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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998.
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number 0-20841
UGLY DUCKLING CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 86-0721358
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2525 E. Camelback Road, Suite 500,
Phoenix, Arizona 85016
(Address of principal executive (Zip Code)
offices)
(Registrant's telephone number, including area code) (602) 852-6600
Securities registered pursuant to Section 12(b) of the Act:
Title of Class Name of each Exchange on which registered
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Cumulative 12% Subordinated Debentures Due 2003 American Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Title of Class Name of each Exchange on which registered
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Common Stock, $.001 par value The Nasdaq Stock Market
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 by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
At March 15, 1999, the aggregate market value of common stock held by
non-affiliates of the registrant was approximately $60,652,000.
Applicable Only to Registrants Involved in Bankruptcy
Proceedings During the Preceding Five Years:
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13 or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court. Yes [ ] No [ ]
(Applicable Only to Corporate Registrants)
Indicate the number of shares outstanding of each of the registrant's classes
of common stock, as of March 24, 1999: 14,948,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the June 2, 1999 Annual Meeting of
Stockholders are incorporated by reference into Part III
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TABLE OF CONTENTS
Page
PART I
Item 1 Business........................................................................ 3
Item 2 Properties...................................................................... 11
Item 3 Legal Proceedings............................................................... 11
Item 4 Submission Of Matters To A Vote Of Security Holders............................. 11
Item 4A Executive Officers Of The Registrant............................................ 12
PART II
Item 5 Market For The Registrant's Common Equity Securities And Related
Stockholder Matters............................................................. 13
Item 6 Selected Consolidated Financial Data............................................ 14
Item 7 Management's Discussion And Analysis Of Financial Condition And
Results Of Operations........................................................... 15
Item 7A Quantitative And Qualitative Disclosures About Market Risk...................... 39
Item 8 Consolidated Financial Statements And Supplementary Data........................ 41
Item 9 Changes In And Disagreements With Accountants On Accounting And
Financial Disclosures........................................................... 67
PART III
Item 10 Directors And Executive Officers Of The Registrant.............................. 67
Item 11 Executive Compensation.......................................................... 67
Item 12 Security Ownership Of Certain Beneficial Owners And Management.................. 67
Item 13 Certain Relationships And Related Transactions.................................. 67
PART IV
Item 14 Exhibits, Consolidated Financial Statement Schedules, And Reports On
Form 8-K....................................................................... 68
Signatures..................................................................................... 73
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PART I
ITEM 1 -- BUSINESS
General
We operate the largest chain of buy here-pay here car dealerships in the
United States. We sell and finance our used vehicles to customers within the
sub-prime segment of the used car market. Our customers will typically have
limited credit histories, low incomes or past credit problems. At December 31,
1998, we operated 56 dealerships located in several large markets, including Los
Angeles, Phoenix, Dallas, San Antonio, Atlanta, and Tampa.
In addition to our own dealership and financing operations, we also
o provide financing to other independent used car dealers through our Cygnet
dealer program,
o service and collect large portfolios of finance receivables owned by
others, and
o manage selected financial assets that we acquire from financially
distressed third parties.
From 1994 through the first quarter of 1998, we maintained a national branch
office network that acquired and serviced retail installment contracts from
numerous independent third party dealers. We discontinued these operations in
1998.
We direct your attention to note 24 to the Consolidated Financial
Statements, which begin at page 41, where we summarize the results of operations
of our business segments.
Below is a summary of our businesses by segment:
[OBJECT OMITTED - DESCRIBED IN FOLLOWING PARAGRAPH]
The chart above shows Ugly Duckling with two operating divisions. Dealership
operations is the first division. Dealership operations has three distinct
segments. Retail sales is its first segment. This is the segment that operates
our chain of Ugly Duckling Car Sales dealerships. Portfolio and loan servicing
is the second segment of dealership operations. This segment holds and services
the loan portfolios originated or acquired by our dealership operations.
Finally, dealership operations has an administration segment that provides
corporate administration to the division. Our non-dealership operations division
also contains three segments. The first non-dealership operations segment is the
bulk purchasing/loan servicing segment. In this segment, we acquire loan
portfolios from third parties and provide loan servicing for third parties. The
second segment of non-dealership operations is the Cygnet dealer program under
which we provide various credit facilities to independent used car dealers.
Finally, the non-dealership operations also have an administration segment that
provides corporate administration to the non-dealership operations. Lastly, the
chart shows our discontinued operations, which contains our branch office
network that we closed in February 1998 and the loans we acquired through that
network.
We commenced operations through various entities beginning in 1989. Ugly
Duckling Corporation was formed in 1992 and was reincorporated in Delaware in
1996.
Overview of Used Car Sales and Finance Industry
Used Car Sales. Used car retail sales typically occur through either
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manufacturer's franchised new car dealerships that sell used cars or through
independent used car dealerships. The market for used car sales in the United
States is significant and has steadily increased over the past five years. There
are over 23,000 franchised and 63,000 independent used car dealership locations
in the United States.
We participate in the sub-prime segment of the independent used car sales
and finance market. This segment is serviced primarily by buy here-pay here
dealers that sell and finance the sale of used cars to sub-prime borrowers. Buy
here-pay here dealers typically offer their customers certain advantages over
more traditional financing sources, including:
o expanded credit opportunities;
o flexible payment terms, including prorating customer payments due
within one month into several smaller payments and scheduling payments
to coincide with a customer's paydays; and
o the ability to make payments in person. This is an important feature to
many sub-prime borrowers who may not have checking accounts or are
otherwise unable to make payments by the due date through use of the
mail because of the timing of paychecks.
Used Car Financing. The automobile financing industry is the third-largest
consumer finance market in the country, after mortgage debt and credit card
revolving debt. This industry is served by such traditional lending sources as
banks, savings and loans, and captive finance subsidiaries of automobile
manufacturers, as well as by independent finance companies and buy here-pay here
dealers. In general, the industry is categorized according to the type of car
sold (new versus used) and the credit characteristics of the borrower.
The industry statistical information presented in this section is derived
from information provided to the Company by CNW Marketing/Research of Bandon,
Oregon.
Company Dealership Operations
We commenced dealership operations in 1992 with the acquisition of two
dealerships in Arizona, and have expanded aggressively since then through a
combination of acquisitions and development of new stores. Our most significant
growth occurred in 1997, when
o we acquired from Seminole Finance, Inc. and related companies (Seminole),
four dealerships in Tampa/St. Petersburg and a contract portfolio of
approximately $31.1 million;
o we purchased from E-Z Plan, Inc. (E-Z Plan), seven dealerships in San
Antonio and a contract portfolio of approximately $24.3 million;
o we purchased from Kars-Yes Holdings, Inc. and related companies (Kars),
six dealerships in the Los Angeles market, two in the Miami market, two
in the Atlanta market, and two in the Dallas market; and
o we opened our first used car dealership in the Las Vegas market, opened
two additional dealerships in the Albuquerque market and opened one
additional dealership in the Phoenix market. We also closed a
dealership in Arizona.
We continued our aggressive growth in 1998, adding 17 new dealerships in our
existing markets. We opened one dealership in the Albuquerque market, four
dealerships in the Atlanta market, three dealerships in the Dallas market, two
dealerships in the Los Angeles market, two dealerships in the Phoenix market,
two dealerships in the San Antonio market, and three dealerships in the Tampa
market. We also closed two dealerships in Miami and exited that market.
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The following table summarizes the number of stores we had in operation by major
market for the three years ended December 31, 1998:
Number of Stores By
Market
As of December 31,
-------------------------------------
1998 1997 1996
----------- --------- ---------
Phoenix........... 9 7 5
San Antonio....... 9 7 --
Atlanta........... 9 5 --
Los Angeles....... 8 6 --
Tampa............. 8 5 --
Dallas............ 6 3 --
Tucson............ 3 3 3
Albuquerque....... 3 2 --
Las Vegas......... 1 1 --
Miami............. -- 2 --
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56 41 8
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Retail Car Sales. We distinguish our dealership operations from those of
typical buy here-pay here dealers through our:
o network of multiple locations,
o upgraded facilities,
o larger inventories of used cars,
o centralized purchasing,
o advertising and marketing programs, and
o dedication to customer service.
Our dealerships are generally located in high visibility, high traffic
commercial areas, and tend to be newer and cleaner in appearance than other buy
here-pay here dealerships. This helps promote our image as a friendly and
reputable business. We believe this, coupled with our widespread brand name
recognition, enables us to attract customers who might otherwise visit another
buy here-pay here dealer.
Our dealerships generally maintain an average inventory of 50 to 150 used
cars and feature a wide selection of makes and models (with ages generally
ranging from 3 to 7 years) and a range of sale prices. This allows us to meet
the tastes and budgets of a broad range of potential customers. We acquire our
inventory from new or late-model used car dealers, used car wholesalers, used
car auctions, and customer trade-ins. In making purchases, we take into account
each car's retail value and the costs of buying, reconditioning, and delivering
the car for resale. After purchase, cars are generally delivered to one of our
nearby inspection centers, where they are inspected and reconditioned for sale.
Upon inspection, certain used cars do not meet our criteria for reconditioning
either because it will cost too much to recondition the car, or because the car
is in a condition too poor for us to recondition and sell. In these instances,
we promptly sell the car in the wholesale market. Although the supply and prices
of used cars are subject to market variance, we do not believe that we will
encounter significant difficulty in maintaining the necessary inventory levels.
Our average sales price per car was $7,997 for the year ended December 31,
1998 compared to $7,443 for the year ended December 31, 1997 and $7,107 in the
year ended December 31, 1996. We typically require down payments of
approximately 5.0% to 15.0% of the purchase price with the balance of the
purchase price financed at fixed interest rates ranging from 21.0% to 29.9% over
periods ranging from 12 to 48 months. We sell cars on an "as is" basis, and
require our customers to sign an agreement at the date of sale releasing us from
any obligation with respect to vehicle-related problems that subsequently occur.
See "Legal Proceedings."
Used Car Financing. We finance substantially all of the used cars that we
sell at our dealerships through retail installment contracts, under which we
provide the financing and service the collection of loan payments. Subject to
the discretion of our sales managers, potential customers must meet our
underwriting guidelines before we will agree to finance the purchase of a car.
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In connection with each sale, customers are required to complete a credit
application. Our employees then analyze and verify the customer application
information, which contains employment and residence histories, income
information, references, and other information regarding the customer's credit
history.
Our credit underwriting process takes into account the ability of our
managers to make sound judgments regarding the extension of credit to sub-prime
borrowers and to personalize financing terms to meet the needs of individual
customers. For example, we may schedule contract payments to coincide with the
customer's paydays, whether weekly, biweekly, semi-monthly, or monthly.
Dealership Operations Computer Systems. We recently completed converting our
chain of dealerships and loan service centers to a single integrated computer
system. The system allows us to make the sale, service the loan, and track the
vehicle and related loan. Once the final sales contract is generated, the system
automatically adds the loan to our loan servicing and collections database and
records the sale and related loan in our accounting system. We use communication
networks that allow us to service large volumes of contracts from our
centralized servicing facilities, while enabling the customer the flexibility to
make payments at any of our dealership locations. In addition, we have developed
comprehensive databases and sophisticated management tools, including static
pool analysis, to analyze customer payment history and contract performance, and
to monitor underwriting effectiveness.
Advertising and Marketing. We have a large advertising budget. In general,
our advertising campaigns emphasize our multiple locations, wide selection of
quality used cars, and ability to provide financing to most sub-prime borrowers.
We believe that our marketing approach creates brand name recognition and
promotes our image as a professional, yet approachable, business. We use
television, radio, billboard, and print advertising to market our dealerships.
A primary focus of our marketing strategy is our ability to finance
consumers with poor credit histories. Consequently, we have initiated innovative
marketing programs designed to attract sub-prime borrowers, assist these
customers in establishing good credit, reward those customers who pay on time,
develop customer loyalty, and increase referral and repeat business. Among these
programs are:
o The Down Payment Back Program. This program encourages customers to make
timely payments on their contracts by allowing them to receive a refund
of their initial down payment at the end of the contract term, if all
payments have been made by the scheduled due date.
o The Income Tax Refund Program. During the first quarter of each year, we
offer assistance to customers in the preparation of their income tax
returns, including forwarding the customers' tax information to a
designated preparer, paying the preparation fee (in most states), and,
if they get a tax refund, crediting the refund toward the required down
payment. This program enables customers to purchase cars without having
to wait to receive their income tax refund.
o $250 Visa Card Program. This program encourages customers to make timely
payments on their contracts by allowing them to receive a Visa credit
card with an initial credit limit of $250. This program offers otherwise
unqualified customers the chance to obtain the convenience of a credit
card and rebuild their credit records.
We also operate a loan-by-phone program using our toll-free telephone number
of 1-800-THE-DUCK, and accept credit inquiries on our web site at
www.uglyduckling.com. Credit inquiries received over the web are reviewed by our
employees, who then contact and schedule an appointment for the customers.
Sales Personnel and Compensation. Each dealership is run by a general manager
who has responsibility for the operations of the dealership facility, including:
o profitability of the dealership,
o final approval of sales and contract originations,
o inventory maintenance,
o the appearance and condition of the facility, and
o the hiring, training, and performance of dealership employees.
We also typically staff each dealership with a sales manager, an assistant
sales manager, three customer service representatives, five to twelve
salespersons, and two lot attendants.
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We train our managers to be contract underwriters. They are paid a base
salary and may earn bonuses based upon the overall performance of the contract
portfolio originated at their dealership, as well as the dealership's
profitability. Sales persons are paid on a commission basis. However, each sale
must be underwritten and approved by a manager.
Monitoring and Collections
One of our goals is to minimize credit losses through close monitoring of
contracts in our portfolio. When a car sale is completed, the contract is
automatically added to our loan servicing database. Our monitoring and
collections staff then uses our collections software to monitor the performance
of the contracts. See "Management's Discussion and Analysis of Financial
Conditions and Results of Operations -- Risk Factors -- We are dependent on our
data processing platforms and other technology. Our computer systems may be
subject to a Year 2000 date failure."
The collections software provides us with, among other things, up-to-date
activity reports, allowing prompt identification of customers whose accounts
have become past due. In accordance with our policy, collections personnel
contact a customer with a past due account within three days of delinquency to
inquire as to the reasons for the delinquency and to suggest ways in which the
customer can resolve the underlying problem. Our early detection of a customer's
delinquent status, as well as our commitment to working with our customers,
allows us to identify and address payment problems quickly, and reduce the
chance of credit loss. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Allowance for Credit Losses."
If our efforts to work with a customer are unsuccessful and the customer
becomes seriously delinquent, we will take the necessary steps to minimize our
loan loss and protect our collateral. Frequently, delinquent customers will
recognize their inability to honor their contractual obligations and will work
with us to coordinate "voluntary repossessions" of their cars. In other cases,
we hire independent firms to repossess the vehicles. After repossession and a
statutorily mandated waiting period, we typically sell the repossessed car in
the wholesale market. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Allowance for Credit Losses."
Unlike most other used car dealership chains or automobile finance
companies, we permit our customers to make payments on their contracts in person
at any of our dealerships or at any of our collection facilities. Payments
received at our dealerships account for a significant portion of monthly
contract receipts on the dealership portfolio.
Non-Dealership Operations
Cygnet Dealer Program. Many independent used car dealers have difficulty
obtaining working capital from traditional financing sources. As a result, they
are forced to sell the finance receivables that they originate from the sale of
used cars at significant discounts in order to obtain the working capital
necessary to operate their businesses. Most financing programs available to
independent used car dealers do not allow the dealer to service the loans sold.
Yet, we believe that dealers prefer to service the loans they originate so they
can maintain contact with the customer to more effectively collect payments and
generate referrals or repeat business.
To capitalize on this opportunity, we developed the Cygnet dealer program,
which provides qualified dealers with warehouse purchase facilities and
revolving lines of credit primarily secured by the dealers' finance receivable
portfolios. The dealer remains responsible for collection of finance receivable
payments and retains control of the customer relationship. The credit facilities
are for specified amounts and are subject to various collateral coverage ratios,
maximum advance rates, and performance measurements, depending on the financial
condition of the dealer and the quality of the finance receivables originated.
As a condition to providing financing, each dealer is required to satisfy
certain criteria to qualify for the program, report collection activities to us
on a daily basis and provide us with periodic financial statements. In addition,
dealers are "audited" by our audit department on a periodic basis. As of
December 31, 1998, we had lending relationships with a total of 63 independent
dealers in 18 states, with principal balances totaling approximately $41
million.
The dealer collection program is the primary product offered to independent
dealers under the Cygnet dealer program. Under this program, we purchase finance
receivables at a discount from qualified dealers. The dealer remains responsible
for the collection of the contract payments and retains control of the customer
relationship. We typically purchase finance receivable contracts at 65% to 75%
of the principal balance subject to a maximum of 170% of the Kelly Blue Book
wholesale price of the underlying collateral. All cash collections, including
regular monthly payments, payoffs and repurchases, are deposited directly by the
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dealer into a bank account that we maintain and control. We keep all regular
monthly cash payments and payoffs, and pay the dealer a servicing fee generally
equal to 20% to 25% of the regular monthly cash payments collected. Generally,
each dealer pays a nonrefundable initial audit fee plus a processing fee per
contract or provides a security deposit. The dealer is required to repurchase
all finance receivable contracts that are 45 days past due. The dealer
collection program is full recourse to the dealer and typically includes
personal guarantees by the principal owners of the dealership.
We also offer a secured revolving line of credit to qualified dealers under
the asset based loan version of the Cygnet dealer program. We generally advance
up to 65% of the principal amount of eligible finance receivables subject to a
maximum of 170% of the Kelly Blue Book wholesale price of the underlying
collateral. We also charge an annual commitment fee of 1% to 2% of the available
line and interest on any amounts outstanding at the rate of prime plus 5% to 9%.
In addition, each dealer generally pays a nonrefundable initial audit fee plus a
processing fee per contract. The dealer is responsible for collection of
contract payments and maintaining the customer relationship. All cash
collections are deposited directly into a bank account that we maintain and
control. Finance receivables that are 45 days delinquent are excluded from the
calculation of the amount available under the line of credit. If the exclusion
of delinquent contracts causes the line to become over funded, then the dealer
must either pay down the line or assign additional qualifying finance
receivables to us. Each line of credit is full recourse to the dealer, typically
with full guarantees by the principal owners of the dealership.
Cygnet dealer's net investment in finance receivables purchased from two
third party dealers totaled approximately $15.1 million representing
approximately 34% of Cygnet dealer's net finance receivables portfolio as of
December 31, 1998. There were no other third party dealer loans that exceeded
10% of Cygnet dealer's finance receivable portfolio as of December 31, 1998.
Bulk Purchasing and Loan Servicing Operations. In 1997 and 1998, we entered
into several large servicing and/or bulk purchasing transactions involving third
party dealer contract portfolios. The most significant of these transactions is
our involvement in the bankruptcy proceedings of First Merchants Acceptance
Corporation ("FMAC") described below. Our non-dealership operations service
loans from facilities in Nashville, Tennessee, Aurora, Colorado and Plano,
Texas. As of December 31, 1998, our loan servicing segment employed
approximately 450 employees and serviced approximately 80,000 loans with an
aggregate principal balance of $587 million.
Our non-dealership operations use separate computer systems from our
dealership operations. However, our collection policies and procedures for
non-dealership operations are generally the same as those used by our dealership
operations. See "Monitoring and Collections" above.
The following describes certain aspects of our involvement in the bankruptcy
case of FMAC and in FMAC's approved plan of reorganization which were undertaken
through our bulk purchasing and loan servicing operations. FMAC emerged from
bankruptcy on April 1, 1998.
Senior Bank Debt Claims. On August 21, 1997, we purchased 78% of the senior
bank debt of FMAC for approximately $69 million, which represented a discount of
10% of the outstanding principal amount of such debt. In addition, we agreed to
pay the selling banks additional consideration up to the amount of this 10%
discount (or approximately $7.6 million) if FMAC makes cash payments or issues
notes at market rates to its unsecured creditors and equity holders in excess of
10% of their allowed claims against FMAC. In connection with the purchase, we
also issued to the selling banks warrants to purchase up to 389,800 shares of
our common stock at an exercise price of $20.00 per share at any time through
February 20, 2000. We subsequently purchased the remaining senior bank debt at a
5% discount.
The contracts securing the senior bank debt were then sold to a third party
(the "Contract Purchaser") at a profit. We guaranteed to the Contract Purchaser
a specified return on the contracts that it purchased. Our maximum exposure on
this guarantee was approximately $8.0 million at December 31, 1998. However, we
do not believe that we will be required to make any payments under this
guarantee. Consequently, we have not accrued any liability related to this
guarantee as of December 31, 1998. We recorded a gain in the fourth quarter of
1997 of approximately $8.1 million ($5.0 million, net of income taxes) from the
senior bank debt transaction.
Once the Contract Purchaser has received its guaranteed return on the
contracts, we are entitled to additional recoveries from the contracts up to a
specified amount. FMAC has guaranteed to us on a non-recourse basis our recovery
8
of this amount, secured by the residual interests and certain equity
certificates in FMAC's securitization transactions (collectively, the "B
Pieces"). However, with certain exceptions, if we do not continue to service the
contracts sold to the Contract Purchaser, the guaranteed amount will be limited
to $10 million.
DIP Facility. We have agreed to provide debtor-in-possession financing to
FMAC (the "DIP Facility"). As of December 31, 1998, our maximum commitment under
the DIP Facility was reduced to $12.4 million, of which $12.2 million was
outstanding. FMAC pays interest on the DIP Facility at 10% per year. The DIP
Facility is scheduled to be repaid with certain income tax refunds and, after
payment of FMAC's guarantee to us, distributions from FMAC's B pieces. Under the
terms of the agreement, FMAC must apply the first $10 million of income tax
refunds to pay down the DIP Facility. These payments will permanently reduce the
maximum that FMAC can borrow under the DIP Facility. Payments from B Pieces will
also pay down and permanently reduce the maximum amount FMAC can borrow under
the DIP Facility. Payments made on the DIP Facility from sources other than
income tax refunds and B Pieces will not permanently reduce the maximum amount
and FMAC is allowed to reborrow such amounts under the DIP Facility. As of
December 31, 1998, FMAC had applied approximately $9.1 million in income tax
refunds to pay down and reduce the maximum availability under this facility.
Although we have declared FMAC in default under the DIP Facility, we are
negotiating a resolution of this matter with FMAC, which may include an increase
in the DIP Facility of up to approximately $2.0 million.
Excess Collections Split. We will split with FMAC any excess recovery on the
contracts sold to the Contract Purchaser and on the B Pieces, after FMAC pays
its guaranteed amount to us, the DIP Facility and our fees. We are entitled to
receive 17 1/2% of the excess with the remaining 82 1/2% being distributed to
FMAC (the "Excess Collections Split"). The Excess Collections Split allocation
may be reduced or eliminated if certain events occur. As of December 31, 1998,
we had not recognized any revenue from the Excess Collections Split. We
anticipate recognizing revenue on this transaction at the time collections under
the arrangement are probable and reasonably estimable. If several conditions are
met, including that our common stock is trading at $8 or more, we have the right
to issue shares of our common stock to FMAC or its unsecured creditors or equity
holders in exchange for all or part of FMAC's portion of the Excess Collection
Split.
Servicing. We service the contracts sold to the Contract Purchaser and the
contracts in all but one of FMAC's securitized pools, and receive servicing
fees.
Other Matters. On the effective date of FMAC's plan of reorganization, in
addition to the warrants described above, we issued warrants to FMAC to purchase
up to 325,000 shares of our common stock at $20.00 per share. These warrants are
exercisable through April 1, 2001. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Risk Factors--We Have Certain
Risks Relating to the FMAC Transaction".
Discontinued Operations/Split-Up of the Company
Contract Purchasing. In 1994, we acquired Champion Financial Services, Inc.,
an independent automobile finance company. In April 1995, we initiated an
aggressive plan to expand Champion's branch office network and, by December 31,
1997, we operated 83 branch offices across the country. In February 1998, we
announced our intention to close the branch office network and exit this line of
business in the first quarter of 1998. We recorded a pre-tax charge to
discontinued operations totaling approximately $9.1 million (approximately $5.6
million, net of income taxes) during the first quarter of 1998. In addition, a
$6.0 million charge (approximately $3.6 million, net of income taxes) was taken
during the third quarter of 1998 due primarily to higher than anticipated loan
losses and servicing expenses. The branch office closure was substantially
complete by the end of the first quarter of 1998.
In the third quarter of 1997, we announced a strategic evaluation of our
non-dealership operations, including the possible sale or spin-off of these
operations. In February 1998, in addition to closing our branch offices, we
announced our intent to evaluate alternatives for our remaining non-dealership
operations. On April 28, 1998, we announced that our Board of Directors had
directed management to proceed with separating current operations into two
companies and subsequently formed a new wholly owned subsidiary, Cygnet
Financial Corporation ("Cygnet"), to operate the Cygnet dealer program and the
bulk purchase and third party loan servicing operations. Since that date, these
businesses were classified as discontinued operations in our consolidated
financial statements. A proposal to split-up the two companies through a rights
offering was approved by our stockholders at the annual stockholders meeting
held in August 1998. We subsequently issued rights to our stockholders to
purchase Cygnet common stock. Due to a lack of stockholder participation,
however, the rights offering was canceled. We recorded a $2.0 million charge
($1.2 million, net of income tax) in the third quarter of 1998 to write off the
costs associated with the rights offering. In the first quarter of 1999, we
9
discontinued efforts to sell or spin off the Cygnet dealer program and bulk
purchasing and loan servicing operations and have reclassified these operations
into continuing operations for all years presented in the consolidated financial
statements and this Form 10-K.
