1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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FORM 10-Q
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 1997
Commission File Number 000-20841
U G L Y D U C K L I N G C O R P O R A T I O N
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. employer
incorporation or organization) identification no.)
2525 E. Camelback Road,
Suite 1150
Phoenix, Arizona 85016
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (602) 852-6600
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
-----
INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE:
At November 14, 1997, there were 18,520,916 shares of Common Stock, $0.001
par value, outstanding.
This document serves both as a resource for analysts, shareholders, and other
interested persons, and as the quarterly report on Form 10-Q of Ugly Duckling
Corporation (Company) to the Securities and Exchange Commission, which has
taken no action to approve or disapprove the report or pass upon its accuracy
or adequacy. Additionally, this document is to be read in conjunction with
the consolidated financial statements and notes thereto included in the
Company's Annual Report on Form 10-K, as amended, for the year ended December
31, 1996.
2
UGLY DUCKLING CORPORATION
FORM 10-Q
TABLE OF CONTENTS
Part I. - FINANCIAL STATEMENTS
Page
Item 1. FINANCIAL STATEMENTS
Condensed Consolidated Balance Sheets - September 30, 1997 and
December 31, 1996 3
Condensed Consolidated Statements of Operations -Three Months and Nine
Months Ended September 30, 1997 and September 30, 1996 4
Condensed Consolidated Statements of Cash Flows - Nine Months Ended
September 30, 1997 and September 30, 1996 5
Notes to Condensed Consolidated Financial Statements 6
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 8
Part II. - OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS 30
Item 2. CHANGES IN SECURITIES 30
Item 3. DEFAULTS UPON SENIOR SECURITIES 30
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 30
Item 5. OTHER INFORMATION 30
Item 6. EXHIBITS AND REPORTS ON FORM 8-K 30
SIGNATURES S-1
Exhibit 10.a
Exhibit 10.b
Exhibit 10.c
Exhibit 11 i
Exhibit 27 ii
Exhibit 99 iii
3
ITEM 1.
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
1997 1996
-------------- --------------
ASSETS
Cash and Cash Equivalents $ 4,401 $ 18,455
Finance Receivables Held for Sale, net 36,346 51,063
Residuals in Finance Receivables Sold 25,755 9,889
Investments Held in Trust 16,192 3,479
Notes Receivable 93,833 1,063
Income Taxes Receivable 3,760 315
Inventory 20,936 5,752
Property and Equipment, net 37,892 20,652
Goodwill and Trademarks, net 17,181 2,150
Other Assets 14,989 5,265
-------------- ---------------
$ 271,285 $ 118,083
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable $ 3,765 $ 2,132
Accrued Expenses and Other Liabilities 19,344 6,728
Notes Payable 58,781 12,904
Subordinated Notes Payable 12,000 14,000
-------------- --------------
Total Liabilities 93,890 35,764
-------------- --------------
Stockholders' Equity:
Common Stock 171,943 82,612
Retained Earnings (Accumulated Deficit) 5,452 (293)
-------------- --------------
Total Stockholders' Equity 177,395 82,319
-------------- --------------
$ 271,285 $ 118,083
============== ==============
See accompanying notes to Condensed Consolidated Financial Statements.
4
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except earnings per common share)
Three Months Ended Nine Months Ended
September 30, September 30, September 30, September 30,
1997 1996 1997 1996
--------------- --------------- --------------- ---------------
Sales of Used Cars $ 33,530 $ 12,320 $ 79,543 $ 42,497
Cost of Used Cars Sold (18,537) (6,977) (42,537) (23,835)
Provision for Credit Losses (6,538) (2,541) (15,367) (7,713)
--------------- --------------- --------------- ---------------
8,455 2,802 21,639 10,949
--------------- --------------- --------------- ---------------
Interest Income 10,645 4,190 23,390 11,881
Gain (Loss) on Sale of Finance Receivables (2,487) 1,400 10,323 2,578
--------------- --------------- --------------- ---------------
8,158 5,590 33,713 14,459
--------------- --------------- --------------- ---------------
Other Income 3,516 349 6,953 780
--------------- --------------- --------------- ---------------
Income before Operating Expenses 20,129 8,741 62,305 26,188
Operating Expenses:
Selling and Marketing 2,887 652 6,680 2,915
General and Administrative 17,629 4,505 40,489 13,551
Depreciation and Amortization 1,001 427 2,459 1,128
--------------- --------------- --------------- ---------------
21,517 5,584 49,628 17,594
--------------- --------------- --------------- ---------------
Operating Income (Loss) (1,388) 3,157 12,677 8,594
Interest Expense 1,578 1,190 2,914 4,479
--------------- --------------- --------------- ---------------
Earnings (Loss) before Income Taxes (2,966) 1,967 9,763 4,115
Income Taxes (Benefit) (1,138) - 4,018 -
--------------- --------------- --------------- ---------------
Net Earnings (Loss) $ (1,828) $ 1,967 $ 5,745 $ 4,115
=============== =============== =============== ===============
Earnings (Loss) per Common Share ($0.10) $ 0.19 $ 0.32 $ 0.46
=============== =============== =============== ===============
Shares Used in Computation 19,000 9,205 18,200 7,230
=============== =============== =============== ===============
See accompanying notes to Condensed Consolidated Financial Statements.
5
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996
(IN THOUSANDS)
1997 1996
---------- --------
Cash Flows from Operating Activities:
Net Earnings $5,745 $4,115
Adjustments to Reconcile Net Earnings to Net
Cash Provided by Operating Activities:
Provision for Credit Losses 15,367 7,713
Gain on Sale of Finance Receivables (10,323) (2,578)
Purchase of Finance Receivables (195,127) (70,847)
Proceeds from Sale of Finance Receivables 193,823 29,029
Collections of Finance Receivables 37,157 31,107
Decrease in Deferred Income Taxes 1,500 -
Depreciation and Amortization 2,459 1,128
Decrease (Increase) in Inventory (8,869) 440
Increase in Other Assets (8,478) (584)
Increase in Accounts Payable, Accrued Expenses, and
Other Liabilities 11,497 1,430
Increase (Decrease) in Income Taxes Receivable/Payable (3,445) 684
---------- ---------
Net Cash Provided by Operating Activities 41,306 1,637
---------- ---------
Cash Flows Used In Investing Activities:
Increase in Investments Held in Trust (12,713) (8,963)
Net Decrease (Increase) in Notes Receivable (29,485) 100
Purchase of Property and Equipment (15,481) (4,013)
Payment for Acquisition of Assets (45,260) -
---------- ---------
Net Cash Used in Investing Activities (102,939) (12,876)
---------- ---------
Cash Flows from Financing Activities:
Issuance of Notes Payable, net (39,084) (2,824)
Net Repayment of Subordinated Notes Payable (2,000) (553)
Proceeds from Issuance of Common Stock 88,719 14,844
Other, Net (56) (963)
---------- ---------
Net Cash Provided by Financing Activities 47,579 10,504
---------- ---------
Net Decrease in Cash and Cash Equivalents (14,054) (735)
Cash and Cash Equivalents at Beginning of Period 18,455 1,419
---------- ---------
Cash and Cash Equivalents at End of Period $4,401 $684
========== =========
See accompanying notes to Condensed Consolidated Financial Statements.
6
UGLY DUCKLING CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
---------------------
The accompanying unaudited condensed consolidated financial statements of Ugly
Duckling Corporation (Company) have been prepared in accordance with
generally accepted accounting principles for interim financial information
and pursuant to rules and regulations of the Securities and Exchange
Commission. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for a complete
financial statement presentation. In the opinion of management, such
unaudited interim information reflects all adjustments, consisting only of
normal recurring adjustments, necessary to present the Company's financial
position and results of operations for the periods presented. The results of
operations for interim periods are not necessarily indicative of the results
to be expected for a full fiscal year. The Condensed Consolidated Balance
Sheet as of December 31, 1996 was derived from audited consolidated financial
statements as of that date but does not include all the information and
footnotes required by generally accepted accounting principles. It is
suggested that these condensed consolidated financial statements be read in
conjunction with the Company's audited consolidated financial statements
included in the Company's Annual Report on Form 10-K, as amended, for the year
ended December 31, 1996.
NOTE 2. SUMMARY OF FINANCE RECEIVABLES, NET
-----------------------------------
Following is a summary of Finance Receivables, net, as of September 30, 1997
and December 31, 1996 (in thousands):
September 30, December 31,
1997 1996
--------------- --------------
Principal Balances. . . . . . . . . . . $ 41,727 $ 58,281
Add: Accrued Interest. . . . . . . . . 447 718
Loan Origination Costs . . . . . . . . 503 189
Finance Receivables . . . . . . . . . . 42,677 59,188
Less Allowance for Credit Losses. . . . (6,331) (8,125)
--------------- --------------
Finance Receivables, net. . . . . . . . $ 36,346 $ 51,063
=============== ==============
Finance Receivables Held for Sale . . . $ 42,677 $ 7,000
Finance Receivables Held for Investment - 52,188
--------------- --------------
$ 42,677 $ 59,188
=============== ==============
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NOTE 3. RESIDUALS IN FINANCE RECEIVABLES SOLD
-----------------------------------------
As of September 30, 1997 and December 31, 1996, the Residuals in Finance
Receivables Sold were comprised of the following (in thousands):
September 30, December 31,
1997 1996
--------------- --------------
Retained interest in subordinated securities
(B Certificates) $ 41,700 $ 10,900
Net interest spreads, less present value discount 29,055 6,839
Reduction for estimated credit losses (45,000) (7,850)
--------------- --------------
Residuals in finance receivables sold $ 25,755 $ 9,889
=============== ==============
Securitized principal balances outstanding $ 228,996 $ 51,663
=============== ==============
Estimated credit losses as a % of securitized
principal balances outstanding. 19.7% 15.2%
=============== ==============
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the three and nine month periods ended September
30, 1997 and 1996, respectively (in thousands).
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -------------------
1997 1996 1997 1996
---------- --------- -------- ---------
Balance, Beginning of Period $ 27,441 $ 5,001 $ 9,889 $ -
Additions 12,377 2,313 34,599 7,445
Amortization (4,063) (410) (8,733) (541)
Write-down of Residual in Finance Receivables Sold (10,000) - (10,000) -
---------- --------- -------- ---------
Balance, End of Period $ 25,755 $ 6,904 $25,755 $ 6,904
========== ========= ======== =========
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NOTE 4. NOTES RECEIVABLE
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Following is a summary of Notes Receivable as of September 30, 1997 and
December 31, 1996 (in thousands).
September 30, December 31,
1997 1996
-------------- -------------
FMAC secured debt . . . . . . . $ 63,599 $ -
FMAC debtor in possession loan 3,878 -
Cygnet Program notes receivable 23,664 -
Others. . . . . . . . . . . . . 2,692 1,063
-------------- -------------
$ 93,833 $ 1,063
============== =============
NOTE 5. NOTES PAYABLE
--------------
Following is a summary of Notes Payable as of September 30, 1997 and December
31, 1996 (in thousands).
September 30, December 31,
1997 1996
-------------- -------------
Revolving Facility with GE Capital $ 128
Mortgage loan with finance company 7,450 7,450
Note with Bank Group secured by FMAC secured debt 50,429 -
Other 774 852
-------------- -------------
$ 58,781 $ 12,904
============== =============
NOTE 6. COMMON STOCK EQUIVALENTS
--------------------------
Net Earnings (Loss) per common share amounts are based on the weighted average
number of common shares and common stock equivalents outstanding as reflected
on Exhibit 11 to this Quarterly Report on Form 10-Q.
NOTE 7. ACQUISITIONS
------------
On January 15, 1997, the Company acquired substantially all of the assets of
Seminole Finance Corporation and related companies ("Seminole"), including
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million (6,953 contracts) in exchange for approximately
$2.5 million in cash and assumption of $29.9 million in debt. The combination
of the Company's audited consolidated statement of operations for the year
ended December 31, 1996 and Seminole's audited combined statement of
operations for the same period (as if the Seminole acquisition had taken place
on January 1, 1996) results in combined net loss for the year ended December
9
31, 1996 of $(3.6) million. These pro forma results are not necessarily
indicative of the future results of operations of the Company or the results
that would have been obtained had the Seminole acquisition occurred on January
1, 1996. In addition, the pro forma results are not intended to be a
projection of future results. The Company's results of operations in 1997 for
the assets acquired from Seminole differ materially from 1996 results because
the Company significantly altered the type of vehicles sold at the newly
acquired car dealerships, the methodology by which the acquired operations
acquire, recondition, and market used cars, and the methodology by which the
related finance receivables are underwritten and collected, which management
believes have resulted in the acquired operations being profitable in 1997.
