, savings and
loans, and captive finance subsidiaries of automobile manufacturers, as well as
by independent finance companies and "buy here-pay here" dealers. The Company's
servicing and financing services historically have been directed primarily to
the sub-prime segment of the market. The Company believes that traditional
providers of financing, servicing, and related services typically avoid this
market because of its high credit risk and the higher costs associated with
increased collection efforts.
38
<PAGE> 40
Recently, a number of automobile financing companies have decided to exit
the market, sell a substantial portion of their receivables, or rely on an
outside servicer to service their portfolios. The primary factors for these
changes in the market include the rapid growth and increased competition in the
sub-prime segment of the market, lowered underwriting standards, increased
credit losses, and a tightening of credit to participants in this market. On the
basis of its access to capital and experience in providing financing and
servicing to the sub-prime industry, the Company has taken advantage of these
market opportunities by bulk purchasing the loan receivables in and servicing
rights to certain large portfolios owned by FMAC and Reliance. The Company
intends to continue to pursue opportunities to purchase loan portfolios in bulk
and the servicing rights to those portfolios from companies operating in the
sub-prime automobile financing market.
Due to the risks involved in providing financing to the sub-prime segment
of the automobile financing industry, many independent used car dealers are
unable to obtain working capital from traditional lending sources such as banks,
credit unions, or major finance companies. These dealers typically finance their
operations through the sale of finance receivables at a substantial discount.
The Company believes that independent dealers prefer to finance their operations
through credit facilities that permit them to retain their receivables, which
enables such dealers to generate servicing income, and prefer to maintain their
relationships with their customers, which the Company, unlike traditional
providers of collateral financing, affords through its Cygnet Dealer Program.
Accordingly, the Company believes that there is a substantial opportunity for a
company capable of serving the needs of such dealers to make significant
penetration into this underdeveloped segment of the sub-prime market. The
Company's Cygnet Dealer Program is intended to fill this niche.
COMPETITIVE STRENGTHS AND BUSINESS STRATEGIES
The Company's goal is to become a leading provider of financing, servicing,
and other complementary services related to finance and other loan receivables,
particularly with respect to the sub-prime segment of the automobile financing
industry. In recent periods, the sub-prime automobile market has been
characterized by rapid growth and increased competition, which has led to
lowered underwriting standards, increased credit losses, and a tightening of
credit. The Company believes these conditions afford significant opportunities
for well-capitalized industry participants with experience in the bulk purchase,
servicing, and financing of receivables in this market segment.
The Company intends to pursue the following business strategies to achieve
its goal:
- Pursue Additional Bulk Purchasing and Servicing Opportunities. The
Company will leverage its financial strength, access to capital, and
experience in the industry to provide creative solutions to financing
companies that desire to sell their sub-prime portfolios in bulk or that
wish to outsource the servicing of their portfolios, including companies
that are experiencing financial difficulties. The Company plans to
continue to seek out opportunities such as its transactions with FMAC and
Reliance as described below.
- Expand the Cygnet Dealer Program. The Cygnet Dealer Program fulfills the
needs of buy here-pay here dealers by providing them working capital
while allowing them to retain their servicing rights and customer
relationships. The program enables the Company to earn finance income at
favorable rates through a diversified asset base. The Company intends to
expand this program in selected markets throughout the country, taking
advantage of the tightening of financing in the sub-prime market
generally.
- Pursue Opportunities to Provide Other Complementary Services. The
Company intends to pursue other opportunities to provide services that
complement its financing and servicing operations. The Company currently
is negotiating the acquisition of or a management arrangement with an
insurance agency that provides insurance-related products and services
designed to decrease the risk of loss to portfolios such as those the
Company currently owns and services. The Company believes that the
combination of its existing financing and servicing operations with other
complementary services will further enhance its ability to provide
turn-key solutions to independent used car dealers, financial
institutions, and other market participants.
39
<PAGE> 41
The Company believes it will possess the following competitive strengths
and intends to leverage these strengths to pursue its business strategies:
- Capitalized for Growth. Assuming the purchase of all of the Offered
Shares pursuant to the Rights Offering, the Company would have had, on a
pro forma basis on March 31, 1998, approximately $72.5 million (or $79.1
million if the Additional Purchase Right and the D&O Purchase Right are
exercised) in stockholders' equity to expand its operations following the
Rights Offering. The Company believes this level of equity will provide
it with the financial strength to take advantage of the opportunities
available in the sub-prime segment of the automobile financing industry
or other market opportunities identified by management.
- Established Track Record. The Company has significant experience in
handling large transactions involving companies operating in the
sub-prime vehicle financing industry. The Company intends to leverage the
experience it has gained in these transactions with additional bulk
purchases of pools of auto loan receivables and related servicing rights
from other market participants and others who desire to transfer these
operations to independent providers. The Company also has significant
experience in underwriting and purchasing sub-prime finance receivable
contracts and in providing credit facilities to independent dealers.
- Experienced Management. The Company's management has extensive
experience providing financing, servicing, and other complementary
services to third party participants in the sub-prime automobile market.
In addition, management has extensive experience in the car dealership
business. The Company intends to leverage its experience in the car
dealership, financing, and servicing businesses to continue to seek out
new opportunities through its bulk purchasing and servicing operations
and the Cygnet Dealer Program.
BULK PURCHASING AND SERVICING OPERATIONS
The Company will pursue opportunities to bulk purchase and acquire the
rights to service portfolios of finance receivables from third-party financing
companies, including companies that are experiencing financial difficulties. The
Company's current focus is on finance receivables in the sub-prime segment of
the vehicle financing market. The Company's access to capital, experience and
expertise in managing complex financial transactions involving distressed
companies, and approved servicing capabilities, particularly with respect to
loan receivables in the sub-prime vehicle financing market, enable the Company
to provide turn-key solutions to financial institutions that encounter
difficulties arising from the ownership and maintenance of large portfolios of
vehicle related loan receivables. As a result of the Company's experience in
managing and understanding the nature of the risks associated with holding and
servicing such portfolios, the Company is able to creatively structure
transactions in which it shares the risk associated with the portfolio in
exchange for a more substantial discount on the purchase price or an increased
share of the return from such portfolios arising from workout situations.
The Company maintains loan servicing facilities in Nashville, Tennessee,
Denver, Colorado and Dallas, Texas to support its bulk servicing operations. As
of May 31, 1998, these facilities employed approximately 260 employees, a number
that enables the Company to service large volumes of finance receivable
contracts. When the Company makes a bulk purchase, it typically employs the
collection personnel, system and software utilized by the existing servicer, and
migrates the collection processes to the Company's system as practicable.
The Company's collectors utilize collections software that provides the
Company with, among other things, up-to-date activity reports, allowing
immediate identification of customers whose accounts have become past due. In
accordance with the Company's policy, collections department personnel contact a
customer as soon as their account becomes delinquent to inquire as to the
reasons for such delinquency and to suggest ways in which the customer can
resolve the underlying problem, thereby enabling the customer to continue making
payments and retain the vehicle securing the finance receivable. The Company's
early detection of a customer's delinquent status, as well as its commitment to
work with borrowers, allows it to identify problems quickly, thereby reducing
the amount of credit losses incurred in the portfolios it services.
40
<PAGE> 42
If the Company's efforts to work with a customer are unsuccessful and the
customer becomes seriously delinquent, the Company will take the necessary steps
to protect the collateral securing the loan in default. Frequently, delinquent
customers will recognize their inability to honor their contractual obligations
and will work with the Company to coordinate "voluntary repossessions" of their
car. In the cases involving uncooperative customers the Company retains
independent firms to repossess the cars pursuant to prescribed legal procedures.
In recent periods, the Company has entered into several large servicing or
bulk purchasing transactions involving independent third party dealer finance
receivable portfolios and, in some cases, has sold or securitized these
portfolios, with servicing retained. The two most significant of such
transactions are described below.
Transactions Regarding First Merchants Acceptance Corporation. UDC has
been actively involved in the bankruptcy proceedings of FMAC. On the Effective
Date, the Company will assume all rights and substantially all liabilities
related to the FMAC transaction accruing on or after the Effective Date from
UDC, subject to the consent of certain participants in the bankruptcy
proceedings.
FMAC was in the business of purchasing and securitizing loans made
primarily to Sub-Prime Borrowers by various Third Party Dealers. On July 11,
1997 (the "FMAC Petition Date"), FMAC filed for reorganization under Title 11 of
the United States Code (the "Bankruptcy Code"). FMAC emerged from bankruptcy on
March 31, 1998, the effective date of FMAC's plan of reorganization (the "Plan
of Reorganization").
During the pendency of the FMAC bankruptcy proceedings, UDC purchased
approximately 78% of FMAC's Senior Bank Debt held by seven members (the "Selling
Banks") of FMAC's original nine-member bank group for approximately $69 million,
which represented a discount of 10% of the outstanding principal amount of such
debt. In December 1997, UDC purchased the remaining 22% of FMAC's Senior Bank
Debt. The Senior Bank Debt was originally secured by (1) automobile receivables
directly owned by FMAC (the "Owned Contracts"), (2) all personal property of
FMAC, (3) accounts, accounts receivable, including tax refunds, contract rights
and other general intangibles, and (4) the common stock of FMARC and FMARC II
(defined below) (collectively, the "Collateral").
On December 15, 1997, LaSalle National Bank, as Agent (the "Agent") for
UDC, as the holder of the Senior Bank Debt, credit bid the entire amount of the
Senior Bank Debt plus certain interest and fees, costs and expenses relating to
the Owned Contracts (collectively, the "Credit Bid Purchase Price"), and the
United States Bankruptcy Court for the District of Delaware (the "Bankruptcy
Court") approved the proposed purchase subject to execution by FMAC of
appropriate transfer documents. On December 18, 1997, FMAC executed the
necessary transfer documents assigning the Owned Contracts to the Agent (the
"Transfer"), and the Agent then sold the Owned Contracts on behalf of UDC to a
third party purchaser (the "Contract Purchaser") for 86% of the principal
balance of certain eligible Owned Contracts (approximately $78.9 million) (the
"Base Price") plus a residual interest in the Owned Contracts. In connection
with this transfer, UDC guaranteed to the Contract Purchaser a net return on the
Owned Contracts equal to the Base Price plus interest at the rate of 10.35% per
annum (the "Guaranteed Return"), subject to a maximum guarantee amount of $10
million. As between the Company and UDC, the Company has agreed to assume the
liabilities with respect to this guarantee. UDC, however, will remain directly
liable on the guarantee to the Contract Purchaser (the "UDC Retained
Guarantee"). UDC has the option to purchase the Owned Contracts from the
Contract Purchaser at certain times upon certain events, including at any time
after three years and if the principal balance on the remaining contracts is
less than 10% of the balance of the Owned Contracts on the date of purchase and
certain other conditions are satisfied, for a price to yield the Contact
Purchaser the Guaranteed Return. UDC will assign this repurchase right to the
Company on the Effective Date of the Split-up.
Concurrently with the Transfer, the Agent released the lien of UDC on the
Collateral, allowing FMAC to retain all assets constituting any part of the
Collateral other than the Owned Contracts (the "Retained Assets"), including but
not limited to uncollected state and federal income tax refunds for 1996 and
prior years (the "Tax Refunds"), certain receivables and related vehicles
pledged to Greenwich Capital (the "Greenwich Collateral"), and FMAC's furniture,
fixtures, equipment, general intangibles, and causes of
41
<PAGE> 43
action. In consideration for UDC's release of its lien on the Retained Assets,
FMAC subsequently (A) guaranteed on a non-recourse basis full and timely payment
to UDC of any shortfall between (i) the Credit Bid Purchase Price of the Owned
Contracts plus interest thereon at the rate of 11% per annum from December 15,
1997, plus an additional charge for servicing the Owned Contracts (the "Owned
Contracts Servicing Fee"), calculated on a monthly basis, of the greater of
1/12 of 3 1/4% of the outstanding principal balance of the Owned Contracts or
$15.00 per Owned Contract, applied only to Owned Contracts that are less than
120 days past due and for which the related vehicle has not been repossessed and
(ii) collections and proceeds (subject to certain limitations) with respect to
the Owned Contracts (collectively, the "Secured Claim Recovery Amount"), and (B)
granted a lien (the "Replacement Lien") to the Agent for the benefit of UDC on
the issued and outstanding stock of First Merchants Auto Receivables Corporation
("FMARC") and First Merchants Auto Receivables Corporation II ("FMARC II"), the
holders of the residual interests and certain equity certificates (collectively,
the "B Pieces") of the various securitized loan pools ("Securitized Pools") of
FMAC, to secure the Secured Claim Recovery Amount and the Modified UDC Fee
(defined below). The Replacement Lien is not a first priority lien and is junior
to a lien in favor of Greenwich Capital with respect to certain obligations of
FMAC to Greenwich Capital and UDC with respect to the DIP Facility. In the event
that the Owned Contracts are not being serviced by UDC, a wholly-owned
subsidiary of UDC or another affiliate or assignee of UDC that meets certain
qualifications and conditions (an "Authorized Servicer"), without the prior
written consent of FMAC (an "Owned Loan Servicing Change"), which consent will
not be unreasonably withheld, the Secured Claim Recovery Amount will be limited
to $10 million. Following the Split-up, UDC's rights described herein with
respect to FMAC's non-recourse guarantee of the Secured Claim Recovery Amount
and in the Replacement Lien will be assigned to the Company, subject to a
security interest in favor of UDC in the Company's security interest in such
collateral to secure the Company's continuing liabilities. The Company will also
begin servicing the Owned Contracts, subject to the consent of the Contract
Purchaser. The Company believes that it will qualify as an Authorized Servicer,
and therefore, FMAC's consent will not be required.
Any recovery on the Owned Contracts in excess of the Secured Claim Recovery
Amount will be shared with FMAC on the basis of 82.5% for the benefit of FMAC
and 17 1/2% for the benefit of UDC (the "Excess Collections Split"). After
payment in full of the Secured Claim Recovery Amount, the DIP Facility , the
Modified UDC Fee (defined below), and certain other amounts, any further
distributions from the B Pieces will be shared between FMAC and UDC on the same
basis as the Excess Collections Split. In the event that an Owned Loan Servicing
Change occurs, the Excess Collections Split will change to 85% for the benefit
of FMAC and 15% to UDC with respect to the B Pieces and, subject to certain
adjustments, 100% for the benefit of FMAC and 0% to UDC with respect to the
Owned Contracts. UDC will not be entitled to receive any share of the Excess
Collections Split relating to a Securitized Pool for any period during which it
is not acting as servicer for such Securitized Pool. In addition, UDC has agreed
in a contingent sharing agreement to pay 10% of the Excess Collections Split
received by UDC to Financial Security Assurance ("FSA"), the insurer of certain
obligations to the holders of the senior certificates representing interests in
the Securitized Pools, in exchange for FSA's consent to amendments to documents
governing servicing of the Securitized Pools as described below. All of UDC's
rights and the Excess Collections Split and the obligations with respect thereto
under the Contingent Sharing Agreement with FSA will be assigned to the Company
on the Effective Date of the Split-up.
At the option of UDC, UDC may distribute up to 5,000,000 shares of UDC
Common Stock (the "Stock Option Shares") to FMAC or, at the request of FMAC and
pursuant to its instructions, directly to the unsecured creditors of FMAC, in
lieu of FMAC's right to receive all or a portion of distributions under the
Excess Collections Split (including both recoveries under the Excess Collections
Split from the Owned Contracts and the B Pieces) in cash (the "Stock Option").
If UDC decides to exercise the Stock Option, UDC must give FMAC at least 15 days
advance written notice (the "Option Notice") (and make a public announcement on
the same date as the giving of the notice) of the date on which UDC will
exercise the Stock Option (the "Exercise Date") and the number of Stock Option
Shares that UDC will issue on the Exercise Date. The number of shares of UDC
Common Stock to be issued will be based on the trading range of the shares prior
to the exercise date. Pursuant to the Capitalization Agreement, the Company will
be required to give notice to UDC at least a stated number of days prior to the
date when cash distributions of the Excess
42
<PAGE> 44
Cash Split to FMAC are likely to begin and the Company's estimate of the amount
and timing of such distributions.
At the commencement of FMAC's bankruptcy case, UDC agreed to provide a DIP
Facility to FMAC of up to $10 million. Borrowings under the DIP Facility
originally were to mature on February 28, 1998 and accrue interest at the rate
of 12% per annum. The DIP Facility was originally secured by super priority
liens on all of FMAC's assets then existing or thereafter acquired. The DIP
Facility was subsequently amended to provide for (i) additional advances to pay
administrative and post-plan confirmation operating expenses of FMAC, provided
that total advances under the DIP Facility could not exceed $21.5 million, (ii)
security in the form of the Retained Assets, including the Tax Refunds, (iii) a
reduction in the interest rate on borrowings outstanding under the DIP Facility
to 10% per annum; and (iv) a waiver of the February 28, 1998 maturity date of
the DIP Facility. The first $10 million of Tax Refunds will be used to pay down
the DIP Facility and will permanently reduce the amount of the DIP Facility. To
date, approximately $ million of Tax Refunds have been used to pay down
the DIP Facility and the maximum amount available to be borrowed has been
reduced from $21.5 million to $12.6 million. Thereafter, the DIP Facility will
be permanently paid down from distributions on the B Pieces, after payment of
the Secured Claim Recovery Amount. Payments made from other sources on the DIP
Facility will not permanently reduce the amount thereof and FMAC will be allowed
to reborrow such amounts under the DIP Facility. Following the Split-up, the
Company will assume all of UDC's rights and liabilities with respect to the DIP
Facility and in the Tax Refunds and other collateral securing the same. UDC,
however, will remain directly liable on the DIP Facility.
The increase in the DIP Facility to $21.5 million was agreed to in exchange
for an agreement by the parties involved to assign the receivables in the
Securitized Pools that were charged off prior to February 28, 1998 to UDC.
Pursuant to that agreement, UDC is entitled to retain a servicing fee of 27.5%
of every dollar collected on the charged off receivables. The remaining 72.5%
out of every dollar collected will be accumulated in an interest bearing escrow
account ("Charged Off Receivable Funds"). The Charged Off Receivable Funds will
be held in the escrow account until an amount equal to one percent of the
remaining principal amount of all receivables charged off prior to or on
November 30, 1997 and two percent of the remaining principal amount of all
receivables charged off from December 1, 1997 to and including February 28, 1998
has been deposited to the escrow account at which time such amount shall be
allocated and paid to Securitized Pools from which the receivables were
transferred and, thereafter if the securitized pools have inadequate funds to
satisfy certain payments and distributions with respect to the senior
certificates issued with respect to such pools, then future deposits to the
escrow account shall be withdrawn to satisfy such payments and distributions.
When the aggregate of the spread accounts in the Securitized Pools reaches a
certain coverage (the "Coverage Point"), to the extent available, all monies
previously transferred to the escrow account to satisfy such payments and
distributions will be deposited back into the escrow account and the Charged Off
Receivable Funds will be released from the escrow account and paid to the
Company. Any additional collections with respect to charged-off receivables
relating to a Securitized Pool that has reached the Coverage Point would be
retained by the Company. Following the Split-up, all rights and obligations with
respect to the Charged Off Receivable Funds will be assigned to the Company.
FMAC has guaranteed to pay UDC $450,000 on a non-recourse basis prior to
any payments pursuant to the Excess Collections Split solely from collections of
the B Pieces, which obligation is secured by a pledge of the stock of FMARC and
FMARC II, subordinate only to the DIP Facility, the Secured Claim Recovery
Amount and prior pledges of the FMARC II stock (the "Modified UDC Fee").
Following the Split-up, the right to receive the Modified UDC Fee will be
assigned to the Company.
UDC entered into a Servicing Agreement dated December 18, 1997 (the "Owned
Contracts Servicing Agreement") between UDC and the Contract Purchaser, pursuant
to which the Owned Contracts would be serviced by UDC in the event that FMAC
ceased to service the Owned Contracts. UDC began servicing the Owned Contracts
on April 1, 1998, and therefore is entitled to receive a servicing fee under the
Owned Contracts Servicing Agreement. On April 1, 1998, UDC also entered into
amendment(s) with FMAC and other parties to the existing Pooling and Servicing
Agreements and Sale and Servicing Agreements that currently govern servicing of
the receivables in the securitized pools of FMAC, which amendments provide for
43
<PAGE> 45
UDC to service the receivables in such securitized pools beginning April 1,
1998. Under these agreements, UDC will receive a servicing fee equal to the
greater of (i) 3.25% per annum of the aggregate outstanding principal balance of
the non-defaulted receivables computed monthly on the basis of the declining
balance of the receivables portfolio or (ii) $15 per receivable per month, plus,
in either case, reimbursement of certain costs and expenses. The Company's right
to receive such servicing fee and reimbursement will be in part contingent on
the past and future collections on each Securitized Pool and the monies
available in the applicable spread account of each such Securitized Pool. All
rights and obligations under the Owned Contracts Servicing Agreement, subject to
the consent of the contract purchaser, and with respect to servicing the
arrangements on the Securitized Pools, subject to the consent of FSA, will be
assigned to the Company following the Split-up.
On March 31, 1998, UDC contributed to FMAC all of its shares of FMAC common
stock in exchange for the furniture, leasehold improvements and equipment
constituting FMAC's servicing platform. Following the Split-up, the FMAC
servicing platform will be transferred to the Company.
Transactions Regarding Reliance Acceptance Group. On February 9, 1998, UDC
announced that it had agreed to enter into servicing and transition servicing
arrangements with Reliance. Reliance filed for reorganization under the
Bankruptcy Code on February 9, 1998. Reliance is a national specialty finance
company, primarily engaged in the business of purchasing and servicing finance
receivables for the purchase of new or used automobiles, trucks, vans and sport
utility vehicles by Sub-Prime Borrowers.