Accordingly, while the branch office network continues to be reported as
discontinued operations, the Cygnet dealer program and bulk purchasing and loan
servicing operations (including the FMAC transaction) have been reclassified
into continuing operations for the years ended December 31, 1998, 1997, and 1996
in our accompanying consolidated financial statements.
Regulation, Supervision, and Licensing
Our operations are subject to ongoing regulation, supervision, and licensing
under various federal, state, and local laws related to the sale of cars, the
extension of credit, and the collections of loans. Among other things, these
laws:
o require that we obtain and maintain certain licenses and qualifications,
o limit or prescribe terms of the contracts that we originate and/or
purchase,
o require specific disclosures to customers,
o limit our right to repossess and sell collateral, and
o prohibit us from discriminating against certain customers.
We typically charge fixed interest rates significantly in excess of
traditional finance companies on the contracts originated at our dealerships.
Currently, a significant portion of our used car sales activities are conducted
in, and a significant portion of the contracts we service were originated in,
states which do not impose limits on the interest rate that a lender may charge.
However, we have expanded, and will continue to expand our operations into
states that impose interest rate limits, such as Florida and Texas.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. However, if
we do not remain in compliance with such laws, this failure could have a
material adverse effect on our operations. In addition, the adoption of
additional laws, changes in the interpretation of existing laws, or our entrance
into jurisdictions with more stringent regulatory requirements could have a
material adverse effect on our business.
Trademarks and Proprietary Rights
We have an ongoing program under which we evaluate our intellectual property
and consider appropriate Federal and State intellectual property related
filings. We believe that the value of our trademarks is increasing with the
development of our business, but that our business as a whole is not materially
dependent on our trademarks. We believe we have taken appropriate measures to
protect our proprietary rights. However, there can be no assurance that such
efforts have been successful.
Competition
Although the used car industry has historically been highly fragmented, it
has attracted significant attention from a number of large companies, including
AutoNation, U.S.A, and Car Max, all of whom have entered the used car sales
business or announced plans to develop large used car sales operations. Many
franchised automobile dealers have increased their focus on the used car market
as well. We believe that these companies are attracted by the relatively high
gross margins that can be achieved in this market as well as the industry's lack
of consolidation. Many of these companies and franchised dealers have
significantly greater financial, marketing and other resources than we have.
However, none of these companies currently represent significant direct
competition in the sub-prime market. Currently, our major competition for our
dealership operations is the numerous independent buy here-pay here dealers that
sell and finance sales of used cars to sub-prime borrowers. See
"Business--Company Dealership Operations" for a description of how we
distinguish our operations from those of typical buy here-pay here dealers.
Our non-dealership operations are also highly competitive. In these
operations, we compete with a variety of finance companies, financial
institutions, and providers of financial services, many of whom have
significantly greater resources, including access to lower priced capital. In
addition, there are numerous financial services companies serving, or capable or
serving, these markets. While traditional financial institutions, such as
commercial banks, savings and loans, credit unions, and captive finance
companies of major automobile manufacturers, have not consistently served the
sub-prime markets, the yields earned by companies involved in sub-prime
financing have encouraged certain of these traditional institutions to enter, or
contemplate entering these markets.
10
Increased competition may cause downward pressure on sales prices and/or on
the interest rate we charge on contracts originated at our dealerships, or cause
us to reduce or eliminate acquisition discounts on the contracts we purchase in
our non-dealership operations. Such events would have a material adverse affect
on us.
Employees
At December 31, 1998, we employed approximately 2,500 persons. None of our
employees are covered by a collective bargaining agreement.
Seasonality
Historically, we have experienced higher same store revenues in the first
two quarters of the year than in the latter half of the year. We believe that
these results are due to seasonal buying patterns resulting in part because many
of our customers receive income tax refunds during the first half of the year,
which are a primary source of down payments on used car purchases.
ITEM 2 -- PROPERTIES
As of December 31, 1998, we leased substantially all of our facilities,
including 55 dealerships, four collection facilities that service our dealership
portfolios, four non-dealership collection facilities, four inspection centers,
and our corporate offices. We are continuing to negotiate lease settlements and
terminations with respect to our branch office network closure. Our corporate
and divisional administrative offices are located in approximately 40,000 square
feet of leased space in Phoenix, Arizona.
ITEM 3 -- LEGAL PROCEEDINGS
We sell our cars on an "as is" basis. We require all customers to
acknowledge in writing on the date of sale that we disclaim any obligation for
vehicle-related problems that subsequently occur. Although we believe that these
disclaimers are enforceable under applicable laws, there can be no assurance
that they will be upheld in every instance. Despite obtaining these disclaimers,
in the ordinary course of business, we receive complaints from customers
relating to vehicle condition problems as well as alleged violations of federal
and state consumer lending or other similar laws and regulations. Most of these
complaints are made directly to us or to various consumer protection
organizations and are subsequently resolved. However, customers occasionally
name us as a defendant in civil suits filed in state, local, or small claims
courts. Additionally, in the ordinary course of business, we are a defendant in
various other types of legal proceedings. Although we cannot determine at this
time the amount of the ultimate exposure from these lawsuits, if any, we, based
on the advice of counsel, do not expect the final outcome to have a material
adverse effect on our financial position.
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
11
ITEM 4A -- EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Information Concerning Our Executive Officers as of March 24, 1999.
Name Age Position
- ------------------------ --- ----------------------------------------------------
Ernest C. Garcia II......... 41 Chairman of the Board (since 1992) and Chief Executive Officer
Gregory B. Sullivan......... 40 Director (since 1998), President and Chief Operating Officer
Steven P. Johnson........... 39 Senior Vice President, General Counsel and Secretary
Steven T. Darak............. 51 Senior Vice President and Chief Financial Officer
Donald L. Addink............ 49 Senior Vice President - Senior Analyst
Ernest C. Garcia II has served as our Chairman of the Board and Chief
Executive Officer since 1992, and served as President from 1992 to 1996. Mr.
Garcia is also a significant stockholder of Ugly Duckling, owning approximately
29.8% of our stock at December 31, 1998. Since 1991, Mr. Garcia has served as
President of Verde Investments, Inc., a real estate investment corporation that
is also an affiliate of us. Mr. Garcia's sister is married to Mr. Johnson. See
below "Involvement in Certain Legal Proceedings by Directors and Executive
Officers."
Gregory B. Sullivan has served as our President and Chief Operating Officer
since March 1996. In 1998, Mr. Sullivan was elected to our Board of Directors.
Mr. Sullivan has also served as President of Ugly Duckling Car Sales, Inc. since
December 1996. From 1995 through February 1996, Mr. Sullivan was a consultant to
us. Mr. Sullivan formerly served as President and principal stockholder of an
amusement game manufacturing company that he co-founded in 1989 and sold in
1994. Prior to 1989, Mr. Sullivan was involved in the securities industry and
practiced law with a large Arizona firm. He is an inactive member of the State
Bar of Arizona. Mr. Sullivan's sister is married to John N. MacDonough, another
member of our Board of Directors.
Steven P. Johnson has served as our Senior Vice President, General Counsel
and Secretary since 1992. Since 1991, Mr. Johnson has also served as the General
Counsel of Verde, an affiliate of us. Prior to 1991, Mr. Johnson practiced law
in Tucson, Arizona. Mr. Johnson is licensed to practice law in Arizona and
Colorado and is married to the sister of Mr. Garcia.
Steven T. Darak has served as our Senior Vice President and Chief Financial
Officer since February 1994, having joined us in 1994 as Vice President and
Chief Financial Officer. From 1989 to 1994, Mr. Darak owned and operated
Champion Financial Services, Inc., a used car finance company we acquired in
early 1994. Prior to 1989, Mr. Darak served in various positions in the banking
industry and in public accounting.
Donald L. Addink has served as our Senior Vice President -- Senior Analyst
since November 1998. From 1995 to November 1998, he served as our Vice President
- - Senior Analyst. From 1988 to 1995, Mr. Addink served as Executive Vice
President of Pima Capital Co., a life insurance holding company. Prior to 1988,
Mr. Addink served in various capacities with a variety of insurance companies.
Mr. Addink is a Fellow of the Society of Actuaries and a Member of the American
Academy of Actuaries.
Our officers serve at the discretion of our Board of Directors. The present
term of office for the officers named above will expire on June 2, 1999 or on
their earlier retirement, resignation, or removal. Except as summarized above,
there is no family relationship among any of our officers.
(b)Involvement in Certain Legal Proceedings by Directors and Executive
Officers.
Prior to 1992, when he founded Ugly Duckling, Mr. Garcia was involved in
various real estate, securities, and banking ventures. Arising out of two
transactions in 1987 between Lincoln Savings and Loan Association ("Lincoln")
and entities controlled by Mr. Garcia, the Resolution Trust Corporation (the
"RTC"), which ultimately took over Lincoln, asserted that Lincoln improperly
accounted for the transactions and that Mr. Garcia's participation in the
transactions facilitated the improper accounting. Facing severe financial
pressures, Mr. Garcia agreed to plead guilty to one count of bank fraud, but in
light of his cooperation with authorities both before and after he was charged,
was sentenced to only three years probation, which has expired, was fined $50
12
(the minimum fine the court could assess), and during the period of his
probation, which ended in 1996, was banned from becoming an officer, director or
employee of any federally-insured financial institutions or a securities firms
without governmental approval. In separate actions arising out of this matter,
Mr. Garcia agreed not to violate the securities laws, and filed for bankruptcy
both personally and with respect to certain entities he controlled. The
bankruptcies were discharged by 1993.
PART II
ITEM 5 -- MARKET FOR THE REGISTRANT'S COMMON EQUITY SECURITIES
AND RELATED STOCKHOLDER MATTERS
Our common stock trades on the Nasdaq Stock Market under the symbol "UGLY."
The high and low closing sales prices of the common stock, as reported by Nasdaq
for the two most recent fiscal years are reported below.
Market Price
---------------------
High Low
------- -------
Fiscal Year 1997:
First Quarter.................................... $ 25.75 $ 16.25
Second Quarter................................... $ 18.06 $ 13.13
Third Quarter.................................... $ 17.00 $ 12.50
Fourth Quarter................................... $ 16.75 $ 7.69
Fiscal Year 1998:
First Quarter.................................... $ 10.88 $ 6.31
Second Quarter................................... $ 12.69 $ 8.00
Third Quarter.................................... $ 9.13 $ 4.63
Fourth Quarter................................... $ 6.00 $ 4.25
On March 22, 1999, the last reported sale price of the common stock on
Nasdaq was $6.44 per share. On March 22, 1999 there were approximately 93 record
owners of our common stock. We estimate that as of such date there were
approximately 2,000 beneficial owners of our common stock.
Dividend Policy. We have never paid dividends on our common stock and do not
anticipate doing so in the foreseeable future. It is the current policy of our
Board of Directors to retain any earnings to finance the operation and expansion
of our business or to repurchase our common stock pursuant to an existing stock
buy back program. In addition, the terms of our primary revolving credit
facility prevent us from declaring or paying dividends in excess of 15.0% of
each year's net earnings available for distribution. Our future financings may
also include such restrictions. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital Resources
- -- Financing Resources -- Revolving Facility."
Exchange Offer. In the fourth quarter of 1998, we issued a total of
approximately $17.5 million of our 12% subordinated debentures due 2003 in
exchange for approximately 2.7 million shares of our common stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources -- Supplemental Borrowings --
Exchange Offer." Beginning on March 2, 1999, the debentures became listed and
trade on the American Stock Exchange under the ticker symbol UGY.
13
ITEM 6 -- SELECTED CONSOLIDATED FINANCIAL DATA
(In thousands, except per share and operating data)
The following table sets forth our selected historical consolidated
financial data for each of the years in the five-year period ended December 31,
1998. The selected annual historical consolidated financial data for 1998, 1997,
1996, 1995, and 1994 are derived from our consolidated financial statements
audited by KPMG LLP, independent auditors. For additional information, see our
consolidated financial statements included elsewhere in this report. The
following table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
Years Ended December 31,
-----------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- -------- --------
(In thousands, except per share amounts)
Statement of Operations Data:
Sales of Used Cars................ $ 287,618 $ 123,814 $ 53,768 $ 47,824 $ 27,768
Less:
Cost of Used Cars Sold.......... 167,014 72,358 31,879 29,733 13,604
Provision for Credit Losses..... 67,634 23,045 9,657 8,359 8,024
--------- --------- --------- -------- --------
52,970 28,411 12,232 9,732 6,140
--------- --------- --------- -------- --------
Interest Income................... 27,828 18,736 8,597 8,227 4,683
Gain on Sale of Loans............. 12,093 14,852 3,925 -- --
Servicing and Other Income........ 38,631 12,681 2,537 308 556
--------- --------- --------- -------- --------
78,552 46,269 15,059 8,535 5,239
--------- --------- --------- -------- --------
Income before Operating Expenses.. 131,522 74,680 27,291 18,267 11,379
Operating Expenses................ 118,702 55,741 18,085 16,758 10,837
--------- --------- --------- -------- --------
Income before Interest Expense.... 12,820 18,939 9,206 1,509 542
Interest Expense.................. 6,904 2,774 2,429 5,328 2,870
--------- --------- --------- -------- --------
Earnings (Loss) before Income
Taxes........................... 5,916 16,165 6,777 (3,819) (2,328)
Income Taxes (Benefit)............ 2,396 6,637 100 -- (334)
--------- --------- --------- -------- --------
Earnings (Loss) from Continuing
Operations...................... $ 3,520 $ 9,528 $ 6,677 $ (3,819) $ (1,994)
========= ========= ========= ========= ========
Earnings (Loss) per Common Share
from Continuing Operations:
Basic ............................ $ 0.19 $ 0.53 $ 0.73 $ (0.69) $ (0.36)
========= ========= ========= ========= =========
Diluted........................... $ 0.19 $ 0.52 $ 0.69 $ (0.69) $ (0.36)
========= ========= ========= ========= =========
EBITDA $ 18,555 $ 22,240 $ 10,588 $ 3,298 $ 1,513
Balance Sheet Data:
Finance Receivables, Net.......... $ 163,209 $ 90,573 $ 17,348 $ 27,732 $14,534
Total Assets...................... 345,975 276,426 117,629 60,712 29,681
Subordinated Notes Payable........ 43,741 12,000 14,000 14,553 18,291
Total Debt........................ 161,035 76,821 28,904 49,754 28,233
Preferred Stock................... -- -- -- 10,000 --
Common Stock...................... 173,828 172,622 82,612 127 77
Treasury Stock.................... (14,510) -- -- -- --
Total Stockholders' Equity
(Deficit)....................... $ 162,767 $ 181,774 $ 82,319 $ 4,884 $(1,194)
- ----------
Note: See "Business-Company Dealership Operations" for a summary of significant
acquisitions during 1997, and a description of our conversion to a single
integrated computer system in 1998. Also, see "Business--Discontinued
Operations/Split-Up of the Company" for a description of significant charges
taken in 1998 for the closure of our branch office network, and our
attempted split-up of Ugly Duckling. Finally, see "Management's Discussion
and Analysis of Financial Condition and Results of Operations --
Securitizations -- Dealership Operations" for a discussion of a change in
our securitization structure in the fourth quarter of 1998.
14
ITEM 7 -- MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
We have experienced a number of significant events during the past three
years. Some of the more important events follow:
o During 1996 we:
o completed our initial public offering and secondary offering of
common stock generating a total of $79.4 million in cash.
o During 1997 we:
o completed a private placement of common stock in February 1997 generating
$88.7 million in cash,
o completed a conversion of one of our loan servicing systems. We
experienced various transitional problems with the conversion, which
resulted in a charge of $5.7 million (approximately $3.4 million, net
of income taxes) to write down our residuals in finance receivables
sold,
o completed three significant acquisitions and developed new stores to
increase our total number of dealerships in operation from seven to 41
at December 31, 1997, and
o expanded our dealership chain from two markets at the end of 1996 to ten
markets at the end of 1997.
o During 1998 we:
o closed our branch office network resulting in two significant charges
to discontinued operations totaling $15.1 million (approximately $9.2
million, net of income taxes),
o completed the conversion of our dealerships to a single computer system,
o attempted to split-up the company through a rights offering to our
stockholders. We terminated the rights offering due to a lack of
stockholder participation. Although the rights offering was
unsuccessful, the exercise of splitting the operations and management
teams has proven beneficial to each of our businesses,
o completed an exchange offer whereby we issued $17.5 million in
subordinated debentures and repurchased approximately 2.7 million
shares of our common stock, and
o changed the way we structure our securitization transactions for
accounting purposes from a sale to a financing. The change had a
significant effect on earnings in 1998.
In this discussion and analysis we explain the general financial condition
and the results of operations of Ugly Duckling and its subsidiaries. In
particular, we analyze and explain the annual changes in the results of
operations of our various business segments. As you read this discussion, you
should refer to our Consolidated Financial Statements beginning on page 41,
which contain the results of our operations for 1998, 1997, and 1996.
Results of Operations- Years Ended December 31, 1998, 1997 and 1996
Income items in our Statement of Operations consist of:
o Sales of Used Cars
less Cost of Used Cars Sold
less Provision for Credit Losses
o Interest Income
o Gain on Sale of Loans
o Servicing and Other Income
15
Sales of Used Cars and Cost of Used Cars Sold
(dollars in thousands)
1998 1997 1996
---------- ----------- ----------
Used Cars Sold (Units).............. 35,964 16,636 7,565
========== =========== ==========
Sales of Used Cars ................. $ 287,618 $ 123,814 $ 53,768
Cost of Used Cars Sold ............. 167,014 72,358 31,879
---------- ----------- ----------
Gross Margin ....................... $ 120,604 $ 51,456 $ 21,889
========== =========== ==========
Gross Margin %...................... 41.9% 41.6% 40.7%
========== =========== ==========
Per Unit Sold:
Sales .............................. $ 7,997 $ 7,443 $ 7,107
Cost of Used Cars Sold ............. 4,644 4,349 4,214
---------- ----------- ----------
Gross Margin ....................... $ 3,353 $ 3,093 $ 2,893
========== =========== ==========
The number of cars sold (units) increased by 116.2% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to an increase
of 119.9% over the year ended December 31, 1996. Same store unit sales in the
year ended December 31, 1998 were compararable to the year ended December 31,
1997. We anticipate future revenue growth would come from increasing the number
of dealerships and not from higher sales volumes at existing dealerships. Same
store unit sales declined by 11.6% in the year ended December 31, 1997 compared
to the year ended December 31, 1996. We believe that this decline was due
primarily to the increased emphasis on underwriting at our dealerships,
particularly at one dealership where unit sales decreased by 742 units, which
represents 85.0% of the net decrease for the year ended December 31, 1997.
Sales of Used Cars (revenues) increased by 132.3% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to a 130.3%
increase over the year ended December 31, 1996. The growth for these periods
reflects increases in the number of dealerships in operation and the average
unit sales price. The Cost of Used Cars Sold increased by 130.8% for the year
ended December 31, 1998 over the year ended December 31, 1997, compared to an
increase of 127.0% over the year ended December 31, 1996. The gross margin on
used car sales (Sales of Used Cars less Cost of Used Cars Sold excluding
Provision for Credit Losses) increased by 134.4% for the year ended December 31,
1998 over the year ended December 31, 1997, compared to an increase of 135.1%
over the year ended December 31, 1996. The gross margin percentage has increased
over the past two years, as we have been successful in increasing our sales
prices by more than the increase in the cost of used cars sold.
Our average sales price per car increased by 7.4% for the year ended
December 31, 1998 over the year ended December 31, 1997, compared to a 4.7%
increase in the year ended December 31, 1997 from the year ended December 31,
1996. The increase in the average sales price was necessary to offset the
increase in the Cost of Used Cars Sold. On a per unit basis, the Cost of Used
Cars Sold increased by 6.8% for the year ended December 31, 1998 over the year
ended December 31, 1997, compared to an increase of 3.2% over the year ended
December 31, 1996.
16
Provision for Credit Losses
We record provisions for credit losses in our dealership operations and our
non-dealership operations.
Dealership Operations. Following is a summary of the Provision for Credit
Losses from our dealership operations:
1998 1997 1996
------- ------- ------
Provision for Credit Losses (in thousands)... $65,318 $22,354 $9,657
======= ======= ======
Provision per contract originated............ 1,837 $1,397 $1,394
======== ======= ======
Provision as a percentage of
principal balances originated.............. 23.6% 19.1% 19.7%
======== ======== ======
The Provision for Credit Losses in our dealership operations increased by
192.2% in the year ended December 31, 1998 over the year ended December 31,
1997, compared to an increase of 131.5% over the year ended December 31, 1996.
The Provision for Credit Losses per unit originated at our dealerships increased
by 31.5% in the year ended December 31, 1998 over the year ended December 31,
1997, compared to an increase of 0.2% over the year ended December 31, 1996. The
increase in 1998 was primarily due to an increase in the average amount financed
to $7,796 per unit in the year ended December 31, 1998 from $7,301 per unit in
the year ended December 31, 1997 and from the change in our securitization
structure beginning in the fourth quarter of 1998.
As a percentage of dealership contract principal balances originated, the
Provision for Credit Losses averaged 23.6% for the year ended December 31, 1998,
19.1% for the year ended December 31, 1997, and 19.7% for the year ended
December 31, 1996. When we changed how we structure securitizations for
accounting purposes in the fourth quarter of 1998, we also changed the timing of
providing for credit losses. For periods prior to the fourth quarter of 1998, we
generally provided a Provision for Credit Losses of approximately 20% of the
loan principal balance at the time of origination to record the loan at the
lower of cost or market. However, as a consequence of our revised securitization
structure, we will now be retaining securitized loans on our balance sheet and
recognizing income over the life of the contracts. Therefore, for loans
originated in the fourth quarter of 1998, we increased the provision for credit
losses to 27% of the principal balance at the time of origination. We also
increased the provision for credit losses to 27% on loans originated in prior
periods that had not been securitized prior to the fourth quarter.
Non-Dealership Operations. The provision for credit losses in our
non-dealership operations increased by 235.2% to $2.3 million in the year ended
December 31, 1998 from $691,000 in the year ended December 31, 1997. The
increase was primarily due to the significant increase in loans under the Cygnet
dealer program. There was no provision for credit losses in our non-dealership
operations in 1996, since there was no significant activity until 1997.
See "Allowance for Credit Losses" below.
Interest Income
We generate Interest Income from both our dealership operations and our
non-dealership operations.
Dealership Operations. Interest Income consists primarily of interest on
finance receivables from our dealership sales and income from Residuals in
Finance Receivables Sold from our prior securitizations. Interest Income
increased by 37.6% to $17.3 million for the year ended December 31, 1998 from
$12.6 million for the year ended December 31, 1997, which increased by 46.1%
from $8.6 million in the year ended December 31, 1996. The increases were
primarily due to the increase in the average finance receivables retained on our
balance sheet during these periods. However, because we structured most of our
securitizations to recognize income as sales during 1998, 1997, and 1996,
Interest Income was lower than if we had structured the securitizations as
secured financings for accounting purposes.
A primary element of our sales strategy is to provide financing to our
customers, almost all of whom are sub-prime borrowers. As summarized in the
following table, we continue to increase the percentage of sales revenue
financed, and the number of units sold.
17
1998 1997 1996
---- ---- ----
Percentage of sales revenue financed... 96.4% 94.4% 90.5%
Percentage of used cars sold financed.. 98.9% 96.2% 91.6%
As a result of our expansion into markets with interest rate limits, the
yield on our dealership receivable contracts has gone down. The average
effective yield on finance receivables from our dealerships was approximately
25.8% for the year ended December 31, 1998, 26.7% for the year ended December
31, 1997, and 29.2% for the year ended December 31, 1996. Our policy is to
charge 29.9% per year on our dealership contracts. However, in those states that
impose interest rate limits, we charge the maximum interest rate permitted.
Non-Dealership Operations. In our non-dealership operations, we generate
interest income primarily from a loan we made to FMAC as part of its bankruptcy
proceedings, and from our Cygnet dealer program. Interest Income from the FMAC
transaction decreased by 52.0% to $1.8 million from $3.8 million in 1997 when we
originated the FMAC loan. During a portion of 1997, in addition to our
debtor-in-possession loan to FMAC, we held other notes receivable from FMAC
totaling approximately $76.3 million. We sold receivables that secured the notes
for a gain at the end of 1997. Interest income from the Cygnet dealer program
increased by 269.2% to $8.7 million from $2.4 million in 1997 when the Cygnet
dealer program commenced significant operations. The increase in interest income
in the Cygnet dealer program reflects a significant increase in the amount of
loans outstanding during 1998 compared to 1997.
Gain on Sale of Loans
A summary of Gain on Sale of Loans follows:
(dollar amounts in thousands)
1998 1997 1996
----------- ------------ ------------
Dealership Operations................... $ 12,093 $ 6,721 $ 3,925
Non-Dealership Operations............... -- 8,131 --
----------- ------------ ------------
$ 12,093 $ 14,852 $ 3,925
=========== =========== =============
Gain on Sale of Loans as a percentage
of principal balances securitized -
dealership operations ................ 5.4% (1) 8.2% 6.7%
=========== =========== ============
(1) Excluding a $5.7 million charge in 1997 described below
Dealership Operations. We recorded Gain on Sale of Loans related to
securitization transactions of $12.1 million during the year ended December 31,
1998, $6.7 million (net of a $5.7 million charge) during the year ended December
31, 1997, and $3.9 million during the year ended December 31, 1996. We recorded
a $5.7 million charge (approximately $3.4 million net of income taxes) in the
third quarter of 1997 in order to adjust our assumptions related to our
previously completed securitization transactions. The decrease in Gain on Sale
(excluding the $5.7 million charge in 1997) as a percentage of principal
balances securitized in 1998 compared to 1997 is primarily due to the use of a
higher cumulative charge off assumption in the 1998 securitizations and the
securitized portfolios in 1998 having a shorter weighted average life than those
in 1997. The increase in Gain on Sale (excluding the $5.7 million charge in
1997) as a percentage of principal balances securitized in 1997 compared to 1996
is primarily due to a decrease in the weighted average borrowing rate of the
underlying Class A certificates. See "Securitizations-Dealership Operations"
below for a summary of the structure of our securitizations.