Furthermore, Seminole's audited combined statement of operations for 1996 was
impacted by several factors that are not expected to have an impact on future
operations. Such factors were related to the deterioration of its loan
portfolio, which the Company believes resulted from poor underwriting and
ineffective collection efforts. First, due to the deterioration of its loan
portfolio in 1996, Seminole recorded a total of $7.1 million in provision for
credit losses. Second, the deterioration of its loan portfolio also reduced
its borrowing capacity, thereby reducing Seminole's liquidity. As a result, in
order to raise cash, Seminole sold vehicles at substantially lower margins and
sold a portfolio of notes in December 1996 for a loss of approximately $1.5
million.
On April 1, 1997, the Company purchased substantially all of the assets of EZ
Plan, Inc. (EZ Plan), a Company engaged in the business of selling and
financing used motor vehicles, including seven dealerships in San Antonio and
a contract portfolio of approximately $24.3 million (6,297 contracts) in
exchange for $26.3 million in cash. The combination of the Company's audited
consolidated statement of operations for the year ended December 31, 1996 and
EZ Plan's audited combined statement of operations for the same period (as if
the EZ Plan acquisition had taken place on January 1, 1996) results in
combined net earnings for the year ended December 31, 1996 of $5.9 million.
These pro forma results are not necessarily indicative of the future results
of operations of the Company or the results that would have been obtained had
the EZ Plan acquisition occurred on January 1, 1996. In addition, the pro
forma results are not intended to be a projection of future results. The
Company's results of operations in 1997 for the assets acquired from EZ Plan
differ from 1996 results because the Company's management altered the type of
vehicles sold at the newly acquired car dealerships, the methodology by which
the acquired operations acquire, recondition, and market used cars, and the
methodology by which the related finance receivables are underwritten and
collected.
On September 19, 1997, the Company purchased substantially all of the
dealership and loan servicing assets of Kars Yes Holdings, Inc. and related
companies (Kars), a company in the business of selling and financing used
motor vehicles, including six dealerships in the Los Angeles market, two in
the Miami market, two in the Atlanta market, and two in the Dallas market in
exchange for approximately $5.5 million in cash. The combination of the
Company's audited consolidated statement of operations for the year ended
December 31, 1996 and Kars' statement of operations for the same period (as if
the Kars acquisition had taken place on January 1, 1996) results in combined
earnings for the year ended December 31, 1996 of $9.8 million. These pro forma
results are not necessarily indicative of the future results of operations of
the Company or the results that would have been obtained had the Kars
acquisition occurred on January 1, 1996. In addition, the pro forma results
are not intended to be a projection of future results. The Company does not
expect the results of operations in 1997 for the assets acquired from Kars to
have a material impact on the Company's results of operations
10
The following summary, prepared on a pro forma basis combines the consolidated
results of operations (unaudited) for the nine months ended September 30, 1997
as if the acquisitions had been consummated as of January 1, 1997. These
proforma results are not necessarily indicative of the future results of
operations of the Company or the results that would have been obtained had the
acquisitions taken place on January 1, 1997. Comparative information for 1996
for the acquired businesses is not available (in thousands, except per share
data).
Nine Months Ended
September 30, 1997
--------------------
Sales of Used Cars $ 179,696
Interest Income $ 25,054
Other Income $ 19,139
Total Revenues $ 223,889
Net Loss $ (2,771)
Loss per Share $ (0.15)
NOTE 8. USE OF ESTIMATES
------------------
The preparation of financial statements requires management to make estimates
and assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statement and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 9. BANKRUPTCY REMOTE ENTITIES
----------------------------
Champion Receivables Corporation ("CRC") and Champion Receivables Corporation
II ("CRC II") (collectively referred to as "Securitization Subsidiaries"), are
the Company's wholly-owned special purpose "bankruptcy remote entities".
Their assets include Residuals in Finance Receivables Sold and Investments
Held In Trust, in the amounts of $25.8 million and $16.2 million,
respectively, at September 30, 1997, which amounts would not be available to
satisfy claims of creditors of the Company on a consolidated basis.
NOTE 10. RECLASSIFICATIONS
-----------------
Certain reclassifications have been made to previously reported information to
conform to the current presentation.
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Quarterly Report on Form 10-Q 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 of 1933, as amended,
11
and Section 21E of the Securities Exchange Act of 1934, as amended. Such
statements may include, but not be limited to, projections of revenues,
income, or 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. 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. Statements in this Quarterly Report, including the Notes to the
Condensed Consolidated Financial Statements and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," describe factors,
among others, that could contribute to or cause such differences. Additional
risk factors that could cause actual results to differ materially from those
expressed in such forward looking statements are set forth in Exhibit 99 which
is attached hereto and incorporated by reference into this Quarterly Report on
Form 10-Q.
INTRODUCTION
General. Ugly Duckling Corporation ("Company") operates a chain of "buy
here-pay here" used car dealerships in the United States and underwrites,
finances, and services retail installment contracts generated from the sale of
used cars by its dealerships ("Company Dealerships") and by third party used
car dealers ("Third Party Dealers") located in selected markets throughout the
country. As part of its financing activities, the Company has initiated a
collateralized dealer financing program ("Cygnet Program") pursuant to which
it provides qualified independent used car dealers with operating lines of
credit secured by the dealers' retail installment contract portfolios and
inventory. The Company targets its products and services to the sub-prime
segment of the automobile financing industry, which focuses on selling and
financing the sale of used cars to persons who have limited credit histories,
low incomes, or past credit problems.
The Company commenced its used car sales and finance operations with the
acquisition of two Company Dealerships in 1992. During 1993, the Company
acquired three additional Company Dealerships. In 1994, the Company
constructed and opened four new Company Dealerships that were built
specifically to meet the Company's new standards of appearance, reconditioning
capabilities, size, and location. During 1994, the Company closed one Company
Dealership because the facility failed to satisfy these new standards and, at
the end of 1995, closed its Gilbert, Arizona dealership. In January 1997, the
Company acquired selected assets of a group of companies engaged in the
business of selling and financing used motor vehicles, including four
dealerships located in the Tampa Bay/St. Petersburg market (Seminole). In
March 1997, the Company opened its first used car dealership in the Las Vegas
market. In April 1997, the Company acquired selected assets of a company in
the business of selling and financing used motor vehicles, including seven
dealerships located in the San Antonio market (EZ Plan). In addition, the
Company opened two additional dealerships in the Albuquerque market and one
additional dealership in the Phoenix market during the second quarter of 1997.
In August 1997, the Company closed a dealership in Prescott, Arizona. In
September 1997, the Company acquired selected assets of a company in the
business of selling used motor vehicles, including six dealerships in the Los
Angeles market, two in the Miami market, two in the Atlanta market and two in
the Dallas market (Kars). The Company operated 35 and 8 dealerships at
12
September 30, 1997 and 1996, respectively.
In 1994, the Company acquired Champion Financial Services, Inc., an
independent automobile finance company. In April 1995, the Company initiated
an aggressive plan to expand the number of contracts purchased from its Third
Party Dealer network. This expansion enabled the Company to leverage its
existing infrastructure and increase its contract portfolio much more quickly
than it could through the expansion of its Company Dealerships. The Company
operated 83 and 22 branch offices at September 30, 1997 and 1996,
respectively. The Company is in the process of further expanding its Third
Party Dealer operations and diversifying its earning asset base by
implementing the Cygnet Program pursuant to which the Company provides Third
Party Dealers with operating credit lines primarily secured by the dealers'
retail installment contract portfolios and inventory.
In 1996 the Company completed an initial public offering and a secondary
offering in which it sold common stock for a total of $82.3 million. In
February 1997, the Company completed a private placement of common stock for a
total of $88.7 million, net of expenses. The registration of the resale of
the shares sold in the private placement was effective in April 1997.
First Merchants Acceptance Corporation ("FMAC") filed for reorganization under
Chapter 11 of the Federal Bankruptcy Code on July 11, 1997 ("Bankruptcy
Case"). In connection with the Bankruptcy Case, the Company, which owns
approximately 2 1/2% of FMAC's outstanding common stock with a cost basis of
approximately $1.5 million, agreed to provide up to $10 million of "debtor in
possession" financing to FMAC, of which approximately $3.8 million was
outstanding at September 30, 1997. On August 20, 1997, the Company acquired
approximately 78% of the senior secured debt ("Secured Debt") of FMAC from
certain members of the senior bank group (Bank Group) that held such debt.
The Secured Debt totaled approximately $97.8 million. The more significant
terms of the purchase of the Secured Debt included, among other things, the
(i) purchase by the Company of the debt at a 10% discount of the outstanding
principal amount; (ii) short-term financing by the Bank Group to the Company
for the purchase, with interest accruing at LIBOR plus 2% and an up-front
payment by the Company to the Bank Group equal to 20% of the purchase price;
and (iii) issuance of stock warrants to the Bank Group to purchase up to
389,800 shares of the Company's common stock at an exercise price of $20 per
share over a thirty-month term and subject to a call feature by the Company.
See Part II, Item 5, Other Information, for subsequent events which impact the
FMAC Secured Debt and debtor in possession loan.
The following discussion and analysis provides information regarding the
Company's consolidated financial position as of September 30, 1997 and
December 31, 1996, and its results of operations for the three month periods
ended September 30, 1997 and 1996, respectively, and the nine month periods
ended September 30, 1997 and 1996, respectively.
Growth in Finance Receivables. As a result of the Company's rapid expansion,
contract receivables serviced increased by 146.3% to $270.7 million at
September 30, 1997 (including $229.0 million in contracts serviced under the
Company's Securitization Program) from $109.9 million at December 31, 1996
(including $51.7 million in contracts serviced under the Company's
Securitization Program).
The following tables reflect the growth in period end balances measured in
terms of the principal amount and the number of contracts.
13
TOTAL CONTRACTS OUTSTANDING:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
- -----------------------------------------------
SEPTEMBER 30, DECEMBER 31,
--------------------- --------------------
1997 1996
--------------------- --------------------
PRINCIPAL NO OF PRINCIPAL NO OF
AMOUNT CONTRACTS AMOUNT CONTRACTS
---------- --------- --------- ---------
Company Dealerships $ 120,307 24,567 $ 49,066 9,615
Third Party Dealers 150,416 31,483 60,878 12,942
---------- --------- ---------- -------
Total Portfolio Managed 270,723 56,050 109,944 22,557
---------- --------- ---------- -------
Less Portfolios Securitized and Sold:
Company Dealerships 103,762 21,912 41,998 8,570
Third Party Dealers 125,234 25,028 9,665 2,042
---------- --------- ---------- -------
Total Portfolios Securitized and Sold 228,996 46,940 51,663 10,612
---------- --------- ---------- -------
Company Total $ 41,727 9,110 $ 58,281 11,945
========== ========= ========== =======
In addition to the Company Dealership and Third Party Dealer loan portfolios
summarized above, the Company also services loan portfolios totaling approxi-
mately $162.0 million for Kars as of September 30, 1997.
The following tables reflect the growth in contract originations by Company
Dealerships and contract purchases from Third Party Dealers measured in terms
of the principal amount and the number of contracts.