Pursuant to a servicing agreement entered into between UDC and Reliance
(the "Servicing Agreement"), UDC will service certain receivables of Reliance in
exchange for (i) a monthly servicing fee of the greater of 4% per annum of the
aggregate outstanding principal balance of all non-defaulted receivables
computed monthly on the basis of the declining balance of the receivables
portfolio (consisting of Reliance's portfolio of (A) prime receivables and (B)
sub-prime receivables), or $15 per receivable per month plus reimbursement of
certain costs and expenses; (ii) $1.3 million in proceeds realized from the sale
of a pool of charged off receivables existing as of the Reliance Petition Date
("Charged-Off Proceeds"); (iii) a total of (A) 4% of the outstanding principal
balance of each receivable (exclusive of defaulted and certain other
receivables) sold in any bulk sale to a person other than UDC or an affiliate of
UDC, and (B) $4.7 million in net collections, recovery and sale proceeds from
the receivables portfolio and certain other cash receipts of Reliance reduced by
any amount previously paid under clause (A) above, following payment of
Reliance's primary bank debt and, if applicable, repayment to Reliance of any
proceeds of litigation, the Reliance Warrants (as defined below) and equity
proceeds used by Reliance to pay its primary bank debt ("Post-Bank Debt
Proceeds"); and (iv) following the Company's receipt of the Post-Bank Debt
Proceeds, 25% of the net collections, recovery and sale proceeds from the
receivables portfolio and certain other cash receipts of Reliance (the
"Incentive Fee"). Reliance, in consideration for entering into the Servicing
Agreement, will receive privately issued warrants (the "Reliance Warrants") to
purchase shares of UDC Common Stock as follows: 50,000 Reliance Warrants will be
granted to Reliance upon the Company's receipt of the Charged-Off Proceeds; up
to 100,000 Reliance Warrants will be granted to Reliance based upon the
Company's receipt of up to $4.7 million of Post-Bank Debt Proceeds; and Reliance
will be granted an additional 75,000 Reliance Warrants for every $1 million
actually received by the Company through the Incentive Fee. The Reliance
Warrants have an exercise price of $12.50 per share for the first 150,000
Reliance Warrants and an exercise price for all other Reliance Warrants of the
greater of $12.50 or 120% of the market price of the UDC Common Stock on the
date of issuance of the Reliance Warrants. The Reliance Warrants will be
exercisable as follows: (i) the first 50,000 Reliance Warrants will be
exercisable for three years from the Reliance Petition Date; and (ii) all
remaining Reliance Warrants will be exercisable for three years from their
respective dates of issuance. The Servicing Agreement has not yet been approved
by the Bankruptcy Court. The Company has agreed to pay to UDC consideration upon
the issuance of each Reliance Warrant equal to the fair value of the Reliance
Warrants (as determined by UDC for financial reporting purposes) on their date
of issuance.
In addition to the Servicing Agreement and the grant of the Reliance
Warrants, UDC and Reliance have entered into a transition services agreement
(the "Transition Agreement"), which governs the rights and obligations of UDC
and Reliance until the Servicing Agreement is approved by the Bankruptcy Court.
The Bankruptcy Court entered an order approving the Transition Agreement.
Pursuant to the Transition
44
<PAGE> 46
Agreement, the Company will provide transition services to Reliance, at
Reliance's request, relating to the current and future servicing of receivables,
for an hourly fee of $175.00 and reimbursement of costs and expenses. In
addition, the Bankruptcy Court also has approved a $2.0 million breakup fee in
the event the Servicing Agreement, the Transition Agreement, or any related
agreements are terminated or materially breached by Reliance or a person other
than the Company is selected as the servicer for the receivables. Similarly, if
the Company breaches the Transition Agreement or elects in the future not to
service the receivables pursuant to the Servicing Agreement, the Company will be
required to pay a $2.0 million breakup fee to Reliance. Reliance has filed a
proposed plan of reorganization, and a tentative hearing for confirmation of
Reliance's proposed plan of reorganization is currently scheduled for June 30,
1998.
Following the Split-up, all of UDC's rights and substantially all of UDC's
obligations in connection with the Reliance transaction accruing on or after the
Effective Date will be assigned to the Company, except that the Reliance
Warrants will be issued from time to time as required by UDC.
There can be no assurance that the Reliance transaction will be concluded
on the terms and conditions outlined above or at all, or if concluded, that such
transaction will prove profitable to the Company.
CYGNET DEALER PROGRAM
The Company believes that many independent used car dealers have difficulty
obtaining traditional working capital and, as a result, are forced to sell the
finance receivables that they originate from used car sales at significant
discounts in order to obtain the working capital necessary to operate their
businesses. In addition, most financing programs available to independent used
car dealers lessen or terminate the customer relationship between the dealer and
the buyer of the used car, which dealers would otherwise maintain in order to
generate referrals and/or repeat business. To capitalize on this opportunity,
the Company initiated the Cygnet Dealer Program, pursuant to which the Company
provides qualified dealers with warehouse purchase facilities and revolving
lines of credit primarily secured by the dealers' finance receivable portfolios.
Under both of these credit facilities, the dealer remains responsible for
collection of finance receivable payments and retains control of the customer
relationship. The credit facilities are for specified amounts and are subject to
various collateral coverage ratios, maximum advance rates, and performance
measurements depending on the financial condition of the dealer and the quality
of the finance receivables originated. As a condition to providing such
financing, each dealer is required to report its collection activities to the
Company on a daily basis and provide the Company with periodic financial
statements. In addition, the Company has initiated an internal audit program
whereby dealers are audited by its internal audit department on a periodic
basis. The goal of these controls is to allow the Company's account officers,
who oversee the operations of each dealer participating in the program, to
better ensure dealer compliance with program covenants and determine the
appropriateness of continued funding under the credit facilities.
The Company believes that the Cygnet Dealer Program fulfills the need of
independent used car dealers for working capital to expand their businesses
while enabling the Company to earn finance income at favorable rates and
diversify its earning asset base. The Company began full-scale marketing of the
program during the first quarter of 1997. As of March 31, 1998, the Company had
lending relationships with a total of 43 independent dealers with advances
totaling approximately $31 million.
Targeted Dealers. The Company provides credit facilities to qualified "buy
here-pay here" dealers primarily throughout the southeastern and western U.S.
through the Cygnet Dealer Program. To qualify for the Cygnet Dealer Program, a
dealer must generally meet the following minimum requirements:
- Monthly sales of at least 25 cars.
- Established management with "buy here-pay here" experience.
- Net worth of at least $150,000 to qualify for the Dealer Collection
Program ("DCP") and at least $500,000 for the Asset Based Loan Program
("ABL").
- Computerized inventory, receivable and collection system.
- Satisfactory inventory and facilities.
45
<PAGE> 47
The Company's strategy is to establish active relationships with a select
group of qualified dealers to which it is a primary source of funding for their
finance receivables. The Company currently has made advances to dealers in 14
states, and intends to expand its operations in selected markets throughout the
country.
The independent dealer financing industry consists of a number of national
and regional finance companies, plus certain institutional lenders, that
typically fund finance receivables on behalf of dealers based upon either
"collection" or "point of sale" programs. Pursuant to the "collection" program,
the dealer submits finance receivables to a finance company for collection and
the dealer is advanced a portion of the finance receivables stream of payments
as an advance, which is non-recourse to the dealer. These finance receivables
are then placed into a pool for collection. The finance company performs all of
the collection activity on these accounts and retains 20% of each dollar
collected as a servicing fee. The remaining 80% of each dollar collected is paid
to the finance company until the up-front advance to the dealer plus accrued
interest is paid in full. If and when the advance to the dealer plus accrued
interest is paid in full, then 80% of the remaining payments collected are
remitted back to the dealer. Under the "point of sale" program, the dealer
submits credit applications to the finance company, and upon approval, the
finance receivable is forwarded to the finance company for funding. Finance
companies may or may not provide financing depending on their own internal
underwriting guidelines. Assuming financing is approved, finance receivables
typically are purchased at a discount with the finance company assuming all
responsibility for collection and servicing. The Company believes that its DCP
and ABL programs are preferred by many dealers because they allow the dealers,
rather than the finance company, to control collection activity and thus allow
the dealers to retain servicing income and maintain the relationship with the
purchaser of the automobile, which is important for customer referrals and
repeat business.
Dealer Collection Program. The DCP is the Company's primary program
offered to independent dealers. Pursuant to this program, the Company purchases
finance receivables from a qualified dealer on a full recourse basis. The dealer
remains responsible for the collection of the contract payments and retains
control of the customer relationship. The Company typically purchases finance
receivable contracts at 60% to 75% of the principal balance subject to a maximum
of 170% of the Kelly Blue Book wholesale price. All cash collections, including
regular monthly payments, payoffs and repurchases, are deposited directly by the
dealer into a bank account maintained by the Company. The Company retains all
regular monthly cash payments and payoffs, subject to the payment of a servicing
fee to the dealer generally equal to 20% to 25% of the regular monthly cash
payments collected, payable on the 10th day following the month of collection.
Finance receivables must have a minimum annual percentage rate of 21% or the
maximum allowed by applicable state usury law. If the interest rate of finance
receivables is less than 21%, then the purchase price is lowered to increase the
effective yield to the Company.
Generally, each dealer pays a nonrefundable initial audit fee plus a
processing fee per contract or provides a security deposit. The dealer is
required to repurchase all finance receivable contracts that are 45 days
delinquent at a price equal to the original purchase percentage multiplied by
the outstanding principal balance plus accrued and unpaid interest on that
contract. The DCP is full recourse to the dealer and typically includes personal
guarantees by the principal owners of the dealership.
Asset Based Loan Program. The Company also provides the ABL program to
dealers pursuant to which the Company provides to qualified dealers a secured
revolving line of credit. Pursuant to the ABL program, the Company advances to
qualified dealers, on a full recourse basis, up to 65% of the principal amount
of finance receivables subject to a maximum of 170% of the Kelly Blue Book
wholesale price of the underlying collateral. The Company also charges an annual
commitment fee of 1% to 2% of the available line and interest on any amounts
outstanding at the rate of prime plus 5% to 9%. In addition, each dealer
generally pays a nonrefundable initial audit fee plus a processing fee per
contract.
Under the ABL program, the dealer is responsible for collection of contract
payments and maintaining the customer relationship. All cash collections,
including regular monthly payments, payoffs and repurchases, are deposited
directly into a bank account maintained by the Company. Finance receivables that
are 45 days delinquent are deemed to be ineligible collateral and are excluded
from the calculation of the amount available
46
<PAGE> 48
under the line of credit. If the exclusion of ineligible collateral causes the
line to become over funded, then the dealer must either pay down the line or
assign additional qualifying finance receivables to the Company. Each line of
credit provides for full recourse to the dealer, typically with full guarantees
by the principal owners of the dealership.
In certain instances when a dealer reaches the maximum commitment amount
under the credit facility, the Company will consider purchasing the finance
receivables from the dealer as part of the overall lending relationship. In such
event, the Company typically purchases the finance receivables for an amount
equal to between 70% to 85% of the net principal balance depending on the
interest rates on the finance receivables, the seasoning of the finance
receivables, and the extent of limited recourse to the dealer.
Qualification Process and Underwriting Guidelines. Each dealer that wishes
to qualify to participate in the Cygnet Dealer Program must provide a fully
completed application form and supporting documentation, including financial
statements, tax returns, contract receivable aging reports, and vehicle
inventory reports, among others. After review of the application form and
supporting documentation, assuming compliance with the Company's minimum
requirements, a proposal letter is sent to the dealer outlining the proposed
terms of the financing program. To participate in the program, the dealer then
must sign and deliver the proposal letter to the Company, together with a
non-refundable deposit of $2,500, after which an initial on-site audit is
performed by the Company's internal audit department. The audit consists of
reviewing and testing payments, inventory, down payments, repos/charge-offs,
systems, collections/servicing, and financial statements. In addition, a member
of the Company's Internal Credit Review Committee typically will visit the
dealer and meet with its owners and key personnel to review its operations.
Following the initial on-site audit, a formal written audit report is prepared
and presented to the Company's Internal Credit Review Committee for approval. A
unanimous vote of this committee is required for approval. After approval has
been received, the Company prepares legal documents, which must be signed and
delivered by the dealer prior to participating in the program.
Each dealer participant in the Cygnet Dealer Program must follow certain
guidelines with respect to originating finance receivables. These guidelines
include customer-related guidelines that focus on the customer's stability,
ability to pay, and willingness to pay, and term, vehicle and rate related
guidelines that deal specifically with the minimum requirements for the car's
mileage as related to the term of finance receivables, and the minimum annual
percentage rate of the finance receivables. Each dealer is required to package
originated finance receivables in accordance with guidelines established by the
Company, which require the dealer to provide certain documentation identified on
a checklist from each borrower. The dealer then sends the finance receivable
packages to the Company's processing center where the contents are reviewed to
ensure compliance with the Company's guidelines. After verification of certain
information by the Company's personnel, the information with respect to each
file is keyed into the Company's loan processing system. Typically, the time
from receipt of the finance receivable packages to actual funding takes from 48
to 72 hours.
The Company follows a variety of procedures to limit losses from defaults
under the DCP and ABL programs. Prior to making an advance under one of its
programs, the Company performs an initial review and audit of each dealer,
verifies finance receivables before funding (which verification may include an
interview of the borrower, verification of the borrower's employment, residence,
and a reference) to ensure compliance with Cygnet Dealer Program credit
guidelines, and obtains agreements and personal guarantees from the dealer and
its owners that provide a variety of remedies to the Company in case of a
default. After an advance has been made, the Company maintains a loan tracking
system that monitors collection activities by the dealer and keeps track of
delinquencies, collections, repurchases and quality of finance receivables,
conducts on-site audits of each dealer at least semiannually, reviews dealer
financial statements on a quarterly basis and, if advances exceed $2.5 million
for a single dealer, requires annual audits to be performed by an independent
certified public accounting firm. In the event of default by a dealer, the
Company is capable of assuming all collection efforts with respect to the
dealer's portfolio. In anticipation of such event, the Company maintains updated
computerized records on all finance receivables and has the infrastructure in
place to directly perform collections with respect to the portfolio. The Company
also may pursue other remedies involving the pursuit of
47
<PAGE> 49
additional collateral, providing assistance to a dealer with respect to the
collection of payments and workout related items, and pursuing personal
guarantees of the owners.
PURSUIT OF OPPORTUNITIES IN INSURANCE MARKET
The finance receivables that the Company purchases in bulk generally
require borrowers to obtain casualty insurance within 30 days of their vehicle
purchase. While all borrowers are free to obtain such coverage from an insurer
of their choice, if a borrower fails to obtain the required coverage, the
Company may purchase a policy on the borrower's behalf and charge back to the
customer the cost of the premiums and fees associated with such policy.
To facilitate its ability to force place mandated insurance coverage, and
to provide continual monitoring of the primary insurance status of each loan
within the Company's portfolio, the Company recently began negotiating the
acquisition of or a management agreement with an insurance agency that offers
insurance-related products and services primarily to holders of large portfolios
of vehicle and residential mortgage loans, including banks, savings and loan
associations, finance companies, credit unions, and automobile dealers, among
others. The Company anticipates that this transaction, if completed, would
enable the Company to more effectively manage the risk of loss related to its
portfolios of loan receivables and offer more a comprehensive set of products
and services to financial institutions and independent used car dealers
participating in the sub-prime segment of the automobile financing industry.
SERVICING SYSTEMS AND SOFTWARE
In its bulk purchase and servicing operations, the Company currently uses a
third party service bureau to process loan collection information. The agreement
with this service bureau expires at the end of December 1998, although the
Company may extend this arrangement on a month-to-month basis at increasing
rates. The Company has entered into an agreement with a new third party service
bureau, Affiliated Computer Services, Inc. ("ACS"), and expects to convert its
loan processing and collection systems by year-end 1998. The Company anticipates
that this service bureau will provide enhanced collection support. ACS will also
provide disaster recovery and Year 2000 compliance services.
In its Cygnet Dealer Program, the Company currently utilizes a proprietary
loan collection system. Pursuant to this system, the Company inputs data on each
finance receivable independently of, but consistently with each dealer's system
in order to effectively monitor portfolio performance. The Company recently
signed a separate agreement with ACS to process the Cygnet Dealer Program. Due
to the unique characteristics of the Cygnet Dealer Program, ACS will make a
number of custom software enhancements to enable the program to run on the ACS
system. The custom software changes and conversion from the Company's in-house
system to ACS is scheduled for completion prior to year end 1998. In addition to
the ACS system, the Company is developing a custom loan underwriting and funding
software module that will also serve as an interface between the individual
dealers' systems and the ACS system. During 1999, the Company intends to migrate
the dealers from their separate, stand alone loan systems to the ACS system for
purposes of loan servicing and collections. Upon full implementation of the ACS
system, dealers will be able to enter transactions directly into the loan
system, eliminating the redundancy of Company input. This system will provide
the Company with real time access to information regarding each dealer's finance
receivable portfolio and allow the Company to audit more closely the activities
of each dealer. In addition, this system will enable the Company to promptly
assume servicing from dealers that go into default to help preserve the
Company's investment.
COMPETITION
The markets in which the Company competes are highly competitive. With
respect to its Cygnet Dealer Program and bulk purchasing and servicing
operations, the Company competes with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater resources, including access to lower priced capital. In
addition, there are numerous financial services companies serving, or capable of
serving, these markets. While traditional financial institutions, such as
48
<PAGE> 50
commercial banks, savings and loans, credit unions, and captive finance
companies of major automobile manufacturers, have not consistently served the
sub-prime markets, the yields earned by companies involved in sub-prime
financing have encouraged certain of these traditional institutions to enter, or
contemplate entering, these markets. Increased competition may adversely affect
the rates earned under the Cygnet Dealer Program and the Company's yields and
fees under its bulk purchasing and servicing arrangements.
REGULATION, SUPERVISION, AND LICENSING
The Company's operations are subject to ongoing regulation, supervision,
and licensing under various federal, state, and local statutes, ordinances, and
regulations. Among other things, these laws require that the Company obtain and
maintain certain licenses and qualifications, limit or prescribe terms of the
finance receivables that the Company bulk purchases, require specified
disclosures to customers, limit the Company's right to repossess and sell
collateral, and prohibit the Company from discriminating against certain
customers.
The Company believes that it is currently in substantial compliance with
all applicable federal, state, and local laws and regulations. There can be no
assurance, however, that the Company will be able to remain in compliance with
such laws, and such failure could have a material adverse effect on the
operations of the Company. In addition, the adoption of additional statutes and
regulations, changes in the interpretation of existing statutes and regulations,
or the Company's entrance into jurisdictions with more stringent regulatory
requirements could have a material adverse effect on the Company's business.
EMPLOYEES
As of the Effective Date, the Company expects to employ approximately 280
persons. None of the Company's employees are covered by a collective bargaining
agreement.
PROPERTIES
As of the Effective Date, the Company will assume leases, or sublease from
UDC, headquarters facilities located at Phoenix, Arizona and servicing
facilities at Nashville, Tennessee, Denver, Colorado, and Plano, Texas. These
leases have expiration dates ranging from September 30, 1998 to June 14, 2002.
The Company believes these facilities are sufficient for its present operations.
LEGAL PROCEEDINGS
The Company currently is not a party to any material pending legal
proceedings. Notwithstanding the foregoing, the Company, in the ordinary course
of business, expects to receive complaints from borrowers relating to alleged
violations of federal and state consumer lending or other similar laws and
regulations. While most of these complaints typically are made directly to the
lender or to various consumer protection organizations and are subsequently
resolved, the Company may be named occasionally as a defendant in civil suits
filed by borrowers in state, local or small claims courts. There can be no
assurance that the Company will not be a target of similar claims in the future.
49
<PAGE> 51
MANAGEMENT
DIRECTORS AND EXECUTIVE OFFICERS
Information concerning the names, ages, terms, positions with the Company,
and business experience of those persons who will become the Company's directors
and executive officers on the Effective Date of the Split-up is set forth below
as of June 19, 1998.
<TABLE>
<CAPTION>
TERM AS
DIRECTOR
NAME AGE POSITION EXPIRES
- ---- --- -------- --------
<S> <C> <C> <C>
Ernest C. Garcia, II................. 41 Chairman of the Board, Chief 1999
Executive Officer, and President
Robert J. Abrahams(1)................ 71 Director 1999
Christopher D. Jennings(1)(2)........ 44 Director 1999
Frank P. Willey(2)................... 44 Director 1999
Steven P. Johnson.................... 38 Senior Vice President and General
Counsel
Donald L. Addink..................... 48 Senior Vice President and Senior
Analyst
Eric J. Splaver...................... 35 Chief Financial Officer
Raymond C. Fidel..................... 40 President -- Cygnet Dealer Finance,
Inc.
Gregory R. Ciccolini................. 42 Chief Information Officer
</TABLE>
- ---------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
Ernest C. Garcia II has served as the Chairman of the Board and Chief
Executive Officer of UDC since its founding in 1992, and served as President
from 1992 to 1996. Since 1991, Mr. Garcia has served as President of Verde
Investments, Inc. ("Verde"), a real estate investment corporation that is
wholly-owned by Mr. Garcia. Prior to 1992, when he founded UDC, Mr. Garcia was
involved in various real estate, securities, and banking ventures. Upon the
Effective Date Mr. Garcia will continue as the Chairman of the Board of UDC. Mr.
Garcia's sister is married to Mr. Johnson. See below, "Management -- Involvement
in Certain Legal Proceedings," "Principal Stockholders," and "Certain
Relationships and Related Transactions."
Robert J. Abrahams has served as a director of UDC since June 1996. Mr.
Abrahams has served since 1988 as a consultant to the financing industry,
including service as a consultant to UDC from 1994 to 1995. From 1960 to 1988,
Mr. Abrahams was an executive officer of Heller Financial, Inc., a finance
company. Prior to joining Heller Financial, Inc., Mr. Abrahams co-founded
Financial Acceptance Company in 1948. Upon the Effective Date Mr. Abrahams will
continue as a director of UDC. Mr. Abrahams is also a director of Smart Choice
Automotive Group, Inc., a retail automotive and finance company, and HMI
Industries, Inc., a manufacturing and direct selling company.
Christopher D. Jennings has served as a director of UDC since June 1996.
Mr. Jennings currently serves as Managing Director of Friedman, Billings, Ramsey
& Co., Inc., an investment banking firm. Mr. Jennings served as a managing
director of Cruttenden Roth Incorporated, an investment banking firm, from 1995
to April 1998. From 1992 to 1994, Mr. Jennings served as Managing Director of
investment banking at Sutro & Co., an investment banking firm. From 1989 to
1992, Mr. Jennings served as Senior Managing Director at Maiden Lane Associates,
Ltd., a private equity fund. Prior to 1989, Mr. Jennings served in various
positions with, among others, Dean Witter Reynolds, Inc., and Warburg Paribas
Becker, Inc., both of which are investment banking firms. Upon the Effective
Date Mr. Jennings will continue as a director of UDC. See "Certain Relationships
and Related Transactions" and "-- Principal Stockholders."
Frank P. Willey has served as a director of UDC since June 1996. Mr. Willey
has served as the President of Fidelity National Financial, Inc., one of the
nation's largest title insurance underwriters, since January 1995. From 1984 to
1995, Mr. Willey served as the Executive Vice President and General Counsel of
Fidelity
50
<PAGE> 52
National Title. Mr. Willey is also a director of Fidelity National Financial,
Inc., CKE Restaurants, Inc., an operator of various quick-service restaurant
chains, and Southern Pacific Funding Corporation, a specialty finance company
that originates, purchases, and sells high-yield, non-conforming mortgage loans.