Non-Dealership Operations. During 1997, our non-dealership operations
entered into a series of transactions with FMAC including transactions in which
we acquired 100% of FMAC's senior bank debt. When FMAC put the finance contracts
securing this debt up for bid, we purchased the contracts by releasing the debt.
We then sold the contracts to a third party purchaser. We recorded a one-time
gain of $8.1 million from this transaction. See "Business--Non-Dealership
Operations--Bulk Purchasing and Loan Servicing Operations."
18
Servicing and Other Income
We generate Servicing and Other Income from both our dealership operations
and our non-dealership operations. A summary of Servicing and Other Income
follows (in thousands):
Non-Dealership
Dealership Operations Operations
--------------------- ---------------
Company
Company Dealership Corporate Cygnet
Dealerships Receivables and Other Loan Servicing Total
----------- ----------- --------- -------------- -----------
1998..................$ 389 $ 15,453 $ 493 $ 22,296 $ 38,631
1997..................$ 1,498 $ 8,814 $ 2,013 $ 356 $ 12,681
1996..................$ 195 $ 1,887 $ 455 $ -- $ 2,537
Dealership Operations. Servicing and Other Income increased by 32.5% to
$16.3 million in the year ended December 31, 1998 over the $12.3 million
recognized in 1997, which was an increase of 385.8% over the $2.5 million in
1996. We service our securitized contracts for monthly fees ranging from .25% to
.33% of the beginning of month principal balances (3.0% to 4.0% per year). The
significant increase in Servicing and Other Income is primarily due to the
increase in the principal balance of contracts being serviced under the
securitization program and the addition in 1997 of the Kars portfolio. Although
we acquired several dealerships in the Kars transaction, the owners retained the
loan portfolio, which we service. In addition, the increase in 1997 was also due
to our investment income on the proceeds from our private placement that we
closed in February 1997. We recorded earnings on these investments of $1.2
million compared to no investment earnings in the year ended December 31, 1996.
Non-Dealership Operations. In April 1998, we began servicing loans on behalf
of FMAC. Shortly thereafter, we entered into additional agreements to service
loan portfolios on behalf of other third parties. Our servicing fee is generally
a percentage of the portfolio balance (generally 3.25% to 4.0% per year) with a
minimum fee per loan serviced (generally $14 to $17 per month). Servicing and
Other Income totaled $22.3 million in the year ended December 31, 1998, compared
to $356,000 in 1997 and $0 in 1996.
Our non-dealership operations have entered into servicing agreements with
two companies that have filed and subsequently emerged from bankruptcy and
continue to operate under their approved plans of reorganization. Under the
terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, we are entitled to certain incentive compensation in excess of the
servicing fees that we have earned to date. Under the terms of the agreements
with FMAC, we are scheduled to receive 17.5% of all collections of the serviced
portfolio once the specified creditors have been paid in full. See
"Business--Non-Dealership Operations--Bulk Purchasing and Loan Servicing
Operations." Under the terms of the second agreement, we are scheduled to
receive the first $3.25 million in collections once the specified creditors have
been paid in full and 15% thereafter. We are required to issue warrants to
purchase up to 150,000 shares of our common stock to the extent we receive the
$3.25 million and, in addition, will be required to issue 75,000 warrants for
each $1.0 million in incentive fee income we receive after we collect the $3.25
million. As of December 31, 1998, we estimate that the incentive compensation
could range from $0 to $8.0 million under both agreements. We have not accrued
any fee income from these incentives.
Income before Operating Expenses
As a result of our continued expansion, Income before Operating Expenses
grew by 76.1% to $131.5 million for the year ended December 31, 1998 from $74.7
million for the year ended December 31, 1997, compared to an increase of 173.6%
from $27.3 million in 1996. Growth of Sales of Used Cars, Interest Income, Gain
on Sale of Loans, and Servicing and Other Income were the primary contributors
to the increase.
19
Operating Expenses
Operating Expenses consist of:
o Selling and Marketing Expenses,
o General and Administrative Expenses, and
o Depreciation and Amortization.
A summary of operating expenses for our business segments for the years
ended December 31, 1998, 1997 and 1996 follows (in thousands):
Dealership Operations Non-Dealership Operations
--------------------- -------------------------
Company Cygnet Cygnet
Company Dealership Corporate Dealer Loan Corporate
Dealerships Receivables and Other Program Servicing and Other Total
----------- ----------- --------- ------- --------- --------- ------
1998:
Selling and Marketing...... $ 20,285 $ -- $ -- $ 242 $ 31 $ 7 $ 20,565
General and Administrative. 32,383 18,491 16,103 2,721 18,664 4,040 92,402
Depreciation and
Amortization............ 2,581 1,334 997 104 614 105 5,735
-------- ------- ------- ------ ------ ------ --------
$ 55,249 $19,825 $17,100 $ 3,067 $19,309 $4,152 $118,702
======== ======= ======= ====== ======= ====== ========
1997:
Selling and Marketing...... $ 10,538 $ -- $ -- $ -- $ -- $ -- $ 10,538
General and Administrative. 17,214 12,303 9,896 917 -- 1,572 41,902
Depreciation and
Amortization........... 1,536 1,108 504 28 -- 125 3,301
-------- ------- ------ ------- ------- ------ --------
$ 29,288 $13,411 $10,400 $ 945 $ -- $1,697 $ 55,741
======== ======= ======= ======= ======= ====== ========
1996:
Selling and Marketing...... $ 3,568 $ -- $ 17 $ -- $ -- $ -- $ 3,585
General and Administrative. 6,306 2,859 3,953 -- -- -- 13,118
Depreciation and
Amortization........... 318 769 295 -- -- -- 1,382
-------- ------- ------ ------- ------- ------- --------
$ 10,192 $ 3,628 $4,265 $ -- $ -- $ -- $ 18,085
======== ======= ====== ======= ======= ======= ========
Selling and Marketing Expenses. A summary of Selling and Marketing Expense
as a percentage of Sales of Used Cars and Selling and Marketing Expense per car
sold from our dealership operations follows:
1998 1997 1996
---- ---- ----
Selling and Marketing Expense as a
Percent of Sales of Used Cars....... 7.1% 8.5% 6.6%
==== ==== ====
Selling and Marketing Expense
per Car Sold....................... $564 $633 $472
==== ==== ====
For the years ended December 31, 1998, 1997, and 1996, Selling and Marketing
Expenses consisted almost entirely of advertising costs and commissions relating
to our dealership operations. Selling and Marketing Expenses increased by 95.2%
to $20.6 million for the year ended December 31, 1998 from $10.5 million for the
year ended December 31, 1997, which was an increase of 193.9% from $3.6 million
in 1996. The decrease in Selling and Marketing Expense as a percentage of Sales
of Used Cars and on a per unit basis from 1997 to 1998 is due to the significant
increase in the number of cars sold in 1998 compared to 1997, and to the fact
that we did not enter any new markets in 1998. The significant increase in per
unit marketing in 1997 was primarily due to our expansion into several new
markets. We operated dealerships in ten markets during 1997, compared to two
markets in 1996. As a result of this expansion, we incurred significant
marketing costs in 1997 in new markets in an effort to establish brand name
recognition.
General and Administrative Expenses. General and Administrative Expenses
increased by 120.5% to $92.4 million for the year ended December 31, 1998 from
$41.9 million for the year ended December 31, 1997, which was an increase of
219.4% from $13.1 million for the year ended December 31, 1996. The increase in
General and Administrative Expenses was primarily a result of the increased
number of used car dealerships in operations, as well the expansion of our bulk
purchasing and loan servicing operations, the Cygnet dealer program, and
continued expansion of infrastructure to administer growth. General and
Administrative expenses for the year ended 1998 includes a $2.0 million charge
20
($1.2 million, net of income taxes) to write off costs associated with the
rights offering.
Depreciation and Amortization. Depreciation and Amortization consists of
depreciation and amortization on our property and equipment and amortization of
goodwill and trademarks. Depreciation and amortization increased by 73.7% to
$5.7 million for the year ended December 31,1998 from $3.3 million for the year
ended December 31, 1997, which was an increase of 138.9% over the $1.4 million
incurred in the year ended December 31, 1996. The increase in 1998 was primarily
due to increases in amortization of goodwill associated with our 1997
acquisitions, increased depreciation expense from the addition of used car
dealerships and the addition of four loan servicing facilities in 1998 to
support our bulk purchase and loan servicing operations.
Interest Expense
Interest expense increased by 148.9% to $6.9 million in 1998 from $2.8
million in 1997, which was an increase of 14.2% from $2.4 million in 1996. The
increase in 1998 was primarily due to increased borrowings of Notes Payable and
Subordinated Notes Payable. The relatively small increase in 1997, despite
significant growth in our total assets, was primarily the result of the private
placement of common stock that we completed in February 1997. Our private
placement generated $88.7 million in cash which we used to pay down debt.
Income Taxes
Income taxes totaled $2.4 million for the year ended December 31, 1998, $6.6
million for the year ended December 31, 1997, and $100,000 for the year ended
December 31, 1996. Our effective tax rate was 40.5% for the year ended December
31, 1998, 41.1% for the year ended December 31, 1997, and 1.6% for the year
ended December 31, 1996. In 1996, we reversed all of the valuation allowance
that existed against our deferred income tax assets as of December 31, 1995,
which significantly reduced our effective income tax rate.
Discontinued Operations
The loss from Discontinued Operations, net of income tax benefits, increased
by $9.1 million to $9.2 million in 1998 from $83,000 in 1997, which was an
improvement from the $811,000 loss we incurred in 1996. The significant increase
in the loss in 1998 was due to the charges we recorded totaling $15.1 million
($9.2 million, net of income taxes) to close our branch office network.
Financial Position
Total assets increased by 25.2% to $346.0 million at December 31, 1998 from
$276.4 million at December 31, 1997. The increase was due in part to an increase
in Finance Receivables of $72.6 million to $163.2 million at December 31, 1998
from $90.6 million at December 31, 1997. The increase in Finance Receivables was
primarily due to a significant increase in loans under the Cygnet dealer
program, and a change in the structure of our securitization transactions for
accounting purposes which resulted in us retaining on balance sheet the Finance
Receivables we securitized in the fourth quarter of 1998. We previously
structured securitizations as sales for accounting purposes and we removed the
related Finance Receivables from the balance sheet upon securitization.
Additionally, our dealership network increased from 41 dealerships at December
31, 1997 to 56 at December 31, 1998. The increase in the number of our
dealerships resulted in an increase in Inventory of $11.8 million to $44.2
million at December 31, 1998 from $32.4 million at December 31, 1997.
We financed the increases in assets primarily through additional borrowings,
represented by increases in Notes Payable, Collateralized Notes Payable, and
Subordinated Notes Payable. Notes Payable and Collateralized Notes Payable
increased by $52.5 million to $117.3 million at December 31, 1998 from $64.8
million at December 31, 1997. This increase was primarily due to the change in
our securitization structure. We retained the debt related to the securitization
transaction we closed in the fourth quarter of 1998 on our balance sheet.
Subordinated Notes Payable increased by $31.7 million to $43.7 million at
December 31, 1998 from $12.0 million at December 31, 1997. The increase in
Subordinated Notes Payable was primarily due to the addition of $20.0 million in
subordinated notes used for working capital and other uses and approximately
$17.5 million used to repurchase our common stock in an exchange transaction.
See "Liquidity and Capital Resources--Supplemental Borrowings--Exchange Offer"
below.
21
Growth in Finance Receivables. As a result of our rapid expansion, contract
receivables managed by our dealership operations have increased significantly
during the past three years.
The following table reflects the growth in period end balances of our
dealership operations measured in terms of the principal amount and the number
of contracts outstanding.
Total Contracts Outstanding-Dealership
Operations
(In thousands, except number of contracts)
as of December 31,
--------------------------------------------
1998 1997
-------------------- ----------------------
Principal No. of Principal No. of
Amount Contracts Amount Contracts
-------- --------- --------- ---------
Principal Amount..................... $292,683 49,601 $ 183,321 35,762
Less: Portfolios Securitized and Sold 198,747 37,186 127,356 27,769
------- ------ --------- ------
Dealership Operations Total........ $ 93,936 12,415 $ 55,965 7,993
======== ====== ========= ======
The following table reflects the growth in the principal amount and number
of contracts generated or acquired by our dealership operations.
Total Contracts Generated or Acquired-Dealership Operations
(Principal Amounts In Thousands)
During the Years Ended December 31,
----------------------------------
1998 1997 1996
-------- -------- --------
Principal Amount... $277,226 $172,230 $ 48,996
Number of Contracts 35,560 29,251 6,929
Average Principal.. $ 7,796 $ 5,888 $ 7,071
Finance Receivable principal balances generated or acquired by our
dealership operations during the year ended December 31, 1998 increased by 61.0%
to $277.2 million from $172.2 million in the year ended December 31, 1997.
During the year ended December 31, 1997, Finance Receivable principal balances
generated or acquired by our dealership operations included the purchase of
approximately $55.4 million (13,250 contracts) in Finance Receivables principal
balances in conjunction with the E-Z Plan and Seminole acquisitions.
In addition to the loan portfolio summarized above, our dealership
operations also serviced loan portfolios totaling approximately $121.2 million
($47.9 million for Kars and $73.3 million from our branch office network) as of
December 31, 1998, and $267.9 million ($127.3 million for Kars and $140.6
million from our branch office network) as of December 31, 1997.
Our non-dealership operations began servicing loans on behalf of FMAC on
April 1, 1998, and began servicing additional loan portfolios on behalf of other
third parties throughout 1998. By December 31, 1998, our non-dealership bulk
purchasing/loan servicing operations were servicing a total of $587.3 million in
finance receivables (approximately 80,000 contracts).
Allowance for Credit Losses
We have established an Allowance for Credit Losses ("Allowance") to cover
anticipated credit losses on the contracts currently in our portfolio. We
established the Allowance by recording an expense through the Provision for
Credit Losses.
For Finance Receivables generated at our dealerships, our policy is to
charge off a contract the earlier of:
o when we believe it is uncollectible, or
o when it is delinquent for more than 90 days.
22
The following table reflects activity in the Allowance, as well as
information regarding charge off activity, for the years ended December 31, 1998
and 1997, in thousands.
Dealership Operations
---------------------
Years Ended
December 31,
---------------------
1998 1997
--------- --------
Allowance Activity:
Balance, Beginning of Period..................... $ 10,356 $ 1,625
Provision for Credit Losses...................... 65,318 22,354
Allowance on Acquired Loans...................... -- 15,309
Reduction Attributable to Loans Sold............. (44,539) (21,408)
Net Charge Offs.................................. (6,358) (7,524)
--------- --------
Balance, End of Period........................... $ 24,777 $10,356
======== =======
Allowance as Percent of Period End Principal
Balances...................................... 26.4% 18.5%
======== ========
Charge off Activity:
Principal Balances............................. $ (8,410) $(10,285)
Recoveries, Net................................ 2,052 2,761
-------- -------
Net Charge Offs.................................. $ (6,358) $(7,524)
========= ========
The Allowance on contracts from dealership operations was 26.4% of the
outstanding principal balances as of December 31, 1998 and 18.5% of outstanding
principal balances as of December 31, 1997. The increase is due to the change in
the structure of our securitization transactions for accounting purposes in the
fourth quarter of 1998. The change resulted in us retaining the securitized
loans from our fourth quarter securitization on balance sheet. As we intend to
hold the balance sheet portfolio for investment and not for sale, we increased
the provision for credit losses to 27% of the principal balance for loans
originated in the fourth quarter of 1998.
The Allowance on contracts from non-dealership operations was 3.9% of the
outstanding principal balances as of December 31, 1998 and 3.8% of outstanding
principal balances as of December 31, 1997. In addition, our non-dealership
operations held non-refundable discounts and security deposits from third party
dealers totaling $15.3 million, which represented 29.9% of outstanding principal
balances as of December 31, 1998. Our non-dealership operations held
non-refundable discounts and security deposits from third party dealers totaling
$7.2 million, which represented 26.0% of the outstanding principal balances as
of December 31, 1997.
Even though a contract is charged off, we continue to attempt to collect the
contract. Recoveries as a percentage of principal balances charged off from
dealership operations averaged 24.4% for the year ended December 31, 1998
compared to 26.8% for the year ended December 31, 1997. Recoveries as a
percentage of principal balances charged off from non-dealership operations
averaged 30.1% for the year ended December 31, 1998 compared to 0% for the year
ended December 31, 1997, when we recorded only one charge off against the
Allowance.
For Finance Receivables acquired by our non-dealership operations with
recourse to the seller, our general policy is to exercise the recourse
provisions in our agreements under the Cygnet dealer program when a contract is
delinquent for 45 days. For contracts not purchased with recourse, our policy is
similar to that of our dealership operations.
Static Pool Analysis
We use a "static pool" analysis to monitor performance for contracts we have
originated at our dealerships. In a static pool analysis, we assign each month's
originations to a unique pool and track the charge offs for each pool
separately. We calculate the cumulative net charge offs for each pool as a
percentage of that pool's original principal balances, based on the number of
complete payments made by the customer before charge off. The table below
displays the cumulative net charge offs of each pool as a percentage of original
contract cumulative balances, based on the quarter the loans were originated.
The table is further stratified by the number of payments made by our customers
prior to charge off. For periods denoted by "x", the pools have not seasoned
sufficiently to allow us to compute cumulative losses. For periods denoted by
"-", the pools have not yet reached the indicated cumulative age. While we
monitor static pools on a monthly basis, for presentation purposes, we are
presenting the information in the table below on a quarterly basis.
23
Currently reported cumulative losses may vary from those previously reported
for the reasons listed below, however, management believes that such variation
will not be material:
o ongoing collection efforts on charged off accounts, and
o the difference between final proceeds on the sale of repossessed
collateral versus our estimates of the sale proceeds.
The following table sets forth as of February 28, 1999, the cumulative net
charge offs as a percentage of original contract cumulative (pool) balances,
based on the quarter of origination and segmented by the number of monthly
payments completed by customers before charge off. The table also shows the
percent of principal reduction for each pool since inception and cumulative
total net losses incurred (TLI).
Pool's Cumulative Net Losses as Percentage of Pool's Original
Aggregate Principal Balance
(dollars in thousands)
Monthly Payments Completed by Customer Before Charge Off
-------------------------------------------------------------------------
Orig. 0 3 6 12 18 24 TLI Reduced
----- --- ---- ---- ---- ---- ---- ---- -------
1994:
1st Quarter $ 6,305 3.4% 10.0% 13.4% 17.9% 20.3% 20.9% 21.0% 100.0%
2nd Quarter $ 5,664 2.8% 10.4% 14.1% 19.6% 21.5% 22.0% 22.1% 100.0%
3rd Quarter $ 6,130 2.8% 8.1% 12.0% 16.3% 18.2% 19.1% 19.2% 100.0%
4th Quarter $ 5,490 2.4% 7.6% 11.2% 16.4% 19.3% 20.2% 20.3% 100.0%
1995:
1st Quarter $ 8,191 1.6% 9.1% 14.7% 20.4% 22.7% 23.6% 23.8% 100.0%
2nd Quarter $ 9,846 2.0% 8.5% 13.3% 18.1% 20.7% 22.2% 22.6% 99.9%
3rd Quarter $ 10,106 2.5% 7.9% 12.2% 18.8% 22.2% 23.6% 24.2% 99.1%
4th Quarter $ 8,426 1.5% 6.6% 11.7% 18.2% 22.6% 24.1% 24.7% 98.7%
1996:
1st Quarter $ 13,635 1.6% 8.0% 13.7% 20.7% 24.9% 26.2% 27.1% 96.5%
2nd Quarter $ 13,462 2.2% 9.2% 13.4% 22.1% 26.1% 27.7% 28.9% 93.6%
3rd Quarter $ 11,082 1.6% 6.9% 12.5% 21.5% 25.7% 28.0% 28.5% 89.3%
4th Quarter $ 10,817 0.6% 8.5% 16.0% 25.0% 29.3% 31.2% 31.2% 85.3%
1997:
1st Quarter $ 16,279 2.1% 10.6% 17.9% 24.6% 29.6% 30.9% 30.9% 80.1%
2nd Quarter $ 25,875 1.5% 9.9% 15.9% 22.8% 27.3% 27.5% 27.5% 71.2%
3rd Quarter $ 32,147 1.4% 8.4% 13.3% 22.6% 25.3% x 25.3% 63.1%
4th Quarter $ 42,529 1.5% 6.9% 12.7% 21.6% x -- 21.9% 55.4%
1998:
1st Quarter $ 69,708 0.9% 6.9% 13.6% x -- -- 18.4% 47.0%
2nd Quarter $ 66,908 1.1% 8.1% x -- -- -- 14.3% 32.2%
3rd Quarter $ 71,027 1.0% x -- -- -- -- 8.1% 18.0%
4th Quarter $ 69,583 x -- -- -- -- -- 1.6% 5.3%
The following table sets forth the principal balances 31 to 60 days
delinquent, and 61 to 90 days delinquent as a percentage of total outstanding
contract principal balances from dealership operations.
Retained Securitized Managed
-------- ----------- -------
December 31, 1998:
31 to 60 days... 2.3% 5.2% 4.6%
61 to 90 days... 0.5% 2.2% 1.9%
December 31,1997:
31 to 60 days... 2.2% 4.5% 3.6%
61 to 90 days... 0.6% 2.2% 1.5%
In accordance with our charge off policy, there are no accounts more than 90
days delinquent as of December 31, 1998 and 1997.
Securitizations-Dealership Operations
Structure of Securitizations. For the securitization transactions closed
prior to the fourth quarter of 1998, we recognized a Gain on Sale of Loans equal
to the difference between the sales proceeds for the Finance Receivables sold
and our recorded investment in the Finance Receivables sold. Our investment in
Finance Receivables consisted of the principal balance of the Finance
Receivables securitized net of the Allowance for Credit Losses related to the
securitized receivables. We then reduced our Allowance for Credit Losses by the
24
amount of Allowance for Credit Losses related to the loans securitized. We
allocated the recorded investment in the Finance Receivables between the portion
of the Finance Receivables sold and the portion retained based on the relative
fair values on the date of sale.
In the fourth quarter of 1998 we announced that we were changing the way we
structure transactions under our securitization program for accounting purposes.
Through September 30, 1998, we had structured these transactions as sales for
accounting purposes. However, beginning in the fourth quarter of 1998, we began
structuring securitizations for accounting purposes to recognize the income over
the life of the contracts. This change will not affect our prior
securitizations. Historically, Gain on Sale of Loans has been material to our
reported revenues and net earnings. Altering the structure of these transactions
so that no gain is recognized at the time of a securitization transaction will
have a material effect on our reported revenues and net earnings until such time
as we accumulate Finance Receivables on our balance sheet sufficient to generate
interest income (net of interest, credit losses, and other expenses) equivalent
to the revenues that we had historically recognized on our securitization
transactions.
Under our securitization program, we sell the securitized Finance
Receivables to our securitization subsidiaries who then assign and transfer the
Finance Receivables to separate trusts. The trusts issue Class A certificates
and subordinated Class B certificates (Residuals in Finance Receivables Sold) to
the securitization subsidiaries. The securitization subsidiaries then sell the
Class A certificates to the investors and retain the Class B certificates. We
continue to service the securitized contracts.
The Class A certificates from our securitization transactions have
historically received investment grade ratings. To secure the payment of the
Class A certificates, the securitization subsidiaries have:
o obtained an insurance policy from MBIA Insurance Corporation which
guarantees payment of amounts to the holders of the Class A
certificates (for transactions closed after July 1, 1997), and
o established a cash "spread" account (essentially, a reserve account) for
the benefit of the certificate holders.
Spread Account Requirements. The securitization subsidiaries make an initial
cash deposit into the spread account, generally equivalent to 4% of the initial
underlying Finance Receivables principal balance and pledge this cash to the
spread account agent. The trustee then makes additional deposits to the spread
account out of collections on the securitized receivables as necessary to fund
the spread account to a specified percentage, ranging from 6.0% to 10.5%, of the
underlying Finance Receivables' principal balance. The trustee will not make
distributions to the securitization subsidiaries on the Class B certificates
unless:
o the spread account has the required balance,
o the required periodic payments to the Class A certificate holders are
current, and
o the trustee, servicer and other administrative costs are current.
During 1998, we made initial spread account deposits totaling approximately
$13.1 million. The required spread account balance based upon the targeted
percentages was approximately $23.7 million at December 31, 1998 with balances
in the spread accounts totaling approximately $20.6 million. Therefore, the
amount remaining to be funded to meet the targeted balance was approximately
$3.1 million as of December 31, 1998.
In addition to the spread account balance of $20.6 million at December 31,
1998, we also had deposited a total of $1.6 million in trust accounts in
conjunction with certain other agreements. We also maintain spread accounts for
the securitization transactions that were consummated by our discontinued
operations. We had satisfied the spread account funding obligation of $3.7
million as of December 31, 1998 with respect to these securitization
transactions.