TOTAL CONTRACTS ORIGINATED/PURCHASED:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
THREE MONTHS ENDED SEPTEMBER 30,
- ------------------------------------------
1997 1996
------------------------------- ---------------------------------
PRINCIPAL NO. OF AVERAGE PRINCIPAL NO. OF AVERAGE
AMOUNT CONTRACTS PRINCIPAL AMOUNT CONTRACTS PRINCIPAL
---------- --------- --------- ---------- --------- ----------
Company Dealerships $ 32,147 4,389 $ 7,324 $ 11,082 1,575 $7,036
Third Party Dealers 52,588 9,236 5,694 15,716 2,678 5,869
---------- --------- --------- ---------- --------- ------
Total $ 84,735 13,625 $ 6,219 $ 26,798 4,253 $6,301
========== ========= ========= ========== ========= ======
14
TOTAL CONTRACTS ORIGINATED/PURCHASED:
(IN THOUSANDS, EXCEPT NUMBER OF CONTRACTS)
NINE MONTHS ENDED SEPTEMBER 30,
- ------------------------------------------
1997 1996
------------------------------- ---------------------------------
PRINCIPAL NO. OF AVERAGE PRINCIPAL NO. OF AVERAGE
AMOUNT CONTRACTS PRINCIPAL AMOUNT CONTRACTS PRINCIPAL
---------- --------- --------- ---------- --------- ----------
Company Dealerships $ 131,526 23,458 $ 5,607 $ 38,179 5,413 $7,053
Third Party Dealers 144,237 26,147 5,516 32,919 5,781 5,694
---------- --------- --------- ---------- --------- ----------
Total $ 275,763 49,605 $ 5,559 $ 71,098 11,194 $6,351
========== ========= ========= ========== ========= ==========
Finance Receivable Principal Balances originated/purchased during the three
months ended September 30, 1997 increased by 216.2% to $84.7 million from
$26.8 million in the three month period ended September 30, 1996. For the
nine month period ended September 30, 1997, Finance Receivable Principal
Balances originated/purchased increased by 287.9% to $275.8 million, including
$55.4 million from the Seminole and EZ Plan acquisitions (13,250 contracts),
from $71.1 million in the nine month period ended September 30, 1996.
RESULTS OF OPERATIONS
FOR THREE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 1996
The prices at which the Company sells its cars and the interest rates that it
charges to finance these sales take into consideration that the Company's
primary customers are high-risk borrowers, many of whom ultimately default.
The Provision for Credit Losses reflects these factors and is treated by the
Company as a cost of both the future interest income derived on the contract
receivables originated at Company Dealerships as well as a cost of the sale of
the cars themselves. Accordingly, unlike traditional car dealerships, the
Company does not present gross profits in its Statements of Operations
calculated as Sales of Used Cars less Cost of Used Cars Sold.
Sales of Used Cars. Sales of Used Cars increased by 172.2% to $33.5 million
for the three month period ended September 30, 1997 from $12.3 million for
the three month period ended September 30, 1996. This growth reflects a
significant increase in the number of used car dealerships in operation. Units
sold increased by 156.1% to 4,523 units in the three month period ended
September 30, 1997 from 1,766 units in the three month period ended September
30, 1996. Same store sales increased by 4.3% in the three months ended
September 30, 1997 compared to the three months ended September 30, 1996.
The average sales price per car increased to $7,413 for the three month period
ended September 30, 1997 from $6,976 for the three month period ended
September 30, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased
by 165.7% to $18.5 million for the three month period ended September 30, 1997
from $7.0 million for the three month period ended September 30, 1996. On a
per unit basis, the Cost of Used Cars Sold increased by 3.7% to $4,098 for the
three month period ended September 30, 1997 from $3,951 for the three month
15
period ended September 30, 1996. The gross margin on used car sales (Sales of
Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses)
increased by 180.6% to $15.0 million for the three month period ended
September 30, 1997 from $5.3 million for the three month period ended
September 30, 1996. As a percentage of sales, the gross margin was 44.7% and
43.4% for the three month periods ended September 30, 1997 and 1996,
respectively. On a per unit basis, the gross margin per car sold was $3,315
and $3,025 for the three month periods ended September 30, 1997 and 1996,
respectively.
Provision for Credit Losses. A high percentage of Company Dealership
customers ultimately do not make all of their contractually scheduled
payments, requiring the Company to charge off the remaining principal balance
due. As a result, the Company recognizes a Provision for Credit Losses in
order to establish an Allowance for Credit Losses. The Provision for Credit
Losses increased by 157.3% to $6.5 million in the three month period ended
September 30, 1997 from $2.5 million for the three month period ended
September 30, 1996. This includes an increase of $ 454,000 in the Provision
for Credit Losses in the three month period ended September 30, 1997 for Third
Party Dealer receivables and Cygnet Program dealer notes receivable over the
three month period ended September 30, 1996 when the Company recorded no such
Provision for Credit Losses. On a percentage basis, the Provision for Credit
Losses per unit originated at Company Dealerships decreased by 14.1% to $1,386
per unit in the three month period ended September 30, 1997 from $1,613 per
unit in the three month period ended September 30, 1996. As a percentage of
contract balances originated at Company Dealerships, the Provision for Credit
Losses averaged 18.2% and 22.9%, for the for the three month periods ended
September 30, 1997 and 1996, respectively. The decrease in the Provision for
Credit Losses per unit and the decrease in the Provision for Credit Losses as
a percentage of contract balances originated, is due in part to the
implementation at the Company's Arizona based dealerships in the three month
period ended September 30, 1997 of the Company's Gold Wing program which
provides the buyer with certain life and disability insurance. The Company
purchases the insurance on behalf of the buyer resulting in an increase in
cost of sales. However, as the Company expects fewer charge offs as a result
of customer death or disability, it reduced its Provision for Credit Losses by
an amount approximating the cost of the insurance coverage.
Interest Income. Interest Income consists primarily of interest on finance
receivables from Company Dealership sales, interest on Third Party Dealer
finance receivables, income from Residuals in Finance Receivables Sold, income
from the Cygnet Program, and other interest income from the FMAC Secured Debt.
Company Dealership Receivables - Interest Income increased by 67.7% to $3.7
million for the three month period ended September 30, 1997 from $2.2 million
for the three month period ended September 30, 1996. Interest Income was
reduced by sales of $155.9 million in Company Dealership contract principal
balances since inception of the Securitization Program, and will continue to
be affected in future periods by additional securitizations. A primary element
of the Company's sales strategy is to provide financing to customers with poor
credit histories who are unable to obtain automobile financing through
traditional sources. The Company financed 99.7% of sales revenue and 97.0% of
the used cars sold at Company Dealerships for the three month period ended
September 30, 1997 compared to 90.0% of sales revenue and 89.2% of the used
cars sold for the three month period ended September 30, 1996. The average
amount financed increased to $7,614 for the three month period ended September
30, 1997 from $7,036 for the three month period ended September 30, 1996.
Primarily as a result of its expansion into markets with interest rate limits,
the Company's yield on its Company Dealership Receivable portfolio has trended
16
downward. The effective yield on Finance Receivables from Company Dealerships
was 26.0% and 29.5%, for the three month periods ended September 30, 1997 and
1996, respectively. The Company's policy is to charge 29.9% per annum on its
Company Dealership contracts. However, in those states that impose usury
limits the Company charges the maximum interest rate permitted.
Third Party Dealer Receivables - Interest Income increased by 96.4% to $3.9
million for the three month period ended September 30, 1997 from $2.0 million
in the three month period ended September 30, 1996. Interest Income was
reduced by sales of $157.9 million in Third Party Dealer contract principal
balances since inception of the Securitization Program, and will continue to
be affected in future periods by additional securitizations. Interest income
has increased in conjunction with the increases in Third Party Dealer
contracts purchased and outstanding. Primarily as a result of its expansion
into markets with interest rate limits, the Company's yield on its Third Party
Dealer portfolio has trended downward. Portfolio yield was 23.6% and 24.2%,
for the three month periods ended September 30, 1997 and 1996, respectively.
Cygnet Program and Other Interest Income - Interest income increased by
100.0% to $3.0 million for the three month period ended September 30, 1997.
This income consisted of $1.2 million in interest income from the Cygnet
Program and $1.8 million in other interest income from the FMAC Secured Debt.
Gain on Sale of Finance Receivables. Champion Receivables Corporation ("CRC")
and Champion Receivables Corporation II ("CRC II") (collectively referred to
as "Securitization Subsidiaries"), are the Company's wholly-owned special
purpose "bankruptcy remote entities". During the first quarter of 1996, the
Company initiated a Securitization Program under which CRC sold securities
backed by contracts to SunAmerica Life Insurance Company ("SunAmerica").
Beginning with the third fiscal quarter of 1997, the Company expanded the
Securitization Program to include CRC II and sales of CRC II securities
through private placement of securities to investors other than Sun America.
Under the Securitization Program, the Securitization Subsidiaries assign and
transfer the contracts to separate trusts ("Trusts") pursuant to Pooling and
Servicing Agreements (the "Pooling Agreements"). Pursuant to the Pooling
Agreements, Class A Certificates and subordinated Class B Certificates are
issued to the Securitization Subsidiaries. The Securitization Subsidiaries
then sell the Class A Certificates to unrelated investors. The transferred
contracts are serviced by Champion Acceptance Corporation ("CAC"), another
subsidiary of the Company. Prior to the Company's securitization in the three
month period ended September 30, 1997, the Company's Class A Certificates
received ratings from Standard & Poors ranging from "BBB" to "A". To obtain
these ratings from Standard & Poors, CRC was required to provide a credit
enhancement by establishing and maintaining a cash spread account for the
benefit of the certificate holders. For the securitization transaction that
was consummated during the three month period ended September 30, 1997, the
Company's Class A Certificates received a "AAA" rating from Standard & Poors,
and a "Aaa" rating from Moody's Investors Service. To obtain these ratings,
CRC II (1) obtained an insurance policy from MBIA Insurance Corporation which
unconditionally and irrevocably guaranteed full and complete payment of the
Class A guaranteed distribution (as defined), and (2) provided a credit
enhancement by establishing and maintaining a cash spread account for the
benefit of the certificate holders. The Securitization Subsidiaries make an
initial cash deposit into the spread account, ranging from 3% to 4% of the
initial underlying finance receivables principal balance and pledges this cash
to the Trusts. The Securitization Subsidiaries are also required to then make
additional deposits to the spread account from the residual cash flow (through
the trustees) as necessary to attain and maintain the spread account at a
specified percentage, ranging from 6.0% to 8.0%, of the underlying finance
17
receivables principal balance. Distributions are not made to the
Securitization Subsidiaries on the Class B Certificates unless the spread
account has the required balance, the required periodic payments to the Class
A Certificate holders are current, and the trustee, servicer and other
administrative costs are current.
During the three months ended September 30, 1997, CRC made initial spread
account deposits totaling $4.2 million. Additional net deposits to the spread
accounts during the three months ended September 30, 1997 totaled $2.3
million. Based upon securitizations in effect as of September 30, 1997, the
Company was required to maintain an aggregate balance in all spread accounts
of $17.8 million, a portion of which may be funded over time. As of September
30, 1997, the Company maintained a spread account balance of $15.1 million.
Accordingly, an additional $2.7 million will need to be funded from future
cash flows. The additional funding requirements will decline as the trustees
deposit additional cash flows into the spread account and as the principal
balance of the underlying finance receivables declines. In addition to the
spread account balance of $15.1 million, the Company had deposited a total of
$1.1 million in trust accounts in conjunction with certain other agreements.
The contracts transferred to the Trusts were purchased by the Securitization
Subsidiaries from either CAC, Champion Financial Services, Inc. ("CFS"), Ugly
Duckling Car Sales Florida, Inc. ("UDCSF"), or Ugly Duckling Cars Sales Texas,
LLP ("UDCST"), in "true sale" transactions pursuant to separate purchase
agreements. The obligations of CAC, as servicer, pursuant to the Pooling
Agreements are guaranteed by the Company and certain other subsidiaries of the
Company, other than CRC, CRC II, CAC, CFS, UDCSF, and UDCST.
The Company recognizes a Gain on Sale of Finance Receivables equal to the
difference between the yield earned on the contract portfolio securitized and
the return on the securities sold plus the release of Allowance for Credit
Losses. The amount of any Gain on Sale of Loans is based upon certain
estimates, which may not subsequently be realized. The amount of Gain on Sale
of Loans recognized is a function of a number of items including, but not
limited to, the seasoning, remaining term, and weighted average net interest
rate spread of the portfolio sold, as well as the amount of Allowance for
Credit Losses available for release. The amount of Allowance for Credit
Losses available for release is evaluated in light of the adequacy of the
Allowance for Credit Losses as a percentage of retained contract principal
balances. To the extent that actual cash flows on a securitization are below
original estimates, and differ materially from the original securitization
assumptions, and in the opinion of management, those differences appear to be
other than temporary in nature, the Company would be required to revalue the
Residual in Finance Receivables Sold, and record a charge to earnings based
upon the reduction. During the three month period ended September 30, 1997,
the Company recorded a $10.0 million charge (approximately $6.0 million, net
of income taxes) to write down the retained portion of the securitization
assets.