Steven P. Johnson has served as Senior Vice President, Secretary, and
General Counsel of UDC since its founding in 1992. Since 1991, Mr. Johnson has
also served as the Senior Vice President and General Counsel of Verde. Prior to
1991, Mr. Johnson practiced law in Tucson, Arizona. Mr. Johnson is licensed to
practice law in Arizona and Colorado and is married to the sister of Mr. Garcia.
Donald L. Addink has served as the Vice President -- Senior Analyst of UDC
since 1995 and also serves as the Vice President of Verde. From 1988 to 1995,
Mr. Addink served as Executive Vice President of Pima Capital Co., a life
insurance holding company. Prior to 1988, Mr. Addink served in various
capacities with a variety of insurance companies. Mr. Addink is a Fellow of the
Society of Actuaries and a Member of the American Academy of Actuaries.
Eric J. Splaver has served as Corporate Controller of UDC since May 1994.
From 1986 to 1994, Mr. Splaver worked as a certified public accountant with KPMG
Peat Marwick LLP.
Ray Fidel has served as President of Cygnet Dealer Finance, Inc., since
February 1997. On the Effective Date, Mr. Fidel will continue in his position
with Cygnet Dealer Finance, Inc. Prior to February 1997, Mr. Fidel served as
Managing Director of two financial corporations engaged in the asset-based
lending industry. Mr. Fidel was so employed from July 1995 to February 1997 with
Fidelity Funding Corporation and from March 1991 to June 1995 with DVI Business
Credit, a subsidiary of DVI, Inc., a New York Stock Exchange listed company.
Gregory R. Ciccolini has served as Chief Information Officer since June
1998. From 1997 to 1998, Mr. Ciccolini was a Consulting Manager for SunGard
Planning Solutions, a company engaged in data center disaster recovery planning
and testing for Fortune 500 companies. From 1993 to 1997, Mr. Ciccolini served
as Vice President and Systems Director for Bank of America Arizona. Prior to
1993, Mr. Ciccolini served as Vice President and Information Systems Audit
Manager for several southwestern financial institutions.
Directors of the Company are elected for one year terms. Each director of
the Company serves until the following annual meeting of the Company, until his
successor is duly elected and qualified, or until retirement, resignation, or
removal. Executive officers of the Company serve at the discretion of the Board
of Directors.
INVOLVEMENT IN CERTAIN LEGAL PROCEEDINGS
Prior to 1992, when he founded UDC, Mr. Garcia was involved in various real
estate, securities, and banking ventures. Arising out of two transactions in
1987 between Lincoln Savings & Loan Association ("Lincoln") and entities
controlled by Mr. Garcia, the Resolution Trust Corporation (the "RTC"), which
ultimately took over Lincoln, asserted that Lincoln improperly accounted for the
transactions and that Mr. Garcia's participation in the transactions facilitated
the improper accounting. Facing severe financial pressures, Mr. Garcia agreed to
plead guilty to one count of bank fraud, but, in light of his cooperation with
authorities both before and after he was charged, was sentenced to only three
years probation (which has expired) and was fined $50 dollars (the minimum fine
the court could assess). In separate actions arising out of this matter, Mr.
Garcia has been banned from affiliating with financial institutions and
securities firms, without governmental approval, has agreed not to violate the
securities laws, and has filed for bankruptcy both personally and with respect
to certain entities he has controlled. The bankruptcies were discharged by 1993.
51
<PAGE> 53
EXECUTIVE COMPENSATION
The table below sets forth information concerning the annual and long-term
compensation for services rendered in all capacities to UDC during the three
fiscal years ended December 31, 1997, of those persons who will be, as of the
Effective Date: (i) the chief executive officer of the Company and (ii) the
three other executive officers of the Company whose compensation from UDC
exceeded $100,000 in the fiscal year ended December 31, 1997 (the "Named
Executive Officers"). The following information is provided in accordance with
SEC rules and regulations and is not necessarily indicative of the compensation
structure that will exist at the Company following the Split-up.
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
----------------------------
ANNUAL COMPENSATION SECURITIES
--------------------------- UNDERLYING ALL OTHER
SALARY BONUS OPTIONS COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($) ($) AWARDS(#)(1) ($)(2)
--------------------------- ---- -------- ------- ------------ ------------
<S> <C> <C> <C> <C> <C>
Ernest C. Garcia, II................ 1997 $131,677 -- -- $ 3,935(3)
Chairman of the Board, Chief 1996 121,538 -- -- 3,873(3)
Executive Officer, and President 1995 100,000 -- -- 3,151(3)
Donald L. Addink.................... 1997 139,671 $10,000 -- 950
Senior Vice President -- Senior 1996 122,142 10,000 42,000 485
Analyst 1995 71,026 10,000 58,000 984
Steven P. Johnson................... 1997 131,677 -- 20,000 820
Senior Vice President and General 1996 121,538 -- 25,000 566
Counsel 1995 100,000 -- -- 177
Raymond C. Fidel.................... 1997 132,692 -- 75,000 11,000(4)
President -- Cygnet Dealer
Finance, 1996 -- -- -- --
Inc. 1995 -- -- -- --
</TABLE>
- ---------------
(1) The amounts shown in this column represent stock options granted pursuant to
UDC's Long-Term Incentive Plan. Generally, options are subject to vesting
over a five-year period, with 20.0% of the options becoming exercisable on
each successive anniversary of the date of grant.
(2) The amounts shown in this column include the dollar value of 401(k) plan
contributions made by UDC for the benefit of the Named Executive Officers.
(3) This amount includes a $2,985 car allowance during 1997, and a $2,950 car
allowance during both 1996 and 1995, respectively, for Mr. Garcia.
(4) This amount represents a car allowance for Mr. Fidel during 1997.
52
<PAGE> 54
OPTION GRANTS IN LAST FISCAL YEAR
The table below sets forth information with respect to UDC options granted
during the fiscal year ended December 31, 1997 to the Named Executive Officers.
As set forth in the Capitalization Agreement between UDC and the Company (the
"Capitalization Agreement"), generally, on the Effective Date, each stock option
for UDC Common Stock held by a Cygnet employee will be surrendered and, in
exchange therefor, a new option will be granted under the Cygnet Financial
Corporate 1998 Executive Incentive Plan (the "1998 Plan") for a number of shares
of Cygnet Common Stock, and at an exercise price, intended to preserve for such
Cygnet employee the economic value of the shares subject to the UDC option,
including the spread between the exercise price and the fair market value of the
shares subject to the UDC option. See "-- Cygnet Financial Corporation 1998
Executive Incentive Plan."
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
----------------------------------------------------
PERCENT
NUMBER OF OF TOTAL POTENTIAL REALIZABLE VALUE AT
SECURITIES OPTIONS/ ASSUMED ANNUAL RATE OF
UNDERLYING SARS STOCK APPRECIATION FOR
OPTIONS/ GRANTED TO EXERCISE OPTION TERM
SARS EMPLOYEES IN PRICE EXPIRATION ------------------------------
NAME GRANTED FISCAL YEAR (PER SHARE) DATE 5% 10%
---- ---------- ------------ ----------- ---------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia, II........ -- -- -- -- -- --
Donald L. Addink(1)......... -- -- -- -- -- --
Steven P. Johnson(2)........ 20,000 3.4% $15.75 5/27/03 $107,130 $ 243,042
Raymond C. Fidel(3)......... 75,000 12.9% 18.75 2/07/07 893,389 2,250,200
</TABLE>
- ---------------
(1) During January 1998, Mr. Addink was granted options to purchase 25,000
shares of UDC Common Stock under the UDC 1998 Executive Incentive Plan (the
"UDC Executive Plan") at an exercise price of $8.25 per share. Such options
will be converted, on the Effective Date, to options to purchase 25,000
shares of Cygnet Common Stock under the 1998 Plan at an exercise price of
$7.00 per share.
(2) During January 1998, Mr. Johnson was granted options to purchase 25,000
shares of UDC Common Stock under the UDC Executive Plan at an exercise price
of $8.25 per share. Such options will be converted, on the Effective Date,
to options to purchase 25,000 shares of Cygnet Common Stock under the 1998
Plan at an exercise price of $7.00 per share. In addition, Mr. Johnson's
remaining options to purchase UDC Common Stock will be cancelled as of the
Effective Date, and in consideration Mr. Johnson will be granted, on the
Effective Date, 15,000 shares of restricted Cygnet Common Stock vesting over
a specified period of time from the Effective Date.
(3) On the Effective Date, Mr. Fidel's options listed above will be converted to
options to purchase 84,000 shares of Cygnet Common Stock under the 1998 Plan
at an exercise price of $7.00 per share. In addition, during January 1998
these UDC Long Term-Incentive Plan options were repriced at an exercise
price of $9.75 per share.
53
<PAGE> 55
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND OPTION VALUES AS OF DECEMBER
31, 1997 OF NAMED EXECUTIVE OFFICERS
The table below sets forth information with respect to UDC Common Stock
options exercised during fiscal year 1997 and held as of December 31, 1997 by
the Named Executive Officers. UDC has never issued any other forms of stock
based awards to its Named Executive Officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES FISCAL YEAR END(#)(1) FISCAL YEAR END($)(2)
ACQUIRED ON VALUE --------------------------- ---------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ----------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Ernest C. Garcia, II... -- -- -- -- -- --
Donald L. Addink....... 63,000 $622,490(3) 17,000 20,000 -- $35,000
Steven P. Johnson(4)... -- -- 5,000 40,000 $3,500 $14,000
Raymond C. Fidel....... -- -- -- -- -- --
</TABLE>
- ---------------
(1) Generally, UDC options are subject to vesting over a five-year period, with
20.0% of the options becoming exercisable on each successive anniversary of
the date of grant under UDC's Long-Term Incentive Plan.
(2) In-the-money UDC options are options for which the option exercise price
(the fair market value on the date of grant) was lower than the market price
of UDC's Common Stock on December 31, 1997, which market price of $8.50 per
share was based on the closing price of UDC's Common Stock on that date as
reported by Nasdaq. The values in the last two columns have not been, and
may never be, received by the Named Executive Officers. Actual gains, if
any, on option exercises will depend on the value of UDC's Common Stock as
applicable on the exercise dates. Accordingly, there can be no assurance
that the values shown in the last two columns will be realized. The closing
price of UDC's Common Stock on June 17, 1998 was $8.125 per share.
(3) The value realized represents the value of stock options exercised by Mr.
Addink during the last fiscal year. During this period, he exercised options
to acquire 63,000 shares of UDC's Common Stock. The value realized was
calculated by subtracting the exercise price of Mr. Addink's options from
the fair market value of UDC's Common Stock underlying the options as of the
exercise date. The fair market value of UDC's Common Stock was based on the
closing price of the stock on the date of exercise as reported by Nasdaq.
Pursuant to UDC's Long-Term Incentive Plan documents, the exercise date was
the date Mr. Addink provided notice of his exercise to the Company and
method of payment.
(4) Does not include $105,000 worth of restricted Common Stock at the $7.00
Subscription Price (15,000 shares) to be issued to Mr. Johnson upon the
Effective Date of the Split-up. The restricted stock will vest over a
specified period from the Effective Date.
CYGNET FINANCIAL CORPORATION 1998 EXECUTIVE INCENTIVE PLAN
The Compensation Committee of the Company's Board of Directors will
administer the 1998 Plan. Under the 1998 Plan, the Company may grant incentive
stock options, non-qualified stock options, stock appreciation rights,
performance shares, restricted stock, and performance-based awards to employees,
consultants, independent directors, and advisors of the Company. The Company
believes that the 1998 Plan will promote the success and enhance the value of
the Company by linking the personal interests of participants to those of the
Company's stockholders and providing participants with an incentive for
outstanding performance. Upon the Effective Date, the total number of shares of
Common Stock available for awards under the 1998 Plan will be 1,000,000, subject
to a proportionate increase or decrease in the event of a stock split, reverse
stock split, stock dividend, or other adjustment to the Company's total number
of issued and outstanding shares of Common Stock. Except with respect to options
to purchase UDC Common Stock held by Mr. Splaver and another employee, each
option to purchase UDC Common Stock, held by each employee of UDC who will
become an employee of the Company will be cancelled as of the Effective Date and
new options to purchase Common Stock will be issued under the 1998 Plan
("Replacement Options"). Thus, it is expected that as of the Effective Date,
Replacement Options to purchase approximately 284,000
54
<PAGE> 56
shares of Common Stock will be outstanding under the 1998 Plan. For additional
information concerning the Replacement Options, see "Aggregated Option Exercises
in the last Fiscal Year and Option Values as of December 31, 1997 of Named
Executive Officers."
The 1998 Plan is administered by the Board of Directors or a committee of
the Board who qualify as non-employee directors and outside directors, which has
the authority to administer the 1998 Plan, including the power to determine
eligibility, the type and number of awards to be granted, and the terms and
conditions of any award granted, including the price and timing of awards,
vesting, and acceleration of such awards (other than performance-based awards).
The 1998 Plan limits the awards that can be granted to a single participant to
no more than 250,000 shares of Common Stock during any single calendar year. The
exercise price of options granted under the 1998 Plan will generally equal the
fair market value of the Common Stock on the date of grant except that the
committee is permitted to grant options at below fair market value. However, the
Replacement Options will be granted with exercise prices designed to approximate
the value of the UDC options previously held by the optionees. The committee
may, with the Board's approval, terminate, amend, or modify the 1998 Plan at any
time but no such termination, amendment, or modification may affect any stock
options, SARs, or restricted stock awards then outstanding under the 1998 Plan
without the participant's consent. Also, any such termination, amendment, or
modification is subject to any stockholder approval required under applicable
law or by any national securities exchange or association on which the Common
Stock is then listed or reported. The committee may amend the term of any award
or option theretofore granted, retroactively or prospectively, but no such
amendment shall adversely affect any such award or option without the holder's
consent.
401(K) PLAN
The Company anticipates that it will adopt a 401(k) plan, under which
eligible employees may direct that a portion of their compensation, up to a
legally established maximum, be withheld by the Company and contributed to their
account. All 401(k) plan contributions will be placed in a trust fund to be
invested by the 401(k) plan's trustee, although the 401(k) plan will permit
participants to direct the investment of their account balances among mutual or
investment funds available under the plan. The 401(k) plan will provide a
matching contribution of 10% of a participant's contributions and discretionary
additional matchings if authorized by the Company.
CHANGE OF CONTROL ARRANGEMENTS
In the event of a "Change of Control" of the Company: (i) all options and
other share-based awards granted under the 1998 Plan will become immediately
exercisable; (ii) any restriction periods and restrictions imposed on restricted
stock granted under the 1998 Plan will lapse; and (iii) the target value
attainable under all performance units and other performance-based awards
granted under the 1998 Plan shall be deemed to have been fully earned, unless,
in each case, the surviving entity agrees to assume the awards in a manner that
substantially preserves the participants' rights and benefits. Under the 1998
Plan, a Change in Control occurs upon any of the following events: (a) any
person (other than a current stockholder or any employee benefit plan) becoming
the beneficial owner of 20% or more of the Company's Common Stock; (b) during
any two-year period, the persons who are on the Company's Board of Directors at
the beginning of such period and any new person elected by two-thirds of such
directors cease to constitute a majority of the persons serving on the Board of
Directors; or (c) the Company's stockholders approve (1) a merger or
consolidation of the Company with another corporation where the Company is not
the surviving entity other than a merger in which the Company's stockholders
before the merger have the same proportionate ownership after the merger, (2) a
plan of complete liquidation or dissolution, or (3) any sale, lease, or other
transfer of 40% or more of the Company's assets, other than pursuant to a
sale-leaseback, structured finance, or other form of financing transaction.
CONTRACTS WITH DIRECTORS AND EXECUTIVE OFFICERS
On January 1, 1996, UDC entered into a three-year employment agreement with
Mr. Ernest C. Garcia II. The agreement establishes Mr. Garcia's base salary for
1997 at $132,000 per year and provides a minimum
55
<PAGE> 57
10.0% increase in the base salary each year throughout the term of the
agreement. In addition, the agreement provides for the continuation of Mr.
Garcia's base salary and certain benefits for a period of one year in the event
Mr. Garcia is terminated by UDC without cause prior to the expiration of that
agreement. The agreement also contains confidentiality and non-compete
covenants. On the Effective Date, Mr. Garcia's employment agreement will be
assigned to and assumed by the Company.
On June 1, 1995, UDC entered into a five-year employment agreement with Mr.
Donald L. Addink, which was amended and restated effective August 1, 1997. The
restated agreement establishes Mr. Addink's base salary at $165,000 per year
beginning on or around the effective date of the restated employment agreement,
a $10,000 bonus payment upon execution of the restated employment agreement,
certain benefits, and the continuation of Mr. Addink's base salary and certain
benefits for a period of one year in the event Mr. Addink is terminated by UDC
without cause prior to expiration of the restated employment agreement. The
restated employment agreement also contains confidentiality and non-compete
covenants. On the Effective Date, Mr. Addink's employment agreement will be
assigned to and assumed by the Company.
On May 14, 1998, the Company entered into an employment agreement with Mr.
Gregory R. Ciccolini, the Company's chief information officer. The agreement
establishes Mr. Ciccolini's base salary at $120,000 per year, beginning on or
around the effective date of the agreement, a stock option grant to purchase
20,000 shares of Company Common Stock, a grant of 7,143 shares of restricted
Company Common Stock, and other benefits.
On June 16, 1998, the Company entered into an employment agreement with Mr.
Eric J. Splaver, the Company's chief financial officer. The agreement
establishes Mr. Splaver base salary at $120,000 per year, beginning on or about
the Effective Date, a stock option grant to purchase 30,000 shares of Company
Common Stock, a grant of 14,286 shares of restricted Company Common Stock, and
other benefits.
COMMITTEES OF THE BOARD OF DIRECTORS
The Company will establish a Compensation Committee and an Audit Committee.
The Compensation Committee will consist of Messrs. Jennings and Willey, and will
review executive salaries and administer any bonus, incentive compensation, and
stock option plans of the Company, including the 1998 Plan. In addition, the
Compensation Committee will consult with management of the Company regarding
compensation policies and practices of the Company. The Audit Committee will
consist of Messrs. Abrahams and Jennings, and will review the professional
services provided by the Company's independent auditors, the annual financial
statements of the Company, and the Company's system of internal controls.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
There will be no compensation committee interlocks and no Company officer
or former officer will be a member of the Company's Compensation Committee.
COMPENSATION OF DIRECTORS
The Company's independent directors will be compensated $1,000 for physical
attendance at meetings of the Board of Directors and at meetings of committees
of the Board of Directors of which they are members, and will be reimbursed for
reasonable travel expenses incurred in connection with attendance at each Board
and committee meeting. Board and committee members will not be compensated for
their telephonic attendance at meetings. If a Board and committee meeting are
held on the same day, a member who attends both meetings will receive combined
total compensation of only $1,000. In addition, pursuant to the 1998 Plan
expected to be adopted by the Company, upon initial appointment or initial
election to the Board of Directors, each independent director of the Company
will receive Company Common Stock valued at $50,000, which will be subject to
vesting in equal annual increments over a three-year period as provided for
under the 1998 Plan. Directors who are also officers of the Company will not be
compensated for their services as directors and will not be entitled to
participate in the directors' portion of the 1998 Plan.
56
<PAGE> 58
PRINCIPAL STOCKHOLDERS
UDC currently owns all of the outstanding shares of the Company's Common
Stock. The following table sets forth the estimated beneficial ownership of the
Company's Common Stock immediately following the Effective Date, based on
beneficial ownership of UDC Common Stock on June 1, 1998 (unless another date is
indicated), by: (1) each director of the Company; (2) the Named Executive
Officers of the Company; (3) all directors and executive officers of the Company
as a group; and (4) each anticipated beneficial owner of more than 5% of the
outstanding Common Stock immediately following the completion of the Rights
Offering. To the knowledge of the Company, each person listed below has sole
voting and investment power with respect to his share of UDC Common Stock,
except (a) to the extent that authority is shared by his spouse under applicable
law, or (b) as otherwise indicated below. The estimated number of shares
beneficially owned and the percentage of ownership each assume the sale of
4,650,000 shares of Common Stock in the Rights Offering, 714,286 shares of
Common Stock to Mr. Garcia pursuant to the Additional Purchase Right, 500,000
additional shares of Common Stock that Mr. Garcia has the right to purchase
pursuant to the exercise of the Standby Warrants, and the issuance of 36,429
restricted shares of Common Stock to certain officers of the Company.
<TABLE>
<CAPTION>
NUMBER OF SHARES PERCENTAGE OF
NAME OF BENEFICIAL OWNER(2)(3) BENEFICIALLY OWNED(1) OWNERSHIP(1)
- ------------------------------ --------------------- -------------
<S> <C> <C>
Ernest C. Garcia II(4)(5)................................... 2,386,161 40.3%
Robert J. Abrahams(6)....................................... 7,143 *
Christopher D. Jennings(6).................................. 7,143 *
Frank P. Willey(6).......................................... 7,143 *
Steven P. Johnson........................................... 77,750 1.3%
Donald L. Addink............................................ 24,500 *
Raymond C. Fidel............................................ 2,500 *
Harris Associates L.P.(5)(7)................................ 456,250 9.9
Wellington Management Company, LLP(5)(8).................... 416,125 9.0%
Merrill Lynch & Co., Inc.(5)(9)............................. 403,750 8.8%
FMR Corp.(5)(10)............................................ 321,000 6.9%
All directors and executive officers as a group (9
persons).................................................. 2,525,690 42.6%
</TABLE>
- ---------------
* Represents less than one percent of the outstanding Common Stock.
(1) A person is deemed to be the beneficial owner of securities that can be
acquired within 60 days following June 1, 1998 through the exercise of any
option, warrant, or right. Shares of Common Stock subject to options,
warrants, or rights that are currently exercisable or exercisable within 60
days are deemed outstanding for computing the percentage of the person
holding such options, warrants, or rights, but are not deemed outstanding
for computing the percentage of any other person. As described above, the
amounts and percentages are based upon an estimate of 5,922,144 shares of
Common Stock outstanding immediately following the completion of the Rights
Offering, including 500,000 shares of the Company's Common Stock that Mr.
Garcia has the right to purchase pursuant to the Standby Warrants.
(2) Unless otherwise noted, the address of each of the listed stockholders is
2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016.
(3) Excludes 214,286 shares of Common Stock that may be purchased pursuant to
the D & O Purchase Right as described herein. Also excludes certain
restricted Common Stock of the Company held by its officers, which has not
vested and will not vest within 60 days following June 1, 1998.
(4) Includes 714,286 shares of Common Stock that Mr. Garcia has the right to
purchase at the Subscription Price and 500,000 additional shares of Common
Stock that Mr. Garcia has the right to purchase pursuant to the exercise of
the Standby Warrants. Also includes shares of Common Stock held indirectly
by Mr. Garcia through a nonprofit corporation and Verde Investments, Inc.