Certain Financial Information Regarding Our Securitizations. During the
first three quarters of 1998, we securitized an aggregate of $222.8 million in
contracts, issuing $161.1 million in Class A certificates, and $61.7 million in
Class B certificates. During the fourth quarter of 1998, we securitized $69.3
million in contracts, issuing $50.6 million of Class A certificates. Due to the
revised securitization structure, the $69.3 million of loans remained classified
as Finance Receivables, and the $50.6 million in Class A certificates were
classified as Notes Payable in our Consolidated Balance Sheet. During the year
ended December 31, 1997, we securitized an aggregate of $151.7 million in
contracts, issuing $121.4 million in Class A certificates, and $30.3 million in
Class B certificates. In 1996, we securitized an aggregate of $58.2 million in
contracts, issuing $44.7 million in Class A certificates, and $13.5 million in
Class B certificates.
25
We recorded the carrying value of the Residuals in Finance Receivables sold
at $36.5 million in 1998, and $17.7 million in 1997. The balance of the
Residuals in Finance Receivables sold was $33.3 million as of December 31, 1998
and $13.3 million as of December 31, 1997.
The table below summarizes certain attributes of our securitizations:
1998 1997 1996
----------------- ------------------ ------------------
Weighted Average Yield of Certificates Issued.......... 5.9% 6.7% 8.4%
Range of Yields for Certificates Issued................ 5.6% - 6.1% 6.3% - 8.1% 8.2% - 8.6%
Average Net Spreads (after fees and expenses).......... 17.6% 15.8% 17.1%
Range of Net Spreads (after fees and expenses)......... 17.0% - 18.1% 13.7% - 17.8% 16.8% - 17.4%
The decrease in net spreads from 1996 to 1997, despite lower certificate
yields, is primarily the result of the decrease in the average contract yield of
the finance receivable contracts securitized due to our expansion into markets
with interest rate limits.
Residuals in Finance Receivables Sold, which are a component of Finance
Receivables, represent our retained portion (the Class B certificates) of the
loans we securitized prior to the fourth quarter of 1998. We utilize a number of
assumptions to determine the initial value of the Residuals in Finance
Receivables Sold. The Residuals in Finance Receivables Sold represent the
present value of the expected net cash flows of the securitization trusts using
the out of the trust method. The net cash flows out of the trusts are the
collections on the loans in the trust in excess of the Class A certificate
principal and interest payments and certain other trust expenses. The
assumptions used to compute the Residuals in Finance Receivables Sold include,
but are not limited to:
o charge off rates,
o repossession recovery rates,
o portfolio delinquency,
o prepayment rates, and
o trust expenses.
The Residuals in Finance Receivables Sold are adjusted monthly to
approximate the present value of the expected remaining net cash flows out of
the trust. To the extent that actual cash flows on a securitization are below
our original estimates, and those differences appear to be other than temporary
in nature, we are required to revalue Residuals in Finance Receivables Sold and
record a charge to earnings based upon the reduction. During the third quarter
of 1997, we recorded a $5.7 million charge (approximately $3.4 million, net of
income taxes) to dealership operations to write down the Residuals in Finance
Receivables Sold. We determined a write down in the Residuals in Finance
Receivables Sold was necessary due to an increase in net losses in the
securitized loan portfolio. The charge resulted in a reduction in the carrying
value of the our Residuals in Finance Receivables Sold and had the effect of
increasing the cumulative net loss at loan origination assumption to
approximately 27.5% for the securitization transactions that took place prior to
September 30, 1997. The revised loss assumption approximates the assumption used
for the securitization transaction consummated during the third quarter of 1997.
For the securitizations that we completed during the nine month period ended
September 30, 1998, net losses were estimated using total expected cumulative
net losses at loan origination of approximately 29.0%, adjusted for actual
cumulative net losses prior to securitization.
One of the assumptions inherent in the valuation of the Residuals in Finance
Receivables Sold is the projected portfolio net charge offs. The remaining net
charge offs in the Residuals in Finance Receivables Sold as a percentage of the
remaining principal balances of securitized contracts was approximately 14.9% as
of December 31, 1998, compared to 17.9% as of December 31, 1997. This decrease
is primarily due to having a more seasoned securitized portfolio as of December
31, 1998 than at December 31, 1997. As a greater portion of our losses tend to
take place in the early stages of the portfolio's existence, a more seasoned
portfolio will have fewer losses remaining than a portfolio that has not aged as
much. There can be no assurance that the charge we recorded in the third quarter
of 1997 was sufficient and that we will not need to record additional charges in
the future in order to write down the Residuals in Finance Receivables Sold.
We classify the residuals as "held-to-maturity" securities in accordance
with SFAS No. 115.
26
Liquidity and Capital Resources
In recent periods, our needs for additional capital resources have increased
in connection with the growth of our business. We require capital for:
o increases in our contract portfolio,
o expansion of our dealership network,
o our commitments under the FMAC transaction,
o expansion of the Cygnet dealer program,
o common stock repurchases,
o the purchase of inventories,
o the purchase of property and equipment, and
o working capital and general corporate purposes.
We fund our capital requirements primarily through:
o operating cash flow,
o our revolving facility with General Electric Capital Corporation,
o securitization transactions,
o supplemental borrowings, and
o in the past, equity offerings.
While to date we have met our liquidity requirements as needed, there can be
no assurance that we will be able to continue to do so in the future.
Operating Cash Flow
Net Cash Provided by Operating Activities increased by $29.9 million in the
year ended December 31, 1998 to $22.1 million from cash used in the year ended
December 31, 1997 of $7.8 million. The increase in 1998 was due primarily to
increases in the Loss from Discontinued Operations, the Provision for Credit
Losses, and Proceeds from the Sale of Finance Receivables, net of decreases in
Net Earnings and purchases of Finance Receivables. Net Cash Used by Operating
Activities totaled $7.8 million in the year ended December 31, 1997 compared to
Cash Provided by Operating Activities of $23.8 million in 1996. This increase in
cash used in 1997 over cash provided in 1996 was primarily due to increases in
the purchases of Finance Receivables and Inventory, and a reduction in
collections of Finance Receivables, net of increases in the Provision for Credit
Losses and Proceeds from the Sale of Finance Receivables.
Net Cash Used in Investing Activities decreased by $12.2 million to $98.7
million in the year ended December 31, 1998 compared to $110.9 million in 1997.
The decrease is primarily due to increases in Cash Used in Investing Activities
from purchases of Finance Receivables, net decreases in Cash advanced under our
Notes Receivable, increased collections of Notes Receivable, and a reduction in
payment for Acquisition of Assets. Net Cash Used in Investing Activities
increased by $100.3 million to $110.9 million in the year ended December 31,
1997 compared to $10.5 million in 1996. The increase was due primarily to net
increases in Notes Receivable of $25.9 million and Payment for Acquisition of
Assets of $45.2 million.
Net Cash Provided by Financing Activities decreased by $40.5 million to
$69.0 million in the year ended December 31, 1998 compared to $109.5 million in
the comparable period in 1997. The decrease is due to increases in Notes
Payable, net of increases in repayments of Notes Payable and a decrease in
proceeds from the issuance of common stock. Net Cash Provided by Financing
Activities decreased by $69.3 million to $109.5 million in the year ended
December 31, 1997 compared to $40.1 million in 1996. The increase was primarily
due to increases in the issuance of Notes Payable, reduction in repayments of
Notes Payable and a lack of any redemption of Preferred Stock.
27
Financing Resources
Revolving Facility. In September 1998, we amended our revolving credit
facility with General Electric Capital Corporation ("GE Capital") increasing the
maximum commitment to $125.0 million. Under the revolving facility, we may
borrow:
o up to 65.0% of the principal balance of eligible contracts originated from
the sale of used cars,
o up to 86.0% of the principal balance of eligible contracts previously
originated by our branch office network,
o the lesser of $20 million or 58% of the direct vehicle costs for
eligible vehicle inventory, and
o starting in January 1999, the lesser of $15 million or 50% of eligible
contracts or loans originated under the Cygnet dealer program.
However, an amount up to $8.0 million of the borrowing capacity under the
revolving facility is not available at any time while our guarantee to the
purchaser of contracts acquired from FMAC is outstanding. See
"Business--Non-Dealership Operations--Bulk Purchasing and Loan Servicing
Operations."
The revolving facility expires in June 2000 and contains a provision that
requires us to pay GE Capital a termination fee of $200,000 if we terminate the
revolving facility prior to the expiration date. We secure the facility with
substantially all of our assets.
As of December 31, 1998, our borrowing capacity under the revolving facility
was $55.5 million, the aggregate principal amount outstanding under the
revolving facility was approximately $52.0 million, and the amount available to
be borrowed under the facility was $3.5 million. The revolving facility bears
interest at the 30-day LIBOR plus 3.15%, payable daily (total rate of 8.40% as
of December 31, 1998).
The revolving facility contains covenants that, among other things, limit
our ability to do the following without GE Capital's consent:
o incur additional indebtedness,
o make any change in our capital structure,
o declare or pay dividends, except in accordance with all applicable laws
and not in excess of fifteen percent (15%) of each year's net earnings
available for distribution, and
o make certain investments and capital expenditures.
The revolving facility also provides that an event of default will occur if
Mr. Ernest C. Garcia II owns less than 15.0% of our voting stock. Mr. Garcia
owned approximately 29.8% of our common stock at December 31, 1998.
In addition, we are also required to:
o be Year 2000 compliant no later than June 30, 1999 (see discussion below
under "Year 2000 Readiness Disclosure"), and
o maintain specified financial ratios, including a debt to equity ratio of
2.2 to 1 and a net worth of at least $110,000,000.
Under the terms of the revolving facility, we are required to maintain an
interest coverage ratio and a cash flow based interest coverage ratio that we
failed to satisfy during the year ended December 31, 1998. We failed to meet
these covenants primarily as a result of the charges we took during 1998 for the
closure of our branch office network. GE Capital has waived the covenant
violations as of December 31, 1998.
Securitizations. Our securitization program is a primary source of our
working capital. Since September 30, 1997, we have closed all of our
securitizations with private investors through Greenwich Capital Markets, Inc.
("Greenwich Capital"). In March 1999, we executed a commitment letter with
Greenwich Capital to act as our exclusive agent in placing up to $300 million of
surety wrapped securities under our securitization program.
Securitizations generate cash flow for us from:
o the sale of Class A certificates,
o ongoing servicing fees, and
28
o excess cash flow distributions from collections on the contracts
securitized after:
o payments on the Class A certificates sold to third party investors,
o payment of fees, expenses, and insurance premiums, and
o required deposits to the spread account.
Securitization also allows us to fix our cost of funds for a given contract
portfolio. Failure to regularly engage in securitization transactions will
adversely affect us. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Securitizations-Dealership Operations" for
a more complete description of our securitization program.
Supplemental Borrowings
Verde Debt. Prior to our public offering in September 1996, we historically
borrowed substantial amounts from Verde Investments Inc. ("Verde"), which is
owned by our Chairman and Chief Executive Officer, Ernest C. Garcia. The
Subordinated Notes Payable balances outstanding to Verde totaled $10.0 million
as of December 31, 1998 and $12 million as of December 31, 1997. Prior to
September 21, 1996, these borrowings accrued interest at an annual rate of
18.0%. Effective September 21, 1996, the annual interest rate on these
borrowings was reduced to 10.0%. Under the terms of this note, we are required
to make monthly payments of interest and annual payments of principal in the
amount of $2.0 million. Except for the debt incurred related to the exchange
offer (see below), this debt is junior to all of our other indebtedness and we
may suspend interest and principal payments if we are in default on obligations
to any other creditors. In July 1997, our Board of Directors approved the
prepayment of the $10.0 million in subordinated debt after the earlier of the
following:
o the completion of a debt offering, or
o at such time as the following:
o the FMAC transactions have been completed or the cash requirements for
completion of the transaction are known, or
o we either have cash in excess of our current needs or have funds available
under our financing sources in excess of our current needs.
No such prepayment has been made as of the date of filing of this Form 10-K.
Any prepayment would require the consent of certain of our lenders.
Senior Subordinated Notes. In February 1998, we borrowed a total of $15.0
million of subordinated debt from unrelated third parties for a three year term.
We pay interest on this debt quarterly at 12% per annum. This debt is:
o senior to the Verde subordinated note (described above) and the
subordinated debentures issued in our exchange offer (described below),
and
o subordinate to our other indebtedness.
We issued warrants to the lenders of this debt to purchase up to 500,000
shares of our common stock at an exercise price of $10.00 per share, exercisable
at any time until the later of February 2001, or when the debt is paid in full.
In July 1998, we borrowed a total of $5.0 million in subordinated debt from
unrelated third parties for a three-year term. Under the terms of the loan
agreement, we were required to issue warrants to purchase 115,000 shares of our
common stock by December 31, 1998 if the loan was not paid in full by that date.
The warrants were to have been issued at an exercise price of 120% of the
average trading price for our common stock for the 20 consecutive trading days
prior to the issuance of the warrants. In January 1999, we prepaid $1.8 million
of the loans and the lenders waived their right to a proportionate amount of the
warrants. We have agreed to pay $1.2 million by March 31, 1999 and the remaining
$2.0 million on June 30, 1999. We will not be required to issue the warrants if
we repay the loans on these dates.
Sale-Leaseback of Real Property. In March 1998, we executed an agreement
with an investment company for the sale and leaseback of up to $37.0 million in
real property. We sold certain real property to the investment company for its
original cost and leased back the properties for an initial term of twenty
years. We have the right to extend the leases in certain cases. We pay monthly
rents of approximately one-twelfth of 10.75% of the purchase price plus all
occupancy costs and taxes. The agreement calls for annual increases in monthly
rent of not less than 2%. As of December 31, 1998, we had sold approximately
$27.4 million of property under this arrangement. However, we do not anticipate
29
closing any additional transactions under this agreement with the investment
company. We used substantially all of the proceeds from the sales to pay down
debt.
Exchange Offer. In the fourth quarter of 1998, we acquired approximately 2.7
million shares of our common stock in exchange for approximately $17.5 million
of subordinated debentures. The debentures are unsecured and are subordinate to
all of our existing and future indebtedness. We must pay interest on the
debentures twice a year at 12% per year. We are required to pay the principal
amount of the debentures on October 23, 2003.
We issued the debentures at a premium of approximately $3.9 million over the
market value of the shares of our common stock that were exchanged for the
debentures. Accordingly, the debt was recorded at $13.6 million on our balance
sheet. The premium will be amortized over the life of the debentures and results
in an effective annual interest rate of approximately 18.8%. We can redeem all
or part of the debentures at any time.
As a result of the exchange offer, the number of our common shares
outstanding decreased to approximately 15,845,000 compared to approximately
18,533,000 shares outstanding prior to the exchange offer.
Additional Financing. On November 12, 1998, we borrowed $15.0 million for a
term of 364 days from Greenwich Capital. We pay interest on this loan at an
interest rate equal to LIBOR plus 400 basis points. We secured the loan with the
common stock of our securitization subsidiaries. In March 1999, we borrowed
$20.0 million for a term of 278 days from Greenwich Capital. $1.5 million was
used to repay the remaining balance of the $15 million Greenwich Capital loan.
The new loan was secured by the common stock of our securitization subsidiaries.
The interest rate is at LIBOR plus 500 basis points and we paid an origination
fee of 100 basis points.
In March 1999, we executed a commitment letter with Greenwich Capital in
which, subject to satisfaction of certain conditions, Greenwich Capital agreed
to provide us with a $100 million surety-wrapped warehouse line of credit at a
rate equal to LIBOR plus 110 basis points. In addition, on March 26, 1999, we
borrowed approximately $28.9 million from Greenwich Capital under a repurchase
facility with a 62% advance rate, bearing interest at 8.5%, and maturing May 31,
1999.
Debt Shelf Registration. In 1997, we registered up to $200 million of our
debt securities under the Securities Act of 1933. There can be no assurance that
we will be able to use this registration statement to sell debt securities, or
successfully register and sell other debt securities in the future.
Capital Expenditures and Commitments
We have pursued an aggressive growth strategy. During the year ended
December 31, 1998, we opened 17 new dealerships. We also have six more
dealerships under development. The magnitude of the direct cost of opening a
dealership is primarily a function of whether we lease a facility or construct a
facility. A leased facility costs approximately $650,000 to develop, while a
facility we construct costs approximately $ 1.7 million. In addition, we require
capital to finance the portfolio that we carry on our balance sheet for each
store. It takes approximately $2.2 million in cash to support a typical
stabilized store portfolio with our existing 65% advance rate under our GE
facility. Additionally, it takes approximately 30 months for a store portfolio
to reach a stabilized level.
On July 11, 1997, we entered into an agreement to provide "debtor in
possession" financing to FMAC (the "DIP Facility"). As of December 31, 1998, the
maximum commitment on the DIP Facility was $12.4 million and the outstanding
balance on the DIP Facility totaled $11.8 million. Subsequent to December 31,
1998, the maximum commitment was reduced to $11.5 million from the receipt of
certain income tax refunds received by FMAC and remitted to us. See
"Business--Non-Dealership Operations--Bulk Purchasing and Loan Servicing
Operations--DIP Facility".
We intend to finance the construction of new dealerships and the DIP
financing through operating cash flows and supplemental borrowings, including
amounts available under the revolving facility and the securitization program.
Common Stock Repurchase Program. In October 1997, our Board of Directors
authorized a stock repurchase program allowing us to purchase up to one million
shares of our common stock from time to time. Purchases may be made depending on
market conditions, share price and other factors. Our Board of Directors
extended the stock repurchase program in February 1999, to December 31, 1999.
30
During 1998, we repurchased 72,000 shares of common stock pursuant to the stock
repurchase program. Subsequent to December 31, 1998, we repurchased
approximately 928,000 additional shares of common stock under this program.
Since January 1, 1998, we have repurchased a total of approximately 3.7
million shares of our common stock under our stock repurchase program and the
exchange offer described above at an average cost of approximately $5.33 per
share.
In September 1997, our Board of Directors approved a director and senior
officer stock purchase loan program. We may make loans of up to $1.0 million in
total to the directors and senior officers under the program to assist
directors' and officers' purchases of common stock on the open market. These
unsecured loans bear interest at 10% per year. During 1997, senior officers
purchased 50,000 shares of common stock under this program and we loaned
$500,000 to the senior officers for these purchases. During 1998, we made
additional loans under similar terms and conditions to senior officers totaling
approximately $393,000 for the purchase of 40,000 shares of our common stock.
Year 2000 Readiness Disclosure
Many older computer programs refer to years only in terms of their final two
digits. Such programs may interpret the year 2000 to mean the year 1900 instead.
The problem affects not only computer software, but also computer hardware and
other systems containing processors and embedded chips. Business systems
affected by this problem may not be able to accurately process date-related
information before, during or after January 1, 2000. This is commonly referred
to as the Year 2000 problem. Our business could be materially adversely affected
by failures of our own business systems due to the Year 2000 problem as well as
those of our suppliers and business partners. We are in the process of
addressing these issues.
Our Year 2000 compliance program consists of:
o identification and assessment of critical computer programs, hardware and
other business equipment and systems,
o remediation and testing,
o assessment of the Year 2000 readiness of our critical suppliers, vendors
and business partners, and
o contingency planning.
Identification and Assessment
The first component of our Year 2000 compliance program is complete. We have
identified our critical computer programs, hardware, and other equipment to
determine which systems are compliant, or must be replaced or remediated.
Remediation and Testing
Dealership Operations. We recently completed converting our dealership
operations to a single automobile sales and loan servicing system (the "CLASS
System"), which has reduced the scope of our compliance program. We have engaged
an outside consulting firm to assist us with remediating our critical computer
programs that must become Year 2000 compliant. We have finished remediating the
program code and underlying data in the CLASS System and are currently
performing regression testing on the program code modifications. We anticipate
placing the modified program code into production and performing future date
testing on the modified code in April 1999.
Non-Dealership Operations. Our non-dealership loan servicing operations
currently utilize several loan processing and collections programs provided
through third party service bureaus. Based upon certifications we have received
from the software vendors, and independent testing we have performed, we believe
that our loan processing and collections programs are Year 2000 compliant.
Our Cygnet dealer program utilizes one of the same loan processing and
collections programs used by our loan servicing operations. The service bureau
that provides the program has written a custom module for us and has stated the
custom module is Year 2000 compliant. We anticipate performing and completing
independent Year 2000 compliance testing in May 1999.
We believe the remediation of the critical business systems used by our
dealership and non-dealership operations will be substantially completed during
the second quarter of 1999.
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Assessment of Business Partners
We have also identified critical suppliers, vendors, and other business
partners and we are taking steps to determine their Year 2000 readiness. These
steps include interviews, questionnaires, and other types of inquiries. Because
of the large number of business systems that our business partners use and their
varying levels of Year 2000 readiness, it is difficult to determine how any Year
2000 issues of our business partners will affect us. We are not currently aware
of any business relationships with third parties that we believe will likely
result in a significant disruption of our businesses. We believe that our
greatest risk is with our utility suppliers, banking and financial institution
partners, and suppliers of telecommunications services, all of which are
operating within the United States. Potential consequences if we, or our
business partners, are not Year 2000 compliant include:
o failure to operate from a lack of power,
o shortage of cash flow,
o disruption or errors in loan collection and processing efforts, and
o delays in receiving inventory, supplies, and services.
If any of these events occurred, the results could have a material adverse
impact on us and our operations.
Contingency Plans
We are also developing contingency plans to mitigate the risks that could
occur in the event of a Year 2000 business disruption. Contingency plans may
include:
o increasing inventory levels,
o securing additional financing,
o relocating operations to unaffected sites,
o vendor/supplier replacement,
o utilizing temporary manual or spreadsheet-based processes, or
o other prudent actions.
We currently estimate that remediation and testing of our business systems
will cost between $2.2 million and $2.7 million. Most of these costs will be
expensed and funded by our operating line of credit. Expenses to date
approximate $1.9 million, including approximately $51,000 of internal payroll
costs, substantially all of which have been charged to general and
administrative expense. We cannot currently estimate costs associated with
developing and implementing contingency measures. The scheduled completion dates
and costs associated with the various components of our Year 2000 compliance
program described above are estimates and are subject to change.
Seasonality
Historically, we have experienced higher revenues in the first two quarters
of the year than in the latter half of the year. We believe that these results
are due to seasonal buying patterns because many of our customers receive income
tax refunds during the first half of the year, which are a primary source of
down payments on used car purchases.
Inflation
Increases in inflation generally result in higher interest rates. Higher
interest rates on our borrowings would decrease the profitability of our
existing portfolio. To date, inflation has not had a significant impact on our
operations. We seek to limit this risk:
o through our securitization program, which allows us to fix our borrowing
costs,
o by increasing the interest rate charged for contracts originated at our
dealerships (if allowed under applicable law), or
o by increasing the profit margin on the cars sold, and for contracts
acquired from third party dealers under our Cygnet dealer program,
either by acquiring contracts at a higher discount or with a higher APR.
32
Accounting Matters
In September 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 131, "Disclosures about Segments of an
Enterprise and Related Information" (SFAS No. 131) which became effective for us
January 1, 1998. SFAS No. 131 establishes standards for the way that public
enterprises report information about operating segments in annual financial
statements and requires that those enterprises report selected information about
operating segments in interim reports issued to stockholders. The adoption of
SFAS No. 131 did not have a material impact on us.
In February 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 132, "Employer's Disclosures about
Pensions and Other Postretirement Benefits" (SFAS No. 132) which becomes
effective for us January 1, 1999. SFAS No. 132 establishes standards for the
information that public enterprises report in annual financial statements. We
believe the adoption of SFAS No. 132 will not have a material impact on us.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133) which becomes effective for us July 1,
1999. We believe the adoption of SFAS No. 133 will not have a material impact on
us.
Risk Factors
There are various risks in purchasing our securities or investing in our
business, including those described below. You should carefully consider these
risk factors together with all other information included in this Form 10-K.
We make forward looking statements
This report contains forward looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The words "believe," "expect," "anticipate," "estimate,"
"project," and similar expressions identify forward looking statements. These
statements may include, but are not limited to, projections of revenues, income,
or loss, estimates of capital expenditures, plans for future operations,
products or services, and financing needs or plans, as well as assumptions
relating to these matters. Forward looking statements speak only as of the date
the statement was made. They are inherently subject to risks and uncertainties,
some of which we cannot predict or quantify. Future events and actual results
could differ materially from the forward looking statements. When considering
each forward looking statement, you should keep in mind the risk factors and
cautionary statements found throughout this Form 10-K and specifically those
found below. We are not obligated to publicly update or revise any forward
looking statements, whether as a result of new information, future events, or
for any other reason.
We have incurred net losses in three of the last five years and could incur
additional net losses in future periods.
We began operations in 1992 and incurred significant operating losses in
1994 and 1995. Although we recorded net earnings in 1996 and 1997, we incurred a
net loss of $5.7 million in 1998. A substantial portion of our net earnings in
1997 and 1996 was attributable to the gains recognized on our securitization
transactions. The net loss in 1998 was due in large part to:
o a charge of approximately $9.1 million ($5.6 million, net of income
taxes) to discontinued operations in the first quarter of 1998 for the
closure of the branch office network,
o a charge of approximately $6.0 million ($3.6 million, net of income
taxes) to discontinued operations during the third quarter of 1998 due
primarily to higher than anticipated loan losses and servicing expenses
in connection with the branch office loan portfolio and to costs
incurred in our terminated rights offering, and
o a change in the fourth quarter of 1998 in the way we structure
securitization transactions for accounting purposes.