The Company utilizes a number of estimates in arriving at the Gain on Sale of
Loans. With the exception of the Company's first two securitization
transactions which took place during the first six months of 1996, the
estimated cash flows into the Trusts were discounted with a rate of 16%. The
two securitization transactions that took place during the first six months of
1996 were discounted with a rate of 25%. For securitization transactions
between June 30, 1996 and June 30, 1997, for contracts originated at Company
Dealerships, net losses were originally estimated using total expected
cumulative net losses at loan origination of approximately 26.0%, adjusted for
actual cumulative net losses prior to securitization. For contracts purchased
18
from Third Party Dealers, net losses were originally estimated using total
expected cumulative net losses at loan origination of approximately 13.5%,
adjusted for actual cumulative net losses prior to securitization. Prepayment
rates were estimated to be 1.5% per month of the beginning of month balances.
The $10.0 million charge (approximately $6.0 million, net of income taxes) in
the three month period ended September 30, 1997, which resulted in a reduction
in the carrying value of the Residuals in Finance Receivables Sold, had the
effect of increasing the cumulative net loss assumption for contracts
originated at Company Dealerships to approximately 27.5%, and for contracts
purchased from Third Party Dealers to approximately 17.5% for the
securitization transactions that took place prior to the three month period
ended September 30, 1997.
For the securitization transaction that took place during the three month
period ended September 30, 1997, for contracts originated at Company
Dealerships, net losses were estimated using total expected cumulative net
losses at loan origination of approximately 27.5%, adjusted for actual
cumulative net losses prior to securitization, and for contracts purchased
from Third Party Dealers, net losses were estimated using total expected
cumulative net losses at loan origination of approximately 17.5%, adjusted for
actual cumulative net losses prior to securitization. Prepayment rates were
estimated to be 1.5% per month of the beginning of month balance.
The assumptions utilized in prior securitizations may not necessarily be the
same as those utilized in future securitizations. The Company classifies the
residuals as "held-to-maturity" securities in accordance with SFAS No. 115.
The Company securitized an aggregate of $103.7 million in contracts, issuing
$85.1 million in securities during the three months ended September 30, 1997.
In conjunction with this transaction, the Company reduced its Allowance for
Credit Losses by $17.7 million during the three months ended September 30,
1997 and retained a Residual in Finance Receivables Sold of $12.4 million for
a balance of $ 25.8 million at September 30, 1997. The Company recorded Loss
on Sale of Loans during the three months ended September 30, 1997 of $2.5
million, which consisted of a Gain on Sale of Loans of $7.5 million from a
securitization, net of the $10.0 million charge to revalue the Residuals in
Finance Receivables Sold from prior securitizations. The Company recognized
Gain on Sale of Loans of $1.4 million during the three month period ended
September 30, 1996. The Gain on Sale of Loans as a percentage of principal
balances securitized in the three month period ended September 30, 1997 was
8.1% and 6.4% for the Company Dealership and Third Party Dealer portfolios
securitized, respectively, compared to 8.2% for the Company Dealership
portfolio securitized in the three month period ended September 30, 1996. No
Third Party Dealer contracts were securitized in the three month period ended
September 30, 1996.
During the three month period ended September 30, 1997, the Trust issued
certificates at a yield of 6.3% resulting in net spread, before net credit
losses and after servicing, insurer, and trustee fees, of 15.0%.
The Company's net earnings may fluctuate from quarter to quarter in the future
as a result of the timing and size of its securitizations.
Champion Receivables Corporation ("CRC") and Champion Receivables Corporation
II ("CRC II") (collectively referred to as "Securitization Subsidiaries"), are
the Company's wholly-owned special purpose "bankruptcy remote entities".
Their assets include Residuals in Finance Receivables Sold and Investments
Held In Trust, in the amounts of $25.8 million and $16.2 million,
respectively, at September 30, 1997, which amounts would not be available to
19
satisfy claims of creditors of the Company on a consolidated basis.
Other Income. Other Income consists primarily of servicing income, insurance
premiums earned on force placed insurance policies, earnings on investments
from the Company's cash and cash equivalents, and franchise fees from the
Company's rent-a-car franchisees. This income increased to $3.5 million for
three months ended September 30, 1997 from $349,000 for the three months ended
September 30, 1996. The Company services the $229.0 million in securitized
contract principal balances for monthly fees ranging from .25% to .33% of the
beginning of period principal balances (3.0% to 4.0% annualized). In
addition, in conjunction with the Kars acquisition in September 1997, the
Company recognizes income from servicing the Kars portfolio at a rate of
approximately .33% (4.0% annualized) of beginning of period principal
balances. Servicing income for the three months ended September 30, 1997
increased to $2.1 million from $240,000 in the three month period ended
September 30, 1996. This increase is due to the increase in the principal
balance of contracts being serviced pursuant to the Securitization Program and
the addition of servicing of the Kars portfolio. The increase is also due to
an increase in insurance premium income of $427,000 over the same period in
the prior year when the Company recognized no insurance premium income. The
Company no longer actively engages in the rent-a-car franchise business.
Income before Operating Expenses. As a result of the Company's continued
expansion, Income before Operating Expenses grew by 130.3% to $20.1 million
for the three month period ended September 30, 1997 from $8.7 million for the
three month period ended September 30, 1996. Growth of Sales of Used Cars,
Interest Income on the loan portfolios and Other Income were the primary
contributors to the increase.
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
The Company has five distinct business segments. These consist of retail car
sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), activities associated with the
origination, administration and collection of finance receivables purchased
from Third Party Dealers (Third Party Dealers), financing activities related
to the collateralized dealer financing program (Cygnet), and corporate and
other operations.
A summary of Operating Expenses by business segment for the three month
periods ended September 30, 1997 and 1996, respectively, follows:
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
1997:
Selling and Marketing . . . . $ 2,887 $ - $ - $ - $ - $ 2,887
General and Administrative. . 6,053 2,999 4,629 674 3,274 17,629
Depreciation and Amortization 426 318 101 7 149 1,001
------------ ---------- ------------ ------- -------- -------
$ 9,366 $ 3,317 $ 4,730 $ 681 $ 3,423 $21,517
============ ========== ============ ======= ======== =======
20
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
1996:
Selling and Marketing . . . . $ 635 $ - $ - $ - $ 17 $ 652
General and Administrative. . 2,000 339 1,260 - 906 4,505
Depreciation and Amortization 85 200 56 - 86 427
------------ ---------- ------------ ------- -------- -------
$ 2,720 $ 539 $ 1,316 $ - $ 1,009 $ 5,584
============ ========== ============ ======= ======== =======
Selling and Marketing Expenses. For the three month periods ended September
30, 1997 and 1996, Selling and Marketing Expenses were comprised almost
entirely of advertising costs and commissions relating to Company Dealership
operations. Selling and Marketing Expenses increased by 342.8% to $2.9 million
for the three month period ended September 30, 1997 from $652,000 for the
three month period ended September 30, 1996. As a percentage of Sales of Used
Cars, these expenses averaged 8.6% for the three month period ended September
30, 1997 and 5.3% for the three month period ended September 30, 1996. On a
per unit sold basis, Selling and Marketing Expenses of Company Dealerships
increased to $638 per unit for the three month period ended September 30, 1997
from $369 per unit for the three month period ended September 30, 1996. This
increase is primarily due to increased marketing production costs, and an
increase in marketing efforts in the Tampa Bay/St. Petersburg, San Antonio,
Las Vegas, and Albuquerque markets where the Company initially commenced
operations in 1997.
General and Administrative Expenses. General and Administrative Expenses
increased by 291.3% to $17.6 million for the three month period ended
September 30, 1997 from $4.5 million for the three month period ended
September 30, 1996. These expenses represented 31.9% and 24.7% of total
revenues, adjusted for the $10.0 million charge, for three month periods ended
September 30, 1997, and 1996, respectively. The increase in General and
Administrative Expenses is a result of the Company's increased number of used
car dealerships, significant expansion of its Third Party Dealer financing
operations, commencement of Cygnet operations, and continued expansion of
infrastructure to administer growth.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on the Company's property and equipment and
amortization of the Company's goodwill and trademarks. Depreciation and
amortization increased by 134.4% to $1.0 million for the three month period
ended September 30, 1997 from $427,000 for the three month period ended
September 30, 1996. The increase was due primarily to the increase in
amortization of goodwill associated with the Company's recent acquisitions,
and increased depreciation expense from the addition of used car dealerships
and Third Party Dealer Branch offices.
Interest Expense. Interest expense increased by 32.6% to $1.6 million in the
three month period ended September 30, 1997 from $1.2 million in the three
month period ended September 30, 1996. The increase in interest expense over
the prior comparable period is due in part to the debt assumed by the Company
in conjunction with the acquisition of the FMAC secured debt, which was
financed by the Company with a note payable to the FMAC senior bank group of
approximately $55.1 million and resulted in incremental interest expense of
21
$514,000. See Liquidity and Capital Resources-FMAC Senior Bank Group Debt.
Income Taxes. As a result of the loss incurred in the three month period
ended September 30, 1997, the Company realized an income tax benefit of $1.1
million, an effective rate of 38.4%. In the three month period ended
September 30, 1996, no income tax was incurred due to income tax benefits
realized from the Company's reduction in its valuation allowance for deferred
income tax assets.
RESULTS OF OPERATIONS
FOR NINE MONTHS ENDED SEPTEMBER 30, 1997
COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 1996
Sales of Used Cars. Sales of Used Cars increased by 87.2% to $79.5 million
for the nine month period ended September 30, 1997 from $42.5 million for the
nine month period ended September 30, 1996. This growth reflects increases in
the number of used car dealerships in operation, and average unit sales price.
Units sold increased by 75.9% to 10,801 units in the nine month period ended
September 30, 1997 from 6,141 units in the nine month period ended September
30, 1996. Same store unit sales declined by 13.4% in the nine month period
ended September 30, 1997 compared to the nine month period ended September 30,
1996. This is due to the increased emphasis on underwriting at the Company
Dealerships, particularly one dealership where unit sales decreased by 619
units, which represents 77.0% of the decrease for the nine month period ended
September 30, 1997 compared to the same period in 1996.
The average sales price per car increased by 6.4% to $7,364 for the nine month
period ended September 30, 1997 from $6,920 for the nine month period ended
September 30, 1996.
Cost of Used Cars Sold and Gross Margin. The Cost of Used Cars Sold increased
by 78.5% to $42.5 million for the nine month period ended September 30, 1997
from $23.8 million for the nine month period ended September 30, 1996. On a
per unit basis, the Cost of Used Cars Sold increased by 1.5% to $3,938 for the
nine month period ended September 30, 1997 from $3,881 for the nine month
period ended September 30, 1996. The gross margin on used car sales (Sales of
Used Cars less Cost of Used Cars Sold excluding Provision for Credit Losses)
increased by 98.3% to $37.0 million for the nine month period ended September
30, 1997 from $18.7 million for the nine month period ended September 30,
1996. As a percentage of sales, the gross margin was 46.5% and 43.9% for the
nine month periods ended September 30, 1997 and 1996, respectively. On a per
unit basis, the gross margin per car sold was $3,426 and $3,039 for the nine
month periods ended September 30, 1997 and 1996, respectively.
Provision for Credit Losses. The Provision for Credit Losses increased by
99.2% to $15.4 million in the nine month period ended September 30, 1997 over
$7.7 million for the nine month period ended September 30, 1996. This includes
an increase of $1.2 million in the Provision for Credit Losses in the nine
month period month ended September 30, 1997 for third party receivables and
the Cygnet dealer notes receivable over the nine month period ended September
30, 1996 when the Company recorded no Provision for Credit losses for third
party receivables or the Cygnet dealer notes receivable. On a percentage
basis, the Provision for Credit Losses per unit originated at Company
Dealerships increased by 12.8% to $1,505 per unit in the nine month period
ended September 30, 1997 from $1,334 per unit in the nine month period ended
September 30, 1996. This increase is primarily due to an increase in the
average amount financed in the nine months ended September 30, 1997 to $7,457
per unit from $6,604 per unit in the nine month period ended September 30,
22
1996. As a percentage of contract balances originated, the Provision for
Credit Losses averaged 20.2% and 20.2%, for the nine month periods ended
September 30, 1997 and 1996, respectively.
Interest Income. Interest Income consists primarily of interest on finance
receivables from Company Dealership sales, interest on Third Party Dealer
finance receivables, income from Residuals in Finance Receivables Sold, income
from the Cygnet Program, and other interest income from the FMAC Secured Debt.