("Verde"), an affiliate of Mr. Garcia. Mr. Garcia has sole voting and
dispositive power over these shares of Common Stock.
57
<PAGE> 59
(5) The Company knows of no other person who would beneficially own more than
five percent of the Common Stock as of the Effective Date based upon
beneficial ownership of UDC Common Stock as of June 1, 1998 (unless another
date is indicated).
(6) The total for each independent Board of Director member includes 7,143
shares of Common Stock granted under the Company's 1998 Plan. Shares having
a total value of $50,000 on or about the date of grant (i.e., approximately
7,143 shares of Common Stock) will be granted and issued to each
independent Board member upon his appointment or election to the Board of
Directors as of the Effective Date. Pursuant to the 1998 Plan, these shares
generally vest over a three-year period at an annual rate of 33%, beginning
on the first anniversary date after the date of grant.
(7) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by Harris
Associates L.P. ("Harris") and an affiliate of Harris, Harris Associates
Investment Trust and related funds ("Harris Trust"), all located at Two
North LaSalle Street, Suite 500, Chicago, Illinois 60602. According to
these Schedule 13Gs, Harris has shared voting and dispositive power over
1,825,000 shares of UDC Common Stock (including 1,750,000 shares
attributable to Harris Trust) and Harris Trust has shared voting and
dispositive power over 1,750,000 shares of UDC Common Stock. The Company
makes no representation as to the accuracy or completeness of the
information provided in this footnote or the above beneficial ownership
table related to the same, which is based solely on the Schedule 13G
filings of Harris and Harris Trust.
(8) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by
Wellington Management Company, LLP, at 75 State Street, Boston,
Massachusetts 02109. According to the Schedule 13G filings, Wellington
Management Company, LLP has shared voting power over 767,100 shares of UDC
Common Stock and shared dispositive power over 1,664,500 shares of UDC
Common Stock. The Company makes no representation as to the accuracy or
completeness of the information provided in this footnote or the above
beneficial ownership table related to the same, which is based solely on
Wellington Management Company, LLP's Schedule 13G filing.
(9) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by
Merrill Lynch & Co., Inc. ("Merrill Parent") and four (4) of its
subsidiaries and/or affiliates, including Merrill Lynch Global Allocation
Fund, Inc. ("Merrill Global"). Merrill Parent and one of its
subsidiary/affiliates that is included within this Merrill Schedule 13G
filing are located at 250 Vesey Street, New York, New York 10281. Merrill
Global and the other two (2) subsidiaries/affiliates that are included
within this Merrill Schedule 13G filing are located at 800 Scudders Mill
Rd., Plainsboro, New Jersey 08536. According to the Schedule 13G, Merrill
Global has shared voting and dispositive power over 1,530,000 shares of UDC
Common Stock and Merrill Parent along with each of its other three
subsidiaries and/or affiliates have shared voting and dispositive power
over 1,615,000 shares of UDC Common Stock. The Company makes no
representation as to the accuracy or completeness of the information
provided in this footnote or the above beneficial ownership table related
to the same, which is based solely on Merrill's Schedule 13G filing.
(10) Beneficial ownership was estimated based on Schedule 13G filings reporting
beneficial ownership of UDC Common Stock as of December 31, 1997, by FMR
Corp., along with certain of its affiliates ("FMR"), at 82 Devonshire
Street, Boston, Massachusetts 02019. According to the Schedule 13G, FMR has
no voting power over shares and has sole dispositive power over 1,284,000
shares of UDC Common Stock. The Company makes no representation as to the
accuracy or completeness of the information provided in this footnote or
the above beneficial ownership table related to the same, which is based
solely on FMR's Schedule 13G filing.
58
<PAGE> 60
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The Company will engage in certain transactions with the affiliated parties
described below. Any future transactions between the Company and its affiliated
entities, executive officers, directors, or significant stockholders will
require the approval of a majority of the independent directors of the Company
and will be on terms no less favorable to the Company than the Company could
obtain from non-affiliated parties.
Ernest C. Garcia, II, the Chairman of the Board, Chief Executive Officer,
and President of Cygnet, will be granted on the Effective Date and in
consideration for the Standby Purchase Obligation, the Cygnet Warrants, which
consist of warrants to purchase up to 500,000 additional shares of Common Stock
at an exercise price equal to 120% of the Subscription Price. In addition, on
the Effective Date, Mr. Garcia will have the Additional Purchase Right, which
gives him the right, at his election, to purchase up to an additional 714,286
shares of Common Stock at the Subscription Price.
On the Effective Date, certain directors and officers of the Company
(excluding Mr. Garcia) will be able to exercise the D&O Purchase Right which
will give them the right, at their election, to purchase in the aggregate
214,286 shares of Company Common Stock at the Subscription Price.
Prior to the Effective Date the Company and UDC will enter into the
Capitalization Agreement. The Capitalization Agreement sets forth, among other
things, and assuming the satisfaction or waiver of specified contingencies, (i)
the obligation of the Company to issue the Rights, (ii) the obligation of the
Company to issue the Common Stock on the Effective Date upon exercise of the
Rights, the Over-Subscription Privilege, and the Standby Purchase Obligation,
(iii) the obligation of UDC and its subsidiaries to transfer the Transferred
Assets to the Company on the Effective Date, (iv) the obligation of the Company
to issue the Preferred Stock to UDC and to make the Cash Payment, (v) the
obligation of the Company to issue other capital stock and warrants as described
herein, (vi) the operational arrangements and agreements between the Company and
UDC during a transition period, including arrangements for the sharing of
certain assets, leases, licenses, and employees, (vii) agreements between the
Company and UDC relating to employee matters, including the issuance or
adjustment of stock options under employee benefit plans, (viii) tax sharing and
indemnity matters, and (ix) certain agreements between the Company and UDC
relating to the FMAC and Reliance transactions.
The Company is currently a wholly-owned subsidiary of UDC. After the
successful completion of the Rights Offering, UDC will hold $40 million of the
Company's Preferred Stock. In connection with the Split-up, UDC will transfer
substantially all of the rights and liabilities related to the FMAC and Reliance
transactions. However, UDC will remain liable with respect to certain
liabilities related to these transactions. As consideration for retaining these
liabilities, UDC will be entitled to certain rights from the Company. For a
description of the respective rights and liabilities of UDC and the Company as
they relate to the FMAC and Reliance transactions, see "Business -- Bulk
Purchasing and Servicing Operations -- Transactions Regarding First Merchants
Acceptance Corporation" and "-- Transactions Regarding Reliance Acceptance
Group."
59
<PAGE> 61
DESCRIPTION OF CAPITAL STOCK
The Company is a Delaware corporation and its affairs are governed by its
Certificate of Incorporation and Bylaws and the Arizona Revised Statutes. The
following description of the Company's capital stock, which is complete in all
material respects, is qualified in its entirety by reference to the provisions
of the Company's Certificate of Incorporation and Bylaws.
The authorized capital stock of the Company consists of 14,000,000 shares
of Common Stock, par value $.001 per share, and 500,000 shares of Preferred
Stock, par value $.001 per share. At June 19, 1998, one share of Common Stock
(issued to UDC) and no shares of Preferred Stock were issued and outstanding.
COMMON STOCK
Holders of Common Stock are entitled to one vote for each share held of
record on all matters on which stockholders are entitled to vote. Holders of
Common Stock do not have cumulative voting rights, and therefore holders of a
majority of the shares voting for the election of directors can elect all of the
directors. In such event, the holders of the remaining shares will not be able
to elect any directors.
Holders of Common Stock are entitled to receive such dividends as may be
declared from time to time by the Board of Directors out of funds legally
available therefor. The Company does not anticipate paying cash dividends in the
foreseeable future. See "Dividend Policy." In the event of liquidation,
dissolution, or winding up of the Company, the holders of Common Stock are
entitled to share ratably in any corporate assets remaining after payment of all
debts, subject to any preferential rights of any outstanding Preferred Stock.
Holders of Common Stock have no preemptive, conversion, or redemption
rights and are not subject to further calls or assessments by the Company. All
of the outstanding shares of Common Stock are validly issued, fully paid, and
nonassessable.
PREFERRED STOCK
If the Rights Offering is successfully concluded, Cygnet will issue to UDC
40,000 shares of Cumulative Convertible Preferred Stock, Series A, $.001 par
value per share (the "Preferred Stock") with an aggregate liquidation preference
of $40 million. The Preferred Stock, in preference to the Common Stock, will be
entitled to receive cumulative cash dividends, from the Effective Date through
the first anniversary of such date, at the initial annual rate of 7% of the Base
Liquidation Amount (defined below), and escalating 1% per annum on each
anniversary thereafter to a maximum rate of 11% per annum on the aggregate Base
Liquidation Amount, in each case payable quarterly in arrears on the first day
of March, June, September, and December of each year, beginning December 1,
1998, when and as declared by the Board of Directors of Cygnet out of funds
legally available for such payment. The Preferred Stock, in preference to the
Common Stock, will be entitled to receive, in the event of dissolution or
liquidation of Cygnet, $1,000 per share (the "Base Liquidation Amount") plus
accrued and unpaid dividends thereon (the "Liquidation Preference Amount").
The Preferred Stock will be redeemable at Cygnet's option in whole or in
part at a redemption price of $1,000 per share, plus dividends accrued and
unpaid thereon to the redemption date, and will be convertible in whole or in
part at any time after the third anniversary following issuance at the option of
the Company into that number of shares of Common Stock determined by dividing
the Liquidation Preference Amount of the shares of Preferred Stock to be
converted by the lower of (a) the Subscription Price or (b) 80% of the average
Market Price (defined below) for the 10 consecutive trading days ending not more
than 15 days prior to the date notice of conversion is given. For purposes of
the conversion of the Preferred Stock, "Market Price" means (i) if the Common
Stock is quoted on the Nasdaq National Market or the Nasdaq SmallCap Market or
on a national securities exchange, the daily per share closing price of the
Common Stock as quoted on the Nasdaq National Market or the Nasdaq SmallCap
Market or on the principal stock exchange on which it is listed on the trading
day in question, as the case may be, whichever is the higher, or (ii) if the
Common Stock is traded in the over-the-counter market and not quoted on the
Nasdaq National Market or the Nasdaq SmallCap Market or on any national
securities exchange, the closing bid price of the Common Stock on the
60
<PAGE> 62
trading day in question, as reported by Nasdaq or an equivalent generally
accepted reporting service. The Preferred Stock will not have any pre-emptive or
other subscription rights.
Except as described below, holders of the Preferred Stock will not be
entitled to vote for the election of directors or for other matters on which
holders of the Common Stock are entitled to vote. In the event that an amount
equal to six quarterly dividend payments on the Preferred Stock shall have
accrued and be unpaid, the holders of the Preferred Stock will have the right,
voting separately as a class, to elect two members to the Board of Directors of
Cygnet at the next meeting of stockholders of Cygnet and thereafter until all
accrued dividends on the Preferred Stock have been paid in full. The Preferred
Stock shall also have voting rights on certain extraordinary matters including:
(i) the authorization, creation, or issuance, or the increase in the authorized
or issued amount, of any class or series of stock senior to the Preferred Stock
as to the payment of dividends and distribution of assets upon dissolution,
liquidation, or winding up of the Company; or (ii) the amendment, alteration, or
repeal of the Certificate of Incorporation or the certificate of designation
through which the Preferred Stock will be issued, that would materially and
adversely change the voting powers, rights or preferences of the Preferred
Stock. In such case, each share of Preferred Stock shall have one vote per Base
Liquidation Amount.
LIMITATION OF LIABILITY AND INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Certificate of Incorporation provides that to the fullest
extent permitted by Delaware law, a director of the Company shall not be
personally liable to the Company or its stockholders for monetary damages for
breach of such director's fiduciary duty, except for liability: (i) for any
breach of the director's duty of loyalty to the Company or its stockholders;
(ii) for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law; (iii) in respect of certain unlawful
dividend payments or stock redemptions or repurchases; and (iv) for any
transaction from which the director derives an improper benefit. The effect of
the provision of the Company's Certificate of Incorporation is to eliminate the
rights of the Company and its stockholders (through stockholders' derivative
suits on behalf of the Company) to recover monetary damages against a director
for breach of the fiduciary duty of care as a director (including breaches
resulting from negligent or grossly negligent behavior), except in the
situations described in clauses (i) through (iv) above. This provision does not
limit or eliminate the rights of the Company or any stockholder to seek
nonmonetary relief such as an injunction or recision in the event of a breach of
a director's duty of care. In addition, the Company's Certificate of
Incorporation provides that the Company shall indemnify any person who is or was
a director or officer of the Company, or who is or was serving at the request of
the Company as a director, officer, employee, or agent of another corporation or
entity, against expenses, liabilities, and losses incurred by any such person by
reason of the fact that such person is or was acting in such capacity. The
Company will obtain insurance on behalf of its directors and officers for any
liability arising out of such person's actions in such capacity.
The Company will enter into agreements to indemnify its directors and
officers. These agreements, among other things, will indemnify the Company's
directors and officers for certain expenses (including attorneys' fees),
judgments, fines, and settlement amounts incurred by any such person in any
action or proceeding, including any action by or in the right of the Company,
arising out of such person's services as a director or officer of the Company,
any subsidiary of the Company, or any other company or enterprise to which such
person provides services at the request of the Company. To the extent that the
Board of Directors or the stockholders of the Company may in the future wish to
limit or repeal the ability of the Company to provide indemnification as set
forth in the Company's Certificate of Incorporation, such repeal or limitation
may not be effective as to directors or officers who are parties to the
indemnification agreements because their rights to full protection would be
contractually assured by such agreements. It is anticipated that similar
contracts may be entered into, from time to time, with future directors of the
Company. The Company believes that the indemnification provisions in its
Certificate of Incorporation and in the indemnification agreements are necessary
to attract and retain qualified persons as directors and officers.
61
<PAGE> 63
CERTAIN BYLAW PROVISIONS
The Company's Bylaws, as amended, contain several provisions that regulate
the nomination of directors and the submission of proposals in connection with
stockholder meetings. The Company's Bylaws require that, subject to certain
exceptions, any stockholder desiring to propose business or nominate a person to
the Board of Directors at a stockholders meeting must give notice of any
proposals not less than 60 days nor more than 90 days prior to the anniversary
date of the immediately preceding annual meeting of stockholders. Such notice is
required to contain certain information as set forth in the Bylaws. No business
matter shall be transacted nor shall any person be eligible for election as a
director of the Company unless proposed or nominated, as the case may be, in
strict accordance with this procedure set forth in the Company's Bylaws.
Although the Bylaws do not give the Board of Directors any power to approve
or disapprove of stockholder nominations for the election of directors or of any
other business desired by stockholders to be conducted at an annual or any other
meeting, the Bylaws may have the effect of precluding a nomination for the
election of directors or the conduct of business at a particular annual meeting
if the proper procedures are not followed or may discourage or deter a third
party from conducting a solicitation of proxies to elect its own slate of
directors or otherwise attempting to obtain control of the Company, even if the
conduct of such solicitation or such attempt might be beneficial to the Company
and its stockholders. The Company's procedures with respect to all stockholder
proposals and the nomination of directors will be conducted in accordance with
Section 14 of the Exchange Act and the rules promulgated thereunder.
TRANSFER AGENT AND REGISTRAR
The Transfer Agent and Registrar for the Common Stock of the Company is
.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of the Rights Offering, the Company will have
shares of Common Stock outstanding. All of the shares of Common
Stock sold in this Rights Offering, except for certain shares described below,
will be freely tradeable without restriction or further registration under the
Act. The remaining shares of Common Stock (the "Control Shares")
will be "restricted securities" as defined in Rule 144, and thus, may not be
sold in the absence of registration under the Act unless an exemption is
available, including an exemption afforded by Rule 144 or Rule 701.
In general, under Rule 144 as currently in effect, if two years have
elapsed since the date of acquisition of restricted securities from the Company
or any affiliate and the acquiror or subsequent holder is not deemed to have
been an affiliate of the Company for at least 90 days prior to a proposed
transaction, such person would be entitled to sell such shares under Rule 144(k)
without regard to the limitations described below. If one year has elapsed since
the date of acquisition of restricted securities from the Company or any
affiliate, the acquiror or subsequent holder thereof (including persons who may
be deemed affiliates of the Company) is entitled to sell within any three-month
period a number of shares that does not exceed the greater of 1% of the then-
outstanding shares of Common Stock or the average weekly trading volume in the
Common Stock an exchange during the four calendar weeks preceding such sale.
Sales under Rule 144 are also subject to certain provisions regarding the manner
of sale, notice requirements and the availability of current public information
about the Company. Approximately Control Shares will be eligible
for future sale subject to the holding period and other conditions imposed by
Rule 144. Certain restrictions apply to any shares of Common Stock purchased in
this offering by affiliates of the Company, which may generally only be sold in
compliance with the limitations of Rule 144, except for the holding period
requirements thereunder.
Rule 144A under the Act provides a nonexclusive safe harbor exemption from
the registration requirements of the Act of specified resales of restricted
securities to certain institutional investors. In general, Rule 144A allows
unregistered resales of restricted securities to a "qualified institutional
buyer," which generally includes an entity, acting for its own account or for
the account of other qualified institutional buyers, that in the aggregate owns
or invests on a discretionary basis at least $100 million in securities of
62
<PAGE> 64
issuers that are not affiliated with the entity, as long as these securities
when issued were not of the same class as securities listed on a national
securities exchange or quoted on the Nasdaq National Market or Nasdaq SmallCap
Market. The shares of Common Stock outstanding as of the date of this Prospectus
would be eligible for resale under Rule 144A because such shares, when issued,
were not of the same class as any listed or quoted securities.
LEGAL MATTERS
The validity of the securities offered hereby is being passed upon for the
Company by Snell & Wilmer L.L.P., Phoenix, Arizona.
AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") a registration statement on Form S-1 (the "Registration
Statement") under the Securities Act with respect to the Rights and shares of
Common Stock offered hereby. This Prospectus constitutes a part of the
Registration Statement and does not contain all of the information set forth
therein and in the exhibits thereto, certain portions of which have been omitted
as permitted by the rules and regulations of the Commission. For further
information with respect to the Company and the Rights and shares of Common
Stock offered hereby, reference is hereby made to such Registration Statement
and exhibits. Statements contained in this Prospectus as to the contents of any
document are not necessarily complete and in each instance are qualified in
their entirety by reference to the copy of the appropriate document filed with
the Commission. The Registration Statement, including the exhibits thereto, may
be examined without charge at the Commission's public reference facility at Room
1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549. In
addition, copies of all or any part of the Registration Statement, including
such exhibits thereto, may be obtained from the Commission at its principal
office in Washington, D.C., upon payment of the fees prescribed by the
Commission.
EXPERTS
The combined financial statements of the Company as of December 31, 1997
and for the year then ended, have been included herein and in the Registration
Statement in reliance upon the report of KPMG Peat Marwick LLP, independent
certified public accountants, appearing elsewhere herein, and upon the authority
of said firm as experts in accounting and auditing.
63
<PAGE> 65
CYGNET FINANCIAL CORPORATION
INDEX TO COMBINED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Independent Auditors' Report................................ F-2
Combined Financial Statements:
Combined Balance Sheets as of March 31, 1998 (unaudited)
and December 31, 1997.................................. F-3
Combined Statements of Operations for the three months
ended March 31, 1998 (unaudited) and 1997 (unaudited)
and the year ended December 31, 1997................... F-4
Combined Statements of Stockholder's Equity for the year
ended December 31, 1997, and the three months ended
March 31, 1998 (unaudited)............................. F-5
Combined Statements of Cash Flows for the three months
ended March 31, 1998 (unaudited) and 1997 (unaudited)
and the year ended December 31, 1997................... F-6
Notes to Combined Financial Statements.................... F-7
</TABLE>
F-1
<PAGE> 66
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholder
Cygnet Financial Corporation:
We have audited the accompanying combined balance sheet of Cygnet Financial
Corporation as of December 31, 1997, and the related combined statements of
operations, stockholder's equity, and cash flows for the year ended December 31,
1997. These combined financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
combined financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the financial position of Cygnet Financial
Corporation as of December 31, 1997, and the results of their operations and
their cash flows for the year ended December 31, 1997 in conformity with
generally accepted accounting principles.
/s/ KPMG PEAT MARWICK LLP
Phoenix, Arizona
June 5, 1998
F-2
<PAGE> 67
CYGNET FINANCIAL CORPORATION
COMBINED BALANCE SHEETS
MARCH 31, 1998 AND DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
MARCH 31,
----------- DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and Cash Equivalents................................. $ 365 $ 1,225
Finance Receivables, Net.................................. 23,023 19,274
Notes Receivable, Net..................................... 28,103 21,861
Property and Equipment, Net............................... 2,082 646
Goodwill, Net............................................. 1,158 1,178
Other Assets.............................................. 2,669 6,146
------- -------
$57,400 $50,330
======= =======
LIABILITIES AND STOCKHOLDER'S EQUITY
Liabilities:
Accrued Expenses and Other Liabilities................. $ 422 $ 548
Advances from Affiliate................................ 16,598 9,402
Note Payable........................................... 380 380
------- -------
Total Liabilities................................. 17,400 10,330
------- -------
Stockholder's Equity:
Preferred Stock; 1,000 shares authorized, none issued
and outstanding....................................... -- --
Common Stock; 14,000 shares authorized, one share
issued and outstanding................................ -- --
Additional Paid-in Capital............................. 40,000 40,000
Retained Earnings...................................... -- --
------- -------
Total Stockholder's Equity........................ 40,000 40,000
------- -------
Commitments and Contingencies............................. -- --
------- -------
$57,400 $50,330
======= =======
</TABLE>
See accompanying notes to Combined Financial Statements.
F-3
<PAGE> 68
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT EARNINGS PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED YEAR
MARCH 31, ENDED
------------------ DECEMBER 31,
1998 1997 1997
------- ------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Revenues:
Interest Income........................................... $3,323 $ 5 $ 7,472
Gain on Sale of Notes Receivable.......................... -- -- 8,132
Other Income.............................................. 59 -- 355
------ ------ -------
3,382 5 15,959
------ ------ -------
Operating Expenses:
Provision for Credit Losses............................... 287 -- 691
Selling and Marketing..................................... 7 3 18
General and Administrative................................ 2,180 477 3,766
Depreciation and Amortization............................. 52 29 153
------ ------ -------
2,526 509 4,628
------ ------ -------
Earnings (Loss) before Interest Expense..................... 856 (504) 11,331
Interest Expense............................................ 854 8 2,067
------ ------ -------
Earnings (Loss) before Income Taxes......................... 2 (512) 9,264
Income Taxes (Benefit)...................................... -- (206) 3,728
------ ------ -------
Net Earnings (Loss)......................................... $ 2 $ (306) $ 5,536
====== ====== =======
Basic/Diluted Earnings per share............................ $ 2 $ (306) $ 5,536
====== ====== =======
Shares used in computation.................................. 1 1 1
====== ====== =======
Pro Forma Basic Earnings per Share (unaudited).............. $(0.13) $(0.05) $0.49
====== ====== ========
Pro Forma Diluted Earnings per Share (unaudited)............ $(0.13) $(0.05) $0.49
====== ====== ========
Pro Forma Shares used in computation - basic (unaudited).... 5,579 5,579 5,579
====== ====== ========
Pro Forma Shares used in computation - diluted
(unaudited)............................................... 5,583 5,583 5,583
====== ====== ========
</TABLE>
See accompanying notes to Combined Financial Statements.