There can be no assurance that we will be profitable again in future
periods. Our failure to be profitable can adversely affect the value of our
outstanding securities.
33
Factors Determining Our Future Profitability. Our ability to achieve
profitability will depend primarily upon our ability to:
o expand our revenue generating operations while not proportionately
increasing our administrative overhead,
o originate and purchase contracts with an acceptable level of credit risk,
o effectively collect payments due on the contracts in our portfolio and
portfolios we service for others,
o locate sufficient financing, with acceptable terms, to fund and maintain
our operations, and
o adapt to the increasingly competitive market in which we operate.
Our inability to achieve or maintain any or all of these objectives could
have a material adverse effect on our business and the value of our outstanding
securities. Outside factors, such as the economic, regulatory, and judicial
environments in which we operate, will also have an effect on our business.
Our operations depend significantly on external financing.
We have borrowed, and will continue to borrow, substantial amounts to fund
our operations. Our operations require large amounts of capital. If we cannot
obtain the financing we need on a timely basis and on favorable terms, our
business will be adversely affected. We currently obtain our financing through
three primary sources:
o a revolving credit facility with General Electric Capital Corporation;
o securitization transactions; and
o loans from other sources.
Each of these financing sources is described in detail in "Management's
Discussion and Analysis of Financial Condition and Results of Operations --
Liquidity and Capital Resources."
Revolving Credit Facility with GE Capital. Our revolving facility with GE
Capital is our primary source of operating capital. We have pledged
substantially all of our assets to GE Capital to secure the borrowings we make
under this facility. Although this facility has a maximum commitment of $125
million, the amount we can borrow is limited by the amount of certain types of
assets that we own. In addition, we cannot borrow approximately $8 million of
the capacity while our guarantee to the FMAC Contract Purchaser is in effect. As
of December 31, 1998, we owed approximately $52.0 million under the revolving
facility, and had the ability to borrow an additional $3.5 million. The
revolving facility expires in June 2000. Even if we continue to satisfy the
terms and conditions of the revolving facility, we may not be able to extend its
term beyond the current expiration date.
Securitization Transactions. We can restore capacity under the GE facility
from time to time by securitizing portfolios of finance receivables. Our ability
to successfully complete securitizations in the future may be affected by
several factors, including:
o the condition of securities markets generally,
o conditions in the asset-backed securities markets specifically,
o the credit quality of our loan contract portfolio, and
o the performance of our servicing operations.
The securitization subsidiaries are wholly-owned "bankruptcy remote"
entities. Their assets, including the line items "Residuals in Finance
Receivables Sold" and "Investments Held in Trust", which are a component of
Finance Receivables on our balance sheet, are not available to satisfy the
claims of our creditors.
On November 17, 1998, we announced that we were changing the way that we
structure transactions under our securitization program. In the past, we
structured these transactions as sales for accounting purposes. In the fourth
quarter of 1998, however, we began to structure securitizations for accounting
purposes to retain the financed receivables and related debt on our balance
sheet and recognize the income over the life of the contracts. In the past, gain
on sales of loans in securitization transactions has been material to our
profitability. This change will cause a material adverse effect on our reported
earnings until the net interest earnings from new contracts added to our balance
sheet approximates those net revenues that we historically recognized on our
securitization sales.
34
Contractual Restrictions. The revolving facility, the securitization
program, and our other credit facilities contain various restrictive covenants
that limit our operations. Under these credit facilities, we must also meet
certain financial tests. As of December 31, 1998, we did not satisfy the
interest coverage ratio and cash flow based interest coverage ratio under the GE
facility. GE Capital waived these defaults for this period. At the present time,
we believe that we are in compliance with the terms and conditions of the
revolving facility and our other credit facilities. Failure to satisfy the
covenants in our credit facilities and/or our securitization program could have
a material adverse effect on our operations.
We have a high risk of credit losses because of the poor creditworthiness of
our borrowers.
Substantially all of the sales financing that we extend and the contracts
that we service are with sub-prime borrowers. Sub-prime borrowers generally
cannot obtain credit from traditional financial institutions, such as banks,
savings and loans, credit unions, or captive finance companies owned by
automobile manufacturers, because of their poor credit histories and/or low
incomes. We have established an Allowance for Credit Losses approximating 26.4%
of contract principal balances as of December 31, 1998 to cover anticipated
credit losses on the contracts currently in our portfolio. Further, the
Allowance for Credit Losses embedded in the Residuals in Finance Receivables
Sold as a percentage of the remaining principal balances of the underlying
contracts was approximately 14.9% as of December 31, 1998. We believe that our
current Allowance for Credit Losses is adequate to cover anticipated credit
losses. There is, however, no assurance that we have adequately provided for, or
will adequately provide for, such credit risks. A significant variation in the
timing of or increase in credit losses on our portfolio would have a material
adverse effect on our net earnings.
We also operate our Cygnet dealer program, under which we provide third
party dealers who finance the sale of used cars to sub-prime borrowers with
warehouse purchase facilities and operating lines of credit primarily secured by
those dealers' retail installment contract portfolios and/or inventory. While we
require third party dealers to meet certain minimum net worth and operating
history criteria before we loan money to them, these dealers may not otherwise
be able to obtain debt financing from traditional lending institutions. Like our
other financing activities, these loans subject us to a high risk of credit
losses that could have a material adverse effect on our operations and ability
to meet our other financing obligations.
We are affected by various industry considerations and legal contingencies.
In recent periods, several major used car finance companies have announced
major downward adjustments to their financial statements, violations of loan
covenants, related litigation, and other events. Companies in the used vehicle
sales and financing market have also been named as defendants in an increasing
number of class action lawsuits brought by customers claiming violations of
various federal and state consumer credit and similar laws and regulations. In
addition, certain of these companies have filed for bankruptcy protection. These
events:
o have lowered the value of securities of sub-prime automobile finance
companies,
o have made it more difficult for sub-prime lenders to borrow money, and
o could cause more restrictive regulation of this industry.
Compliance with additional regulatory requirements may increase our
operating expenses and reduce our profitability.
Interest rates affect our profitability.
A substantial portion of our financing income results from the difference
between the rate of interest we pay on the funds we borrow and the rate of
interest we earn on the contracts in our portfolio. While we earn interest on
the contracts we own at a fixed rate, we pay interest on our borrowings under
our GE facility at a floating rate. When interest rates increase, our interest
expense increases and our net interest margins decrease. Increases in our
interest expense that we cannot offset by increases in interest income will
lower our profitability.
35
Impact of Laws Limiting Interest Rates. Historically, we conducted a
significant portion of our used car sales activities in, and a significant
portion of the contracts we service were originated in states that did not
impose limits on the interest rate that a lender may charge. However, we have
expanded, and will continue to expand, into states that impose interest rate
limitations. When a state limits the amount of interest we can charge on our
installment sales contracts, we may not be able to offset any increased interest
expense caused by rising interest rates or greater levels of borrowings under
our credit facilities. Therefore, these interest rate limitations or additional
laws, rules, or regulations that may be adopted in the future can adversely
affect our profitability.
Our business is subject to federal and state regulation, supervision, and
licensing.
We are subject to ongoing regulation, supervision, and licensing under
various federal, state, and local statutes, ordinances, and regulations. Among
other things, these laws:
o require that we obtain and maintain certain licenses and qualifications,
o limit or prescribe terms of the contracts that we originate and/or
purchase,
o require specified disclosures to customers,
o limit our right to repossess and sell collateral, and
o prohibit us from discriminating against certain customers.
We believe that we are currently in substantial compliance with all
applicable material federal, state, and local laws and regulations. We may not,
however, be able to remain in compliance with such laws. If we do not comply
with these laws, we could be fined or certain of our operations could be
interrupted or shut down. Failure to comply could, therefore, have a material
adverse effect on our operations. In addition, the adoption of additional
statutes and regulations, changes in the interpretation of existing statutes and
regulations, or our entry into jurisdictions with more stringent regulatory
requirements could also have a material adverse effect on our operations.
We are dependent on our data processing platforms and other technology. Our
computer systems may be subject to a Year 2000 date failure.
Conversion of Our Data Processing Platforms. We recently converted our chain
of dealerships and related loan servicing data processing operations to a single
computer system. These conversions can cause various implementation and
integration problems that can affect our servicing operations and result in
increases in contract delinquencies and charge-offs and decreases in our
servicing income. Failure to successfully complete our conversions could
materially affect our business and profitability.
Year 2000 Readiness. We are continuing to study our computer systems to
determine our exposure to Year 2000 issues. We expect to make the necessary
modifications or changes to our computer systems to allow them to properly
process transactions relating to the Year 2000 and beyond. We estimate that we
will spend between $2.2 million to $2.7 million for Year 2000 evaluation,
remediation, testing, and replacement. We have spent approximately $1.9 million
to date. If we have to replace certain systems to make them Year 2000 compliant,
we will record the costs as assets and subsequently amortize them. If we have to
modify existing systems, we will expense the costs as incurred. We can be
adversely affected by Year 2000 problems in the business systems of our
suppliers, vendors, and business partners, such as utility suppliers, banking
partners and telecommunication service providers. We can also be adversely
affected if Year 2000 problems result in business disruptions or failures that
impact our customers' ability to make their loan payments. Failure to fully
address and resolve these Year 2000 issues could have a material adverse effect
on our operations. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Year 2000 Readiness Disclosure."
Our Current Contingency Plan is Being Revised. We depend on our loan
servicing and collection facilities and on long-distance and local
telecommunications access to transmit and process information among our various
facilities. We use a standard program to prepare and store off-site backup tapes
of our main system applications and data files on a routine basis. However, we
believe that we need to revise our current contingency plan because of our
recent system conversions and significant growth. Although we intend to update
our contingency plan during 1999, there could be a failure in the interim. In
addition, the plan as revised may not prevent a system failure or allow us to
timely resolve any systems failure. Also, a natural disaster, calamity, or other
significant event that causes long-term damage to any of these facilities or
that interrupts our telecommunications networks could have a material adverse
effect on our operations.
36
We have certain risks relating to the FMAC transaction.
We have entered into several transactions in the bankruptcy proceedings of
First Merchants Acceptance Corporation ("FMAC"). We purchased 78% of FMAC's
senior bank debt at a 10% discount. We agreed to pay the selling banks
additional consideration up to the amount of this 10% discount (or approximately
$7.6 million) if FMAC makes cash payments or issues notes at market rates to its
unsecured creditors and equity holders in excess of 10% of their allowed claims
against FMAC. FMAC may make future cash payments to its unsecured creditors and
equity holders from recoveries on the contracts which originally secured the
senior bank debt and from certain residual interests in FMAC's securitized loan
pools, after FMAC pays certain other amounts ("Excess Collections").
Under FMAC's plan of reorganization, we will split these Excess Collections with
FMAC.
If we satisfy certain requirements, we may be able to issue shares of our
common stock in exchange for all or part of FMAC's share of the Excess
Collections. This would reduce the cash distributions that could be made to
FMAC's unsecured creditors and/or equity holders. We would then be entitled to
receive FMAC's share of the Excess Collections. The shares would be priced at
98% of the average closing price of our common stock for the 10 trading days
prior to the date of issuance. This market price must be at least $8.00 per
share or we cannot exercise this option.
Even if we are able to issue common stock for this purpose:
o the number of shares that we issue may not be sufficient to prevent FMAC
from paying unsecured creditors and equity holders more than 10% of
their claims against FMAC. Should this happen, we would be required to
pay the selling banks additional consideration for our purchase of 78%
of FMAC's senior bank debt, and
o the issuance of shares would cause dilution to our common stock.
We also have other risks in the FMAC bankruptcy case:
o we sold the contracts securing the bank claims at a profit to a third
party purchaser (the "Contract Purchaser"). We guaranteed the Contract
Purchaser a specified return on the contracts with a current maximum of
$8 million. Although we obtained a related guarantee from FMAC secured
by certain assets, there is no assurance that the FMAC guarantee will
cover all of our obligations under our guarantee to the Contract
Purchaser,
o we have made debtor-in-possession loans to FMAC, secured by certain
assets. We have continuing obligations under our debtor-in-possession
credit facility. FMAC is currently in default on the DIP Facility and we
are negotiating a settlement with them that might increase our funding
obligation in exchange for other concessions,
o we entered into various agreements to service the contracts in the
securitized pools of FMAC and the contracts sold to the Contract
Purchaser. If we lose our right to service these contracts, our 17 1/2%
share of the Excess Collections can be reduced or eliminated.
Each of the FMAC risks described in this section could have a material
adverse effect on our operations.
If we make additional acquisitions, there is no assurance they will be
successful.
In 1997 we completed three significant acquisitions (Seminole, E-Z Plan, and
Kars). We intend to consider additional acquisitions, alliances, and
transactions involving other companies that could complement our existing
business. We may not, however, be able to identify suitable acquisition parties,
joint venture candidates, or transaction counterparties. Additionally, even if
we can identify suitable parties, we may not be able to consummate these
transactions on terms that we find favorable.
Furthermore, we may not be able to successfully integrate any businesses
that we acquire into our existing operations. If we cannot successfully
integrate acquisitions, our operating expenses may increase in the short-term.
This increase would affect our net earnings, which could adversely affect the
value of our outstanding securities. Moreover, these types of transactions may
result in potentially dilutive issuances of equity securities, the incurrence of
additional debt, and amortization of expenses related to goodwill and intangible
assets, all of which could adversely affect our profitability. In addition to
the risks already mentioned, these transactions involve numerous other risks,
including the diversion of management attention from other business concerns,
entry into markets in which we have had no or only limited experience, and the
potential loss of key employees of acquired companies. Occurrence of any of
these risks could have a material adverse effect on us.
37
Our industry is highly competitive.
Although a large number of smaller companies have historically operated in
the used car sales industry, this industry has recently attracted significant
attention from a number of large companies. These large companies include
AutoNation, U.S.A., CarMax, and Driver's Mart. These companies have either
entered the used car sales business or announced plans to develop large used car
sales operations. Many franchised new car dealerships have also increased their
focus on the used car market. We believe that these companies are attracted by
the relatively high gross margins that can be achieved in this market and the
industry's lack of consolidation. Many of these companies and franchised dealers
have significantly greater financial, marketing, and other resources than we do.
Among other things, increased competition could result in increased wholesale
costs for used cars, decreased retail sales prices, and lower margins.
Like the sale of used cars, the business of purchasing and servicing
contracts originated from the sale of used cars to sub-prime borrowers is highly
fragmented and very competitive. In recent years, several consumer finance
companies have completed public offerings. Through these public offerings, these
companies have been able to raise the capital necessary to fund expansion and
support increased purchases of contracts. These companies have increased the
competition for the purchase of contracts, in many cases purchasing contracts at
higher prices than we would be willing to pay.
There are numerous financial services companies serving, or capable of
serving, our market. These companies include traditional financial institutions
such as banks, savings and loans, credit unions, and captive finance companies
owned by automobile manufacturers, as well as other non-traditional consumer
finance companies, many of which have significantly greater financial and other
resources than our own. Increased competition may cause downward pressure on the
interest rates that we charge. This pressure could affect the interest rates we
charge on contracts originated by our dealerships or cause us to reduce or
eliminate the acquisition discount on the contracts we purchase from third party
dealers. Either change could have a material adverse effect on the value of our
securities.
The success of our operations depends on certain key personnel.
We believe that our ability to successfully implement our business strategy
and to operate profitably depends on the continued employment of our senior
management team. The unexpected loss of the services of any of our key
management personnel or our inability to attract new management when necessary
could have a material adverse effect on our operations. We do not currently
maintain any key person life insurance on any of our executive officers.
We may be required to issue stock in the future that will dilute the value of
our existing stock.
Issuance of any or all of the following securities may dilute the value of
the securities that our existing stockholders now hold:
o we have granted warrants to purchase a total of approximately 1.6
million shares of our common stock to various parties with exercise
prices ranging from $6.75 to $20.00 per share,
o we may be required to issue additional warrants in the future in
connection with both a completed and as yet unidentified transactions,
and
o we may issue common stock in the FMAC transaction in exchange for FMAC's
portion of the Excess Collections.
38
A significant percentage of our stock is controlled by a principal stockholder.
Mr. Ernest C. Garcia, II, our Chairman, Chief Executive Officer, and
principal stockholder, or his affiliates held approximately 29.8% of our
outstanding common stock as of December 31, 1998. This percentage includes
136,500 shares held by The Garcia Family Foundation, Inc., an Arizona non-profit
corporation, and 88,000 shares held by Verde Investments, Inc., a real estate
investment corporation controlled by Mr. Garcia. As a result, Mr. Garcia has a
significant influence upon our activities as well as on all matters requiring
approval of our stockholders. These matters include electing or removing members
of our board of directors, engaging in transactions with affiliated entities,
causing or restricting our sale or merger, and changing our dividend policy. The
interests of Mr. Garcia may conflict with the interests of our other
stockholders.
There is a potential anti-takeover effect if we issue preferred stock.
Our Certificate of Incorporation authorizes us to issue "blank check"
preferred stock. Our Board of Directors may fix or change from time to time the
designation, number, voting powers, preferences, and rights of this stock. Such
issuances could make it more difficult for a third party to acquire us by
reducing the voting power or other rights of the holders of our common stock.
Although we have no present intention of issuing any shares of our authorized
preferred stock, we may do so in the future.
ITEM 7A -- QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk
We are exposed to market risk on our financial instruments from changes in
interest rates. We do not use financial instruments for trading purposes or to
manage interest rate risk. Our earnings are substantially affected by our net
interest income, which is the difference between the income earned on
interest-bearing assets and the interest paid on interest bearing notes payable.
Increases in market interest rates could have an adverse effect on
profitability.
Our financial instruments consist primarily of fixed rate finance
receivables, residual interests in pools of fixed rate finance receivables,
short term variable rate revolving Notes Receivable, and variable and fixed rate
Notes Payable. Our finance receivables are classified as subprime loans and
generally bear interest at the lower of 29.9% or the maximum interest rate
allowed in states that impose interest rate limits. At December 31, 1998, the
scheduled maturities on our finance receivables range from one to 52 months with
a weighted average maturity of 31.3 months. The interest rates we charge our
customers on finance receivables has not changed as a result of fluctuations in
market interest rates, although we may increase the interest rates we charge in
the future if market interest rates increase. A large component of our debt at
December 31, 1998 is the Collateralized Note Payable (Class A certificates)
issued under our securitization program. Issuing debt through our securitization
program allows us to mitigate our interest rate risk by reducing the balance of
the variable revolving line of credit and replacing it with a lower fixed rate
note payable. We are subject to interest rate risk on fixed rate Notes Payable
to the extent that future interest rates are higher than the interest rates on
our existing Notes Payable.
The table below illustrates the impact that hypothetical changes in interest
rates could have on our earnings before income taxes over a twelve month period.
We compute the impact on earnings for the period by first computing the baseline
net interest income on our financial instruments with interest rate risk, which
are the variable rate revolving credit lines and the variable rate notes
payable. We then determine the net interest income based on each of the interest
rate changes listed below and compare the results to the baseline net interest
income to determine the estimated change in pretax earnings. The table does not
give effect to our fixed rate receivables and borrowings.
Change in Interest Rates Change in Pretax Earnings
------------------------ -------------------------
(in thousands)
+ 2% $ (1,208)
+ 1% $ (604)
- 1% $ 627
- 2% $ 1,581
39
In computing the effect of hypothetical changes in interest rates, we have
assumed that:
o interest rates used for the baseline and hypothetical net interest income
amounts are in effect for the entire twelve month period,
o interest for the period is calculated on financial instruments held at
December 31, 1998 less contractually scheduled payments and maturities,
and
o there is no change in prepayment rates as a result of the interest rate
changes.
Our sensitivity to interest rate changes could be significantly different if
actual experience differs from the assumptions used to compute the estimates.
40
ITEM 8 -- CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Independent Auditors' Report............................................ 42
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 1998 and 1997.......... 43
Consolidated Statements of Operations for the years ended December 31,
1998, 1997 and 1996................................................ 44
Consolidated Statements of Stockholders' Equity for the years ended
December 31, 1998, 1997, and 1996.................................. 45
Consolidated Statements of Cash Flows for the years ended December 31,
1998, 1997 and 1996................................................ 46
Notes to Consolidated Financial Statements.............................. 47
41
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Ugly Duckling Corporation:
We have audited the accompanying consolidated balance sheets of Ugly
Duckling Corporation and subsidiaries as of December 31, 1998 and 1997, and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the years in the three-year period ended December 31, 1998.
These consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Ugly
Duckling Corporation and subsidiaries as of December 31, 1998 and 1997, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 1998 in conformity with generally accepted
accounting principles.
KPMG LLP
Phoenix, Arizona
February 18, 1999
42
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31,
---------------------
1998 1997
--------- ---------
(In thousands, except
share amounts)
ASSETS
Cash and Cash Equivalents......................................... $ 2,751 $ 3,537
Finance Receivables, Net.......................................... 163,209 90,573
Notes Receivable, Net............................................. 28,257 26,745
Inventory......................................................... 44,167 32,372
Property and Equipment, Net....................................... 32,970 39,827
Intangible Assets, Net............................................ 15,530 17,543
Other Assets...................................................... 20,575 11,246
Net Assets of Discontinued Operations............................. 38,516 54,583
--------- ---------
$ 345,975 $ 276,426
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts Payable................................................ $ 2,479 $ 2,867
Accrued Expenses and Other Liabilities.......................... 19,694 14,964
Notes Payable................................................... 55,093 64,821
Collateralized Notes Payable.................................... 62,201 --
Subordinated Notes Payable...................................... 43,741 12,000
--------- ---------
Total Liabilities....................................... 183,208 94,652
--------- ---------
Stockholders' Equity:
Preferred Stock $.001 par value, 10,000,000 shares authorized,
none issued and outstanding.................................. -- --
Common Stock $.001 par value, 100,000,000 shares authorized,
18,605,000 and 18,521,000 issued, respectively, and
15,841,000 and 18,521,000 outstanding, respectively.......... 19 19
Additional Paid in Capital ..................................... 173,809 172,603
Retained Earnings............................................... 3,449 9,152
Treasury Stock, 2,761,000 shares at cost....................... (14,510) --
--------- ---------
Total Stockholders' Equity.............................. 162,767 181,774
Commitments and Contingencies .................................... -- --
--------- ---------
$ 345,975 $ 276,426
========= =========
See accompanying notes to Consolidated Financial Statements.
43
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended December 31,
---------------------------------
1998 1997 1996
--------- --------- ---------
(In thousands, except earnings
per share amounts)
Sales of Used Cars...................................... $ 287,618 $ 123,814 $ 53,768
Less:
Cost of Used Cars Sold................................ 167,014 72,358 31,879
Provision for Credit Losses........................... 67,634 23,045 9,657
-------- --------- ---------
52,970 28,411 12,232
-------- --------- ---------
Other Income:
Interest Income....................................... 27,828 18,736 8,597
Gain on Sale of Loans................................. 12,093 14,852 3,925
Servicing and Other Income............................ 38,631 12,681 2,537
-------- --------- ---------
78,552 46,269 15,059
-------- --------- ---------
Income before Operating Expenses........................ 131,522 74,680 27,291
-------- --------- ---------
Operating Expenses:
Selling and Marketing................................. 20,565 10,538 3,585
General and Administrative............................ 92,402 41,902 13,118
Depreciation and Amortization......................... 5,735 3,301 1,382
-------- --------- ---------
118,702 55,741 18,085
-------- --------- ---------
Income before Interest Expense.......................... 12,820 18,939 9,206
Interest Expense........................................ 6,904 2,774 2,429
-------- --------- ---------
Earnings before Income Taxes............................ 5,916 16,165 6,777
Income Taxes............................................ 2,396 6,637 100
-------- --------- ---------
Earnings from Continuing Operations..................... 3,520 9,528 6,677
Discontinued Operations:
Loss from Operations of Discontinued Operations,
net of income tax benefit of $489, $58, and $0..... (768) (83) (811)
Loss from Disposal of Discontinued Operations,
net of income tax benefit of $5,393, $0, and $0.... (8,455) -- --
--------- --------- ---------
Net Earnings (Loss)..................................... $ (5,703) $ 9,445 $ 5,866
========= ========= =========
Earnings per Common Share from Continuing Operations:
Basic................................................. $ 0.19 $ 0.53 $ 0.73
======== ========= =========
Diluted............................................... $ 0.19 $ 0.52 $ 0.69
======== ========= =========
Net Earnings (Loss) per Common Share:
Basic................................................. $ (0.32) $ 0.53 $ 0.63
========= ========= =========
Diluted............................................... $ (0.31) $ 0.52 $ 0.60
========= ========= =========
See accompanying notes to Consolidated Financial Statements.
44
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
Years Ended December 31, 1998, 1997, and 1996
(in thousands)
Retained
Number of Shares Amount ($'s) Earnings Total
----------------------------- ------------------- (Accumulated Stockholders'
Preferred Common Treasury Preferred Common Treasury Deficit) Equity
-------- ------- -------- -------- --------- -------- ---------- ---------
Balances at December 31,
1995........................ 1,000 5,580 -- $10,000 $ 127 $ -- $ (5,243) $ 4,884
Issuance of Common Stock
for Cash................... -- 7,281 -- -- 79,335 -- -- 79,335
Conversion of Debt to
Common Stock................ -- 444 -- -- 3,000 -- -- 3,000
Issuance of Common Stock
to Board of Director's..... -- 22 -- -- 150 -- -- 150
Redemption of Preferred (1,000) -- -- (10,000) -- -- -- (10,000)
Stock......................