Company Dealership Receivables - Interest Income increased by 30.0% to $9.6
million for the nine month period ended September 30, 1997 from $7.4 million
for the nine month period ended September 30, 1996. Interest Income was
reduced by sales of $155.9 million in Company Dealership contract principal
balances since inception of the Securitization Program, including sales of
$95.7 million in Company Dealership contract principal balances in the nine
months ended September 30, 1997, and will continue to be affected in future
periods by additional securitizations. The Company financed 95.7% of sales
revenue and 94.5% of the used cars sold at Company Dealerships for the nine
month period ended September 30, 1997 compared to 89.8% of sales revenue and
94.1% of the used cars sold for the nine month period ended September 30,
1996. The average amount financed increased to $7,457 for the nine month
period ended September 30, 1997 from $6,604 for the nine month period ended
September 30, 1996. As a result of its expansion into markets with interest
rate limits, the Company's yield on its Company Dealership Receivable contract
portfolio has trended downward. The effective yield on Finance Receivables
from Company Dealerships was 27.7% and 29.2%, for the nine month periods ended
September 30, 1997 and 1996, respectively. The Company's policy is to charge
29.9% per annum on its Company Dealership contracts. However, in those states
that impose usury limits the Company charges the maximum interest rate
permitted.
Third Party Dealer Receivables - Interest Income increased by 135.5% to $10.6
million for the nine month period ended September 30, 1997 from $4.5 million
in the nine month period ended September 30, 1996. Interest Income was
reduced by sales of $157.9 million in Third Party Dealer contract principal
balances since inception of the Securitization Program, including sales of
$147.9 million in Third Party Dealer contract principal balances in the nine
months ended September 30, 1997, and will continue to be effected in future
periods by additional securitizations. Interest income has increased in
conjunction with the increases in Third Party Dealer contracts purchased and
outstanding. Primarily as a result of its expansion into markets with interest
rate limits, the Company's yield on its Third Party Dealer portfolio has
trended downward. Portfolio yield was 23.2% and 24.7%, for the nine month
periods ended September 30, 1997 and 1996, respectively.
Cygnet Program and Other Interest Income - Interest income increased by
100.0% to $3.2 million for the three month period ended September 30, 1997.
This income consisted of $1.3 million in interest income from the Cygnet
Program and $1.8 million in interest income from the aforementioned FMAC
Secured Debt.
Gain on Sale of Finance Receivables. During the nine month period ended
September 30, 1997, the Company securitized an aggregate of $245.5 million in
contracts, issuing $202.0 million in securities. Pursuant to these
transactions, the Company reduced its Allowance for Credit Losses by $39.5
million during the nine month period ended September 30, 1997. The Company
recorded Gain on Sale of Loans during the nine month period ended September
30, 1997 of $10.3 million, which consisted of a Gain on Sale of Loans of $20.3
million from securitization transactions during the nine month period ended
23
September 30, 1997, net of the $10.0 million charge (approximately $6.0
million, net of income taxes) to revalue the Residuals in Finance Receivables
Sold. The Company recognized Gain on Sale of Loans of $2.6 million during the
nine month period ended September 30, 1996. The Gain on Sale of Loans as a
percentage of principal balances securitized was 8.6% and 8.1% respectively,
for the Company Dealership and Third Party Dealer portfolios securitized in
the nine month period ended September 30, 1997, compared to 6.2% for the
Company Dealership portfolios securitized in the nine month period ended
September 30, 1996. No Third Party Dealer contracts were securitized in the
nine month period ended September 30, 1996. The difference in the gain
percentage on the Company Dealership portfolios is due to the fact that the
portfolios securitized in the first nine months of 1996 were more seasoned,
resulting in a much shorter remaining life than the portfolios securitized in
the first nine months of 1997, and lower "A" certificate coupon rates, which
results in an increase in gain on sale, net of the impact of increasing the
cumulative net credit loss assumptions.
During the nine month period ended September 30, 1997, the Company made
initial spread account deposits totaling $7.4 million. Additional net deposits
to the spread accounts during the nine month period ended September 30, 1997
totaled $4.9 million resulting in a total balance in the spread accounts of
$15.1 million as of September 30, 1997. In addition to the spread account
balance of $15.1 million, the Company had deposited a total of $1.1 million in
trust accounts in conjunction with certain other agreements.
During the nine month period ended September 30, 1997, the Trusts issued
certificates at a weighted average yield of 7.5% with the yields ranging from
6.3% to 8.2%, resulting in net spreads, before net credit losses and after
servicing and trustee fees, ranging from 12.5% to 17.8%, and averaging 15.0%.
Other Income. Other Income which consists primarily of servicing income,
insurance premiums earned on force placed insurance policies, earnings on
investments from the Company's cash and cash equivalents, and franchise fees
from the Company's rent-a-car franchisees increased by 791.4% to $7.0 million
for nine months ended September 30, 1997 from $780,000 for the nine month
period ended September 30, 1996. The Company services the $229.0 million in
securitized contract principal balances for monthly fees ranging from .25% to
.33% of the beginning of period principal balances (3.0% to 4.0% annualized In
addition, in conjunction with the Kars acquisition in September 1997, the
Company recognizes income from servicing the Kars portfolio at a rate of
approximately .33% (4.0% annualized) of beginning of period principal
balances. Servicing income for the nine months ended September 30, 1997
increased to $3.8 million from $487,000 in the nine month period ended
September 30, 1996. The significant increase is due to the increase in the
principal balance of contracts being serviced pursuant to the Securitization
Program and the addition of servicing of the Kars portfolio. The increase is
also due to an increase in insurance premium income of $607,000 over the same
period in the prior year when the Company recognized no insurance premium
income and an increase in earnings on investments of $1.2 million compared to
no investment earnings in the nine month period ended September 30, 1996. The
Company no longer actively engages in the rent-a-car franchise business.
Income before Operating Expenses. As a result of the Company's continued
expansion, Income before Operating Expenses grew by 137.9% to $62.3 million
for the nine month period ended September 30, 1997 from $26.2 million for the
nine month period ended September 30, 1996. Growth of Sales of Used Cars,
Interest Income on the loan portfolios, Gain on Sale of Loans, and Other
Income were the primary contributors to the increase.
24
Operating Expenses. Operating Expenses consist of Selling and Marketing
Expenses, General and Administrative Expenses, and Depreciation and
Amortization.
The Company has five distinct business segments. These consist of retail car
sales operations (Company Dealerships), operations attributable to the
administration and collection of finance receivables generated at the Company
Dealerships (Company Dealership Receivables), activities associated with the
origination, administration and collection of finance receivables purchased
from Third Party Dealers (Third Party Dealers), financing activities related
to the collateralized dealer financing program (Cygnet), and corporate and
other operations.
A summary of Operating Expenses by business segment for the nine month periods
ended September 30, 1997 and 1996, respectively, follows:
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
1997
Selling and Marketing . . . . $ 6,670 $ - $ - $ 9 $ 1 $ 6,680
General and Administrative. . 14,196 7,563 10,076 896 7,758 40,489
Depreciation and Amortization 984 785 261 7 422 2,459
------------ ---------- ----------- -------- -------- -------
$ 21,850 $ 8,348 $ 10,337 $ 912 $ 8,181 $49,628
============ =========== ========== ======== ======== =======
Company Third
Company Dealership Party Corporate
Dealerships Receivables Receivables Cygnet & Other Total
------------ ----------- ----------- ------- --------- -------
1996:
Selling and Marketing . . . . $ 2,898 $ - $ - $ - $ 17 $ 2,915
General and Administrative. . 6,225 2,067 2,470 - 2,789 13,551
Depreciation and Amortization 235 567 131 - 195 1,128
------------ ----------- ----------- -------- -------- -------
$ 9,358 $ 2,634 $ 2,601 $ - $ 3,001 $17,594
============ =========== =========== ======== ======== =======
Selling and Marketing Expenses. For the nine month periods ended September
30, 1997 and 1996, Selling and Marketing Expenses were comprised almost
entirely of advertising costs and commissions relating to Company Dealership
operations. Selling and Marketing Expenses increased by 129.2% to $6.7 million
for the nine month period ended September 30, 1997 from $2.9 million for the
nine month period ended September 30, 1996. As a percentage of Sales of Used
Cars, these expenses averaged 8.4% and 6.9% for the nine month periods ended
September 30, 1997, and 1996, respectively. On a per unit sold basis, Selling
and Marketing Expenses of Company Dealerships increased by 30.3% to $618 per
unit for the nine month period ended September 30, 1997 from $475 per unit for
the nine month period ended September 30, 1996. This increase is primarily
due to increased marketing production costs, and an increase in marketing
efforts in the Tampa Bay/St. Petersburg, San Antonio, Las Vegas, and
25
Albuquerque markets where the Company initially commenced operations in 1997,
combined with a decrease in same store unit sales.
General and Administrative Expenses. General and Administrative Expenses
increased by 198.8% to $40.5 million for the nine month period ended September
30, 1997 from $13.6 million for the nine month period ended September 30,
1996. These expenses represented 33.7% and 23.5% of total revenues for nine
month periods ended September 30, 1997, and 1996, respectively. The increase
in General and Administrative Expenses is primarily a result of the Company's
increased number of used car dealerships and significant expansion of its
Third Party Dealer financing operations as well as continued expansion of
infrastructure to administer growth.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on the Company's property and equipment and
amortization of the Company's goodwill and trademarks. Depreciation and
amortization increased by 118.0% to $2.5 million for the nine month period
ended September 30, 1997 from $1.1 million for the nine month period ended
September 30, 1996. The increase was due primarily to the increase in
amortization of goodwill associated with the Company's recent acquisitions,
and increased depreciation expense from the addition of used car dealerships
and Third Party Dealer Branch offices
Interest Expense. Interest expense decreased by 34.9% to $2.9 million from
$4.5 million in the nine month period ended September 30, 1996. The decrease
in 1997, despite significant growth in Company assets, is primarily the result
of the two public offerings that were completed in 1996, a private placement
that was completed in February of 1997 which generated, in the aggregate,
approximately $168.1 million in cash, and the Company's Securitization Program
which generated cash from the sale of Finance Receivables which the Company
utilized to pay down debt. Further, concurrent with the Company's initial
public offering on June 21, 1996, the Company restructured its Subordinated
Notes Payable reducing the borrowing rate on that debt from 18% to 10% per
annum.
Income Taxes. Income taxes totaled $4.0 million in the nine month period
ended September 30, 1997, an effective tax rate of 41.2%. In the nine month
period ended September 30, 1996, no income tax was incurred due to income tax
benefits realized from the Company's reduction in its valuation allowance for
deferred income tax assets.
ALLOWANCE FOR CREDIT LOSSES
The Company has established an Allowance for Credit Losses ("Allowance") to
cover anticipated credit losses on the contracts currently in its portfolio.
The Allowance has been established through the Provision for Credit Losses,
and through nonrefundable acquisition discounts on contracts purchased from
Third Party Dealers. The Allowance on contracts originated at Company
Dealerships decreased to 20.0% of outstanding principal balances as of
September 30, 1997 compared to 23.0% as of December 31, 1996. The Allowance as
a percentage of Third Party Dealer contracts decreased to 12.0% from 12.7%
over the same period. The Allowance as a percentage of the Company's combined
contract portfolio increased to 15.2% at September 30, 1997 from 13.9% at
December 31, 1996. The increase in the Allowance percentage is primarily due
to the composition of the total portfolio with an increase in the Company
Dealership Receivable portfolio relative to the total portfolio compared to
December 31, 1996.
26
The following table reflects activity in the Allowance, as well as information
regarding charge off activity, for the three month periods ended September 30,
1997 and 1996, in thousands.
COMPANY DEALERSHIPS THIRD PARTY DEALERS
--------------------- -----------------------
THREE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- -----------------------
1997 1996 1997 1996
----------- --------- ---------- ----------
Allowance Activity:
Balance, Beginning of Period $ 9,929 $ 5,974 $ 4,506 $ 2,074
Provision for Credit Losses 6,084 2,541 228 -
Discount Acquired - - 6,581 1,816
Reduction Attributable to Loans Sold (10,325) (3,263) (7,354) -
Net Charge Offs (2,379) (1,681) (939) (835)
----------- ---------- ---------- ----------
Balance, End of Period $ 3,309 $ 3,571 $ 3,022 $ 3,055
=========== ========== ========== ==========
Charge off Activity:
Principal Balances:
Collateral Recovered $ (2,319) $ (1,664) $ (1,066) $ (1,003)
Collateral Not Recovered (820) (342) (198) (191)
----------- ---------- ---------- ----------
Total Principal Balances (3,139) (2,006) (1,264) (1,194)
Accrued Interest - (114) - (64)
Recoveries, Net 760 439 325 423
----------- ---------- ---------- ----------
Net Charge Offs $ (2,379) $ (1,681) $ (939) $ (835)
=========== ========== ========== ==========
Net Charge Offs as % of Average 23.8% 28.3% 17.5% 10.2%
Principal Outstanding =========== ========== ========= ===========
27
The following table reflects activity in the Allowance, as well as information
regarding charge off activity, for the nine month periods ended September 30,
1997 and 1996, in thousands.