F-4
<PAGE> 69
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF STOCKHOLDER'S EQUITY
THREE MONTHS ENDED MARCH 31, 1998 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS, EXCEPT SHARES)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL TOTAL
---------------- PAID-IN RETAINED STOCKHOLDER'S
SHARES AMOUNT CAPITAL EARNINGS EQUITY
------ ------ ---------- -------- -------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1996............ -- $-- $ -- $ -- $ --
Issuance of Common Stock................. 1 -- -- -- --
Contributed Capital...................... -- -- 40,000 -- 40,000
Distributions to Ugly Duckling
Corporation............................ -- -- -- (5,536) (5,536)
Net Earnings for the Year................ -- -- -- 5,536 5,536
-- -- ------- ------ -------
Balances at December 31, 1997............ 1 -- 40,000 -- 40,000
Three Months Ended March 31, 1998
(unaudited):
Distributions to Ugly Duckling
Corporation............................ -- -- -- (2) (2)
Net Earnings for the Period.............. -- -- -- 2 2
-- -- ------- ------ -------
Balances at March 31, 1998 (unaudited)... 1 $-- $40,000 $ -- $40,000
== == ======= ====== =======
</TABLE>
See accompanying notes to Combined Financial Statements.
F-5
<PAGE> 70
CYGNET FINANCIAL CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED MARCH 31, 1998 AND 1997 AND
YEAR ENDED DECEMBER 31, 1997
(IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------- DECEMBER 31,
1998 1997 1997
-------- ------- ------------
(UNAUDITED)
<S> <C> <C> <C>
Cash Flows from Operating Activities:
Net Earnings (Loss)..................................... $ 2 $ (306) $ 5,536
Adjustments to Reconcile Net Earnings (Loss) to Net
Cash Provided by Operating Activities:
Provision for Credit Losses.......................... 287 -- 691
Increase in Deferred Income Taxes.................... -- (296)
Depreciation and Amortization........................ 52 29 153
Decrease (Increase) in Other Assets.................. 1,965 (7) (87)
Increase (Decrease) in Accrued Expenses and Other
Liabilities........................................ (126) 26 396
-------- ------- --------
Net Cash Provided by (Used In) Operating
Activities.................................... 2,180 (258) 6,393
-------- ------- --------
Cash Flows from Investing Activities:
Increase in Finance Receivables......................... (8,735) -- (20,941)
Collections of Finance Receivables...................... 4,741 85 9,330
Increase in Notes Receivable............................ (11,131) (1,330) (12,700)
Collections of Notes Receivable......................... 4,889 -- 6,900
Purchase of Property and Equipment...................... -- -- (146)
Payment for Acquisition of Assets....................... -- -- (9,098)
-------- ------- --------
Net Cash Used in Investing Activities........... (10,236) (1,245) (26,655)
-------- ------- --------
Cash Flows from Financing Activities:
Payment of note payable................................. -- -- (120)
Advances from Affiliate................................. 7,196 1,408 9,402
Net Increase in Additional Paid-in Capital.............. -- -- 12,205
-------- ------- --------
Net Cash Provided by Financing Activities....... 7,196 1,408 21,487
-------- ------- --------
Net Increase (Decrease) in Cash and Cash Equivalents...... (860) 95 1,225
Cash and Cash Equivalents at Beginning of Period.......... 1,225 -- --
-------- ------- --------
Cash and Cash Equivalents at End of Period................ $ 365 $ 95 $ 1,225
======== ======= ========
Supplemental Statement of Cash Flows Information:
Interest Paid........................................... $ -- $ -- $ 1,416
======== ======= ========
Contribution of certain assets to the Company........... $ -- $ 601 $ 27,795
======== ======= ========
Assumption of note payable.............................. $ -- $ 500 $ 500
======== ======= ========
</TABLE>
See accompanying notes to Combined Financial Statements.
F-6
<PAGE> 71
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS
MARCH 31, 1998 AND DECEMBER 31, 1997
(1) ORGANIZATION, PURPOSE, BASIS OF PRESENTATION AND ACQUISITION
Cygnet Financial Corporation (the Company), a wholly-owned subsidiary of
Ugly Duckling Corporation (Ugly Duckling), was formed on June 1, 1998 for the
purpose of consummating a transaction whereby Ugly Duckling would split-up its
operations into two publicly-held companies (the split-up). The Company will
purchase from Ugly Duckling, substantially all of Ugly Duckling's non-dealership
operations including, the bulk purchasing and certain servicing operations
(excluding the branch office network), it's third party dealer financing
operations, and substantially all other non-dealership assets and contract
rights including those acquired in the First Merchants Acceptance Corporation
Transaction and assume the liabilities related thereto (collectively referred to
as the acquired assets). In exchange for the acquired assets, the Company will
issue $40.0 million of its cumulative, convertible preferred stock and a cash
payment equivalent to the greater of the appraised value or the book value of
the acquired assets, which the Company does not expect to materially differ.
These combined financial statements reflect the results of operations, financial
position, changes in stockholder's equity and cash flows of the Company, as if
the Company were a separate entity operating the acquired assets for all periods
presented. The combined financial statements have been prepared using the
historical basis in the assets and liabilities and historical results of
operations of the Company. In connection with the split-up, the Company intends,
through a rights offering to Ugly Duckling stockholders, to issue up to 5.6
million shares of common stock at an offering price of $7.00 per share.
The accompanying unaudited combined financial statements of the Company as
of March 31, 1998 and for the three month periods ended March 31, 1998 and 1997,
have been prepared in accordance with generally accepted accounting principles
for interim financial information and pursuant to rules and regulations of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for a complete financial statement presentation. In the opinion of management,
such unaudited interim information reflects all adjustments, consisting only of
normal recurring adjustments, necessary to present the Company's financial
position and results of operations for the periods presented. The results of
operations for interim periods are not necessarily indicative of the results to
be expected for a full fiscal year.
General corporate overhead related to the Company's corporate headquarters
and common support functions has been allocated to the Company, to the extent
such amounts are applicable to the Company. However, the costs of these services
charged to the Company are not necessarily indicative of the costs that would
have been incurred if the Company had performed these functions as a stand-alone
entity. As a result of the split-up, the Company will be required to perform
these functions using its own resources or purchased services and will be
responsible for the costs and expenses associated with the management of a
public corporation. The financial information included herein may not
necessarily reflect the combined results of operations, financial position,
changes in stockholder's equity and cash flows of the Company in the future or
amounts that would have been reported had it been a separate, stand-alone entity
during the periods presented.
The Company operates various business segments. The Company operates it's
Cygnet Dealer Program, whereby the Company provides independent used car dealers
(Third Party Dealers) with warehouse purchase facilities and operating credit
lines primarily secured by the dealers' retail installment contract portfolio.
In addition, the Company operates a bulk purchasing business segment in which
the Company acquires via bulk purchase large portfolios of retail installment
contract loan portfolios. Further, in conjunction with acquisition of the
contributed assets, the Company received certain rights to service the finance
receivable portfolios of various parties. The Third Party Dealers' retail
installment contract portfolios are substantially comprised of loans to persons
who have limited credit histories, low incomes, or past credit problems.
In August 1997, the Company acquired substantially all of the assets of
American National Acceptance Corporation (ANAC) in exchange for approximately
$9.3 million in cash. The acquisition was recorded in accordance with the
"purchase method" of accounting, and, accordingly, the purchase price has been
F-7
<PAGE> 72
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
allocated to the assets purchased and the liabilities assumed based upon the
estimated fair values at the date of acquisition. The excess of the purchase
price over the fair values of the net assets acquired was approximately $1.2
million and has been recorded as goodwill, which is being amortized over a
period of 15 years. The results of operations of ANAC have been included in the
accompanying statement of operations from the acquisition date.
The following summary, prepared on a pro forma basis, combines the results
of operations (unaudited) as if the acquisition had taken place on January 1,
1997. Such pro forma amounts are not necessarily indicative of what the actual
results of operations might have been if the acquisition had been effective on
January 1, 1997, (in thousands, except per share amounts):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1997
------------
<S> <C>
Interest Income............................................. $ 10,920
Fee Income.................................................. $ 861
Other Income................................................ $ 8,198
Total Revenues.............................................. $ 19,979
Net Earnings................................................ $ 4,210
Basic/Diluted Earnings Per Share............................ $ 4,210
Proforma Basic Earnings Per Share........................... $ 0.25
Proforma Diluted Earnings Per Share......................... $ 0.25
</TABLE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk
As of December 31, 1997, the Company had warehouse purchase facilities and
revolving lines of credit with a total of 42 Third Party Dealers. The finance
receivables balance of loans the Company had purchased from one third party
dealer totaled $7,756,000, representing approximately 28.1% of the Company's
total finance receivables portfolio as of December 31, 1997. There were no other
Third Party Dealer's loans which exceeded 10% of the Company's total finance
receivables portfolio as of December 31, 1997.
Periodically during the year, the Company maintains cash in financial
institutions in excess of the amounts insured by the federal government.
Cash Equivalents
The Company considers all highly liquid debt instruments purchased with
maturities of three months or less to be cash equivalents. Cash equivalents
generally consist of interest bearing money market accounts.
Revenue Recognition
Interest income is recognized using the interest method. Direct loan
origination costs are deferred and charged against finance income over the life
of the related installment sales contract as an adjustment of yield
F-8
<PAGE> 73
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
using the interest method. The accrual of interest is suspended if collection
becomes doubtful, generally 90 days past due, and is resumed when the loan
becomes current.
Fee income generally represents revenues from services such as periodic
audits of borrowers, collateral monitoring and maintenance fees and is
recognized when the services have been performed.
Servicing income is recognized when earned. Servicing costs are charged to
expense as incurred. In the event delinquencies and/or losses on the respective
serviced portfolios exceed specified levels, the Company may be required to
transfer the servicing of the portfolio to another servicer.
Finance Receivables and Allowance for Credit Losses
The largest portion of the Company's business is with Third Party Dealers
who participate in the "Dealer Collection Program." Under this program, the
Company purchases retail installment sales contracts from Third Party Dealers on
a full recourse basis. The dealer retains servicing rights and collects the
contract on behalf of the Company. The purchase price of the contracts is
generally 65% to 75% of the principal balance of the respective contracts. The
difference between the par value of the purchased contracts and the amount paid
by the Company is nonrefundable acquisition discount (the "acquired allowance").
The acquired allowance is allocated between acquired allowance available for
credit losses and acquired allowance available for accretion to interest income.
The portion of acquired allowance allocated to the allowance for credit losses
is based upon historical performance and write-offs of contracts acquired from
Third Party Dealers, as well as the general credit worthiness of the borrowers
and the wholesale value of the vehicle. The remaining acquired allowance, if
any, is deferred and accreted to income using the interest method.
Finance receivables consist of contractually scheduled payments from the
installment sales contracts net of unearned finance charges, accrued interest
receivable, direct loan origination costs, and an allowance for credit losses,
including acquired allowances.
Notes Receivable
Notes receivable are recorded at cost, less related allowance for impaired
notes receivable. Management, considering information and events regarding the
borrowers ability to repay their obligations, including an evaluation of the
estimated value of the related collateral, considers a note to be impaired when
it is probable that the Company will be unable to collect all amounts due
according to the contractual terms of the note agreement. When a loan is
considered to be impaired, the amount of impairment is measured based on the
present value of expected future cash flows discounted at the note's effective
interest rate. Impairment losses are included in the allowance for credit losses
through a charge to provision for credit losses. Cash receipts on impaired notes
receivable are applied to reduce the principal amount of such notes until the
principal has been received and are recognized as interest income, thereafter.
The Company follows the provisions of Statement of Financial Accounting
Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases". Accordingly,
direct loan origination costs are offset against loan origination fees with the
difference capitalized and amortized to finance income using a method.
Property and Equipment
Property and Equipment are stated at cost. Depreciation is computed using
straight-line and accelerated methods over the estimated useful lives of the
assets which range from three to ten years for equipment. Leasehold improvements
are amortized using straight-line and accelerated methods over the shorter of
the lease term or the estimated useful lives of the related improvements.
F-9
<PAGE> 74
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Goodwill
Goodwill, which represents the excess of purchase price over fair value of
net assets acquired, is amortized on a straight-line basis over the expected
periods to be benefited, generally fifteen years.
Income Taxes
The Company utilizes the asset and liability method of accounting for
income taxes. Under the asset and liability method, deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
The Company has recognized income taxes pursuant to a Tax Sharing Agreement
between the Company and its parent. Under the terms of the agreement, the
Company is obligated to pay to its parent, amounts approximating the federal and
state income taxes incurred by the parent as a result of the Company's actual
contribution to the consolidated income taxes of its parent.
Stock Option Plan
The Company has adopted SFAS No. 123, Accounting for Stock-Based
Compensation, which permits entities to recognize as expense over the vesting
period the fair value of all stock-based awards on the date of grant.
Alternatively, SFAS No. 123 also allows entities to continue to apply the
provisions of APB Opinion No. 25 and provide pro forma net earnings and pro
forma earnings per share disclosures for employee stock option grants as if the
fair-value-based method defined in SFAS No. 123 had been applied. The Company
has elected to continue to apply the provisions of APB Opinion No. 25 and
provide the pro forma disclosure provisions of SFAS No. 123.
The Company uses one of the most widely used option pricing models, the
Black-Scholes model (the Model), for purposes of valuing its stock option
grants. The Model was developed for use in estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In
addition, it requires the input of highly subjective assumptions, including the
expected stock price volatility, expected dividend yields, the risk free
interest rate, and the expected life. Because the Company's stock options have
characteristics significantly different from those of traded options, and
because changes in subjective input assumptions can materially affect the fair
value estimate, in management's opinion, the value determined by the Model is
not necessarily indicative of the ultimate value of the granted options.
Earnings Per Share
Basic earnings per share is computed by dividing income available to the
common stockholder by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share reflects the potential dilution that
could occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company. For purposes of computing the pro
forma earnings per share for the periods presented, the Company has assumed the
maximum potential issuance of shares of common stock pursuant to its planned
rights offering, and the payment of dividends at a rate of 7.0% per annum as if
preferred stock totaling $40.0 million was outstanding for the periods
presented.
Impairment of Long-Lived Assets and Long-Lived Assets to Be Disposed Of
The Company reviews long-lived assets and certain identifiable intangibles
for impairment whenever events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable.
F-10
<PAGE> 75
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Recoverability of assets to be held and used is measured by a comparison of the
carrying amount of an asset to future undiscounted net cash flows expected to be
generated by the asset. If such assets are considered to be impaired, the
impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceed the fair value of the assets. Assets to be disposed
of are reported at the lower of the carrying amount or fair value less costs to
sell.
(3) FINANCE RECEIVABLES AND ALLOWANCE FOR CREDIT LOSSES
A summary of finance receivables as of March 31, 1998 and December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Installment Sales Contract Principal Balances....... $32,843 $27,481
Add: Accrued Interest Receivable.................... 179 147
------- -------
Principal Balances, Net............................. 33,022 27,628
Allowance for Credit Losses:
Finance Receivables............................... (937) (485)
Acquired Allowance................................ (8,817) (7,706)
Refundable Security Deposits...................... (245) (163)
------- -------
Finance Receivables, Net............................ $23,023 $19,274
======= =======
</TABLE>
A summary of allowance for credit losses on finance receivables for the
periods ended March 31, 1998 and December 31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Balance, Beginning of Period......................... $8,191 $ --
Provision for Credit Losses........................ 287 491
Acquired Allowance................................. 1,662 7,706
Net Charge Offs.................................... (386) (6)
------ ------
Balance, End of Period............................... $9,754 $8,191
====== ======
</TABLE>
(4) NOTES RECEIVABLE
In July 1997, First Merchants Acceptance Corporation (FMAC) filed for
bankruptcy. Immediately subsequent to the bankruptcy filing, the Company
executed a loan agreement with FMAC to provide FMAC with up to $10.0 million in
debtor in possession (the DIP facility) financing. The DIP facility accrues
interest at 12.0%, was initially scheduled to mature on February 28, 1998, and
is secured by substantially all of FMAC's assets. The Company and FMAC
subsequently amended the DIP facility to increase the maximum commitment to
$21.5 million, decrease the interest rate to 10.0% per annum, and extend the
maturity date indefinitely. In connection with the amendment, FMAC pledged the
first $10.0 million of income tax refunds receivable, which FMAC anticipates
collecting in 1998, to the Company. 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 $16,250,000 (unaudited) and
$10,868,000 at March 31, 1998 and December 31, 1997, respectively.
F-11
<PAGE> 76
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
During the third and fourth fiscal quarters of 1997, the Company acquired
the senior bank debt of FMAC from the bank group members holding such debt. In
December 1997, a credit bid for the outstanding balance of the senior bank debt
plus certain fees and expenses (the "credit bid purchase price") was entered and
approved in the bankruptcy court resulting in the transfer of the senior bank
debt for the loan portfolio which secured the senior bank debt (the "owned
loans"). Simultaneous with the transfer to the Company, General Electric Capital
Corporation purchased the owned loans for 86% of the principal balance of the
loan portfolio, and the Company retained a 14% participation in the loan
portfolio (See note 7). FMAC has guaranteed that the Company will receive an
11.0% return on the credit bid purchase price from the cash flows generated by
the owned loans, and further collateralized by FMAC's residual interests in
certain securitization transactions. The balance of the participation totaled
$5,558,000 (unaudited) and $5,399,000 at March 31, 1998 and December 31, 1997,
respectively.
Various revolving notes receivable from used car dealers with a total
commitment of $8,125,000 (unaudited) and $8,750,000 at March 31, 1998 and
December 31, 1997, respectively, expiring through September 1999 with interest
rates ranging from prime plus 5.50% to prime plus 9.75% per annum (14% to 18.25%
at December 31, 1997), interest payable monthly. The respective revolving notes
subject the borrower to borrowing base requirements with advances on eligible
collateral (retail installment contracts) of sixty-five percent of the par value
of the underlying collateral. The balance outstanding on these revolving notes
receivable totaled $6,295,000 (unaudited), net of allowance for credit of
$200,000 (unaudited), at March 31, 1998 and $5,594,000, net of an allowance for
credit losses of $200,000, at December 31, 1997.
A summary of the allowance for credit losses for notes receivable for the
periods ended March 31, 1998 and December 31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Balance, Beginning of Period...... $200 $ --
Provision for Credit Losses....... -- 200
Net Charge Offs................... -- --
---- ----
Balance, End of Period............ $200 $200
==== ====
</TABLE>
(5) PROPERTY AND EQUIPMENT
A summary of Property and Equipment as of March 31, 1998 and December 31,
1997 follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Furniture and Equipment (note
7).............................. $2,134 $ 666
Leasehold Improvements............ 44 44
Vehicles.......................... 63 63
------ ------
2,241 773
Less Accumulated Depreciation and
Amortization.................... (159) (127)
------ ------
Property and Equipment, Net....... $2,082 $ 646
====== ======
</TABLE>
Depreciation expense relating to property and equipment totaled $32,000
(unaudited) and $127,000 for the periods ended March 31, 1998 and December 31,
1997, respectively.
F-12
<PAGE> 77
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(6) GOODWILL
A summary of goodwill as of March 31, 1998 and December 31, 1997 follows
(in thousands):
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
1998 1997
----------- ------------
(UNAUDITED)
<S> <C> <C>
Goodwill.......................... $1,204 $1,204
Accumulated Amortization.......... (46) (26)
------ ------
Goodwill, Net..................... $1,158 $1,178
====== ======
</TABLE>
Amortization expense relating to goodwill totaled $20,000 (unaudited) and
$26,000 for the periods ended March 31, 1998 and December 31 1997, respectively.
(7) OTHER ASSETS
A summary of Other Assets as of March 31, 1998 and December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
(UNAUDITED)
<S> <C> <C>
Due from GE Capital
Corporation................. $ 700 $3,000
Investment in Marketable
Securities (note 5)......... -- 1,451
Due from First Merchants
Acceptance Corp............. -- 971
Accrued Interest Receivable-
Notes Receivable............ 436 77
Deferred Income Taxes......... 296 296
Other Assets.................. 1,237 351
------ ------
$2,669 $6,146
====== ======
</TABLE>
In connection with the GE Capital Corporation purchase of the owned loans,
a sum of $3,000,000 was held in escrow pending completion of certain conditions
precedent. Such conditions were substantially satisfied subsequent to December
31, 1997 and $2.3 million of the funds were remitted to the Company. The Company
expects to begin collecting the remaining balance in December 1998.
During March 1998, the Bankruptcy Court handling the bankruptcy of FMAC
(note 4) approved the exchange of the $1,451,000 investment in common stock of
FMAC held by the Company for the property and equipment that constitute FMAC's
loan servicing platform.
(8) NOTE PAYABLE
The Company has executed a note payable with an unrelated party which calls
for annual payments of $120,000. Interest has been imputed at 10%. The note
which matures in May 2000 is secured by certain furniture and equipment. The
balance related to this note payable totaled $380,000 at March 31, 1998
(unaudited) and at December 31, 1997.
F-13
<PAGE> 78
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(9) INCOME TAXES
Income taxes amounted to $3,728,000, for the year ended December 31, 1997
(an effective corporate income tax rate of 40.2%). A reconciliation between
taxes computed at the federal statutory rate of 34% in 1997 at the effective tax
rate on earnings before income taxes follows (in thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
Computed "Expected" Income Taxes.................... $3,150
State Income Taxes, Net of Federal Effect........... 585
Other, Net.......................................... (7)
------
$3,728
======
</TABLE>
Components of income taxes (benefit) for the year ended December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
CURRENT DEFERRED TOTAL
------- -------- ------
<S> <C> <C> <C>
Federal.................................................. $3,066 $(225) $2,841
State.................................................... 958 (71) 887
------ ----- ------
$4,024 $(296) $3,728
====== ===== ======
</TABLE>
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1997 are presented below (in thousands):
<TABLE>
<CAPTION>
AMOUNT
------
<S> <C>
Deferred Tax Assets:
Finance Receivables, Principally Due to the
Allowance for Credit Losses.................... $ 281
Deferred Revenue.................................. 15
------
Total Gross Deferred Tax Assets................... 296
Less: Valuation Allowance......................... --
------
Net Deferred Tax Assets................... 296
Deferred Tax Liabilities............................ --
------
Net Deferred Tax Asset.................... $ 296
======
</TABLE>
The Valuation Allowance for deferred tax assets as of December 31, 1997 was
zero. There was no change in the Valuation Allowance for the year ended December
31, 1997. In assessing the realization 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.