Preferred Stock Dividends..... -- -- -- -- -- -- (916) (916)
Net Earnings for the Year..... -- -- -- -- -- -- 5,866 5,866
------- ------- ------ ------- --------- ------ -------- ---------
Balances at December 31,
1996........................ -- 13,327 -- -- 82,612 -- (293) 82,319
Issuance of Common Stock
for Cash................... -- 5,194 -- -- 89,398 -- -- 89,398
Issuance of Common Stock
Warrants.................... -- -- -- -- 612 -- -- 612
Net Earnings for the Year..... -- -- -- -- -- -- 9,445 9,445
------- ------- ------ ------- --------- ------ -------- ---------
Balances at December 31,
1997........................ -- 18,521 -- -- 172,622 -- 9,152 181,774
Issuance of Common Stock
for Casg................... -- 84 -- -- 306 -- -- 306
Issuance of Common Stock
Warrants.................... -- -- -- -- 900 -- -- 900
Purchase of Treasury Stock
for Cash................... -- -- (72) -- -- (535) -- (535)
Acquisition of Treasury
Stock for Subordinated
Debentures................. -- -- (2,689) -- -- (13,975) -- (13,975)
Net Loss for the Year......... -- -- -- -- (5,703) (5,703)
------- ------- --------- ------- --------- -------- --------- ----------
Balances at December 31,
1998........................ -- 18,605 (2,761) $ -- $ 173,828 $(14,510) $ 3,449 $ 162,767
======= ======= ========= ======= ========= ========= ======== =========
See accompanying notes to Consolidated Financial Statements.
45
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years Ended December 31,
-----------------------------------
1998 1997 1996
----------- ---------- --------
(In thousands)
Cash Flows from Operating Activities:
Net Earnings (Loss).......................................... $ (5,703) $ 9,445 $ 5,866
Adjustments to Reconcile Net Earnings (Loss) to Net Cash
Provided by (Used in) Operating Activities from
Continuing Operations:
Loss from Discontinued Operations............................ 9,223 83 811
Provision for Credit Losses.................................. 67,634 23,045 9,657
Gain on Sale of Loans........................................ (12,093) (6,721) (3,925)
Deferred Income Taxes........................................ (3,344) 1,094 498
Depreciation and Amortization................................ 5,735 3,301 1,382
Purchase of Finance Receivables for Sale..................... (207,085) (116,830) (48,996)
Proceeds from Sale of Finance Receivables.................... 159,498 81,098 30,259
Collections of Finance Receivables........................... 22,000 15,554 26,552
Decrease (Increase) in Inventory............................. (11,795) (20,592) 778
Increase in Other Assets..................................... (6,020) (2,779) (2,155)
Increase in Accounts Payable, Accrued Expenses, and Other
Liabilities............................................... 5,425 6,905 2,571
Increase (Decrease) in Income Taxes Receivable/Payable....... (1,233) (1,378) 535
Other, Net................................................... (156) -- --
----------- ---------- --------
Net Cash Provided by (Used in) Operating Activities
of Continuing Operations................................. 22,086 (7,775) 23,833
---------- ---------- --------
Cash Flows from Investing Activities:
Increase in Finance Receivables.............................. (111,467) (20,941) --
Collections of Finance Receivables........................... 22,779 9,160 --
Increase in Investments Held in Trust........................ (13,802) (8,475) (3,162)
Advances under Notes Receivable.............................. (13,669) (32,782) --
Repayments of Notes Receivable............................... 11,857 6,900 137
Proceeds from disposal of Property and Equipment............. 27,413 -- --
Purchase of Property and Equipment........................... (21,786) (19,509) (5,549)
Payment for Acquisition of Assets............................ -- (45,220) --
Other, Net................................................... -- -- (1,944)
---------- ---------- --------
Net Cash Used in Investing Activities of Continuing
Operations.............................................. (98,675) (110,867) (10,518)
---------- ---------- --------
Cash Flows from Financing Activities:
Additions to Notes Payable................................... 95,191 22,228 1,000
Repayments of Notes Payable.................................. (43,169) -- (28,610)
Issuance of Subordinated Notes Payable....................... 19,630 -- --
Repayment of Subordinated Notes Payable...................... (2,000) (2,000) (553)
Redemption of Preferred Stock................................ -- -- (10,000)
Proceeds from Issuance of Common Stock....................... 306 89,398 79,435
Acquisition of Treasury Stock................................ (535) -- --
Other, Net................................................... (464) (178) (1,158)
---------- ---------- --------
Net Cash Provided by Financing Activities of Continuing
Operations.............................................. 68,959 109,448 40,114
---------- ---------- --------
Net Cash Provided by (Used in) Discontinued Operations......... 6,844 (5,724) (36,393)
---------- ---------- --------
Net Increase (Decrease) in Cash and Cash Equivalents........... (786) (14,918) 17,036
Cash and Cash Equivalents at Beginning of Year................. 3,537 18,455 1,419
---------- ---------- --------
Cash and Cash Equivalents at End of Year....................... $ 2,751 $ 3,537 $ 18,455
========== ========== ========
Supplemental Statement of Cash Flows Information:
Interest Paid................................................ $ 10,483 $ 5,382 $ 5,144
Income Taxes Paid............................................ 1,633 6,570 450
Assumption of Debt in Connection with Acquisition of Assets.. -- 29,900 --
Conversion of Note Payable to Common Stock................... -- -- 3,000
Purchase of Property and Equipment with Notes Payable........ 825 -- 8,313
Purchase of Property and Equipment with Capital Leases....... -- 357 57
Purchase of Treasury Stock with Subordinated Notes Payable... 13,835 -- --
Issuance of Warrants for Subordinated Note Payable........... 900 -- --
See accompanying notes to Consolidated Financial Statements.
46
UGLY DUCKLING CORPORATION AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Organization and Acquisitions
Ugly Duckling Corporation, a Delaware corporation (the Company), was
incorporated in April 1996 as the successor to Ugly Duckling Holdings, Inc.
(UDH), an Arizona corporation formed in 1992. Contemporaneous with the formation
of the Company, UDH was merged into the Company with each share of UDH's common
stock exchanged for 1.16 shares of common stock in the Company and each share of
UDH's preferred stock exchanged for one share of preferred stock in the Company
under identical terms and conditions. UDH was effectively dissolved in the
merger. The resulting effect of the merger was a recapitalization increasing the
number of authorized shares of common stock to 20,000,000 and a 1.16-to-1 common
stock split effective April 24, 1996. The stockholders' equity section of the
Consolidated Balance Sheets and the Statements of Stockholders' Equity reflect
the number of authorized shares after giving effect to the merger and common
stock split. The Company's principal stockholder is also the sole stockholder of
Verde Investments, Inc. (Verde). The Company's subordinated debt is held by, and
the land for certain of its car dealerships and loan servicing facilities was
leased from Verde until December 31, 1996, see Note 16.
During 1997, the Company completed several acquisitions. In January 1997,
the Company acquired substantially all of the assets of Seminole Finance
Corporation and related companies (Seminole) including four dealerships in
Tampa/St. Petersburg and a contract portfolio of approximately $31.1 million in
exchange for approximately $2.5 million in cash and assumption of $29.9 million
in debt. In April 1997, the Company purchased substantially all of the assets of
E-Z Plan, Inc. (EZ Plan), including seven dealerships in San Antonio and a
contract portfolio of approximately $24.3 million in exchange for approximately
$26.3 million in cash. In September 1997, the Company acquired substantially all
of the dealership and loan servicing assets (but not the loan portfolio) of
Kars-Yes Holdings Inc. and related companies (Kars), including six dealerships
in the Los Angeles market, two in the Miami market, two in the Atlanta market
and two in the Dallas market, in exchange for approximately $5.5 million in
cash. These acquisitions were recorded in accordance with the "purchase method"
of accounting, and, accordingly, the purchase price has been allocated to the
assets purchased and the liabilities assumed based upon the estimated fair
values at the date of acquisition. The excess of the purchase price over the
fair values of the net assets acquired was approximately $16.0 million and has
been recorded as goodwill, which is being amortized over periods ranging from
fifteen to twenty years. The results of operations of the acquired operations
have been included in the accompanying statements of operations from the
respective acquisition dates.
(2) Discontinued Operations
In February 1998, the Company announced its intention to close its branch
office network (the "Branch Offices") through which the Company purchased retail
installment contracts, and exit this line of business in the first quarter of
1998. The Company recorded a pre-tax charge to discontinued operations of $15.1
million (approximately $9.2 million, net of income taxes) in 1998. The closure
was substantially complete as of March 31, 1998 and included the termination of
approximately 400 employees, substantially all of whom were employed at the
Company's 76 branches that were in place on the date of the announcement.
Approximately $1.7 million of the discontinued operations charge was for
termination benefits, $6.7 million for portfolio allowance and collection costs,
$2.5 million for write-off of pre-opening and start-up costs, and the remainder
for lease payments on idle facilities, writedowns of leasehold improvements,
data processing and other equipment. The Company has reclassified the
accompanying consolidated balance sheets and consolidated statements of
operations of the Branch Offices to Discontinued Operations.
In April 1998, the Company announced that its Board of Directors directed
management to proceed with separating the Company's operations into two
companies. The Company formed a new subsidiary to operate the Cygnet Dealer
Program and Cygnet Financial Services ("Non Dealership Operations"). A proposal
to split-up the Company through a rights offering was approved by stockholders
at the annual meeting held in August 1998 and rights were subsequently issued to
Company stockholders. The Company had previously reported the net assets,
results of operations, and cash flows of the Non Dealership Operations in
Discontinued Operations. However, the rights offering failed due to a lack of
shareholder participation. The Board of Directors has directed management to
cease its efforts, for the time being, to separate the Non Dealership Operations
of the Company. As a result of the aforementioned, the assets, liabilities,
results of operations, and cash flows of the Non Dealership Operations have been
reclassified into continuing operations for the periods presented in these
consolidated financial statements. Total assets and liabilities for Non
Dealership Operations were $77.2 million and $8.7 million, and $49.9 million and
$559,000 at December 31, 1998 and 1997, respectively. Revenues and Earnings
47
(Loss) before Interest Expense were $32,837,000 and $3,993,000, $14,664,000 and
$11,331,000, and zero and zero, respectively, for the years ended December 31,
1998, 1997, and 1996. The Company did not record any charges to record the net
assets of the Non Dealership Operations at net realizable value at the time the
separation was announced, and, consequently, did not reverse any loss accruals
during 1998.
The components of Net Assets of Discontinued Operations as of December 31,
1998 and December 31, 1997 follow (in thousands):
December 31,
-------------------
1998 1997
--------- --------
Finance Receivables, net..................... $ 30,649 $ 26,780
Residuals in Finance Receivables Sold........ 7,875 16,099
Investments Held in Trust.................... 3,665 7,277
Property and Equipment....................... 1,198 1,424
Capitalized Start-up Costs................... -- 2,453
Other Assets, net of Accounts Payable and
Accrued Liabilities........................ 1,153 550
Disposal Liability........................... (6,024) --
--------- --------
$ 38,516 $ 54,583
======== ========
Following is a summary of the operating results of the Discontinued
Operations for the years ended December 31, 1998, 1997, and 1996 (in thousands):
December 31,
--------------------------------
1998 1997 1996
-------- -------- -------
Revenues................................. $ 3,095 $ 21,213 $ 7,768
Expenses................................. (18,200) (21,354) (8,579)
-------- -------- -------
Loss before Income Tax (Benefit)......... (15,105) (141) (811)
Income Tax Benefit....................... (5,882) (58) --
--------- --------- -------
Loss from Discontinued Operations........ $ (9,223) $ (83) $ (811)
========= ========= =======
(3) Summary of Significant Accounting Policies
Operations
The Company, through its subsidiaries, owns and operates used car sales
dealerships, a collateralized dealer finance program, and a third party bulk
purchasing and loan servicing operation. Additionally, Ugly Duckling Receivables
Corporation (UDRC) and Ugly Duckling Receivables Corporation II (UDRC II),
"bankruptcy remote entities" are the Company's wholly-owned special purpose
securitization subsidiaries. Their assets include residuals in finance
receivables sold and investments held in trust, including amounts classified as
discontinued operations, in the amounts of $7,875,000 and $3,665,000,
respectively, at December 31, 1998 and in the amounts of $16,099,000 and
$7,277,000, respectively, at December 31, 1997. These amounts would not be
available to satisfy claims of creditors of the Company.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of the Company
and its subsidiaries. Significant intercompany accounts and transactions have
been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amount of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
48
Concentration of Credit Risk
The Company provides sales finance services in connection with the sales of
used cars to individuals residing in numerous metropolitan areas. The Company
operated a total of 56, 41, and 8 used car dealerships (company dealerships) in
nine, ten and two metropolitan markets at December 31, 1998, 1997, and 1996,
respectively.
As of December 31, 1998, the Company's Cygnet Dealer Program had warehouse
purchase facilities and revolving lines of credit with a total of approximately
63 third party dealers. Cygnet Dealer's net investment in finance receivables
purchased from 2 third party dealers totaled approximately $15.1 million,
representing approximately 34% of Cygnet dealer's net finance receivables
portfolio as of December 31, 1998. There were no other third party dealer loans
that exceeded 10% of the Company's finance receivables portfolio as of December
31, 1998.
Periodically during the year, the Company maintains cash in financial
institutions in excess of the amounts insured by the federal government.
Cash Equivalents
The Company considers all highly liquid debt instruments purchased with
maturities of three months or less to be cash equivalents. Cash equivalents
generally consist of interest bearing money market accounts.
Revenue Recognition
Interest income is recognized using the interest method. Direct loan
origination costs related to contracts originated at Company dealerships are
deferred and charged against finance income over the life of the related
installment sales contract as an adjustment of yield. The accrual of interest is
suspended if collection becomes doubtful, generally 90 days past due, and is
resumed when the loan becomes current. Interest income also includes income on
the Company's residual interests from its Securitization Program.
Revenue from the sales of used cars is recognized upon delivery, when the
sales contract is signed and the agreed-upon down payment has been received.
Residuals in Finance Receivables Sold, Investments Held in Trust, and Gain on
Sale of Loans
In 1996, the Company initiated a Securitization Program under which it sold
(securitized), on a non-recourse basis, finance receivables to a trust which
used the finance receivables to create asset backed securities which were
remitted to the Company in consideration for the sale. The Company then sold
senior certificates (A certificates) to third party investors and retained
subordinated certificates certificates). In consideration of such sale, the
Company received cash proceeds from the sale of certificates collateralized by
the finance receivables and the right to future cash flows under the
subordinated certificates (residual in finance receivables sold, or residual)
arising from those receivables to the extent not required to make payments on
the A certificates sold to a third party or to pay associated costs.
Gains or losses were determined based upon the difference between the sales
proceeds for the portion of finance receivables sold and the Company's recorded
investment in the finance receivables sold. The Company allocated the recorded
investment in the finance receivables between the portion of the finance
receivables sold and the portion retained based on the relative fair values on
the date of sale.
To the extent that actual cash flows on a securitization are below original
estimates and differ materially from the original securitization assumptions,
and in the opinion of management, if those differences appear to be other than
temporary in nature, the Company's residual will be adjusted, with corresponding
charges against income in the period in which the adjustment is made. Such
evaluations are performed on a security by security basis, for each certificate
or spread account retained by the Company.
The structure of the Company's securitization transaction consummated in the
fourth quarter of 1998 was changed from the structure of the transactions
previously effected under its Securitization Program and has been accounted for
as a secured financing in accordance with SFAS 125, Accounting for Transfers and
49
Servicing of Financial Assets and Extinguishments of Liabilities (SFAS No. 125).
The loan contracts included in the transaction remain in Finance Receivables and
the A Certificates are reflected in Collateralized Notes Payable.
The Company is required to make an initial deposit into an account held by
the trustee (spread account) and to pledge this cash to the trust to which the
finance receivables were sold. The trustee in turn invests the cash in highly
liquid investment securities. In addition, the Company (through the trustee)
deposits additional cash flows from the residual to the spread account as
necessary to attain and maintain the spread account at a specified percentage of
the underlying finance receivable principal balances. These deposits are
classified as Finance Receivables.
Residuals in Finance Receivables Sold are classified as "held-to-maturity"
securities in accordance with SFAS No. 115.
Servicing Income
Servicing Income is recognized when earned. Servicing costs are charged to
expense as incurred. In the event delinquencies and/or losses on the portfolio
serviced exceed specified levels, the Company may be required to transfer the
servicing of the portfolio to another servicer.
Finance Receivables and Allowance for Credit Losses
Finance receivables consist of contractually scheduled payments from
installment sales contracts net of unearned finance charges, accrued interest
receivable, direct loan origination costs, investments held in trust, and an
allowance for credit losses, including nonaccretable discounts.
The Company follows the provisions of Statement of Financial Accounting
Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases." Direct loan
origination costs represent the unamortized balance of costs incurred in the
origination of contracts at the Company's dealerships.
An allowance for credit losses (allowance) is established by charging the
provision for credit losses and the allocation of acquired allowances. For
contracts generated by the Company dealerships, the allowance is established by
charging the provision for credit losses. Contracts purchased from third party
dealers are generally purchased with an acquisition discount (discount). The
discount is negotiated with third party dealers pursuant to a financing program
that bases the discount on, among other things, the credit risk of the borrower
and the amount to be financed in relation to the car's wholesale value. The
discount is allocated between nonaccretable discount and discount available for
accretion to interest income. The portion of discount allocated to the allowance
is based upon historical performance and write-offs of contracts acquired from
third party dealers, as well as the general credit worthiness of the borrowers
and the wholesale value of the vehicle. The remaining discount, if any, is
deferred and accreted to income using the interest method.
To the extent that the allowance is considered insufficient to absorb
anticipated credit losses, additions to the allowance are established through a
charge to the provision for credit losses. The evaluation of the allowance
considers such factors as the performance of each dealerships loan portfolio,
the Company's historical credit losses, the overall portfolio quality and
delinquency status, the review of specific problem loans, the value of
underlying collateral, and current economic conditions that may affect the
borrower's ability to pay.
Notes Receivable
Notes receivable are recorded at cost, less related allowance for impaired
notes receivable. Management, considering information and events regarding the
borrowers ability to repay their obligations, including an evaluation of the
estimated value of the related collateral, considers a note to be impaired when
it is probable that the Company will be unable to collect amounts due according
to the contractual terms of the note agreement. When a loan is considered to be
impaired, the amount of impairment is measured based on the present value of
expected future cash flows discounted at the note's effective interest rate or
the fair value of the collateral if the loan is collateral dependent. Impairment
losses are included in the allowance for credit losses through a charge to the
provision for credit losses. Cash receipts on impaired notes receivable are
applied to reduce the principal amount of such notes until the principal has
been received and are recognized as interest income, thereafter.
50
Inventory
Inventory consists of used vehicles held for sale which is valued at the
lower of cost or market, and repossessed vehicles which are valued at market
value. Vehicle reconditioning costs are capitalized as a component of inventory
cost. The cost of used vehicles sold is determined on a specific identification
basis.
Property and Equipment
Property and Equipment are stated at cost. Depreciation is computed using
straight-line and accelerated methods over the estimated useful lives of the
assets which range from three to ten years for equipment and thirty years for
buildings. Leasehold and land improvements are amortized using straight-line and
accelerated methods over the shorter of the lease term or the estimated useful
lives of the related improvements.
The Company has capitalized costs related to the development of software
products for internal use. Capitalization of costs begins when technological
feasibility has been established and ends when the software is available for
general use. Amortization is computed using the straight-line method over the
estimated economic life of five years.
Goodwill
Goodwill, which represents the excess of purchase price over fair value of
net assets acquired, is amortized on a straight-line basis over the expected
periods to be benefited, generally fifteen to twenty years.
Post Sale Customer Support Programs
A liability for the estimated cost of post sale customer support, including
car repairs and the Company's down payment back and credit card programs, is
established at the time the used car is sold by charging Cost of Used Cars Sold.
The liability is evaluated for adequacy through a separate analysis of the
various programs' historical performance.
Income Taxes
The Company utilizes the asset and liability method of accounting for income
taxes. Under the asset and liability method, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.
Stock Option Plan
The Company accounts for its stock option plan in accordance with the
provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. As such, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeded the exercise price. The Company has adopted the
disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation,
which permits entities to provide pro forma net earnings and pro forma earnings
per share disclosures for employee stock option grants made in 1995 and future
years as if the fair-value-based method as defined in SFAS No. 123 had been
applied.
The Company uses one of the most widely used option pricing models, the
Black-Scholes model (Model), for purposes of valuing its stock option grants.
The Model was developed for use in estimating the fair value of traded options
that have no vesting restrictions and are fully transferable. In addition, it
requires the input of highly subjective assumptions, including the expected
stock price volatility, expected dividend yields, the risk free interest rate,
and the expected life. Because the Company's stock options have characteristics
significantly different from those of traded options, and because changes in
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the value determined by the Model is not necessarily
indicative of the ultimate value of the granted options.
51
Earnings Per Share
Basic earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
Impairment of Long-Lived Assets
Long-Lived Assets and certain identifiable intangibles are reviewed for
impairment whenever events or changes in circumstances indicate the carrying
amount of an asset may not be recoverable. Recoverability of assets to be held
and used is measured by a comparison of the carrying amount of an asset to
future undiscounted net cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceed the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities
The Company adopted the provisions of SFAS No. 125 on January 1, 1997. This
Statement provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities based on
consistent application of a financial-components approach that focuses on
control. It distinguishes transfers of financial assets that are sales from
transfers that are secured borrowings. Adoption of SFAS No. 125 did not have a
material impact on the Company.
Reclassifications
Certain reclassifications have been made to the prior years' consolidated
financial statement amounts to conform to the current year presentation.
(4) Finance Receivables and Allowance for Credit Losses
A summary of finance receivables as of December 31, 1998 and 1997 follows
(in thousands):
December 31,
-----------------------------------------------------------------------
1998 1997
---------------------------------- ---------------------------------
Non Non
Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total
--------- ---------- -------- --------- ---------- --------
Installment Sales Contract Principal
Balances............................ $ 93,936 $ 51,282 $145,218 $ 55,965 $ 27,480 $ 83,445
Add: Accrued Interest Receivable....... 877 473 1,350 462 147 609
Loan Origination Costs, Net............ 2,237 -- 2,237 1,431 -- 1,431
-------- -------- -------- -------- -------- --------
Principal Balances, Net................ 97,050 51,755 148,805 57,858 27,627 85,485
Residuals in Finance Receivables Sold.. 33,331 2,625 35,956 13,277 -- 13,277
Investments Held in Trust.............. 20,564 -- 20,564 10,357 -- 10,357
-------- -------- -------- -------- -------- --------
150,945 54,380 205,325 81,492 27,627 109,119
Allowance for Credit Losses............ (24,777) (2,024) (26,801) (10,356) (1,035) (11,391)
Discount on Acquired Loans............. -- (15,315) (15,315) -- (7,155) (7,155)
-------- --------- -------- -------- --------- --------
Finance Receivables, net............... $126,168 $ 37,041 $163,209 $ 71,136 $ 19,437 $ 90,573
======== ======== ======== ======== ======== ========
Classification:
Finance Receivables Held for Sale $ -- $ -- $ -- $ 52,000 $ -- $ 52,000
Finance Receivables Held for Investment 97,050 51,755 148,805 5,858 27,627 33,485
-------- -------- -------- -------- -------- --------
$ 97,050 $ 51,755 $148,805 $ 57,858 $ 27,627 $ 85,485
======== ======== ======== ======== ======== ========
52
A summary of the allowance for credit losses on finance receivables for the
years ended December 31, 1998, 1997 and 1996 follows (in thousands):
1998 1997
------------------------------- -------------------------------
1996
Non Non ----------
Dealership Dealership Dealership Dealership Dealership
Operations Operations Total Operations Operations Total Operations
---------- ---------- --------- ---------- ---------- --------- ----------
Balances, Beginning of Year $ 10,356 $ 1,035 $ 11,391 $ 1,625 $ -- $ 1,625 $ 7,500
Provision for Credit Losses 65,318 2,016 67,334 22,354 491 22,845 9,657
Allowance on Acquired Loans -- 801 801 15,309 550 15,859 --
Net Charge Offs............ (6,358) (1,828) (8,186) (7,524) (6) (7,530) (6,202)
Sale of Finance Receivables (44,539) -- (44,539) (21,408) -- (21,408) (9,330)
--------- --------- --------- --------- -------- --------- ---------
Balances, End of Year...... $ 24,777 $ 2,024 $ 26,801 $ 10,356 $ 1,035 $ 11,391 $ 1,625
========= ========= ========= ========= ========= ========= =========
The valuation of the Residual in Finance Receivables Sold as of December 31,
1998, which totaled $33.3 million, represents the present value of the
Dealership Operations' interests in the distributions of future cash flows from
the underlying portfolio out of the securitization trusts and Investments Held
in Trust (see note 5) which totaled $20.6 million at December 31, 1998. The
Company's securitization transactions were discounted with a rate of 12% using
the "cash out method". For securitizations between June 30, 1996 and June 30,
1997, net losses were originally estimated using total expected cumulative net
losses at loan origination of approximately 26.0%, adjusted for actual
cumulative net losses prior to securitization. Prepayment rates were estimated
to be 1.5% per month of the beginning of month balances.