COMPANY DEALERSHIPS THIRD PARTY DEALERS
--------------------- ------------------------
NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------------
1997 1996 1997 1996
----------- --------- ---------- -----------
Allowance Activity:
Balance, Beginning of Period $ 1,625 $ 7,500 $ 6,500 $ 1,000
Provision for Credit Losses 14,193 7,713 948 -
Discount Acquired 15,309 - 17,713 3,646
Discount accreted to interest income - - (642) -
Reduction Attributable to Loans Sold (21,407) (6,187) (18,096) -
Net Charge Offs (6,411) (5,455) (3,401) (1,591)
----------- --------- --------- ------------
Balance, End of Period $ 3,309 $ 3,571 $ 3,022 $ 3,055
========== ========== ========= ============
Allowance as Percent of Period 20.0% 23.1% 12.0% 8.3%
Ended Principal Balance ========== ========== ========= ============
Charge off Activity:
Principal Balances:
Collateral Recovered $ (6,865) $ (5,260) $ (3,873) $ (2,070)
Collateral Not Recovered (1,490) (1,619) (858) (416)
----------- ---------- --------- -----------
Total Principal Balances (8,355) (6,879) (4,731) (2,486)
Accrued Interest - (486) - (123)
Recoveries, Net 1,944 1,910 1,330 1,018
---------- ----------- --------- -----------
Net Charge Offs $ (6,411) $ (5,455) $ (3,401) $ (1,591)
=========== ========== ========= ===========
Net Charge Offs as % of Average 23.9% 25.3% 15.8% 9.18%
Principal Outstanding =========== ========== ========= ===========
During the nine month period ended September 30, 1997, the Company experienced
rapid growth in the number of states in which it operated Company Dealerships
and Third Party Dealer branches. As a result, the Company's loan base was
more geographically diversified throughout the country, which in turn led to
the Company repossessing significantly more vehicles throughout the country
than it historically had, in markets where it did not operate reconditioning
centers or repossession lots. The Company, therefore, relied extensively on
third parties to dispose of its repossessed collateral. This led to the
Company not realizing its expected recovery amount on the liquidation of these
repossessions. The Company has taken several actions to reverse this trend
including consolidation of auction locations through which repossessed
vehicles are liquidated, expansion of its repossession administration
department, development of an enhanced repossession tracking and monitoring
system, hiring of staff whose primary responsibility is to represent the
Company at auctions, and expansion of efforts to better recondition
repossessions prior to liquidation. The Company believes these actions will
improve recovery rates to levels it historically experienced prior to the nine
28
month period ended September 30, 1997. For loans originated at Company
Dealerships, recoveries as a percentage of principal balances charged off
where collateral has been recovered averaged 28.3% for the nine month period
ended September 30, 1997 compared to 36.3% for the nine month period ended
September 30, 1996. Company Dealership loan recoveries in Arizona are
positively effected by the Company's ability to receive a sales tax benefit
for charged off loans that it does not receive in other markets. As a result
of the Company's expansion outside of the Arizona market in 1997, recovery
rates for the Company Dealership loan portfolio were negatively effected. For
Third Party Dealer loans, recoveries as a percentage of principal balances
charged off where collateral has been recovered averaged 34.3% for the nine
months period ended September 30, 1997 compared to 49.2% for the nine month
period ended September 30, 1996.
The Company's Net Charge Offs on its Third Party Dealer contract portfolio are
lower than those incurred on its Company Dealership contract portfolio. This
is attributable to the relationship of the average amount financed to the
underlying collateral's wholesale value and to a lesser degree the generally
more creditworthy customers served by Third Party Dealers. In its Third Party
Dealer portfolio, the Company generally limits the amount financed to not more
than 120.0% of the wholesale value of the underlying car, although the Company
will make exceptions on a case-by-case basis.
Static Pool Analysis. To monitor contract performance, beginning in June
1995, the Company implemented "static pool" analysis for contracts originated
since January 1, 1993. Static pool analysis is a monitoring methodology by
which each month's originations and subsequent charge offs are assigned a
unique pool and the pool performance is monitored separately. Improving or
deteriorating performance is measured based on cumulative gross and net charge
offs as a percentage of original principal balances, based on the number of
complete payments made by the customer before charge off. The table below sets
forth the cumulative net charge offs as a percentage of original contract
cumulative balances, based on the quarter of origination and segmented by the
number of payments made prior to charge off. For periods denoted by "x", the
pools have not seasoned sufficiently to allow for computation of cumulative
losses. For periods denoted by "-", the pools have not yet attained the
indicated cumulative age. While the Company monitors its static pools on a
monthly basis, for presentation purposes the information in the tables are
presented on a quarterly basis.
Effective January 1, 1997, the Company modified its methodology to reflect
additional historical experience in computing "Monthly Payments Completed by
Customer Before Charge Off" as it relates to loan balances charged off after
final insurance settlements and on loans modified from their original terms.
Resulting adjustments affect the timing of previously reported interim
cumulative losses, but do not impact ending cumulative losses. For loan
balances charged off after insurance settlement principal reductions, the
revised calculation method only gives credit for payments actually made by the
customer and excludes credit for reductions arising from insurance proceeds.
For modified loans, completed payments now reflect customer payments made both
before and after the loan was modified. The numbers presented below reflect
the adoption of the revised calculation method.
Currently reported cumulative losses may also vary from those previously
reported due to ongoing collection efforts on charged off accounts and the
difference between final proceeds on the liquidation of repossessed collateral
versus original accounting estimates. Management believes that such variation
will not be material.
29
CONTRACTS ORIGINATED AT COMPANY DEALERSHIPS
The following table sets forth the cumulative net charge offs as a percentage
of original contract cumulative (pool) balances, based on the quarter of
origination and segmented by the number of monthly payments completed by
customer before charge off. Additionally, set forth is the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF PERCENT
----------------------------------------------------------------
0 3 6 12 18 24 TLI REDUCED
----- ----- ----- ----- ----- ----- ----- --------
1993:
1st Quarter 6.9% 18.7% 26.5% 31.8% 33.9% 35.1% 35.4% 100.0%
2nd Quarter 7.2% 18.9% 25.1% 29.4% 31.7% 32.1% 32.4% 100.0%
3rd Quarter 8.6% 19.6% 23.7% 28.5% 30.7% 31.6% 31.9% 100.0%
4th Quarter 6.3% 16.1% 21.6% 27.0% 28.9% 29.5% 29.6% 100.0%
1994:
1st Quarter 3.4% 10.0% 13.4% 18.1% 20.5% 21.2% 21.3% 100.0%
2nd Quarter 2.8% 10.5% 14.2% 19.7% 21.9% 22.4% 22.5% 100.0%
3rd Quarter 2.8% 8.2% 12.2% 16.5% 18.6% 19.5% 19.6% 100.0%
4th Quarter 2.4% 7.7% 11.3% 16.9% 20.0% 21.0% 21.1% 100.0%
1995:
1st Quarter 1.1% 7.4% 12.5% 17.8% 20.3% 21.3% 21.5% 97.6%
2nd Quarter 1.7% 7.1% 12.1% 16.7% 19.6% 21.1% 21.1% 93.0%
3rd Quarter 2.0% 7.0% 11.1% 18.1% 21.7% x 22.8% 86.6%
4th Quarter 1.2% 5.7% 10.8% 17.8% 22.3% - 22.6% 81.7%
1996:
1st Quarter 1.4% 7.6% 13.2% 20.6% x - 23.6% 74.4%
2nd Quarter 2.2% 9.2% 14.1% 22.6% - - 23.1% 64.4%
3rd Quarter 1.6% 7.2% 12.9% x - - 18.9% 53.1%
4th Quarter 1.6% 8.7% 16.0% - - - 17.6% 44.5%
1997:
1st Quarter 2.5% 10.4% x - - - 12.7% 34.0%
2nd Quarter 1.8% x - - - - 4.7% 15.4%
3rd Quarter x - - - - - 0.2% 1.8%
Trends set forth in the table above indicate a deterioration in the
performance of the associated loan portfolio. Management believes the
deterioration is primarily attributable to less effective collection
procedures resulting from a loan servicing and collection data processing
system conversion in the first and second quarters of 1997 rather than from
any fundamental change in loan quality or underwriting. As a result of this
trend, the Company recorded a charge against its Residuals in Finance
Receivables Sold during the three month period ended September 30, 1997.
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
Company Dealership contract principal balances.
30
Retained Securitized Managed
--------- ------------ --------
September 30,1997:
31 to 60 days 1.5% 3.9% 3.6%
61 to 90 days 2.8% 1.4% 1.6%
December 31,1996:
31 to 60 days 2.3% 5.4% 5.0%
61 to 90 days 0.6% 1.9% 1.7%
In accordance with the Company's charge off policy, there are no accounts more
than 90 days delinquent as of September 30, 1997 and December 31, 1996.
CONTRACTS PURCHASED FROM THIRD PARTY DEALERS
Non-refundable acquisition discount ("Discount") acquired totaled $6.6 million
and $1.8 million for the three month periods ended September 30, 1997 and
1996, respectively. The Discount, attributable to Third Party Dealer
purchases, averaged approximately 12.5% as a percentage of principal balances
purchased in the three month period ended September 30, 1997, compared to
11.6% in the three month period ended September 30, 1996. For the nine month
period ended September 30, 1997 and 1996, Discount acquired totaled $17.7
million and $3.6 million, respectively. As a percentage of contracts
purchased, Discount averaged 12.2% and 11.1% during the same periods,
respectively.
The following table sets forth the cumulative net charge offs as a percentage
of original contract cumulative (pool) balances, based on the quarter of
origination and segmented by the number of monthly payments completed by
customer before charge off. Additionally, set forth is the percent of
principal reduction for each pool since inception and cumulative total net
losses incurred (TLI).
POOL'S CUMULATIVE NET LOSSES AS PERCENTAGE OF POOL'S ORIGINAL
AGGREGATE PRINCIPAL BALANCE
MONTHLY PAYMENTS COMPLETED BY CUSTOMER BEFORE CHARGE OFF PERCENT
----------------------------------------------------------------
0 3 6 12 18 24 TLI REDUCED
----- ----- ------ ----- ----- ------ ----- --------
1995:
2nd Quarter 0.9% 4.1% 5.7% 7.7% 9.4% 10.6% 10.6% 90.1%
3rd Quarter 1.2% 3.7% 4.6% 6.3% 7.5% x 8.1% 82.4%
4th Quarter 1.0% 4.3% 6.7% 9.3% 11.0% - 11.2% 82.5%
1996:
1st Quarter 0.8% 3.7% 6.9% 10.8% x - 12.1% 74.5%
2nd Quarter 1.6% 6.2% 9.7% 13.6% - - 13.6% 67.8%
3rd Quarter 1.3% 6.0% 9.2% x - - 14.7% 56.2%
4th Quarter 1.4% 7.4% 12.0% - - - 15.2% 45.6%
1997:
1st Quarter 1.4% 7.6% x - - - 8.2% 30.9%
2nd Quarter 1.5% x - - - - 2.4% 14.3%
3rd Quarter x - - - - - 0.1% 2.6%
31
Trends set forth in the table above indicate a deterioration in the
performance of the associated loan portfolio. Management believes the
deterioration is primarily attributable to less effective collection
procedures resulting from a loan servicing and collection data processing
system conversion in the first and second quarters of 1997 rather than from
any fundamental change in loan quality or underwriting. As a result of this
trend, the Company recorded a charge against its Residuals in Finance
Receivables Sold during the three month period ended September 30, 1997.
Beginning April 1, 1995, the Company initiated a new purchasing program for
Third Party Dealer contracts which included an emphasis on higher quality
contracts. As of March 31, 1995, the Third Party Dealer portfolio originated
under the prior program had a principal balance of $2.0 million which are paid
in full. Therefore, contract performance under this prior program has been
excluded from the table above.