F-14
<PAGE> 79
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(10) LEASE COMMITMENTS
The Company leases certain office space and equipment from unrelated
entities under various operating leases which expire through August 2001. The
leases require monthly rental payments aggregating approximately $30,000 and
contain various renewal options from one to ten years. The Company is also
responsible for occupancy and maintenance costs, including real estate taxes,
insurance, and utility costs. Rent expense totaled $78,000 (unaudited) for the
three months ended March 31, 1998 and $270,000 for the year ended December 31,
1997.
A summary of future minimum lease payments required under noncancelable
operating leases with remaining lease terms in excess of one year as of December
31, 1997 follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, AMOUNT
- ------------ ------
<S> <C>
1998................................................ $ 293
1999................................................ 302
2000................................................ 320
2001................................................ 213
------
Total..................................... $1,128
======
</TABLE>
(11) STOCKHOLDER'S EQUITY
The Company has authorized 14,000,000 shares of $.001 par value common
stock. There was one share issued and outstanding at December 31, 1997. However,
in connection with the proposed split-up, the Company expects to issue up to a
maximum number of shares of common stock totaling approximately 5,579,000 upon
closure of the proposed rights offering. The accompanying proforma earnings per
share amounts included in these combined financial statements have been
presented to reflect the expected issuance of these shares.
The Company has authorized 1,000,000 shares of $.001 par value preferred
stock. There were no shares issued and outstanding at March 31, 1998 or at
December 31, 1997.
(12) STOCK OPTION PLAN
Concurrent with the split-up of Ugly Duckling, the Company will adopt a
long-term incentive plan (stock option plan). The stock option plan will set
aside 1,000,000 shares of common stock to be granted to employees at a price of
not less than fair market value of the stock at the date of grant. Options are
to vest over a period to be determined by the Board of Directors upon grant and
will generally expire ten years after the date of grant. The options generally
vest over a period of five years.
Concurrent with the establishment of the plan, the Company's Board of
Directors intend to approve the grant of certain options to employees of the
Company who had formerly received stock option grants under the Ugly Duckling
long-term incentive plan. These employees forfeited their Ugly Duckling stock
options in exchange for the grants they received under this plan. In the opinion
of management, the value of these grants approximates the value of the options
forfeited by the respective employees.
The Company applies APB Opinion 25 in accounting for its Plan, and
accordingly, no compensation cost has been recognized for its stock options in
the combined financial statements. Had the Company determined compensation cost
based on the fair value at the grant date for its stock options under SFAS No.
123, the Company's net earnings and earnings per share for the year ended
December 31, 1997, as if the options
F-15
<PAGE> 80
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
granted by Ugly Duckling had been granted by the Company, would have been
reduced to the pro forma amounts indicated below:
<TABLE>
<CAPTION>
AMOUNT
----------
<S> <C> <C>
Net Earnings As reported.......................... $5,536,000
Pro forma............................ $5,397,000
Basic/Diluted Earnings As reported.......................... $5,536,000
per share Pro forma............................ $5,397,000
Proforma Basic Earnings As reported.......................... $ 0.49
per Share Pro forma as adjusted................ $ 0.47
Proforma Diluted Earnings As reported.......................... $ 0.49
per Share Pro forma as adjusted................ $ 0.47
</TABLE>
(13) EARNINGS (LOSS) PER SHARE
A reconciliation from basic earnings per share to diluted earnings per
share for the periods ended March 31, 1998 and December 31, 1997 follows:
<TABLE>
<CAPTION>
MARCH 31,
1998 DECEMBER 31,
(UNAUDITED) 1997
----------- ------------
<S> <C> <C>
Net Earnings....................................... $ 2,000 $5,536,000
========== ==========
Income available to Common Stockholders............ $ 2,000 $5,536,000
========== ==========
Basic EPS -- Weighted Average Shares Outstanding... 1 1
========== ==========
Basic EPS -- Proforma Weighted Average Shares
Outstanding...................................... 5,578,571 5,578,571
========== ==========
Basic/Diluted EPS -- Weighted Average Shares
Outstanding...................................... 5,578,571 5,578,571
Effect of Dilutive Securities:
Stock Options.................................... 4,447 4,447
---------- ----------
Diluted EPS -- Proforma Weighted Average Shares
Outstanding...................................... 5,583,018 5,583,018
========== ==========
Basic/Diluted Earnings Per Share................... $ 2,000 $5,536,000
========== ==========
Net Earnings....................................... $ 2,000 $5,536,000
Proforma Dividends on Preferred Stock.............. (700,000) (2,800,000)
Proforma Net Earnings Available to Common
Stockholders..................................... $ (698,000) $2,736,000
========== ==========
Proforma Basic Earnings Per Share.................. $(0.13) $0.49
====== ======
Proforma Diluted Earnings Per Share................ $(0.13) $0.49
====== ======
</TABLE>
(14) COMMITMENTS AND CONTINGENCIES
The Company has commenced a study of its computer systems in order to
assess its exposure to year 2000 issues. The Company expects to make the
necessary modifications or changes to its computer information systems to enable
proper processing of transactions relating to the year 2000 and beyond. The
Company will evaluate appropriate courses of action, including replacement of
certain systems whose
F-16
<PAGE> 81
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
associated costs would be recorded as assets and subsequently amortized, or
modification of its existing systems which costs would be expensed as incurred.
The Company is involved in various claims and actions arising in the
ordinary course of business. In the opinion of management, based on consultation
with legal counsel, the ultimate disposition of these matters will not have a
material adverse effect on the Company. No provision has been made in the
accompanying combined financial statements for losses, if any, that might result
from the ultimate disposition of these matters.
During 1997, the Company acquired certain notes receivable collateralized
by a loan portfolio. Thereafter, the Company exchanged the notes receivable for
the underlying collateral (the acquired collateral) and received a guarantee
from the borrower of an 11.0% return on the acquired collateral. General
Electric Capital Corporation purchased the acquired collateral, and Ugly
Duckling guaranteed to General Electric Capital Corporation a return of 10.35%,
not to exceed $10,000,000. The Company has agreed to indemnify Ugly Duckling
related to this guarantee.
During 1997, the Company acquired approximately 2.5% of the outstanding
common stock of FMAC with a cost of approximately $1,450,000. In connection with
FMAC's proposed plan of reorganization, and subject to bankruptcy court
approval, the Company and FMAC have agreed to exchange the Company's common
stock in FMAC for the property and equipment that constitute FMAC's servicing
platform. The Company received bankruptcy court approval for the plan of
reorganization during the first fiscal quarter of 1998 and exchanged the common
stock in FMAC for the servicing platform immediately thereafter.
The Company has executed agreements with FMAC and other interested parties
whereby the Company has agreed to replace FMAC as servicer on loan portfolios
which totaled approximately $525 million at December 31, 1997. The agreements
were approved by the bankruptcy court and the Company began servicing the loan
portfolios on April 1, 1998.
(15) RETIREMENT PLAN
During 1995, Ugly Duckling established a qualified 401(k) retirement plan
(defined contribution plan) which became effective on October 1, 1995. Under the
terms of the plan, employees of the Company are eligible to participate in the
plan subject to the eligibility criteria of the plan. The plan, as amended,
covers substantially all employees having no less than three months of service,
have attained the age of 21, and work at least 1,000 hours per year.
Participants may voluntarily contribute to the plan up to the maximum limits
established by Internal Revenue Service regulations. The Company will match 10%
of the participants' contributions. Participants are immediately vested in the
amount of their direct contributions and vest over a five-year period, as
defined by the plan, with respect to the Company's contribution. Pension expense
for the three months ended March 31, 1998 and year ended December 31, 1997 was
immaterial. Concurrent with the completion of the planned split-up of Ugly
Duckling, the Company expects to adopt a separate plan which will be similar in
all material respects to the plan described herein.
(16) 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
F-17
<PAGE> 82
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
of judgment and, therefore, cannot be determined with precision. These estimates
do not reflect any premium or discount that could result from offering for sale
at one time the Company's entire holdings of a particular instrument. Changes in
assumptions could significantly affect these estimates.
Since the fair value is estimated as of December 31, 1997, the amounts that
will actually be realized or paid in settlement of the instruments could be
significantly different.
Cash and Cash Equivalents
The carrying amount is estimated to be the fair value because of the
liquidity of these instruments.
Finance Receivables and Notes Receivable
The carrying amount is estimated to be the fair value because of the
relative short maturity and repayment terms of the portfolio as compared to
similar instruments.
Accrued Expenses and Other Liabilities and Note Payable
The carrying amount approximates fair value because of the short maturity
of these instruments. The terms of the Company's note payable approximate the
terms in the market place at which it could be replaced. Therefore, the fair
market value approximates the carrying value of these financial instruments.
(17) BUSINESS SEGMENTS
Operating results and other financial data are presented for the principal
business segments of the Company for the year ended December 31, 1997. The
Company has three distinct business segments. These consist of finance income
generated from third party finance receivables, bulk purchasing operations, and
corporate and other operations.
In computing operating profit by business segment, the following items were
considered in the Corporate and Other category: portions of administrative
expenses, interest expense and other items not considered direct operating
expenses. Identifiable assets by business segment are those assets used in each
segment of Company operations.
<TABLE>
<CAPTION>
CYGNET BULK CORPORATE
PROGRAM PURCHASING AND OTHER TOTAL
------- ---------- --------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Interest Income................................... $ 3,654 $ 3,818 $ -- $ 7,472
Gain on Sale of Loans............................. -- 8,132 -- 8,132
Other Income...................................... 355 -- -- 355
------- ------- --------- -------
4,009 11,950 -- 15,959
------- ------- --------- -------
Operating Expenses:
Provision for Credit Losses..................... 691 -- -- 691
Selling and Marketing........................... 18 -- -- 18
General and Administrative...................... 2,296 437 1,033 3,766
Depreciation and Amortization................... 28 -- 125 153
------- ------- --------- -------
3,033 437 1,158 4,628
------- ------- --------- -------
Earnings (Loss) before Interest Expense........... $ 976 $11,513 $ (1,158) $11,331
======= ======= ========= =======
Capital Expenditures.............................. $ 17 $ -- $ 129 $ 146
======= ======= ========= =======
Identifiable Assets............................... $27,539 $21,525 $ 1,266 $50,330
======= ======= ========= =======
</TABLE>
F-18
<PAGE> 83
CYGNET FINANCIAL CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
(18) QUARTERLY FINANCIAL DATA -- UNAUDITED
A summary of the quarterly data for the year ended December 31, 1997
follows (in thousands):
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER TOTAL
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Total Revenue............................... $ 5 $ 132 $3,337 $12,485 $15,959
====== ====== ====== ======= =======
Operating Expenses.......................... 509 570 1,332 2,217 4,628
====== ====== ====== ======= =======
Earnings (Loss) before Interest Expense..... (504) (438) 2,006 10,267 11,331
====== ====== ====== ======= =======
Net Earnings (Loss)......................... $ (306) $ (279) $ 757 $ 5,364 $ 5,536
====== ====== ====== ======= =======
Basic Earnings (Loss) Per Share............. $ (306) $ (279) $ 757 $ 5,364 $ 5,536
====== ====== ====== ======= =======
Proforma Basic Earnings (Loss) Per Share.... $(0.18) $(0.18) $0.01 $0.84 $0.49
====== ====== ====== ======= =======
Proforma Diluted Earnings (Loss) Per
Share..................................... $(0.18) $(0.18) $0.01 $0.84 $0.49
====== ====== ====== ======= =======
</TABLE>
F-19
<PAGE> 84
======================================================
NO DEALER, SALESMAN, OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS PROSPECTUS AND,
IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE RELIED UPON AS
HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY OTHER PERSONS. NEITHER THE DELIVERY
OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
COMPANY SINCE THE DATE HEREOF. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER OF
ANY SECURITIES OTHER THAN THOSE TO WHICH IT RELATES OR AN OFFER TO SELL, OR A
SOLICITATION OF AN OFFER TO BUY, TO ANY PERSON IN ANY JURISDICTION WHERE SUCH AN
OFFER OR SOLICITATION WOULD BE UNLAWFUL.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 10
The Rights Offering................... 20
Federal Income Tax Consequences....... 24
Use of Proceeds....................... 26
Dividend Policy....................... 26
Capitalization........................ 27
Selected Combined Financial Data...... 28
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 30
Business.............................. 38
Management............................ 50
Principal Stockholders................ 57
Certain Relationships and Related
Transactions........................ 59
Description of Capital Stock.......... 60
Shares Eligible for Future Sale....... 62
Legal Matters......................... 63
Experts............................... 63
Available Information................. 63
Index to Financial Statements......... F-1
</TABLE>
======================================================
======================================================
5,578,572
SHARES OF COMMON STOCK
AND
4,650,000
RIGHTS TO PURCHASE COMMON STOCK
[CYGNET LOGO]
------------------------
PROSPECTUS
------------------------
, 1998
======================================================
<PAGE> 85
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION
Other expenses in connection with the issuance and distribution of the
securities to be registered hereunder, all of which will be paid by the
registrant, will be substantially as follows:
<TABLE>
<CAPTION>
ITEM AMOUNT
- ---- --------
<S> <C>
SEC Registration Fee........................................ $ 11,520
*Exchange Filing Fee........................................ 58,725
*Blue Sky Fees and Expenses (including legal fees).......... 10,000
*Accounting Fees and Expenses............................... 75,000
*Legal Fees and Expenses.................................... 250,000
*Printing and Engraving..................................... 200,000
*Registrar and Transfer Agent's Fees........................ 10,000
*Miscellaneous Expenses..................................... 9,755
--------
Total............................................. $625,000
========
</TABLE>
- ---------------
* Estimated
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS
The Company's Certificate of Incorporation provides that to the fullest
extent permitted by Delaware law, a director of the Company shall not be
personally liable to the Company or its stockholders for monetary damages for
breach of such director's fiduciary duty except (i) for any breach of the
director's duty of loyalty to the Company or its stockholders; (ii) for acts or
omissions not in good faith or that involve intentional misconduct or a knowing
violation of law; (iii) for payments of dividends or stock purchases or
redemptions in violation of Section 174 of the Delaware General Corporation Law;
or (iv) for any transaction from which the director derived an improper personal
benefit. In addition, the Company's Certificate of Incorporation provides that
the Company shall to the fullest extent authorized by the Delaware General
Corporation Law, as the same exists or may hereafter be amended (but, in the
case of any such amendment, only to the extent that such amendment permits the
corporation to provide broader indemnification rights than such law permitted
the corporation to provide prior to such amendment), indemnify and hold harmless
any person who was or is a party, or is threatened to be made a party to or is
otherwise involved in any threatened, pending or completed action, suit or
proceeding, whether civil, criminal, administrative or investigative by reason
of the fact that such person is or was a director or officer of the corporation,
or is or was serving at the request of the corporation as a director, officer,
employee or agent of another corporation, partnership, joint venture, trust or
other enterprise, including service with respect to an employee benefit plan
(hereinafter an "Indemnitee") against expenses, liabilities and losses
(including attorneys' fees, judgments, fines, excise taxes or penalties paid in
connection with the Employee Retirement Income Security Act of 1974, as amended,
and amounts paid in settlement) reasonably incurred or suffered by such
Indemnitee in connection therewith; provided, however, that except as otherwise
provided with respect to proceedings to enforce rights to indemnification, the
Company shall indemnify any such Indemnitee in connection with a proceeding (or
part thereof) initiated by such Indemnitee only if such proceeding or part
thereof was authorized by the board of directors of the Company.
The right to indemnification set forth above includes the right to be paid
by the Company the expenses (including attorneys' fees) incurred in defending
any such proceeding in advance of its final disposition; provided, however,
that, if the Delaware General Corporation Law requires, an advancement of
expenses incurred by an Indemnitee in his capacity as a director or officer (and
not in any other capacity in which service was or is rendered by such
Indemnitee, including, without limitation, service to an employee benefit
II-1
<PAGE> 86
plan) shall be made only upon delivery to the Company of an undertaking, by or
on behalf of such Indemnitee, to repay all amounts so advanced if it shall
ultimately be determined by final judicial decision from which there is not
further right to appeal that such Indemnitee is not entitled to be indemnified
for such expenses under this section or otherwise. The rights to indemnification
and to the advancement of expenses described above are contract rights and
continue as to an Indemnitee who has ceased to be a director, officer, employee
or agent and inure to the benefit of the Indemnitee's heirs, executors and
administrators.
The Delaware General Corporation Law provides that indemnification is
permissible only when the director, officer, employee, or agent acted in good
faith and in a manner reasonably believed to be in or not opposed to the best
interests of the Company, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe the conduct was unlawful. The
Delaware General Corporation Law also precludes indemnification in respect of
any claim, issue, or matter as to which an officer, director, employee, or agent
shall have been adjudged to be liable to the Company unless and only to the
extent that the Court of Chancery or the court in which such action or suit was
brought shall determine that, despite such adjudication of liability but in view
of all the circumstances of the case, such person is fairly and reasonably
entitled to indemnity for such expenses which the Court of Chancery or such
other court shall deem proper.
For information regarding the Company's undertaking to submit to
adjudication the issue of indemnification for violation of the securities laws,
see Item 17 hereof.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES
The Company issued one share of Common Stock to UDC in consideration for
which UDC will pay $10,000. Exemption from registration for this transaction was
claimed pursuant to Section 4(2) of the Securities Act regarding transactions by
an issuer not involving any public offering.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULE
(a) Exhibits:
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ------- ----------------------
<C> <S>
3.1 Certificate of Incorporation of the Registrant
3.2 Bylaws of the Registrant
4.1 Certificate of Incorporation of the Registrant (filed as
Exhibit 3.1)
4.2 Form of Certificate representing Common Stock(1)
5 Opinion of Snell & Wilmer L.L.P. regarding the legality of
the securities being registered
11 Earnings (Loss) per Share Computation (see Note 13 to Notes
to Consolidated Financial Statements)
23.1 Consent of KPMG Peat Marwick LLP
23.2 Consent of Snell & Wilmer L.L.P. (included in Exhibit 5)
24 Power of Attorney (included in signature pages)
27 Financial Data Schedule
</TABLE>
- ---------------
(1) To be filed with a pre-effective amendment.
II-2
<PAGE> 87
ITEM 17. UNDERTAKINGS
The undersigned Registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement;
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant pursuant to the foregoing provisions, or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes to supplement the prospectus,
after the expiration of the subscription period, to set forth the results of the
subscription offer, the transactions by the underwriters during the subscription
period, the amount of unsubscribed securities to be purchased by the
underwriters, and the terms of any subsequent reoffering thereof. If any public
offering by the underwriters is to be made on terms differing from those set
forth on the cover page of the prospectus, a post-effective amendment will be
filed to set forth the terms of such offering.
The undersigned registration hereby undertakes to deliver or cause to be
delivered with the prospectus, to each person to whom the prospectus is sent or
given, the latest annual report, to security holders that is incorporated by
reference in the prospectus and furnished pursuant to and meeting the
requirements of Rule 14a-3 or Rule 14c-3 under the Securities Exchange Act of
1934; and, where interim financial information required to be presented by
Article 3 of Regulation S-X is not set forth in the prospectus, to deliver, or
cause to be delivered to each person to whom the prospectus is sent or given,
the latest quarterly
II-3
<PAGE> 88
report that is specifically incorporated by reference in the prospectus to
provide such interim financial information.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities Act
of 1933, the information omitted from the form of prospectus filed as part
of this Registration Statement in reliance upon Rule 430A and contained in
a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4), or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act of 1933, each post-effective amendment that contains a form of
prospectus shall be deemed to be a new Registration Statement relating to
the securities offered therein, and the offering of such securities at that
time shall be deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 89
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Phoenix, State of
Arizona, on June 19, 1998.
Cygnet Financial Corporation
By: /s/ ERNEST C. GARCIA, II
------------------------------------
Ernest C. Garcia, II
Chairman of the Board,
Chief Executive Officer, and
President
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS that each person whose signature appears
below constitutes and appoints Ernest C. Garcia, II and Steven P. Johnson, and
each of them, in his true and lawful attorneys-in-fact and agents, with full
power of substitution and resubstitution, for him and in his name, place and
stead, in any and all capacities, to sign any and all amendments to this Form
S-1 Registration Statement and to sign any registration statement for the same
offering that is to be effective upon filing pursuant to Rule 462(b) of the
Securities Act, and to file the same, with all exhibits thereto, and all
documents in connection therewith, with the Commission, granting unto said
attorneys-in-fact and agents, and each of them, in full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully and to all intents and purposes as he might
or could do in person hereby ratifying and confirming that all said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME AND SIGNATURE TITLE DATE
------------------ ----- ----
<C> <S> <C>
/s/ ERNEST C. GARCIA, II Chairman of the Board, Sole June 19, 1998
- --------------------------------------------------- Director, Chief Executive
Ernest C. Garcia, II Officer, and President (Principal
executive officer)
/s/ ERIC J. SPLAVER Chief Financial Officer (Principal June 19, 1998
- --------------------------------------------------- financial officer and principal
Eric J. Splaver accounting officer)
</TABLE>
II-5
<PAGE> 90
EXHIBIT INDEX
<TABLE>
<CAPTION>
SEQUENTIALLY
EXHIBIT NUMBERED
NUMBER DESCRIPTION OF EXHIBIT PAGE
- ------- ---------------------- ------------
<C> <S> <C>
3.1 Certificate of Incorporation of the Registrant
3.2 Bylaws of the Registrant
4.1 Certificate of Incorporation of the Registrant (filed as
Exhibit 3.1)
4.2 Form of Certificate representing Common Stock(1)
5 Opinion of Snell & Wilmer L.L.P. regarding the legality of
the securities being registered
11 Earnings (Loss) per Share Computation (see Note 13 to Notes
to Consolidated Financial Statements)
23.1 Consent of KPMG Peat Marwick LLP
23.2 Consent of Snell & Wilmer L.L.P. (included in Exhibit 5)
24 Power of Attorney (included in signature pages)
27 Financial Data Schedule
</TABLE>
- ---------------
(1) To be filed with a pre-effective amendment.
<PAGE> 1
EXHIBIT 3.1
CERTIFICATE OF INCORPORATION
OF
CYGNET FINANCIAL CORPORATION
ARTICLE ONE
The name of the corporation is CYGNET FINANCIAL CORPORATION.