During the year ended December 31, 1997, the Company recorded a $5.7 million
charge to write-down the Residuals in Finance Receivables Sold. The charge had
the effect of increasing the cumulative net loss assumption to approximately
27.5%, for the securitization transactions that took place prior to June 30,
1997. For the securitization transaction that took place in September 1997, net
losses were estimated using total expected cumulative net losses at loan
origination of approximately 27.5%, adjusted for actual cumulative net losses
prior to securitization. For securitization transactions completed during the
nine month period ended September 30, 1998, net losses were estimated using
total expected cumulative net losses at loan origination of approximately 29.0%,
adjusted for actual cumulative net losses prior to securitization. Prepayment
rates were estimated to be 1% per month of the beginning of month balance.
As of December 31, 1998 and 1997, the Residuals in Finance Receivables Sold
for the Company's Dealership Operations were comprised of the following (in
thousands):
December 31,
----------------------
1998 1997
-------- --------
Retained interest in subordinated securities (B
Certificates)................................. $ 51,243 $ 25,483
Net interest spreads, less present value discount.. 25,838 10,622
Reduction for estimated credit loss................ (43,750) (22,828)
--------- --------
Residuals in finance receivables sold.............. $ 33,331 $ 13,277
========= =========
Securitized principal balances outstanding......... $ 198,747 $ 127,356
========= =========
Estimated credit losses and allowances as a % of
securitized principal balances outstanding...... 22.0% 17.9%
======== ==========
The following table reflects a summary of activity for the Residuals in
Finance Receivables Sold for the Company's Dealership Operations for the years
ended December 31, 1998 and 1997, respectively (in thousands):
December 31,
---------------------
1998 1997
-------- --------
Balance, Beginning of Year....................... $ 13,277 $ 8,512
Additions........................................ 35,435 17,734
Amortization..................................... (15,381) (7,242)
Write-down of Residual in Finance Receivables Sold -- (5,727)
-------- --------
Balance, End of Year............................. $ 33,331 $ 13,277
======== ========
The Company also has an investment in subordinate certificates originated by
a third party approximating $2.6 million at December 31, 1998 held by its Non
Dealership Operations classified as Residuals in Finance Receivables Sold.
53
(5) Investments Held in Trust
In connection with its securitization transactions, the Company is required
to provide a credit enhancement to the investor. The Company makes an initial
cash deposit, ranging from 4% to 6% of the initial underlying finance
receivables principal balance, of cash into an account held by the trustee
(spread account) and pledges this cash to the trust to which the finance
receivables were sold. Additional deposits from the residual cash flow (through
the trustee) are made to the spread account as necessary to attain and maintain
the spread account at a specified percentage, ranging from 6.0% to 10.5%, of the
underlying finance receivables principal balance.
In the event that the cash flows generated by the finance receivables are
insufficient to pay obligations of the trust, including principal or interest
due to certificate holders or expenses of the trust, the trustee will draw funds
from the spread account as necessary to pay the obligations of the trust. The
spread account must be maintained at a specified percentage of the principal
balances of the finance receivables held by the trust, which can be increased in
the event delinquencies or losses exceed specified levels. If the spread account
exceeds the specified percentage, the trustee will release the excess cash to
the Company from the pledged spread account. Except for releases in this manner,
the cash in the spread account is restricted from use by the Company.
During 1998, the Company made initial spread account deposits totaling $13.1
million and additional net deposits through the trustee totaling $4.8 million.
The total balance in the spread accounts was $20.6 million as of December 31,
1998. In connection therewith, the specified spread account balance based upon
the aforementioned specified percentages of the balances of the underlying
portfolios was $23.7 million, resulting in additional funding requirements from
future cash flows of $3.1 million as of December 31, 1998. The additional
funding requirement will decline as the trustee deposits additional cash flows
into the spread account and as the principal balance of the underlying finance
receivables declines.
During 1997, the Company made initial spread account deposits totaling $6.1
million and additional net deposits through the trustee totaling $1.8 million.
The total balance in the spread accounts was $10.4 million as of December 31,
1997. In connection therewith, the specified spread account balance based upon
the aforementioned specified percentages of the balances of the underlying
portfolios as of December 31, 1997 was $10.5 million, resulting in additional
funding requirements of $101,000 as of December 31, 1997.
(6) Notes Receivable
The Company's Cygnet Dealer Program has various notes receivable from
used car dealers. Under its Asset Based Loan program, the Company had
commitments for revolving notes receivable totaling $13.8 million at December
31, 1998. These notes have various maturity dates through June 2001 with
interest rates ranging from prime plus 5.00% to prime plus 9.75% per annum
(12.75% to 17.50% at December 31, 1998) payable monthly. The revolving notes
subject the borrower to borrowing base requirements with advances on eligible
collateral (retail installment contracts) ranging from forty-five percent to
sixty-five percent of the par value of the underlying collateral. The balance
outstanding on notes receivable totaled $8.8 million, and $5.6 million at
December 31, 1998 and 1997, respectively. The allowance for credit losses for
notes receivable totaled $500,000 and $200,000 at December 31, 1998 and 1997,
respectively.
In July 1997, First Merchants Acceptance Corporation (FMAC) filed for
bankruptcy. Immediately subsequent to the bankruptcy filing, the Company
executed a loan agreement to provide FMAC with up to $10.0 million in debtor in
possession (the DIP facility) financing. The DIP facility accrued interest at
12.0%, was initially scheduled to mature on February 28, 1998, and was secured
by substantially all of FMAC's assets. The Company and FMAC subsequently amended
the DIP facility to increase the maximum commitment to $21.5 million, decrease
the interest rate to 10.0% per annum, and extend the maturity date indefinitely.
In connection with the amendment, FMAC pledged the first $10.0 million of income
tax refunds receivable, the balance of which FMAC anticipates collecting in
1999, to the Company. The maximum commitment under the DIP facility had been
reduced to $12.4 million at December 31, 1998. Once the proceeds from the income
tax refunds are remitted to the Company, such amounts permanently reduce the
maximum commitment under the DIP facility. Thereafter, the Company anticipates
collecting the balance of the DIP facility from distributions to FMAC from
FMAC's residual interests in certain securitization transactions. The
outstanding balance on the DIP facility totaled $12.2 million and $11.0 million
at December 31, 1998 and 1997, respectively.
54
During the third and fourth fiscal quarters of 1997, the Company acquired
the senior bank debt of FMAC from the bank group members holding such debt. In
December 1997, a credit bid for the outstanding balance of the senior bank debt
plus certain fees and expenses (the "credit bid purchase price") was entered and
approved in the bankruptcy court resulting in the transfer of the senior bank
debt for the loan portfolio which secured the senior bank debt (the "owned
loans"). Simultaneous with the transfer to the Company, a finance company
purchased the owned loans for 86% of the principal balance of the loan
portfolio, and the Company retained a 14% participation in the loan portfolio.
FMAC has guaranteed that the Company will receive an 11.0% return on the credit
bid purchase price from the cash flows generated by the owned loans, and further
collateralized by FMAC's residual interests in certain securitization
transactions. The balance of the participation totaled $6.9 million and $9.2
million at December 31, 1998 and 1997, respectively.
A summary of notes receivable as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
-------- --------
1998 1997
-------- --------
Notes Receivable under the Asset Based Loan Program, net
of allowance for doubtful accounts of $500, and $200,
respectively......................................... $ 8,311 $ 5,594
FMAC Debtor in Possession Note Receivable............... 12,228 10,994
FMAC Bank Group Participation........................... 6,856 9,244
Other Notes Receivable.................................. 862 913
-------- --------
Notes Receivable, net................................... $ 28,257 $ 26,745
======== ========
(7) Property and Equipment
A summary of Property and Equipment as of December 31, 1998 and 1997 follows
(in thousands):
December 31,
---------------------
1998 1997
-------- --------
Land................................................ $ 3,721 $ 13,813
Buildings and Leasehold Improvements................ 9,984 16,274
Furniture and Equipment............................. 24,373 11,668
Vehicles............................................ 219 306
Construction in Process............................. 2,872 2,817
-------- --------
41,169 44,878
Less Accumulated Depreciation and Amortization...... (8,199) (5,051)
-------- --------
Property and Equipment, Net......................... $ 32,970 $ 39,827
======== ========
In March 1998, the Company executed a commitment letter with an investment
company for the sale-leaseback of up to $37.0 million in real property. Pursuant
to the terms of the agreement, the Company would sell certain real property to
the investment company at its cost and leaseback the properties for an initial
term of twenty years. During 1998, the Company sold approximately $27.4 million
of property under this agreement and recognized no gain or loss on the
sale-leaseback transactions.
Interest expense capitalized in 1998, 1997 and 1996 totaled $135,000,
$229,000, and zero, respectively.
(8) Intangible Assets
A summary of intangible assets as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
------------------
1998 1997
-------- -------
Original Cost:
Goodwill.................... $ 17,037 $17,945
Trademarks.................. 581 581
Covenants not to Compete.... 250 250
-------- -------
17,868 18,776
Accumulated Amortization.... (2,338) (1,233)
-------- -------
Intangibles, Net............ $ 15,530 $17,543
======== =======
Amortization expense relating to intangible assets totaled $1,105,000,
$857,000, and $63,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
55
(9) Other Assets
A summary of Other Assets as of December 31, 1998 and 1997 follows (in
thousands):
December 31,
------------------
1998 1997
------- -------
Prepaid Expenses.............. $2,484 $1,957
Income Taxes Receivable....... 2,926 1,693
Servicing Receivables......... 4,266 1,389
Restricted Cash............... 1,565 1,280
Deposits...................... 1,286 829
Employee Advances............. 1,431 821
Deferred Income Taxes......... 2,626 --
Other......................... 3,991 3,277
------- -------
$20,575 $11,246
======= =======
(10) Accrued Expenses and Other Liabilities
A summary of Accrued Expenses and Other Liabilities as of December 31, 1998
and 1997 follows (in thousands):
December 31,
-----------------
1998 1997
------- -------
Sales Taxes.................... $ 3,033 $ 3,909
Accrued Payroll, Benefits & Taxes 2,192 2,366
Collections Liability.......... 3,121 1,503
Accrued Advertising............ 1,234 850
Accrued Post Sale Support...... 1,809 771
Deferred Income Taxes.......... -- 718
Others......................... 8,305 4,847
------- -------
$19,694 $14,964
======= =======
In connection with the retail sale of vehicles, the Company is required to
pay sales taxes to certain government jurisdictions. In certain of these
jurisdictions, the Company has elected to pay these taxes using the "cash
basis", which requires the Company to pay the sales tax obligation for a sale
transaction as principal is collected over the life of the related finance
receivable contract.
(11) Notes Payable
A summary of Notes Payable at December 31, 1998 and 1997 follows (in
thousands):
December 31,
--------------------
1998 1997
--------- ---------
$125,000,000 revolving loan with a finance company, interest
payable daily at 30 day LIBOR (5.24% at December 31, 1998)
plus 3.15% through June 2000, secured by substantially all
assets of the Company............................................. $ 51,765 $ 56,950
Two notes payable to a finance company totaling $7,450,000,
monthly interest payable at the prime rate plus 1.50%
(9.25 % at December 31, 1998) through January 1998; thereafter,
monthly payments of $89,000 plus interest through April 1999
when the remaining unpaid principal is due, secured by first
deeds of trust and assignments of rents on certain real property.. 3,386 7,450
Other notes bearing interest at rates ranging from 9% to 11% due
through August 2001, secured by certain real property and
certain property and equipment .................................. 967 771
--------- ---------
Subtotal................................................... 56,119 65,171
Less: Unamortized Loan Fees............................... 1,025 350
--------- ---------
Total...................................................... $ 55,093 $ 64,821
========== =========
The aforementioned revolving loan agreement contains various reporting and
performance covenants including the maintenance of certain ratios, limitations
on additional borrowings from other sources, restrictions on certain operating
activities, and a restriction on the payment of dividends under certain
circumstances. The Company was in compliance with the covenants at December 31,
1998 and 1997 except for interest coverage ratios at December 31, 1998, for
which the Company obtained a waiver.
56
(12) Collateralized Notes Payable
The Company has Collateralized Notes Payable consisting of a note payable
under a securitization and a note payable secured by the common stock of the
Company's securitization subsidiaries. These notes do not have contractually
scheduled principal payments but require the Company to remit all collections on
the collateral to the note holders. A summary of Collateralized Notes Payable at
December 31, 1998 and 1997, respectively, follows (in thousands):
December 31,
-------------------
1998 1997
-------- ---------
$50,607,000 of A Certificates issued pursuant to the Company's
Securitization Program, interest payable monthly at 5.90%,
secured by the pool of finance receivable contracts and spread
account ($5.7 million at December 31, 1998), monthly principal
payments are 73% of principal reductions of the underlying
pool of finance receivable contracts........................... 50,607 --
$15 million note payable to a finance company, bearing interest at
LIBOR plus 4% (9.54% at December 31, 1998), secured by the
capital stock of UDRC and UDRC II, Lender will receive all
UDRC II, Lender will receive all distributions for Residuals in
distributions for Residuals in Finance Receivables Sold until
until note is paid in full..................................... 12,234 --
-------- ---------
Subtotal................................................ 62,841 --
Less: Unamortized Loan Fees............................ 640 --
-------- ---------
Total................................................... $ 62,201 $ --
======== =========
(13) Subordinated Notes Payable
A summary of Subordinated Notes Payable at December 31, 1998 and 1997
follows:
December 31,
-------------------
1998 1997
--------- -------
(In thousands)
$17.5 million Subordinated debentures, interest at 12% per
annum (approximately 18.8% effective rate) payable
semi-annually with the entire principal balance due October
23, 2003; the debentures are subordinate to all other Company
indebtedness except the Verde note and contain certain call
provisions at the option of the Company.......................... $ 17,479 $ --
$15 million notes payable to unrelated parties, bearing interest at
12% per annum payable quarterly, principal due February 2001
senior to the Verde subordinated note payable and the
subordinated debentures.......................................... 15,000 --
$5 million notes payable to unrelated parties, bearing interest 12%
per annum payable quarterly, principal due July 2001 senior to
the Verde subordinated note payable and the subordinated
debentures....................................................... 5,000 --
$14 million unsecured note payable with Verde, interest payable
monthly at 10% per annum with annual principal payments of
$2 million, maturing June 2003................................... 10,000 12,000
---------- ------
Subtotal.................................................. 47,479 12,000
Less: Unamortized Premium................................ 3,738 --
--------- --------
Total..................................................... $ 43,741 $ 12,000
======== ========
During the year the Company issued $17.5 million of subordinated debentures
in exchange for 2.7 million shares of Company common stock valued at $14.0
million ("Exchange Offer"), including $370,000 of costs incurred for the
Exchange Offer. The debentures are unsecured and subordinate to all existing and
future indebtedness of the Company and bear interest at 12% per annum payable
semi-annually each April and October, approximately $2.9 million per year, until
they are paid in full on October 23, 2003. The debentures were issued at a
premium of approximately $3,874,000 in excess of the market value of the shares
tendered, which will be amortized over the life of the debentures and results in
an effective interest rate of approximately 18.8%. The Company is required to
pay the principal amount of debentures on the fifth anniversary of their
issuance date.
In connection with the issuance of the $15 million senior subordinated notes
payable, the Company issued warrants, which were valued at approximately
$900,000, to the lenders to purchase up to 500,000 shares of the Company's
Common Stock at an exercise price of $10.00 per share exercisable at any time
until the later of (1) February 2001, or (2) such time as the notes have been
paid in full.
Interest expense related to the subordinated note payable with Verde totaled
$1,073,000, $1,232,000, and $1,933,000, during the years ended December 31,
1998, 1997 and 1996, respectively.
57
A summary of the future minimum principal payments required under the
aforementioned notes payable and subordinated notes payable after December 31,
1998 follows (in thousands):
Subordinated
December 31, Notes Payable Notes Payable Total
------------ ------------- ------------- ----------
1999.......... $ 3,634 $ 2,000 $ 5,634
2000.......... 51,903 2,000 53,903
2001.......... 581 22,000 22,581
2002.......... -- 2,000 2,000
2003.......... -- 19,479 19,479
------------- ------------- ----------
$ 56,118 $ 47,479 $ 103,597
=========== ============= ==========
(14) Income Taxes
Income taxes amounted to $2,396,000, $6,637,000, and $100,000 for the years
ended December 31, 1998, 1997 and 1996, respectively (an effective tax rate of
40.5%, 41.1%, and 1.6%, respectively). A reconciliation between taxes computed
at the federal statutory rate of 35% in 1998 and 1997 and 34% in 1996 at the
effective tax rate on earnings before income taxes follows (in thousands):
December 31,
-----------------------------
1998 1997 1996
------- ------ --------
Computed "Expected" Income Taxes ....... $2,071 $5,658 $ 2,142
State Income Taxes, Net of Federal Effect 96 962 41
Change in Valuation Allowance........... 735 -- (2,315)
Other, Net.............................. (506) 17 232
------- ------ --------
$2,396 $6,637 $ 100
====== ====== ========
Components of income taxes (benefit) for the years ended December 31, 1998,
1997 and 1996 follow (in thousands):
Current Deferred Total
-------- ------- -------
1998:
Federal.............. $ 91 $ 2,158 $ 2,249
State................ 6 141 147
------- ------- -------
97 2,299 2,396
Discontinued operations (239) (5,643) (5,882)
-------- -------- --------
$ (142) $(3,344) $(3,486)
======== ======== ========
1997:
Federal.............. $ 3,743 $ 1,414 $ 5,157
State................ 1,197 283 1,480
------- ------- -------
4,940 1,697 6,637
Discontinued operations (40) (18) (58)
-------- -------- --------
$ 4,900 $ 1,679 $ 6,579
======= ======= =======
1996:
Federal.............. $ (149) $ 187 $ 38
State................ -- 62 62
------- ------- -------
$ (149) $ 249 $ 100
======= ======= =======
58
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities as of December
31, 1998 and 1997 are presented below (in thousands):
December 31,
-----------------
1998 1997
------- ------
Deferred Tax Assets:
Finance Receivables, Principally Due to the
Allowance for Credit Losses.................... $2,282 $ 473
Inventory......................................... -- 246
Federal and State Income Tax Net Operating Loss
Carryforwards.................................. 1,224 28
Discontinued Operations Liability................. 2,410 --
Accrued Post Sale Support......................... 717 357
Other............................................. 934 395
------ ------
Total Gross Deferred Tax Assets................... 7,567 1,499
Less: Valuation Allowance......................... (735) --
------- ------
Net Deferred Tax Assets................... 6,832 1,499
------ ------
Deferred Tax Liabilities:
Software Development Costs........................ (2,191) (237)
Inventory......................................... (1,176) --
Pre-Opening and Start Up Costs.................... -- (1,236)
Loan Origination Fees............................. (255) (586)
Other............................................. (584) (158)
------ ------
Total Gross Deferred Tax Liabilities........... (4,206) (2,217)
------ -------
Net Deferred Tax Asset (Liability)........ $2,626 $ (718)
====== ======
The valuation allowance for deferred tax assets as of December 31, 1998 and
1997 was $735,000 and zero, respectively. The net change in the total valuation
allowance for the year ended December 31, 1998 was an increase of $735,000. The
allowance is attributable primarily to future deductions and net operating loss
carryforwards in certain states where the Branch Offices operated and
realization of a tax benefit is unlikely. There was no change in the Valuation
Allowance for the year ended December 31, 1997. In assessing the realizability
of Deferred Tax Assets, management considers whether it is more likely than not
that some portion or all of the Deferred Tax Assets will not be realized. The
ultimate realization of Deferred Tax Assets is dependent upon generation of
future taxable income during the periods in which those temporary differences
become deductible. Management considers the reversal of Deferred Tax
Liabilities, projected future taxable income, and tax planning strategies in
making this assessment. Based upon the level of historical taxable income and
projections for future taxable income over the periods in which the Deferred Tax
Assets are deductible, management believes it is more likely than not that the
Company will realize the benefits of these deductible differences, net of the
established valuation allowance at December 31, 1998.
At December 31, 1998, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $1,822,000, which, subject to
annual limitations, are available to offset future taxable income, if any,
through 2011.
(15) Servicing
Pursuant to the Company's securitization program that began in 1996, the
Company securitizes loan portfolios with servicing retained. The Company
services the securitized portfolios for a monthly fee ranging from .25% to .33%
(generally, 3.0% to 4.0% per annum) of the beginning of month principal balance
of the serviced portfolios. The Company has retained the servicing rights on the
contracts it has sold in connection with its securitization transactions. The
Company has not established any servicing assets or liabilities in connection
with its securitizations as the revenues from contractually specified servicing
fees and other ancillary sources have been just adequate to compensate the
Company for its servicing responsibilities.
In 1998 the Company's Non Dealership Operations entered into several
agreements with third parties to service loan portfolios on their behalf. The
service fees are generally a percentage of the outstanding principal balance
ranging from generally, 3.25% to 4.0% per annum, subject to a minimum dollar
amount per contract, and are paid monthly.
The Company recognized servicing income of $33.3 million, $8.8 million, and
$1.9 million in the years ended December 31, 1998, 1997 and 1996, respectively.
59
A summary of portfolios serviced by the Company's respective segments as of
December 31, 1998 and 1997 follows (in thousands):
Dealership Operations: 1998 1997
----------- ---------
Finance Receivables from continuing operations....... $ 93,936 $ 55,965
Finance Receivables from discontinued operations 30,219 29,965
Securitized with servicing retained.................. 242,297 238,025
Servicing on behalf of others........................ 47,947 127,322
----------- ---------
Total serviced portfolios Dealership Operations ..... 414,399 451,277
----------- ---------
Non Dealership Operations:
Finance Receivables ................................. 1,237 --
Servicing on behalf of others........................ 586,081 --
----------- --------
Total serviced portfolios Non Dealership
Operations.................................. 587,318 --
----------- ---------
Total serviced portfolios...................... $ 1,001,717 $ 451,277
=========== =========
Pursuant to the terms of the various servicing agreements, the serviced
portfolios are subject to certain performance criteria. In the event the
serviced portfolios do not satisfy such criteria the servicing agreements
contain various remedies up to and including the removal of servicing rights
from the Company.
(16) Lease Commitments
The Company leases used car sales facilities, loan servicing centers,
offices, and certain office equipment from unrelated entities under various
operating leases that expire through March 2019. The leases require monthly
rental payments aggregating approximately $871,000 and contain various renewal
options from one to ten years. In certain instances, the Company is also
responsible for occupancy and maintenance costs, including real estate taxes,
insurance, and utility costs. Rent expense totaled $11,419,000, $5,398,000 and
$2,394,000 for the years ended December 31, 1998, 1997, and 1996, respectively.
During 1996, the Company purchased six car lots, a vehicle reconditioning
center, and two office buildings from Verde. These properties had previously
been rented from Verde pursuant to various leases which called for base monthly
rents aggregating approximately $123,000 plus contingent rents as well as all
occupancy and maintenance costs, including real estate taxes, insurance, and
utilities. In connection with the purchase, Verde returned security deposits
that totaled $364,000. Rent expense for the year ended December 31, 1996 totaled
$2,394,000, which included rents paid to Verde totaling $1,498,000 including
contingent rents of $440,000.
A summary of future minimum lease payments required under noncancelable
operating leases with remaining lease terms in excess of one year as of December
31, 1998 follows (in thousands):
Continuing Discontinued
December 31, Operations Operations Total
------------ ---------- ------------ --------
1999.......... $11,320 $ 567 $ 11,887
2000.......... 10,216 178 10,394
2001.......... 8,263 -- 8,263
2002.......... 5,849 -- 5,849
2003.......... 3,874 -- 3,874
Thereafter.... 45,181 -- 45,181
------- ------ --------
Total $84,703 $ 745 $ 85,448
======= ====== ========
(17) Stockholders' Equity
During 1998 the Company acquired approximately 2.7 million shares of Company
Common Stock with a value of approximately $14.0 million in the Exchange Offer.
The Company also acquired 72,000 shares of Treasury Stock for approximately
$535,000 under its Stock Repurchase Program.
During 1997, the Company completed a private placement of 5,075,500 shares
of common stock for a total of approximately $88.7 million cash, net of stock
issuance costs. The registration of the shares sold in the private placement was
effective in April 1997. During 1996, the Company completed two public offerings
in which it issued a total of 7,245,000 shares of common stock for approximately
$79.4 million cash, net of stock issuance costs.
60
During 1998, the Company issued 50,000 warrants to a third party to purchase
Company common stock. The warrants are exercisable through February 2001 at an
exercise price of $12.50 per share of common stock.
During 1998, the Company issued warrants, valued at approximately $900,000,
to purchase 500,000 shares of Company common stock at $10 per share in
connection with senior subordinated note payable agreements. The warrants are
exercisable at any time until (1) February 2001, or (2) the notes are paid in
full.
During the year the Company issued 325,000 warrants to a third party to
purchase Company common stock at $20.00 per share. The warrants expire on April
1, 2001 and are subject to a call feature by the Company.
During 1997, the Company issued warrants for the right to purchase 389,800
shares of the Company's common stock for $20.00 per share exercisable through
February 2000. The warrants were valued at approximately $612,000. These
warrants remained outstanding at December 31, 1998. In addition, warrants to
acquire 116,000 shares of the Company's common stock at $6.75 per share and
170,000 shares of the Company's common stock at $9.45 per share were outstanding
at December 31, 1997.
On April 24, 1996, the Company effectuated a 1.16-to-1 stock split. The
effect of this stock split has been reflected for all periods presented in the
Consolidated Financial Statements.
The Company's Board of Directors declared quarterly dividends on preferred
stock totaling approximately $916,000 during the year ended December 31, 1996.
There were no cumulative unpaid dividends at December 31, 1996.