While the static pool information is developing, management augments its
evaluation of the adequacy of the Allowance for Third Party Dealers through
comparisons in the characteristics of collateral ratios and borrowers on Third
Party Dealer contracts versus those of the Company Dealership contracts, as
well as through comparisons of portfolio delinquency, actual contract
performance and, to the extent information is available, industry statistics.
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
Third Party Dealer contract principal
Retained Securitized Managed
--------- ------------ --------
September 30, 1997:
31 to 60 days . . . 1.7% 4.7% 4.2%
61 to 90 days . . . 2.5% 1.6% 1.8%
December 31, 1996:
31 to 60 days . . . 3.1% 4.3% 3.3%
61 to 90 days . . . 1.1% 1.0% 1.1%
In accordance with the Company's charge off policy there are no Third Party
Dealer contracts more than 90 days delinquent as of September 30, 1997 and
December 31, 1996.
During 1996 and continuing throughout 1997, the Company elected to extend the
time period before repossession is ordered with respect to those customers who
exhibit a willingness and capacity to bring their contracts current. As a
result of this revised repossession policy, delinquencies increased as
expected.
RESIDUALS IN FINANCE RECEIVABLES SOLD
Residuals in Finance Receivables Sold represent the Company's retained potion
of the securitization assets. The Company utilizes a number of estimates in
arriving at the initial valuation of the Residuals in Finance Receivables
Sold, which represent the expected present value of net cash flows into the
trust in excess of those required to pay principal and interest on the Class A
certificates. The present value of expected cash flows are a function of a
number of items including, but not limited to, charge off rates, repossession
32
recovery rates, portfolio delinquency, prepayment rates, and trust expenses.
Subsequent to the initial recording of the Residuals in Finance Receivables
Sold, the carrying value is adjusted for the actual cash flows into the
respective trusts in order to maintain a carrying value which approximates the
present value of the expected net cash flows into the trust in excess of those
required to pay all obligations of the respective trust other than the
obligations to the Class B certificates. To the extent that actual cash flows
on a securitization are below original estimates, and differ materially from
the original securitization assumptions, and in the opinion of management,
those differences appear to be other than temporary in nature, the Company
would be required to revalue the residual portion of the securitization which
it retains, and record a charge to earnings based upon the reduction.
During the three month period ended September 30, 1997, the Company recorded
a $10.0 million charge (approximately $6.0 million, net of income taxes) to
write down the Residuals in Finance Receivables Sold. The Company determined
a write down in the Residuals in Finance Receivables Sold was necessary due to
an increase in net losses in the securitized loan portfolio, particularly the
Third Party Dealer portfolio. For securitization transactions between June 30,
1996 and June 30, 1997, for contracts originated at Company Dealerships, net
losses were originally estimated using total expected cumulative net losses at
loan origination of approximately 26.0%, adjusted for actual cumulative net
losses prior to securitization. For contracts purchased from Third Party
Dealers, net losses were originally estimated using total expected cumulative
net losses at loan origination of approximately 13.5%, adjusted for actual
cumulative net losses prior to securitization. Prepayment rates were estimated
to be 1.5% per month of the beginning of month balance. The $10.0 million
charge (approximately $6.0 million, net of income taxes) in the three month
period ended September 30, 1997 which resulted in a reduction in the carrying
value of the Company's Residuals in Finance Receivables Sold had the effect of
increasing the cumulative net loss assumption for contracts originated at
Company Dealerships to approximately 27.5%, and for contracts purchased from
Third Party Dealers to approximately 17.5% for the securitization transactions
that took place prior to the three month period ended September 30, 1997. As
a result of this charge, the remaining allowance for credit losses inherent in
the securitization assumptions as a percentage of the remaining principal
balances of securitized contracts was approximately 19.7% as of September 30,
1997, compared to 15.2% as of December 31, 1996. There can be no assurance
that the charge taken by the Company is sufficient and that the Company will
not record additional charges in the future in order to write down the
Residuals in Finance Receivables Sold.
LIQUIDITY AND CAPITAL RESOURCES
The Company requires capital to support increases in its contract portfolio,
expansion of Company Dealerships, Branch Offices, the Cygnet Program, the
purchase of inventories, the purchase of property and equipment, and for
working capital and general corporate purposes. The Company funds its capital
requirements through equity offerings, operating cash flow, the sale of
finance receivables, and supplemental borrowings.
The Company's Net Cash Provided by Operating Activities increased by $39.7
million to $41.3 million for the nine month period ended September 30, 1997
from $1.6 million in the nine month period ended September 30, 1996. The
increase was primarily due to an increase in proceeds from sales of finance
receivables, provision for credit losses, and increases in Accounts Payable,
Accrued Liabilities and Other Liabilities offset by increases in Finance
Receivables Held for Sale, Gain on Sale of Finance Receivables, and increases
in Inventory and Other Assets.
33
The Net Cash Used in Investing Activities increased by $90.1 million to $103.0
million in the nine months ended September 30, 1997 from $12.9 million in the
nine months ended September 30, 1996. The increase was due to an increase in
notes receivable of $29.6 million, an increase in the purchase of property and
equipment of $11.5 million, and the purchase of the assets of Seminole, EZ
Plan, and Kars, for $45.3 million.
The Company's Net Cash Provided by Financing Activities increased by $37.1
million to $47.6 million in the nine month period ended September 30, 1997
from $10.5 million in the nine month period ended September 30, 1996. This
increase was primarily the result of the $88.7 million in proceeds from the
Company's sale of common stock, net of the $39.1 million of repayment of Notes
Payable and the repayment of Subordinated Notes Payable of $2.0 million.
Revolving Facility. The Company maintains a Revolving Facility with GE Capital
that has a maximum commitment of up to $100.0 million. Under the Revolving
Facility, the Company may borrow up to 65.0% of the principal balance of
eligible Company Dealership contracts and up to 86.0% of the principal balance
of eligible Third Party Dealer contracts. The Revolving Facility expires in
December 1998. The facility is secured by substantially all of the Company's
assets. As of September 30, 1997, the Company's borrowing capacity under the
Revolving Facility was $19.0 million, the aggregate principal amount
outstanding under the Revolving Facility was approximately $128,000, and the
amount available to be borrowed under the facility was $18.9 million. The
Revolving Facility bears interest at the 30-day LIBOR plus 3.15%, payable
daily (total rate of 8.8% as of September 30, 1997).
The Revolving Facility contains covenants that, among other things, limit the
Company's ability to, without GE Capital's consent: (i) incur additional
indebtedness; (ii) make unsecured loans or other advances of money to
officers, directors, employees, stockholders or affiliates in excess of
$25,000 in total; (iii) engage in securitization transactions (other than the
Securitization Program, for which GE Capital has consented); (iv) merge with,
consolidate with, acquire or otherwise combine with any other person or
entity, transfer any division or segment of its operations to another person
or entity, or form new subsidiaries; (v) make any change in its capital
structure; (vi) declare or pay dividends except in accordance with all
applicable laws and not in excess of fifteen percent (15%) of each year's net
earnings available for distribution; (vii) make certain investments and
capital expenditures; and (viii) engage in certain transactions with
affiliates. These covenants also require the Company to maintain specified
financial ratios, including a debt ratio of 2.1 to 1 and a net worth of at
least $75,000,000, and to comply with all laws relating to the Company's
business. The Revolving Facility also provides that a transfer of ownership of
the Company that results in less than 15.0% of the Company's voting stock
being owned by Mr. Ernest C. Garcia II, will result in an event of default
under the Revolving Facility.
FMAC Senior Bank Group Debt. In conjunction with the acquisition of the
Secured Debt from the Bank Group, the Company executed a note payable of
approximately $55.1 million payable to the Bank Group with a balance at
September 30, 1997 at approximately $50.4 million. The note payable, which is
due in full in February 1998, bears interest at 30-day LIBOR plus 2.0% (7.65%
at September 30, 1997), and is payable daily.
Subordinated Indebtedness and Preferred Stock. Prior to its public offering
in June 1996, the Company historically borrowed substantial amounts from Verde
Investments Inc. ("Verde"), an affiliate of the Company. The Subordinated
Notes Payable balances outstanding to Verde totaled $12.0 million and $14.0
34
million as of September 30, 1997 and December 31, 1996, respectively. Prior
to June 21, 1996, these borrowings accrued interest at an annual rate of
18.0%. Effective June 21, 1996 the annual interest rate on these borrowings
was reduced to 10.0%. The Company is required to make monthly payments of
interest and annual payments of principal in the amount of $2.0 million. This
debt is junior to all of the Company's other indebtedness and the Company may
suspend interest and principal payments in the event it is in default on
obligations to any other creditors. In July 1997, the Company's Board of
Directors approved the prepayment of the $12.0 million in subordinated debt
subject to various conditions including the Company's completion of a debt
offering. No such prepayment has been made as of the date of filing of this
Form 10-Q.
On December 31, 1995, Verde converted $10.0 million of subordinated debt to
Preferred Stock of the Company. Prior to June 21, 1996, the Preferred Stock
accrued a dividend of 12.0% annually, increasing one percent per year up to a
maximum of 18.0%. Effective June 21, 1996, the dividend on the Preferred Stock
was decreased from 12.0% to 10.0%. During the nine month period ended
September 30, 1996, the Company paid a total of $817,000 in dividends to Verde
on the Preferred Stock which was redeemed in November 1996. As the preferred
stock was redeemed in 1996, there were no dividends paid in 1997.
Securitizations. Pursuant to the Company's Securitization Program, the
Company and SunAmerica entered into an agreement under which SunAmerica would
purchase $175.0 million of certificates secured by contracts. As of June 30,
1997, the Company had substantially utilized its maximum commitment from, and
does not expect to complete any further securitizations with SunAmerica under
the existing Securitization Program. The Securitization Program has provided
the Company with a source of funding in addition to the Revolving Facility. At
the closing of each securitization, the Securitization Subsidiaries receive
payment for the certificates sold (net of Investments Held in Trust). The
Company also generates cash flow under this program from ongoing servicing
fees and excess cash flow distributions resulting primarily from the
difference between the payments received from customers on the contracts and
the payments paid on the Class A Certificates. In addition, securitization
allows the Company to fix its cost of funds for a given contract portfolio,
and broadens the Company's capital source alternatives. The Company sold its
securitization that was consummated during the three month period ended
September 30, 1997 to private investors. Failure to periodically engage in
securitization transactions will adversely affect the Company.
In connection with its securitization transactions, the Securitization
Subsidiaries are required to make an initial cash deposit into an account held
by the trustee (spread account) and to pledge this cash to the Trust to which
the finance receivables were sold. The Trust in turn invests the cash in high
quality liquid investment securities. In addition, the cash flows due to the B
Certificates first are deposited into the spread account as necessary to
attain and maintain the spread account at a specified percentage of the
underlying finance receivables principal balance. In the event that the cash
flows generated by the finance receivables sold to the Trust are insufficient
to pay obligations of the Trust, including principal or interest due to
certificate holders or expenses of the Trust, the trustee will draw funds from
the spread account as necessary to pay the obligations of the Trust. The
spread account must be maintained at a specified percentage of the principal
balances of the finance receivables held by the Trust, which can be increased
in the event delinquencies or losses exceed specified levels. If the spread
account exceeds the specified percentage, the trustee will release the excess
cash to the Securitization Subsidiaries from the pledged spread account.
35
Debt Shelf Registration. On July 18, 1997, the Company filed a Form S-3
registration statement for the purpose of registering up to $200 million of
its debt securities in one or more series at prices and on terms to be
determined at the time of sale. The registration statement has been declared
effective by the Securities and Exchange Commission and is available for
future debt offerings.
Transactions regarding First Merchants Acceptance Corporation. First Merchants
Acceptance Corporation ("FMAC") filed for reorganization under Chapter 11 of
the Federal Bankruptcy Code on July 11, 1997 ("Bankruptcy Case"). In
connection with the Bankruptcy Case, the Company, which owns approximately 2
1/2% of FMAC's outstanding common stock with a cost basis of approximately
$1.5 million, agreed to provide up to $10 million of "debtor in possession"
financing to FMAC, of which approximately $3.8 million was outstanding at
September 30, 1997. On August 20, 1997, the Company acquired approximately 78%
of the senior secured debt ("Secured Debt") of FMAC from certain members of
the senior bank group (Bank Group) that held such debt. The Secured Debt
totaled approximately $97.8 million. The more significant terms of the
purchase of the Secured Debt included, among other things, the (i) purchase by
the Company of the debt at a 10% discount of the outstanding principal amount;
(ii) short-term financing by the Bank Group to the Company for the purchase,
with interest accruing at LIBOR plus 2% and an up-front payment by the Company
to the Bank Group equal to 20% of the purchase price; and (iii) issuance of
stock warrants to the Bank Group to purchase up to 389,800 shares of the
Company's common stock at an exercise price of $20 per share over a
thirty-month term and subject to a call feature by the Company.