ARTICLE TWO
The address of the corporation's registered office in the State of
Delaware is 1209 Orange Street, in the City of Wilmington, County of New Castle.
The name of its registered agent at such address is The Corporation Trust
Company.
ARTICLE THREE
The purpose of the corporation is to engage in any lawful act or
activity for which corporations may be organized under the General Corporation
Law of the State of Delaware.
ARTICLE FOUR
The Corporation shall have perpetual existence.
ARTICLE FIVE
A. The corporation shall be authorized to issue two classes of shares
of stock to be designated, respectively, "Common Stock" and "Preferred Stock";
the total number of shares of Common Stock that the corporation shall have
authority to issue shall be 14,000,000, and each of such shares shall have a par
value of $.001; and the total number of shares of Preferred Stock that the
corporation shall have the authority to issue shall be 500,000, and each of such
shares shall have a par value of $.001.
B. Shares of Preferred Stock may be issued from time to time in one
or more series as may from time to time be determined by the Board of Directors
of the corporation, each of said series to be distinctly designated. The voting
powers, preferences and relative, participating, optional, and other special
rights, and the qualifications, limitations, or restrictions thereof, if any, of
each such series may differ from those of any and all other series of Preferred
Stock at any time outstanding, and the Board of Directors
<PAGE> 2
is hereby expressly granted authority to fix or alter, by resolution or
resolutions, the designation, number, voting powers, preferences, and relative,
participating, optional, and other special rights, and the qualifications,
limitations, and restrictions thereof, of each such series.
ARTICLE SIX
The power to adopt, amend, and repeal any or all of the Bylaws of the
corporation is reserved to the Board of Directors of the corporation.
ARTICLE SEVEN
Election of members to the Board of Directors need not be by written
ballot unless the Bylaws of the corporation shall so provide.
Meetings of the stockholders of the corporation may be held within or
without the State of Delaware, as the Bylaws may provide. The books of the
corporation may be kept (subject to any provision contained in the Delaware
General Corporation Law) outside the State of Delaware at such place or places
as may be designated from time to time by the Board of Directors or in the
Bylaws of the corporation.
ARTICLE EIGHT
A director of the corporation shall not be personally liable to the
corporation or its stockholders for monetary damages for breach of fiduciary
duty as a director, except for liability (i) for any breach of the director's
duty of loyalty to the Corporation or its stockholders; (ii) for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law; (iii) under Section 174 of the Delaware General Corporation
Law; or (iv) for any transaction from which the director derived an improper
personal benefit. If the Delaware General Corporation Law is amended to
authorize corporate action further eliminating or limiting the personal
liability of directors, then the liability of a director of the corporation
shall be eliminated or limited to the fullest extent permitted by the Delaware
General Corporation Law, as so amended. Any repeal or modification of this
provision shall not adversely affect any right or protection of a director of
the corporation existing at the time of such repeal or modification. The
limitation of liability provided herein shall continue after a director has
ceased to occupy such position as to acts or omissions occurring during such
director's term or terms of office.
ARTICLE NINE
A. The corporation shall to the fullest extent authorized by the
Delaware
-2-
<PAGE> 3
General Corporation Law, as the same exists or may hereafter be amended (but, in
the case of any such amendment, only to the extent that such amendment permits
the corporation to provide broader indemnification rights than such law
permitted the corporation to provide prior to such amendment), indemnify and
hold harmless any person who was or is a party, or is threatened to be made a
party to or is otherwise involved in any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative or
investigative by reason of the fact that such person is or was a director or
officer of the corporation, or is or was serving at the request of the
corporation as a director, officer, employee or agent of another corporation,
partnership, joint venture, trust or other enterprise, including service with
respect to an employee benefit plan (hereinafter an "Indemnitee") against
expenses, liabilities and losses (including attorneys' fees, judgments, fines,
excise taxes or penalties paid in connection with the Employee Retirement Income
Security Act of 1974, as amended, and amounts paid in settlement) reasonably
incurred or suffered by such Indemnitee in connection therewith; provided,
however, that except as provided in this section with respect to proceedings to
enforce rights to indemnification, the corporation shall indemnify any such
Indemnitee in connection with a proceeding (or part thereof) initiated by such
Indemnitee only if such proceeding or part thereof was authorized by the board
of directors of this corporation.
B. The right to indemnification conferred in this section shall
include the right to be paid by the corporation the expenses (including
attorneys' fees) incurred in defending any such proceeding in advance of its
final disposition; provided, however, that, if the Delaware General Corporation
Law requires, an advancement of expenses incurred by an Indemnitee in his
capacity as a director or officer (and not in any other capacity in which
service was or is rendered by such Indemnitee, including, without limitation,
service to an employee benefit plan) shall be made only upon delivery to the
corporation of an undertaking, by or on behalf of such Indemnitee, to repay all
amounts so advanced if it shall ultimately be determined by final judicial
decision from which there is not further right to appeal that such Indemnitee is
not entitled to be indemnified for such expenses under this section or
otherwise. The rights to indemnification and to the advancement of expenses
conferred in this section shall be contract rights and such rights shall
continue as to an Indemnitee who has ceased to be a director, officer, employee
or agent and shall inure to the benefit of the Indemnitee's heirs, executors and
administrators.
C. If a claim under the two preceding paragraphs of this section is
not paid in full by the corporation within sixty (60) days after a written claim
has been received by the corporation, except in the case of a claim for an
advancement of expenses, in which case the applicable period shall be twenty
(20) days, the Indemnitee may at any time thereafter bring suit against the
corporation to recover the unpaid amount of the claim. If successful in whole or
in part in any such suit, or in a suit brought by the corporation to recover an
advancement of expenses pursuant to the terms of an undertaking, the Indemnitee
shall be
-3-
<PAGE> 4
entitled to be paid also the expense of prosecuting or defending such suit. In
(i) any suit brought by the Indemnitee to enforce a right to indemnification
hereunder (but not in a suit brought by the Indemnitee to enforce a right to an
advancement of expenses) and (ii) in any suit brought by the corporation to
recover an advancement of expenses pursuant to the terms of an undertaking, the
corporation shall be entitled to recover such expenses upon a final adjudication
that the Indemnitee has not met any applicable standard for indemnification set
forth in the Delaware General Corporation Law. Neither the failure of the
corporation (including its board of directors, independent legal counsel, or its
stockholders) to have made a determination prior to the commencement of such
suit that indemnification of the Indemnitee is proper in the circumstances
because the Indemnitee has met the applicable standard of conduct set forth in
the Delaware General Corporation Law, nor an actual determination by the
corporation (including its board of directors, independent legal counsel, or its
stockholders) that the Indemnitee has not met such applicable standard of
conduct, shall create a presumption that the Indemnitee has not met the
applicable standard of conduct or, in the case of such a suit brought by the
Indemnitee, be a defense to such suit. In any suit brought by the Indemnitee to
enforce a right to indemnification or to an advancement of expenses hereunder,
or brought by the corporation to recover an advancement of expenses pursuant to
the terms of an undertaking, the burden of proving that the Indemnitee is not
entitled to be indemnified, or to such advancement of expenses under this
section or otherwise shall be on the corporation.
D. The rights to indemnification and advancement of expenses
conferred in this section shall not be exclusive of any other rights which any
person may have or hereafter acquire under any statute, the corporation's
certificate of incorporation, as it may be amended or restated from
time-to-time, any agreement, vote of stockholders or disinterested directors, or
otherwise. No amendment or repeal of this Article Nine shall apply to or have
any effect on any right to indemnification provided hereunder with respect to
any acts or omissions occurring prior to such amendment or repeal.
E. The corporation shall have the power to purchase and maintain
insurance, at its expense, to protect itself and any director, officer, employee
or agent of the corporation or another corporation, partnership, joint venture,
trust or other enterprise (including an employee benefit plan) against any
expense, liability or loss, whether or not the corporation would have the power
to indemnify such person against such expense, liability or loss under the
Delaware General Corporation Law. The corporation may also create a trust fund,
grant a security interest and/or use other means (including, but not limited to
letters of credit, surety bonds and/or similar arrangements), as well as enter
into contracts providing indemnification to the full extent authorized or
permitted by law and including as part thereof provisions with respect to any or
all of the foregoing, to ensure the payment of such amounts as may become
necessary to effect indemnification as provided therein, or elsewhere.
-4-
<PAGE> 5
F. For purposes of this section, references to the "corporation"
shall include any subsidiary of this corporation from and after the acquisition
thereof by this corporation, so that any person who is a director, officer,
employee or agent of such subsidiary after the acquisition thereof by this
corporation shall stand in the same position under the provisions of this
section as such person would have had such person served in such position for
this corporation.
G. The corporation may, to the extent authorized from time to time by
the board of directors, grant rights to indemnification and to the advancement
of expenses to any employee or agent of the corporation to the fullest extent of
the provisions of this section with respect to the indemnification and
advancement of expenses of directors and officers of the corporation.
ARTICLE TEN
The name and mailing address of the incorporator is Steven P.
Johnson, 2525 East Camelback Road, Suite 1150, Phoenix, Arizona 85016.
ARTICLE ELEVEN
The number of directors constituting the initial Board of Directors
of the corporation is one (1). The size of the Board of Directors may be
increased or decreased in the manner provided in the Bylaws of the corporation.
All corporate powers of the corporation shall be exercised by or under the
direction of the Board of Directors except as otherwise provided herein or by
law. The name and address of the persons who are to serve as directors until the
first annual meeting of stockholders or until their successors are elected and
qualified are:
-5-
<PAGE> 6
Name Address
---- -------
Ernest C. Garcia, II 2525 East Camelback Road, Suite 1150
Phoenix, Arizona 85016
ARTICLE TWELVE
Subject to any conditions imposed by law, the corporation expressly
denies the application of the Arizona Corporate Takeover Laws, Arizona Revised
Statutes Sections 10-2701 et seq., or any successor thereto.
ARTICLE THIRTEEN
The corporation reserves the right to amend, alter, change, or repeal
any provision contained in this Certificate of Incorporation, in the manner now
or hereafter prescribed by the Delaware General Corporation Law.
I, THE UNDERSIGNED, for the purposes of forming a corporation under
the laws of the State of Delaware, do make, file and record this Certificate,
and do certify that the facts herein stated are true.
DATED this ____ day of June, 1998.
___________________________________
Steven P. Johnson
Incorporator
-6-
<PAGE> 1
EXHIBIT 3.2
BY-LAWS
OF
CYGNET FINANCIAL CORPORATION
(the "Corporation")
ARTICLE 1
OFFICES
Section 1.1 Registered Office. The registered office of the
Corporation shall be in the City of Wilmington, County of New Castle, State of
Delaware.
Section 1.2 Other Offices. The Corporation may also have offices at
such other places both within and without the State of Delaware as the Board of
Directors or the officers may from time to time determine.
ARTICLE 2
MEETINGS OF STOCKHOLDERS
Section 2.1 Place of Meetings. Meetings of the stockholders for the
election of directors or for any other purpose shall be held at such time and
place, either within or without the State of Delaware, as shall be designated
from time to time by the Board of Directors and stated in the notice of the
meeting or in a duly executed waiver of notice thereof.
Section 2.2 Annual Meetings. The annual meetings of stockholders
shall be held on such date and at such time as shall be designated from time to
time by the Board of Directors and stated in the notice of the meeting, at which
meetings the stockholders shall elect by a plurality vote members of the Board
of Directors in the class whose term shall expire at such annual meeting, and
transact such other business as may properly be brought before the meeting.
Written notice of the annual meeting stating the place, date and hour of the
meeting shall be given to each stockholder entitled to vote at such meeting not
less than ten nor more than sixty days before the date of the meeting.
Section 2.3 Special Meetings. Unless otherwise prescribed by law or
by the Certificate of Incorporation, special meetings of stockholders, for any
purpose or purposes, may be called by either the Chairman, the President, or the
holders of 10% or more of the issued and outstanding shares of capital stock
entitled to vote thereat and shall be called by either such officer
<PAGE> 2
at the request in writing of a majority of the Board of Directors. Such request
shall state the purpose or purposes of the proposed meeting. Written notice of a
special meeting stating the place, date and hour of the meeting and the purpose
or purposes for which the meeting is called shall be given not less than ten nor
more than sixty days before the date of the meeting to each stockholder entitled
to vote at such meeting.
Section 2.4 Quorum. Except as otherwise provided by law or by the
Certificate of Incorporation, the holders of a majority of the capital stock
issued and outstanding and entitled to vote thereat, present in person or
represented by proxy, shall constitute a quorum at all meet ings of the
stockholders for the transaction of business. If, however, such quorum shall not
be present or represented at any meeting of the stockholders, the stockholders
entitled to vote thereat, present in person or represented by proxy, shall have
power to adjourn the meeting from time to time, without notice other than
announcement at the meeting, until a quorum shall be present or represented. At
such adjourned meeting at which a quorum shall be present or represented, any
business may be transacted which might have been transacted at the meeting as
originally noticed. If the adjournment is for more than thirty days, or if after
the adjournment a new record date is fixed for the adjourned meeting, a notice
of the adjourned meeting shall be given not less than ten nor more than sixty
days before the date of the adjourned meeting to each stockholder entitled to
vote at the meeting.
Section 2.5 Voting. Unless otherwise required by law, the
Certificate of Incorporation or these By-Laws, any question brought before any
meeting of stockholders shall be decided by the vote of the holders of a
majority of the stock represented and entitled to vote thereat. Each stockholder
represented at a meeting of stockholders shall be entitled to cast one vote for
each share of the capital stock entitled to vote thereat held by such
stockholder. Such votes may be cast in person or by proxy but no proxy shall be
voted on or after three years from its date, unless such proxy provides for a
longer period. The Board of Directors, in its discretion, or the officer of the
Corporation presiding at a meeting of stockholders, in such officer's
discretion, may require that any votes cast at such meeting shall be cast by
written ballot.
Section 2.6 List of Stockholders Entitled to Vote. The officer of
the Corporation who has charge of the stock ledger of the Corporation shall
prepare and make, at least ten days before every meeting of stockholders, a
complete list of the stockholders entitled to vote at the meeting, arranged in
alphabetical order, and showing the address of each stockholder and the number
of shares registered in the name of each stockholder. Such list shall be open to
the examination of any stockholder, for any purpose germane to the meeting,
during ordinary business hours, for a period of at least ten days prior to the
meeting, either at a place within the city where the meeting is to be held,
which place shall be specified in the notice of the meeting, or, if not so
specified, at the place where the meeting is to be held. The list shall also be
produced and kept at the time and place of the meeting during the whole time
thereof, and may be inspected by any stockholder of the Corporation who is
present.
2
<PAGE> 3
Section 2.7 Stock Ledger. The stock ledger of the Corporation shall
be the only evidence as to who are the stockholders entitled to examine the
stock ledger, the list required by Section 2.6 or the books of the Corporation,
or to vote in person or by proxy at any meeting of stockholders. Any good faith
decision in regard to such matters by the officer of the Corporation who has
charge of the stock ledger of the Corporation, which may be the Secretary, any
Assistant Secretary or any other appropriate officer of the Corporation, shall
be final.
Section 2.8 Nomination of Directors. Only persons who are nominated
in accordance with the following procedures shall be eligible for election as
directors of the Corporation. Nominations of persons for election to the Board
of Directors may be made at any annual meeting of stockholders (a) by or at the
direction of the Board of Directors (or any duly authorized committee thereof)
or (b) by any stockholder of the Corporation (i) who is a stockholder of record
on the date of the giving of the notice provided for in this Section 2.8 and on
the record date for the determination of stockholders entitled to vote at such
annual meeting and (ii) who complies with the notice procedures set forth in
this Section 2.8.
In addition to any other applicable requirements, for a nomination
to be made by a stockholder, such stockholder must have given timely notice
thereof in proper written form to the Secretary of the Corporation, as
prescribed below.
No person shall be elected to the Board of Directors of this
Corporation at an annual meeting of the stockholders, or at a special meeting
called for that purpose, unless, with respect to a person nominated by a
stockholder of the Corporation, a written notice of nomination of such person by
the stockholder shall have been received by the Secretary of the Corporation at
least ninety (90) days prior to the anniversary date of the immediately
preceding annual meeting if an annual meeting, or seven (7) days after notice of
the meeting is mailed to stockholders if a special meeting. Each such notice
shall set forth: (a) the name and address of the stockholder who intends to make
the nomination and of the person or persons to be nominated; (b) a
representation that the stockholder is a holder of record of stock of the
Corporation entitled to vote at such meeting (including the number of shares of
stock of the Corporation owned beneficially or of record by such stockholder and
the nominee or nominees) and intends to appear in person or by proxy at the
meeting to nominate the person or persons specified in the notice; (c) a
description of all arrangements or understandings between the stockholders and
each nominee and any other person or persons (naming such person or persons)
pursuant to which the nomination or nominations are to be made by the
stockholder; (d) such other information regarding each nominee proposed by such
stockholder as would have been required to be included in a proxy statement
filed pursuant to the proxy rules of the Securities and Exchange Commission had
each nominee been nominated, or intended to be nominated, by the Board of
Directors; and (e) the consent of each nominee to serve as a director of the
Corporation if so elected.
No person shall be eligible for election as a director of the
Corporation unless nominated in accordance with the procedures set forth in this
Section 2.8. If the Chairman of the meeting determines that a nomination was not
made in accordance with the foregoing procedures,
3
<PAGE> 4
the Chairman shall declare to the meeting that the nomination was defective and
such defective nomination shall be disregarded.
Notwithstanding compliance with the foregoing provisions, the Board
of Directors shall not be obligated to include information as to any stockholder
nominee for director in any proxy statement or other communication sent to
stockholders.
Section 2.9 Business at Annual Meetings. No business may be
transacted at an annual meeting of stockholders, other than business that is
either (a) specified in the notice of meeting (or any supplement thereto) given
by or at the direction of the Board of Directors (or any duly authorized
committee thereof), (b) otherwise properly brought before the annual meeting by
or at the direction of the Board of Directors (or any duly authorized committee
thereof) or (c) otherwise properly brought before the annual meeting by any
stockholder of the Corporation (i) who is a stockholder of record on the date of
the giving of the notice provided for in this Section 2.9 and on the record date
for the determination of stockholders entitled to vote at such annual meeting
and (ii) who complies with the notice procedures set forth in this Section 2.9.
In addition to any other applicable requirements, for business to be
properly brought before an annual meeting by a stockholder, such stockholder
must have given timely notice thereof in proper written form to the Secretary of
the Corporation.
To be timely, a stockholder's notice to the Secretary must be
delivered to or mailed and received at the principal executive offices of the
Company not less than sixty (60) days nor more than ninety (90) days prior to
the anniversary date of the immediately preceding annual meeting of
stockholders; provided, however, that in the event that the annual meeting is
called for a date that is not within thirty (30) days before or after such
anniversary date, notice by the stock holder in order to be timely must be so
received not later than the close of business on the tenth day following the day
on which such notice of the date of the annual meeting was mailed or such public
disclosure of the date of the annual meeting was made, whichever first occurs.
To be in proper written form, a stockholder's notice to the
Secretary must set forth as to each matter such stockholder proposes to bring
before the annual meeting (i) a brief description of the business desired to be
brought before the annual meeting and the reasons for conducting such business
at the annual meeting, (ii) the name and record address of such stockholder,
(iii) the class or series and number of shares of capital stock of the
Corporation that are owned beneficially or of record by such stockholder, (iv) a
description of all arrangements or understandings between such stockholder and
any other person or persons (including their names) in connection with the
proposal of such business by such stockholder and any material interest of such
stockholder in such business and (v) a representation that such stockholder
intends to appear in person or by proxy at the annual meeting to bring such
business before the meeting.
No business shall be conducted at the annual meeting of stockholders
except business brought before the annual meeting in accordance with the
procedures set forth in this
4
<PAGE> 5
Section 2.9, provided, however, that, once business has been properly brought
before the annual meeting in accordance with such procedures, nothing in this
Section 2.9 shall be deemed to preclude discussion by any stockholder of any
such business. If the Chairman of an annual meeting determines that business was
not properly brought before the annual meeting in accordance with the foregoing
procedures, the Chairman shall declare to the meeting that the business was not
properly brought before the meeting and such business shall not be transacted.
ARTICLE 3
DIRECTORS
Section 3.1 Duties and Powers. The business and affairs of the
Corporation shall be managed and controlled by a Board of Directors, which may
exercise all such powers of the Corporation and do all such lawful acts and
things as are not by statute or by the Certificate of Incorporation or by these
By-Laws directed or required to be exercised or done by the stockholders.
Section 3.2 Number. The first Board of Directors shall consist of
the persons named in the Certificate of Incorporation. Thereafter, the Board
shall consist of not less than one (1) nor more than nine (9) members. The Board
of Directors will have the power to increase or decrease its size within the
aforesaid limits and to fill any vacancies that may occur in its membership,
whether resulting from an increase in the size of the Board or otherwise.
Section 3.3 Election of Directors. Directors shall be elected by a
plurality of the votes cast at annual meetings of stockholders. Any director may
resign at any time upon notice to the Corporation. Directors need not be
stockholders. Each director elected shall hold office until his or her successor
is duly elected and qualified.
Section 3.4 Meetings. The Board of Directors of the Corporation may
hold meetings both regular and special, either within or without the State of
Delaware. Regular meetings of the Board of Directors may be held without notice
at such time and at such place as may from time to time be determined by the
Board of Directors. Special meetings of the Board of Directors may be called by
the Chairman or the President or by a majority of the directors then in office.
Notice thereof stating the place, date and hour of the meeting shall be given to
each director either by mail not less than forty-eight hours before the date of
the meeting, by telephone, facsimile or telegram on twenty-four hours' notice,
or on such shorter notice as the person or per sons calling such meeting may
deem necessary or appropriate in the circumstances.
Section 3.5 Quorum. Except as may be otherwise specifically provided
by law, the Certificate of Incorporation or these By-Laws, at all meetings of
the Board of Directors, a majority of the entire Board of Directors shall
constitute a quorum for the transaction of business and the act of a majority of
the directors present at any meeting at which there is a quorum shall
5
<PAGE> 6
be the act of the Board of Directors. If a quorum shall not be present at any
meeting of the Board of Directors, the directors present thereat may adjourn the
meeting from time to time, without notice other than announcement at the
meeting, until a quorum shall be present.
Section 3.6 Actions of Board. Unless otherwise provided by the
Certificate of Incorporation or these By-Laws, any action required or permitted
to be taken at any meeting of the Board of Directors or of any committee thereof
may be taken without a meeting, if all the members of the Board of Directors or
committee, as the case may be, consent thereto in writing, and the writing or
writings are filed with the minutes of proceedings of the Board of Directors or
committee.
Section 3.7 Meetings by Means of Conference Telephone. Unless
otherwise provided by the Certificate of Incorporation or these By-Laws, members
of the Board of Directors of the Corporation, or any committee designated by the
Board of Directors, may participate in a meeting of the Board of Directors or
such committee by means of a conference telephone or similar communications
equipment by means of which all persons participating in the meeting can hear
each other, and participation in a meeting pursuant to this Section 3.6 shall
constitute presence in person at such meeting.
Section 3.8 Committees. The Board of Directors may, by resolution
passed by a majority of the entire Board of Directors, designate one or more
committees, each committee to consist of one or more of the directors of the
Corporation. The Board of Directors may designate one or more directors as
alternate members of any committee, who may replace any absent or disqualified
member at any meeting of any such committee. In the absence or disqualification
of a member of a committee, and in the absence of a designation by the Board of
Directors of an alternate member to replace the absent or disqualified member,
the member or members thereof present at any meeting and not disqualified from
voting, whether or not he or they constitute a quorum, may unanimously appoint
another member of the Board of Directors to act at the meeting in the place of
any absent or disqualified member. A majority of the members of a committee,
including any alternate members, shall constitute a quorum of such committee.
Any committee, to the extent allowed by law and provided in the resolution
establishing such committee, shall have and may exercise all the powers and
authority of the Board of Directors in the management of the business and
affairs of the Corporation. Each committee shall keep regular minutes and report
to the Board of Directors when required.
Section 3.9 Compensation. The directors may be paid their expenses,
if any, of attendance at each meeting of the Board of Directors and may be paid
a fixed sum for attendance at each meeting of the Board of Directors or a stated
salary as director. No such payment shall preclude any director from serving the
Corporation in any other capacity and receiving compensa tion therefor. Members
of special or standing committees may be allowed like compensation for attending
committee meetings. In addition, the Board of Directors may adopt one or more
director compensation plans using securities of the Corporation.
6
<PAGE> 7
Section 3.10 Interested Directors. No contract or transaction
between the Corporation and one or more of its directors or officers, or between
the Corporation and any other corporation, partnership, association, or other
organization in which one or more of its directors or officers are directors or
officers, or have a financial interest, shall be void or voidable solely for
this reason, or solely because the director or officer is present at or
participates in the meeting of the Board of Directors or committee thereof which
authorizes the contract or transaction, or solely because such director's vote
is counted for such purpose if (i) the material facts as to such director's
relationship or interest and as to the contract or transaction are disclosed or
are known to the Board of Directors or the committee, and the Board of Directors
or committee in good faith authorizes the contract or transaction by the
affirmative votes of a majority of the disinterested directors, even though the
disinterested directors be less than a quorum; or (ii) the material facts as to
such director's relationship or interest and as to the contract or transaction
are disclosed or are known to the stockholders entitled to vote thereon, and the
contract or transaction is spe cifically approved in good faith by vote of the
stockholders; or (iii) the contract or transaction is fair as to the Corporation
as of the time it is authorized, approved or ratified, by the Board of
Directors, a committee thereof or the stockholders. Interested directors may be
counted in determining the presence of a quorum at a meeting of the Board of
Directors or of a committee which authorizes the contract or transaction.
ARTICLE 4
OFFICERS
Section 4.1 General. The officers of the Corporation shall be chosen
by the Board of Directors and may include a President, a Secretary and a
Treasurer. The Board of Directors, in its discretion, may also choose a Chairman
of the Board of Directors (who must be a director) and one or more Vice
Presidents, Assistant Secretaries, Assistant Treasurers and other officers. Any
number of offices may be held by the same person, unless otherwise prohibited by
law, the Certificate of Incorporation or these By-Laws. The officers of the
Corporation need not be stockholders of the Corporation nor, except in the case
of the Chairman of the Board of Directors, need such officers be directors of
the Corporation. The officers of the Corporation may sign and execute documents
on behalf of the Corporation, whether requiring a seal or otherwise, when
authorized by these By-Laws, the Board of Directors, the Chairman or President.
Section 4.2 Election. The Board of Directors at its first meeting
held after each annual meeting of stockholders shall elect the officers of the
Corporation who shall hold their offices for such terms and shall exercise such
powers and perform such duties as shall be deter mined from time to time by the
Board of Directors; and all officers of the Corporation shall hold office until
their successors are chosen and qualified, or until their earlier resignation or
removal. Any officer elected by the Board of Directors may be removed at any
time by the affirmative vote of a majority of the Board of Directors. Any
vacancy occurring in any office of the Corporation
7
<PAGE> 8
shall be filled by the Board of Directors. The salaries of all officers of the
Corporation shall be fixed by the Board of Directors or by a committee thereof.
Section 4.3 Voting Securities Owned by the Corporation. Powers of
attorney, proxies, waivers of notice of meeting, consents and other instruments
relating to securities owned by the Corporation may be executed in the name of
and on behalf of the Corporation by the Chairman, President or any Vice
President and any such officer may, in the name of and on behalf of the
Corporation, take all such action as any such officer may deem advisable to vote
in person or by proxy at any meeting of security holders of any corporation in
which the Corporation may own securities and at any such meeting shall possess
and may exercise any and all rights and power incident to the ownership of such
securities and which, as the owner thereof, the Corporation might have exercised
and possessed if present. The Board of Directors may, by resolution, from time
to time confer like powers upon any other person or persons.
Section 4.4 Chairman of the Board of Directors. The Chairman of the
Board of Directors, if there be one, shall preside at all meetings of the
stockholders and of the Board of Directors. The Chairman shall be the Chief
Executive Officer of the Corporation, and except where by law the signature of
the President is required, the Chairman of the Board of Directors shall possess
the same power as the President to sign all contracts, certificates and other
instruments of the Corporation which may be authorized by the Board of
Directors. During the absence or disability of the President, the Chairman of
the Board of Directors shall exercise all the powers and discharge all the
duties of the President. The Chairman of the Board of Directors shall also
perform such other duties and may exercise such other powers as from time to
time may be assigned to the Chairman by these By-Laws or by the Board of
Directors. All officers of the Corporation shall be under the supervision of the
Chairman, if there be one, and shall perform all such duties as shall be
assigned by the Chairman.
Section 4.5 President. The President, if there shall be one, shall,
subject to the control of the Board of Directors and, if there be one, the
Chairman of the Board of Directors, have general supervision of the business of
the Corporation and shall see that all orders and resolutions of the Board of
Directors are carried into effect. In the absence or disability of the Chairman
of the Board of Directors, or if there be none, the President shall preside at
all meetings of the stockholders and the Board of Directors. If there be no
Chairman of the Board of Directors, the President shall be the Chief Executive
Officer of the Corporation. The President shall also perform such other duties
and may exercise such other powers as from time to time may be assigned to the
President by these By-Laws, by the Board of Directors or by the Chairman.
Section 4.6 Vice Presidents. At the request of the President or in
the President's absence or in the event of the President's inability or refusal
to act (and if there be no Chairman of the Board of Directors), the Vice
President or the Vice Presidents if there is more than one (in the order
designated by the Board of Directors) shall perform the duties of the President,
and when so acting, shall have all the powers of and be subject to all the
restrictions upon the President.
8
<PAGE> 9
Each Vice President shall perform such other duties and have such other powers
as the Board of Directors, Chairman and/or the President from time to time may
prescribe.
Section 4.7 Secretary. The Secretary shall attend all meetings of
the Board of Directors and all meetings of stockholders and record all the
proceedings thereat in a book or books to be kept for that purpose; the
Secretary shall also perform like duties for the standing committees when
requested or appropriate. The Secretary shall give, or cause to be given, notice
of all meetings of the stockholders and special meetings of the Board of
Directors, and shall perform such other duties as may be prescribed by the Board
of Directors, Chairman or President. If the Secretary shall be unable or shall
refuse to cause to be given notice of all meetings of the stockholders and
special meetings of the Board of Directors, and if there be no Assistant Secre
tary, then either the Board of Directors or the President may choose another
officer to cause such notice to be given. The Secretary shall have custody of
the seal of the Corporation, if there is one, and the Secretary or any Assistant
Secretary, shall have authority to affix the same to any instrument requiring it
and when so affixed, it may be attested by the signature of the Secretary or by
the signature of any Assistant Secretary. The Board of Directors may give
general authority to any other officer to affix the seal of the Corporation and
to attest the affixing by such officer's signature. The Secretary shall see that
all books, reports, statements, certificates and other documents and records
required by law to be kept or filed are properly kept or filed, as the case may
be.
Section 4.8 Treasurer. The Treasurer shall supervise the maintenance
of the corporate funds and securities and shall keep full and accurate accounts
of receipts and disbursements in books belonging to the Corporation and shall
deposit all moneys and other valuable effects in the name and to the credit of
the Corporation in such depositories as may be designated by the Board of
Directors or Chairman. The Treasurer shall disburse the funds of the Corporation
as may be ordered by the Board of Directors, Chairman or President for such
disbursements, and shall render to the Chairman, President and the Board of
Directors, at its regular meetings, or when the Board of Directors or Chairman
so requires, an account of all transactions as Treasurer and of the financial
condition of the Corporation. The Treasurer shall perform such other duties and
have such powers as the Board of Directors, Chairman and/or President from time
to time may prescribe. If required by the Board of Directors or Chairman, the
Treasurer shall give the Corporation a bond in such sum and with such surety or
sureties as shall be satisfactory to the Board of Directors or Chairman for the
faithful performance of the duties of such office and for the restoration to the
Corporation, in case of the Treasurer's death, resignation, retirement or
removal from office, of all books, papers, vouchers, money and other property of
whatever kind in the Treasurer's possession or under such officer's control
belonging to the Corporation.
Section 4.9 Assistant Secretaries. Assistant Secretaries, if there
be any, shall per form such duties and have such powers as from time to time may
be assigned to them by the Board of Directors, the Chairman, the President, any
Vice President, if there be one, or the Secretary, and in the absence of the
Secretary or in the event of such officer's disability or refusal to act,
9
<PAGE> 10
shall perform the duties of the Secretary, and when so acting, shall have all
the powers of and be subject to all the restrictions upon the Secretary.
Section 4.10 Assistant Treasurers. Assistant Treasurers, if there be
any, shall perform such duties and have such powers as from time to time may be
assigned to them by the Board of Directors, the Chairman, the President, any
Vice President, if there be one, or the Treasurer, and in the absence of the
Treasurer or in the event of such officer's disability or refusal to act, shall
perform the duties of the Treasurer, and when so acting, shall have all the
powers of and be subject to all the restrictions upon the Treasurer. If required
by the Board of Directors or Chairman, an Assistant Treasurer shall give the
Corporation a bond in such sum and with such surety or sureties as shall be
satisfactory to the Board of Directors or Chairman for the faithful performance
of the duties of such officer's office and for the restoration to the
Corporation, in case of the Assistant Treasurer's death, resignation, retirement
or removal from office, of all books, papers, vouchers, money and other property
of whatever kind in such officer's possession or under such officer's control
belonging to the Corporation.
Section 4.11 Other Officers. Such other officers as the Board of
Directors may choose shall perform such duties and have such powers as from time
to time may be assigned to them by the Board of Directors, Chairman, or
President. The Board of Directors may delegate to any other officer of the
Corporation the power to choose such other officers and to prescribe their
respective duties and powers.
ARTICLE 5
STOCK
Section 5.1 Form of Certificates. Every holder of stock in the
Corporation shall be entitled to have a certificate signed, in the name of the
Corporation (i) by the Chairman of the Board of Directors, the President or a
Vice President and (ii) by the Treasurer or an Assistant Treasurer, or the
Secretary or an Assistant Secretary of the Corporation, certifying the number of
shares owned by such holder in the Corporation.
Section 5.2 Signatures. Where a certificate is countersigned by (i)
a transfer agent other than the Corporation or its employee, or (ii) a registrar
other than the Corporation or its employee, any other signature on the
certificate may be a facsimile. In case any officer, transfer agent or registrar
who has signed or whose facsimile signature has been placed upon a certificate
shall have ceased to be such officer, transfer agent or registrar before such
certificate is issued, it may be issued by the Corporation with the same effect
as if such person were such officer, transfer agent or registrar at the date of
issue.
Section 5.3 Lost Certificates. The Secretary may direct a new
certificate to be issued in place of any certificate theretofore issued by the
Corporation alleged to have been lost,
10
<PAGE> 11
stolen or destroyed, upon the making of an affidavit of that fact by the person
claiming the certificate of stock to be lost, stolen or destroyed. When
authorizing such issue of a new certifi cate, the Secretary may, in such
officer's discretion and as a condition precedent to the issuance thereof,
require the owner of such lost, stolen or destroyed certificate, or such owner's
legal representative, to advertise the same in such manner as the Secretary
shall require and/or to give the Corporation a bond in such sum as it may direct
as indemnity against any claim that may be made against the Corporation with
respect to the certificate alleged to have been lost, stolen or destroyed.
Section 5.4 Transfers. Stock of the Corporation shall be
transferable in the manner prescribed by law and in these By-Laws. Transfers of
stock shall be made on the books of the Corporation only by the person named in
the certificate or by such person's attorney lawfully constituted in writing and
upon the surrender of the certificate therefor, which shall be cancelled before
a new certificate shall be issued.
Section 5.5 Record Date. In order that the Corporation may determine
the stockholders entitled to notice of or to vote at any meeting of stockholders
or any adjournment thereof, or entitled to receive payment of any dividend or
other distribution or allotment of any rights, or entitled to exercise any
rights in respect of any change, conversion or exchange of stock, or for the
purpose of any other lawful action, the Board of Directors may fix, in advance,
a record date, which shall not be more than sixty days nor less than ten days
before the date of such meet ing, nor more than sixty days prior to any other
action. A determination of stockholders of record entitled to notice of or to
vote at a meeting of stockholders shall apply to any adjournment of the meeting;
provided, however, that the Board of Directors may fix a new record date for the
adjourned meeting.
Section 5.6 Beneficial Owners. The Corporation shall be entitled to
recognize the exclusive right of a person registered on its books as the owner
of shares to receive dividends, and to vote as such owner, and to hold liable
for calls and assessments a person registered on its books as the owner of
shares, and shall not be bound to recognize any equitable or other claim to or
interest in such share or shares on the part of any other person, whether or not
it shall have express or other notice thereof, except as otherwise provided by
law.
ARTICLE 6
NOTICES
Section 6.1 Notices. Whenever written notice is required by law, the
Certificate of Incorporation or these By-Laws, to be given to any director,
member of a committee or stock holder, such notice may be given by mail,
addressed to such director, member of a committee or stockholder, at such
person's address as it appears on the records of the Corporation, with postage
thereon prepaid or such notice may be given personally, by facsimile, overnight
delivery,
11
<PAGE> 12
telegram, telex, or cable at such address. Such notice shall be deemed to be
given at the earlier of receipt of such notice or at the time when the same
shall be deposited in the United States mail or otherwise transmitted.
Section 6.2 Waivers of Notice. Whenever any notice is required by
law, the Certificate of Incorporation or these By-Laws, to be given to any
director, member of a committee or stockholder, a waiver thereof in writing,
signed by the person or persons entitled to said notice, whether before or after
the time stated therein, shall be deemed equivalent thereto.
ARTICLE 7
GENERAL PROVISIONS
Section 7.1 Dividends. Dividends upon the capital stock of the
Corporation, subject to the provisions of the Certificate of Incorporation, if
any, may be declared by the Board of Directors at any regular or special
meeting, and may be paid in cash, in property, or in shares of the capital
stock. Before payment of any dividend, there may be set aside out of any funds
of the Corporation available for dividends such sum or sums as the Board of
Directors from time to time, in its absolute discretion, deems proper as a
reserve or reserves for any proper purpose, and the Board of Directors may
modify or abolish any such reserve.
Section 7.2 Disbursements. All checks or demands for money and notes
of the Corporation shall be signed by such officer or officers or such other
person or persons as the Board of Directors may from time to time designate.
Section 7.3 Fiscal Year. The fiscal year of the Corporation shall be
fixed by resolution of the Board of Directors.
Section 7.4 Corporate Seal. The Corporation may have a corporate
seal, which shall have inscribed thereon the words "Corporate Seal". The seal
may be used by causing it or a facsimile thereof to be impressed or affixed or
reproduced or otherwise. However, nothing in these By-Laws or in the Certificate
of Incorporation of the Corporation shall be construed to require a corporate
seal to be affixed to any document.
ARTICLE 8
AMENDMENTS
Section 8.1 These By-Laws may be altered, amended or repealed, in
whole or in part, or new By-Laws may be adopted by the stockholders or by the
Board of Directors; provided, however, that notice of such alteration,
amendment, repeal or adoption of new By-Laws be
12
<PAGE> 13
contained in the notice of such meeting of stockholders or Board of Directors as
the case may be. All such amendments must be approved by either the holders of a
majority of the outstanding capi tal stock entitled to vote thereon or by a
majority of the entire Board of Directors then in office.
Section 8.2 Entire Board of Directors. As used in this Article and
in these ByLaws generally, the term "entire Board of Directors" means the total
number of directors which the Corporation would have if there were no vacancies.
13
<PAGE> 1
Exhibit 5
June 19, 1998
Cygnet Financial Corporation
2525 East Camelback Road, Suite 1150
Phoenix, Arizona 85016
Re: Registration Statement on Form S-1
Ladies and Gentlemen:
We have acted as counsel to Cygnet Financial Corporation, a Delaware
corporation (the "Company"), in connection with the preparation and filing with
the United States Securities and Exchange Commission under the Securities Act of
1933, as amended (the "Securities Act"), of the Company's Registration Statement
on Form S-1 (the "Registration Statement"), relating to the registration of
4,650,000 transferable rights (the "Rights") to subscribe for shares of common
stock, $.001 par value ("Common Stock") and 5,578,571 shares of Common Stock
(the "Company Common Stock"). In arriving at the opinion expressed below, we
have reviewed the Registration Statement and the exhibits thereto. In addition,
we have reviewed the originals or copies certified or otherwise identified to
our satisfaction, of all such corporate records of the Company and such other
instruments and other certificates of public officials, officers and
representatives of the Company, and other persons, and we have made such
investigation of law, as we have deemed appropriate as a basis for the opinions
expressed below. In rendering the opinions expressed below, we have assumed (i)
the genuineness of signatures not witnessed, the authenticity of documents
submitted as originals, and the conformity to originals of documents submitted
as copies, (ii) the legal capacity of all natural persons executing the
documents discussed herein, (iii) that such documents accurately describe and
contain the mutual understanding of the parties and that there are no oral or
written statements or agreements that modify, amend, or vary or purport to
modify, amend, or vary any of the terms of such documents, (iv) that, as to
documents executed by entities other than the Company, that such entity had the
power to enter into and perform its obligations under such documents, and that
such documents have been duly authorized, executed, and delivered by, and are
valid, binding upon, and enforceable against, such entities, and (v) that the
Rights and Company Common Stock will conform in all material respects to the
description thereof set forth in the Registration Statement.
Based upon the foregoing, we advise you that, in our opinion, when the
following events have occurred:
(a) The Registration Statement has become effective under the Securities
Act;
<PAGE> 2
Cygnet Financial Corporation
June 19, 1998
Page 2
(b) The due authorization, registration, and delivery of the certificate or
certificates evidencing the Rights and the Company Common Stock;
(c) The Rights and Company Common Stock are issued and sold and
consideration has been received therefor in the manner specified in the
Registration Statement and the exhibits thereto;
(d) The compliance with all applicable contracts, agreements, and
instruments in respect of the issuance of the Rights and Company Common Stock
has occurred; and
(e) The receipt of all necessary approvals, consents or waivers, and the
satisfaction of all necessary conditions, to the issuance of the Rights and
Common Stock shall have been obtained or satisfied; then
1. The Company Common Stock to be issued by you will be legally
issued, fully paid, and non-assessable.
2. The Rights to be issued by you will be legally issued and will
constitute the valid and binding obligation of the Company enforceable in
accordance with their terms, except as enforceability thereof may be limited by
(i) applicable bankruptcy, insolvency, reorganization, moratorium, fraudulent
transfer or conveyance or other similar laws relating to or affecting the rights
of creditors generally and (ii) the application of general principles of equity
(whether such enforceability is considered in a proceeding in equity or at law).
The foregoing opinions are limited to the federal law of the United States
of America, the laws of the State of Arizona, and the General Corporation Law of
the State of Delaware. We express no opinion as to the application of the
various state securities laws to the offer, sale, issuance, or delivery of the
Rights and Company Common Stock.
We hereby consent to the filing of this opinion as Exhibit 5 to the
Registration Statement and to the use of our name under the caption "Legal
Matters" in the Registration Statement and in the Prospectus included therein.
Very truly yours,
SNELL & WILMER L.L.P.
/s/ Snell & Wilmer L.L.P.
<PAGE> 1
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Cygnet Financial Corporation:
We consent to the use of our report included herein and to the reference to
our firm under the headings "Experts" and "Selected Combined Financial Data" in
the prospectus.
/s/ KPMG PEAT MARWICK LLP
Phoenix, Arizona
June 19, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE COMBINED
BALANCE SHEETS OF CYGNET FINANCIAL CORPORATION AT MARCH 31, 1998 AND DECEMBER
31, 1997 AND THE CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE THREE MONTHS
ENDED MARCH 31, 1998 AND THE YEAR ENDED DECEMBER 31, 1997 AND IS QUALIFIED IN
ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C> <C>
<PERIOD-TYPE> 3-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997
<PERIOD-START> JAN-01-1998 JAN-01-1997
<PERIOD-END> MAR-31-1998 DEC-31-1997
<CASH> 365 1,225
<SECURITIES> 0 0
<RECEIVABLES> 61,080 49,526
<ALLOWANCES> 9,954 8,191
<INVENTORY> 0 0
<CURRENT-ASSETS> 0<F1> 0<F1>
<PP&E> 2,241 646
<DEPRECIATION> (159) (127)
<TOTAL-ASSETS> 57,400 50,330
<CURRENT-LIABILITIES> 0<F1> 0<F1>
<BONDS> 0 0
0 0
0 0
<COMMON> 0 0
<OTHER-SE> 40,000 40,000
<TOTAL-LIABILITY-AND-EQUITY> 57,400 50,330
<SALES> 0 0
<TOTAL-REVENUES> 3,382 15,959
<CGS> 0 0
<TOTAL-COSTS> 0 0
<OTHER-EXPENSES> 2,239 3,937
<LOSS-PROVISION> 287 691
<INTEREST-EXPENSE> 854 2,067
<INCOME-PRETAX> 2 9,264
<INCOME-TAX> 0 3,728
<INCOME-CONTINUING> 0 0
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 2 (306)
<EPS-PRIMARY> 0.00 (0.05)
<EPS-DILUTED> 0.00 (0.05)
<FN>
<F1>UNCLASSIFIED BALANCE SHEET
</FN>
</TABLE>