Subsequent to September 30, 1997, the Company entered into a contract to
acquire, subject to various conditions that have not yet been satisfied, the
remaining approximately 22% of the Secured Debt from two (2) unrelated third
parties (the "Sellers"). The more significant terms of the purchase include,
among other things, (i) the Company's right to purchase by an exercise of a
call right that expires on February 20, 1998 (the "Call Period"), and which is
followed by a put right by the Sellers that expires on March 15, 1998 (the
"Put Period"); (ii) a purchase price equal to ninety-five percent (95%) during
the Call Period (and one hundred percent (100%) during the Put Period) of the
outstanding principal balance of the purchased Secured Debt, plus interest on
such purchase price from November 12, 1997 through the closing date of such
purchase at approximately 8.0% per annum, less all payments received by the
Sellers with respect to the purchased Secured Debt through the date of
closing; and (iii) the issuance of stock warrants to the Sellers to purchase
up to 110,200 shares of the Company's common stock at an exercise price of
$20.00 per share over a 36 month term and subject to a call feature of the
Company.
Capital Expenditures and Commitments. The Company is pursuing an aggressive
growth strategy. In the fourth quarter of 1996, the Company acquired the
leasehold rights to an existing dealership in Las Vegas, Nevada, which
commenced operations in March 1997, and has opened two new dealerships in
Phoenix, Arizona and two new dealerships in Albuquerque, New Mexico. In
addition, the Company has two dealerships in Phoenix, Arizona, one in San
Antonio, two in Dallas, one in Miami and one in Tampa currently under
development. Further, the Company opened 11 new Branch Offices during the
three month period ended September 30, 1997, and recently completed expansion
of its contract servicing and collection facility.
On September 19, 1997, the Company purchased substantially all of the
dealership and loan servicing assets of Kars Yes Holdings, Inc. (Kars), a
Company in the business of selling and financing used motor vehicles,
36
including six dealerships in the Los Angeles market, two in the Miami market,
two in the Atlanta market, and two in the Dallas market in exchange for $5.5
million in cash. In addition, the Company intends to open 2 or more new
Branch Offices and six or more Company Dealerships through the end of 1997.
The Company believes that it will expend approximately $50,000 to establish
each new Branch Office. New Company Dealerships cost approximately $1.5 to
$1.7 million to construct (excluding inventory). Further, on July 11, 1997,
the Company entered into an agreement to provide "debtor in possession"
financing to First Merchants Acceptance Corporation in an amount up to $10.0
million. The Company had advanced $3.8 million against this commitment as of
September 30, 1997. The Company intends to finance these expenditures through
operating cash flows and supplemental borrowings, including amounts available
under the Revolving Facility and the Securitization Program, if any.
Common Stock Repurchase Program. In October 1997 the Company's Board of
Directors authorized a stock repurchase program by which the Company may
acquire up to one million shares of its common stock from time to time on the
open market. Under the program, purchases may be made depending on market
conditions, share price and other factors. The stock repurchase program will
terminate on December 31, 1998, unless extended by the Company's Board of
Directors, and may be discontinued at any time. As of the date of filing of
this Form 10-Q, the Company had not repurchased any shares of common stock.
Year 2000. The Company has commenced a study of its computer systems in order
to assess its exposure to year 2000 issues. The Company expects to make the
necessary modifications or changes to its computer information systems to
enable proper processing of transactions relating to the year 2000 and beyond.
The Company will evaluate appropriate courses of action, including replacement
of certain systems whose associated costs would be recorded as assets and
subsequently amortized. However, there can be no assurance that year 2000
costs and expenses will not have a material adverse affect on the Company.
SEASONALITY
Historically, the Company has experienced higher revenues in the first two
quarters of the year than in the latter half of the year. The Company believes
that these results are due to seasonal buying patterns resulting in part from
the fact that many of its customers receive income tax refunds during the
first half of the year, which are a primary source of down payments on used
car purchases.
INFLATION
Increases in inflation generally result in higher interest rates. Higher
interest rates on the Company's borrowings would decrease the profitability of
the Company's existing portfolio. The Company will seek to limit this risk
through its Securitization Program and, to the extent market conditions
permit, for contracts originated at Company Dealerships, either by increasing
the interest rate charged, or the profit margin on, the cars sold, or for
contracts acquired from Third Party Dealers, either by acquiring contracts at
a higher discount or with a higher APR. To date, inflation has not had a
significant impact on the Company's operations.
ACCOUNTING MATTERS
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS No. 128).
This statement is effective for both interim and annual periods ending after
December 15, 1997, and replaces the presentation of "primary" earnings per
37
share with "basic" earnings per share and the presentation of "fully diluted"
earnings per share with "diluted" earnings per share. Earlier application is
not permitted. When adopted, all previously reported earnings per common
share amounts must be restated based upon the provisions of the new standard.
Management of the Company does not expect that adoption of SFAS No. 128 will
have a material impact on the Company.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS
No. 130). This statement is effective for interim and fiscal periods
beginning after December 15, 1997, and requires the Company to classify items
of other comprehensive income by their nature in a financial statement, and to
display the accumulated balance of other comprehensive income separately from
retained earnings and additional paid-in capital in the equity section of the
statement of financial position. Management of the Company does not expect
that the adoption of SFAS No. 130 will have a material impact on the Company.
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). This statement is
effective for fiscal years beginning after December 15, 1997, and requires the
Company to report information about operating segments in its annual financial
statements and further requires the Company to disclose selected information
about operating segments in interim reports to shareholders. It also
establishes standards for related disclosures about products and services,
geographic areas, and major customers. Management of the Company does not
expect that the adoption of SFAS No. 131 will have a material impact on the
Company.
The Securities and Exchange Commission has approved rule amendments to clarify
and expand existing disclosure requirements for derivative financial
instruments. The amendments require enhanced disclosure of accounting
policies for derivative financial instruments in the footnotes to the
financial statements. In addition, the amendments expand existing disclosure
requirements to include quantitative and qualitative information about market
risk inherent in market risk sensitive instruments. The required quantitative
and qualitative information are to be disclosed outside the financial
statements and related notes thereto. The enhanced accounting policy
disclosure requirements are effective for the quarter ended June 30, 1997. As
the Company believe that the derivative financial instrument disclosure
contained within the notes to the financial statements of its 1996 Form 10-K
substantially conform with the accounting policy requirements of these
amendments, no further interim period disclosure has been provided. The rule
amendments that require expanded disclosure of quantitative and qualitative
information about market risk are effective with the 1998 Form 10-K.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
The Company sells its cars on an "as is" basis, and requires all
customers to sign an agreement on the date of sale pursuant to which the
Company disclaims any obligation for vehicle-related problems that
subsequently occur. Although the Company believes that such disclaimers are
enforceable under applicable state, federal and other laws and regulations,
there can be no assurance that they will be upheld in every instance. Despite
obtaining these disclaimers, the Company, in the ordinary course of business,
receives complaints from customers relating to such vehicle-related problems
38
as well as alleged violations of federal and state consumer lending or other
similar laws and regulations. While most of these complaints are made directly
to the Company or to various consumer protection organizations and are
subsequently resolved, the Company is named as a defendant in civil suits
filed by customers in state, local, or small claims courts. Additionally, in
the ordinary course of business, the Company is a defendant in various other
types of legal proceedings. There can be no assurance that the Company will
not be a target of similar claims and legal proceedings in the future. The
Company believes that the ultimate disposition of these matters on a
cumulative basis will not have a material adverse effect on the Company.
However, there can be no assurance in this regard.
In connection with the Seminole acquisition, a purported creditor of the
sellers filed, on January 21, 1997, to enjoin the sale as a fraudulent
conveyance. Alternatively, the suit seeks to void any transfer of the assets
that has already occurred, to attach the assets that have been transferred, or
to appoint a receiver to take charge of the assets transferred. The Company
has not been named in this action, has received a specific indemnity from the
sellers relating to this action, and has been advised by the sellers that, in
their view, the claim is without merit. The Company believes that the
ultimate disposition of this matter will not have a material adverse effect on
the Company.
Item 2. Changes in Securities and Use of Proceeds.
Warrants to purchase 389,800 shares of common stock of the Company were
issued in a private placement under Section 4(2) of the Securities Act of 1933
to a group of banks in connection with the acquisition of senior Secured Debt
of First Merchants Acceptance Corporation from such banks. See a description
of the transaction herein under "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Introduction."
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 5. Other Information.
Subsequent to September 30, 1997, the Company entered into a contract to
acquire, subject to various conditions that have not yet been satisfied, the
remaining approximately 22% of the Secured Debt from two (2) unrelated third
parties (the "Sellers"). The more significant terms of the purchase include,
among other things, (i) the Company's right to purchase by an exercise of a
call right that expires on February 20, 1998 (the "Call Period"), and which is
followed by a put right by the Sellers that expires on March 15, 1998 (the
"Put Period"); (ii) a purchase price equal to ninety-five percent (95%) during
the Call Period (and one hundred percent (100%) during the Put Period) of the
outstanding principal balance of the purchased Secured Debt, plus interest on
such purchase price from November 12, 1997 through the closing date of such
purchase at approximately 8.0% per annum, less all payments received by the
Sellers with respect to the purchased Secured Debt through the date of
closing; and (iii) the issuance of stock warrants to the Sellers to purchase
up to 110,200 shares of the Company's common stock at an exercise price of
$20.00 per share over a 36 month term and subject to a call feature of the
Company.
39
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
Exhibit 10.a - Amended and Restated Motor Vehicle Installment
Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation
Exhibit 10.b - Employment Agreement between Registrant and Steven A.
Tesdahl*
Exhibit 10.c - Amended and Restated Employment Agreement between
Registrant and Donald L. Addink*
Exhibit 11 - Statement Regarding Computation of Earnings Per Share
Exhibit 27 - Financial Data Schedule
Exhibit 99 - Cautionary Statement Regarding Forward Looking
Statements and Risk Factors
____________________________
*- Denotes a management contract or compensatory plan, contract, or
arrangement.
(b) Reports on Form 8-K.
During the third quarter of 1997, the Company filed two reports on Form
8-K. The first report on Form 8-K, dated July 17, 1997 and filed July
18,1997, pursuant to Items 5 and 7, filed a copy of the Company's press
release entitled "Ugly Duckling Corporation to Purchase Secured Bank Debt of
First Merchants Acceptance Corporation." The second report on Form 8-K, dated
August 21, 1997 and filed September 5, 1997, pursuant to Items 2, 5, and 7,
reported (1) the purchase by the Company of approximately 78% of the FMAC
senior bank debt, (2) the expected recording of a third quarter charge to net
earnings of between $4 million to $6 million (after taxes), and (3)
negotiations between the Company and Kars to acquire certain dealership and
servicing assets of Kars. After the third quarter 1997, the Company filed one
Form 8-K. This Form 8-K, dated September 19, 1997 and filed October 5, 1997
pursuant to Items 2, 5, and 7, reported (1) the completion of the acquisition
by the Company of certain assets of Kars, and (2) the securitization of
approximately $104 million of vehicle receivables by CRC II.
40
SIGNATURE
---------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Ugly Duckling Corporation
Date: November 14, 1997
-------------------
/s/ Steven T. Darak
- ----------------------
Steven T. Darak
Senior Vice President and
Chief Financial Officer
(Principal Financial and Accounting Officer)
S-1
===
41
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
- ------ -----------
10.a - Amended and Restated Motor Vehicle Installment Contract Loan and
Security Agreement between Registrant and General Electric Capital
Corporation
10.b - Employment Agreement between Registrant and Steven A. Tesdahl*
10.c - Amended and Restated Employment Agreement between Registrant and
Donald L. Addink*
11 - Statement Regarding Computation of Earnings Per Share
27 - Financial Data Schedule
99 - Cautionary Statement Regarding Forward Looking Statements and Risk
Factors