(18) Earnings (Loss) Per Share
A summary of the reconciliation from basic earnings (loss) per share to
diluted earnings (loss) per share for the years ended December 31, 1998, 1997,
and 1996 follows (in thousands, except for per share amounts):
1998 1997 1996
-------- -------- -------
Earnings From Continuing Operations.............. $ 3,520 $ 9,528 $ 6,677
Less: Preferred Stock Dividends.................. -- -- (916)
------- -------- -------
Earnings available to Common Stockholders........ $ 3,520 $ 9,528 $ 5,761
======= ======== =======
Net Earnings (Loss).............................. $(5,703) $ 9,445 $ 5,866
Less: Preferred Stock Dividends.................. -- -- (916)
------- -------- -------
Earnings (Loss) available to Common Stockholders. $(5,703) $ 9,445 $ 4,950
======== ======== =======
Basic Earnings Per Share From Continuing
Operations..................................... $ 0.19 $ 0.53 $ 0.73
======= ======== =======
Diluted Earnings Per Share From Continuing
Operations..................................... $ 0.19 $ 0.52 $ 0.69
======= ======== =======
Basic Earnings (Loss) Per Share.................. $ (0.32) $ 0.53 $ 0.63
======= ======== =======
Diluted Earnings (Loss) Per Share................ $ (0.31) $ 0.52 $ 0.60
======= ======== =======
Basic EPS-Weighted Average Shares Outstanding.... 18,082 17,832 7,887
Effect of Diluted Securities:
Warrants....................................... 41 98 71
Stock Options.................................. 282 304 340
------- -------- -------
Dilutive EPS-Weighted Average Shares Outstanding. 18,405 18,234 8,298
======= ======== =======
Warrants Not Included in Diluted EPS Since
Antidilutive.................................. 1,044 390 --
======= ======== =======
Stock Options Not Included in Diluted EPS Since
Antidilutive................................... 1,044 828 --
======= ======== =======
(19) Stock Option Plan
In June, 1995, the Company adopted a long-term incentive plan (Stock Option
Plan) under which it has set aside 1,800,000 shares of common stock to be
granted to employees. Options are to vest over a period to be determined by the
Board of Directors upon grant and will generally expire 6 to 10 years after the
date of grant. The options generally vest over a period of 5 years.
In August 1998, the Company's stockholders approved an executive incentive
stock option plan (Executive Plan). The Company has reserved 800,000 shares of
its common stock for issuance. Options granted under the plan expire ten years
after the grant date and vest 20% per year upon completion of each year of
service after the date of grant (beginning 1 year after the grant date) subject
to meeting additional vesting hurdles that are based on the trading price of the
Company's stock. Even if these additional vesting hurdles are not met, the
options will fully vest 7 years after the date of grant.
61
A summary of the aforementioned stock plan activity follows:
Stock Option Plan Executive Plan
----------------------- -----------------------
Weighted Weighted
Average Average
Price Per Price Per
Number Share Number Share
----------- ---------- ----------- ----------
Balance, December 31, 1996 912,000 $ 8.60 -- $ --
Granted................. 582,000 15.07 -- --
Forfeited............... (78,000) 14.00 -- --
Exercised............... (118,000) 2.04 -- --
----------- -----------
Balance, December 31, 1997 1,298,000 11.76 -- --
Granted................. 925,000 7.68 525,000 8.25
Forfeited............... (995,000) 13.64 (25,000) 8.25
Exercised............... (76,000) 3.61 -- --
----------- -----------
Balance, December 31, 1998 1,152,000 7.43 500,000 8.25
=========== ===========
At December 31, 1998, there were 409,000 and 300,000 additional shares
available for grant under the Stock Option Plan and Executive Plan,
respectively. The per share weighted-average fair value of stock options granted
during 1998, 1997 and 1996 was $3.22, $6.54 and $8.39, respectively, on the date
of grant using the Black-Scholes option-pricing model. The following are the
weighted-average assumptions: 1998 -- expected dividend yield 0%, risk-free
interest rate of 5.25%, expected volatility of 50.0%, and an expected life of 5
years; 1997 -- expected dividend yield 0%, risk-free interest rate of 5.53%,
expected volatility of 40.0%, and an expected life of 5 years; 1996 -- expected
dividend yield 0%, risk-free interest rate of 6.4%, expected volatility of 56.5%
and an expected life of 7 years.
During 1998 the Board of Directors approved separate plans to reprice the
Company's outstanding stock options under the Stock Option Plan, one in January
1998 and a second in November 1998. The forfeited options had exercise prices
ranging from $9.75 to $20.75 and were repriced at $8.25 or $5.13 per share, the
fair market value on the date of the respective repricings. Approximately
391,000 options were issued under the repricing program. The vesting period was
not affected for the options repriced under the January 1998 repricing plan.
However, the vesting period started over on the repricing date for the options
issued under the November 1998 repricing plan. Generally vesting occurs 20% per
year beginning one year after the grant date. The fair values of these options
were estimated at the date of grant using the criteria noted above. The
repricing resulted in additional pro forma compensation expense in 1998 of
$795,000, which is reflected in the pro forma table below. The repricing
activity has been reflected in table above and is included in the options
granted and forfeited in 1998.
The Company applies APB Opinion 25 in accounting for its Plan, and
accordingly, no compensation cost has been recognized for its stock options in
the consolidated financial statements. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options under SFAS
No. 123, the Company's net earnings (loss) and earnings (loss) per share would
have been reduced to the pro forma amounts indicated below:
1998 1997 1996
------------- ------------- ---------
Pro Forma Earnings from Continuing Operations
Available to Common Stockholders............. $ 2,533 $ 8,650 $ 5,642
Pro forma Net Earnings (Loss) Available to
Common Stockholders ......................... $ (6,690) $ 8,567 $ 4,831
Earnings (Loss) per Share -- Basic:
Continuing Operations Pro Forma.............. $ 0.14 $ 0.49 $ 0.72
Net Earnings (Loss) Pro Forma................ $ (0.37) $ 0.48 $ 0.61
Earnings (Loss) per Share -- Diluted:
Continuing Operations Pro Forma.............. $ 0.14 $ 0.48 $ 0.72
Net Earnings (Loss) Pro Forma................ $ (0.37) $ 0.48 $ 0.61
62
A summary of stock options granted at December 31, 1998 follows:
Options Outstanding Options Exercisable
------------------------------------------------- -------------------------------
Number Weighted-Avg. Weighted-Avg. Number Weighted-Avg.
Range of Outstanding Remaining Exercise Exercisable Exercise
Exercise Prices at 12/31/98 Contractual Life Price at 12/31/98 Price
- --------------- --------------- ---------------- ------------ --------------- ------------
$ .50 to $1.00. 65,000 5.4 years $ 0.86 -- $ --
$1.50 to $7.00. 543,000 5.9 years 4.68 117,000 3.78
$8.00 to $8.25. 816,000 7.8 years 8.25 -- --
$8.30 to $18.63 228,000 5.4 years 14.71 86,000 15.76
---------- ------- --------- -------
1,652,000 $ 7.68 203,000 $ 8.86
========== ======= ========= =======
(20) Year 2000 Readiness Disclosure
In 1998, the Company developed a plan to deal with the Year 2000 problem and
began modifying and testing, or converting its computer systems to be Year 2000
compliant. The plan provides for the modification, testing, and conversion
efforts to be completed by June 30, 1999. The Year 2000 problem is the result of
computer programs being written using two digits rather than four to define the
applicable year. Management has also assessed the Year 2000 remediation efforts
of the Company's significant suppliers. Although management believes its efforts
minimize the potential adverse effects that a supplier's failure would have on
the Company, there can be no absolute assurance that all its suppliers will
become Year 2000 compliant on time. The Company will evaluate appropriate
courses of action, including replacement of certain systems whose associated
costs would be recorded as assets and subsequently amortized, or modification of
its existing systems which costs would be expensed as incurred. The Company
estimates it will cost between $2.2 million and $2.7 million to become Year 2000
compliant and had incurred $1.3 million of these costs during 1998. However,
there can be no assurance that the Company will be able to completely resolve
all Year 2000 issues or that the ultimate cost to identify and implement
solutions to all Year 2000 problems will not exceed the Company's estimate.
(21) Commitments and Contingencies
The Company's Non Dealership operations have entered into servicing
agreements with two companies that have filed and subsequently emerged from
bankruptcy and continue to operate under their approved plans of reorganization.
Under the terms of the respective servicing agreements and approved plans of
reorganization, once certain creditors of the bankrupt companies have been paid
in full, the Company is entitled to certain incentive compensation in excess of
the servicing fees earned to date. Under the terms of one of the agreements, the
Company is scheduled to receive 17.5% of all collections of the serviced
portfolio once the specified creditors have been paid in full. Under the terms
of the second agreement, the Company is scheduled to receive the first $3.25
million in collections once the specified creditors have been paid in full and
15% thereafter. The Company is required to issue up to 150,000 warrants to the
extent the Company receives the $3.25 million and in addition will be required
to issue 75,000 warrants for each $1.0 million in incentive fee income after
collection of the $3.25 million. As of December 31, 1998, management estimates
that the incentive compensation could range from $0 to $8.0 million under these
agreements. The Company has not accrued any fee income with regard to these
incentives.
On July 18, 1997, the Company filed a Form S-3 registration statement for
the purpose of registering up to $200 million of its debt securities in one or
more series at prices and on terms to be determined at the time of sale. The
registration statement has been declared effective by the Securities and
Exchange Commission and may be available for future debt offerings. There can be
no assurance, however, that the Company will be able to use this registration
statement to sell debt or other securities.
The Company is involved in various claims and actions arising in the
ordinary course of business. In the opinion of management, based on consultation
with legal counsel, the ultimate disposition of these matters will not have a
material adverse effect on the Company. No provision has been made in the
accompanying consolidated financial statements for losses, if any, that might
result from the ultimate disposition of these matters.
(22) Retirement Plan
The Company has established qualified 401(k) retirement plans (defined
contribution plans) which became effective on October 1, 1995. The plans, as
amended, cover substantially all employees having no less than three months of
service, have attained the age of 21, and work at least 1,000 hours per year.
63
Participants may voluntarily contribute to the plan up to the maximum limits
established by Internal Revenue Service regulations.
The Company will match from 10% to 25% of the participants' contributions.
Participants are immediately vested in the amount of their direct contributions
and vest over a five-year period, as defined by the plan, with respect to the
Company's contribution. Pension expense totaled $121,000, $49,000, and $23,000
during the years ended December 31, 1998, 1997, and 1996, respectively.
(23) Disclosures About Fair Value of Financial Instruments
Statement of Financial Accounting Standards No. 107, "Disclosures about Fair
Value of Financial Instruments", requires that the Company disclose estimated
fair values for its financial instruments. The following summary presents a
description of the methodologies and assumptions used to determine such amounts.
Limitations
Fair value estimates are made at a specific point in time and are based on
relevant market information and information about the financial instrument; they
are subjective in nature and involve uncertainties, matters of judgment and,
therefore, cannot be determined with precision. These estimates do not reflect
any premium or discount that could result from offering for sale at one time the
Company's entire holdings of a particular instrument. Changes in assumptions
could significantly affect these estimates.
Since the fair value is estimated as of December 31, 1998 and 1997, the
amounts that will actually be realized or paid in settlement of the instruments
could be significantly different.
Cash and Cash Equivalents
The carrying amount is estimated to be the fair value because of the
liquidity of these instruments.
Finance Receivables, Residuals in Finance Receivables Sold, Investments Held in
Trust, and Notes Receivable
The carrying amount is estimated to be the fair value because of the
relative short maturity and repayment terms of the portfolio as compared to
similar instruments.
Accounts Payable, Accrued Expenses, and Notes Payable
The carrying amount approximates fair value because of the short maturity of
these instruments. The terms of the Company's notes payable approximate the
terms in the market place at which they could be replaced. Therefore, the fair
market value approximates the carrying value of these financial instruments.
Subordinated Notes Payable
The terms of the Company's subordinated notes payable approximate the terms
in the market place at which they could be replaced. Therefore, the fair value
approximates the carrying value of these financial instruments.
(24) Business Segments
Operating results and other financial data are presented for the principal
business segments of the Company for the years ended December 31, 1998, 1997,
and 1996, respectively. The Company has 6 distinct business segments. Within the
Dealership Operations division, these consist of retail car sales operations
(Company dealerships), the income generated from the finance receivables
generated at the Company dealerships and corporate and other operations. Within
the Non Dealership Operations division, these consist of the Cygnet dealer
program, bulk purchasing and loan servicing, and corporate and other operations.
In computing operating profit by business segment, the following items were
considered in the Corporate and Other category: portions of administrative
expenses, interest expense and other items not considered direct operating
expenses. Identifiable assets by business segment are those assets used in each
segment of Company operations.
64
Dealership Operations Non Dealership Operations
---------------------------------- -----------------------------------
Company Cygnet
Company Dealership Corporate Cygnet Loan Corporate
Dealerships Receivables and Other Dealer Servicing and Other Total
---------- ----------- ---------- --------- ---------- --------- ---------
(In thousands)
December 31, 1998:
Sales of Used Cars............... $ 287,618 $ -- $ -- $ -- $ -- $ -- $ 287,618
Less: Cost of Cars Sold.......... 167,014 -- -- -- -- -- 167,014
Provision for Credit Losses...... 59,770 5,548 -- 2,316 -- -- 67,634
--------- --------- --------- --------- ---------- ---------- ---------
60,834 (5,548) -- (2,316) -- -- 52,970
Interest Income.................. -- 16,946 341 8,709 1,832 -- 27,828
Gain on Sale of Loans............ -- 12,093 -- -- -- -- 12,093
Service Fee and Other Income..... 389 15,453 493 -- 22,296 -- 38,631
--------- --------- --------- --------- ---------- ---------- ---------
Income before Operating Expenses. 61,223 38,944 834 6,393 24,128 -- 131,522
--------- --------- --------- --------- ---------- ---------- ---------
Operating Expenses:
Selling and Marketing............ 20,285 -- -- 242 31 7 20,565
General and Administrative....... 32,383 18,491 16,103 2,721 18,664 4,040 92,402
Depreciation and Amortization.... 2,581 1,334 997 104 614 105 5,735
--------- --------------------- --------- ---------- ---------- ---------
55,249 19,825 17,100 3,067 19,309 4,152 118,702
--------- --------- --------- --------- ---------- ---------- ---------
Income (loss) before Interest
Expense....................... $ 5,974 $ 19,119 $ (16,266) $ 3,326 $ 4,819 $ (4,152) $ 12,820
========= ========= ========= ========= ========== =========== =========
Capital Expenditures............. $ 14,265 $ 1,297 $ 2,352 $ 449 $ 2,260 $ 1,163 $ 21,786
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 75,366 $ 145,880 $ 47,543 $ 44,250 $ 31,589 $ 1,347 $ 345,975
========= ========= ========= ========= ========== ========== =========
December 31, 1997:
Sales of Used Cars............... $ 123,814 $ -- $ -- $ -- $ -- $ -- $ 123,814
Less: Cost of Cars Sold.......... 72,358 -- -- -- -- -- 72,358
Provision for Credit Losses...... 22,354 -- -- 691 -- -- 23,045
--------- --------- --------- --------- ---------- ---------- ---------
29,102 -- -- (691) -- -- 28,411
Interest Income.................. -- 12,559 -- 2,359 3,818 -- 18,736
Gain on Sale of Loans............ -- 6,721 -- -- 8,131 -- 14,852
Service Fee and Other Income..... 1,498 8,814 2,013 356 -- -- 12,681
--------- --------- --------- --------- ---------- ---------- ---------
Income before Operating Expenses. 30,600 28,094 2,013 2,024 11,949 -- 74,680
--------- --------- --------- --------- ---------- ---------- ---------
Operating Expenses:
Selling and Marketing............ 10,538 -- -- -- -- -- 10,538
General and Administrative....... 17,214 12,303 9,896 917 -- 1,572 41,902
Depreciation and Amortization.... 1,536 1,108 504 28 -- 125 3,301
--------- --------- --------- --------- ---------- ---------- ---------
29,288 13,411 10,400 945 -- 1,697 55,741
--------- --------- --------- --------- ---------- ---------- ---------
Income (loss) before Interest
Expense....................... $ 1,312 $ 14,683 $ (8,387) $ 1,079 $ 11,949 $ (1,697) $ 18,939
========= ========= ========= ========= ========== =========== =========
Capital Expenditures............. $ 13,571 $ 3,791 $ 2,104 $ 19 $ -- $ 24 $ 19,509
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 74,287 $ 78,514 $ 72,799 $ 27,539 $ 22,318 $ 969 $ 276,426
========= ========= ========= ========= ========== ========== =========
December 31, 1996:
Sales of Used Cars............... $ 53,768 $ -- $ -- $ -- $ -- $ -- $ 53,768
Less: Cost of Cars Sold.......... 31,879 -- -- -- -- -- 31,879
Provision for Credit Losses...... 9,657 -- -- -- -- -- 9,657
--------- --------- --------- --------- ---------- ---------- ---------
12,232 -- -- -- -- -- 12,232
Interest Income.................. -- 8,426 171 -- -- -- 8,597
Gain on Sale of Loans............ -- 3,925 -- -- -- -- 3,925
Service Fee and Other Income..... 195 1,887 455 -- -- -- 2,537
--------- --------- --------- --------- ---------- ---------- ---------
Income before Operating Expenses. 12,427 14,238 626 -- -- -- 27,291
--------- --------- --------- --------- ---------- ---------- ---------
Operating Expenses:
Selling and Marketing............ 3,568 -- 17 -- -- -- 3,585
General and Administrative....... 6,306 2,859 3,953 -- -- -- 13,118
Depreciation and Amortization.... 318 769 295 -- -- -- 1,382
--------- --------- --------- --------- ---------- ---------- ---------
10,192 3,628 4,265 -- -- -- 18,085
--------- --------- --------- --------- ---------- ---------- ---------
Income (loss) before Interest
Expense....................... $ 2,235 $ 10,610 $ (3,639) $ -- $ -- $ -- $ 9,206
========= ========= ========= ========= ========== ========== =========
Capital Expenditures............. $ 4,530 $ 455 $ 564 $ -- $ -- $ -- $ 5,549
========= ========= ========= ========= ========== ========== =========
Identifiable Assets.............. $ 20,698 $ 12,775 $ 84,156 $ -- $ -- $ -- $ 117,629
========= ========= ========= ========= ========== ========== =========
65
(25) Quarterly Financial Data -- unaudited
A summary of the quarterly data for the years ended December 31, 1998, and
1997 follows:
First Second Third Fourth
Quarter Quarter Quarter Quarter Total
-------- -------- -------- -------- ---------
(In thousands, except per share amounts)
1998:
Total Revenue..................... $ 87,777 $ 88,819 $ 96,714 $ 92,860 $ 366,170
======== ======== ======== ======== =========
Income before Operating Expenses.. 31,246 32,678 37,653 29,945 131,522
======== ======== ======== ======== =========
Operating Expenses................ 23,514 26,359 33,542 35,287 118,702
======== ======== ======== ======== =========
Income (Loss) before Interest
Expense........................ 7,732 6,319 4,111 (5,342) 12,820
======== ======== ======== ======== =========
Earnings (Loss) from Continuing
Operations..................... $ 3,729 $ 2,942 $ 1,527 $ (4,678) $ 3,520
======== ======== ======== ========= =========
(Loss) from Discontinued Operations (5,595) -- (3,628) -- (9,223)
========= ======== ======== ======== ==========
Net Earnings (Loss)............... $ (1,866) $ 2,942 $ (2,101) $ (4,678) $ (5,703)
========= ======== ======== ========= ==========
Basic Earnings (Loss) Per Share from
Continuing Operations.......... $ 0.20 $ 0.16 $ 0.08 $ (0.28) $ 0.19
========= ======== ======== ======== ==========
Diluted Earnings (Loss) Per Share
from Continuing Operations..... $ 0.20 $ 0.16 $ 0.08 $ (0.28) $ 0.19
========= ======== ======== ======== =========
Basic Earnings (Loss) Per Share... $ (0.10) $ 0.16 $ (0.11) $ (0.28) $ (0.32)
========== ======== ======== ========= ==========
Diluted Earnings (Loss) Per Share. $ (0.10) $ 0.16 $ (0.11) $ (0.28) $ (0.31)
========== ======== ======== ========= ==========
1997:
Total Revenue..................... $ 22,301 $ 36,279 $ 45,737 $ 65,766 $ 170,083
======== ======== ======== ======== =========
Income before Operating Expenses.. 9,101 15,480 19,415 30,684 74,680
======== ======== ======== ======== =========
Operating Expenses................ 8,133 11,988 14,780 20,840 55,741
======== ======== ======== ======== =========
Income before Interest Expense.... 968 3,492 4,635 9,844 18,939
======== ======== ======== ======== =========
Earnings from Continuing Operations $ 408 $ 1,896 $ 2,220 $ 5,004 $ 9,528
======== ======== ======== ======== =========
Earnings (Loss) from Discontinued
Operations..................... 2,854 2,415 (4,048) (1,304) (83)
======== ======== ========= ========= ==========
Net Earnings (Loss)............... $ 3,262 $ 4,311 $ (1,828) $ 3,700 $ 9,445
======== ======== ======== ======== =========
Basic Earnings Per Share from
Continuing Operations.......... $ 0.03 $ 0.10 $ 0.12 $ 0.27 $ 0.53
========= ======== ======== ======== ==========
Diluted Earnings Per Share from
Continuing Operations.......... $ 0.02 $ 0.10 $ 0.12 $ 0.26 $ 0.52
========= ======== ======== ======== ==========
Basic Earnings (Loss) Per Share... $ 0.21 $ 0.23 $ (0.10) $ 0.20 $ 0.53
========= ======== ======== ======== ==========
Diluted Earnings (Loss) Per Share. $ 0.20 $ 0.23 $ (0.10) $ 0.20 $ 0.52
========= ======== ======== ======== ==========
66
ITEM 9 -- CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURES
The Company has had no disagreements with its independent accountants in
regard to accounting and financial disclosure and has not changed its
independent accountants during the two most recent fiscal years.
PART III
ITEM 10 -- DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this Item pertaining to executive officers of Ugly
Duckling is set forth above in Part I of this Form 10-K under the caption,
"Executive Officers of the Registrant," and is incorporated by reference into
this Item. Information concerning directors of the registrant and persons
nominated to become directors is incorporated by reference from the text under
the captions, "Board of Directors, Board Committees and Other Board Information"
and "Proposal to Be Voted on -- Item No. 1 --Election of Directors" in the Proxy
Statement for the June 2, 1999 Annual Meeting of Stockholders. Information
required by this Item pertaining to compliance with Section 16(a) of the
Securities Act of 1934 is set forth under the caption, "Section 16(a) Beneficial
Ownership Reporting Compliance" in the Proxy Statement for the June 2, 1999
Annual Meeting of Stockholders and is incorporated by reference into this Item.
ITEM 11 -- EXECUTIVE COMPENSATION
Information concerning executive compensation is incorporated by reference
from the text under the captions, "Certain Relationships and Related
Transactions" and "Compensation of Executive Officers, Benefits and Related
Matters" (excluding the material under the headings "Compensation Committee
Report on Executive Compensation" and "Stockholder Return Performance Graph"
therein) in the Proxy Statement for the June 2, 1999 Annual Meeting of
Stockholders.
ITEM 12 -- SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information concerning ownership of equity stock of the Company by certain
beneficial owners and management is incorporated by reference from the text
under the caption, "Security Ownership of Certain Beneficial Owners and
Management--Beneficial Ownership Table" in the Proxy Statement for the June 2,
1999 Annual Meeting of Stockholders.
ITEM 13 -- CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information concerning certain relationships and related transactions with
officers and directors is incorporated by reference from the text under the
caption, "Certain Relationships and Related Transactions" in the Proxy Statement
for the June 2, 1999 Annual Meeting of Stockholders.
67
PART IV
ITEM 14 -- EXHIBITS, CONSOLIDATED FINANCIAL STATEMENT SCHEDULES,
AND REPORTS ON FORM 8-K
(a) Consolidated Financial Statements.
The following consolidated financial statements of Ugly Duckling Corporation
are filed as part of this Form 10-K.
Page
----
Independent Auditors' Report............................................. 42
Consolidated Financial Statements and Notes thereto of Ugly Duckling
Corporation:
Consolidated Balance Sheets--December 31, 1998 and 1997.................. 43
Consolidated Statements of Operations--for the years ended
December 31, 1998, 1997 and 1996..................................... 44
Consolidated Statements of Stockholders' Equity--for the years ended
December 31, 1998, 1997 and 1996...................................... 45
Consolidated Statements of Cash Flows--for the years ended
December 31, 1998, 1997 and 1996..................................... 46
Notes to Consolidated Financial Statements............................... 47
All schedules have been omitted because they are not applicable, not
required, or the information has been disclosed in the consolidated
financial statements and related notes thereto or otherwise in this
Form 10-K Report.
(b) Reports on Form 8-K.
During the fourth quarter of 1998, the Company filed five reports on Form
8-K. The first report on Form 8-K, dated October 8, 1998 and filed on October
13, 1998, pursuant to Items 5 and 7 (1) reported an expected charge to
Discontinued Operations totaling approximately $4.8 million (net of income
taxes) in the third quarter ended September 30, 1998, and (2) filed as exhibits
to the Form 8-K a Supplement No. 2 dated October 9, 1998 to the Offering
Circular for the Exchange Offer regarding the third quarter charge and Ugly
Duckling Corporation's press release dated October 8, 1998 titled "Ugly Duckling
Corporation Announces Third Quarter Charges to Discontinued Operations." The
second report on Form 8-K, dated October 20, 1998 and filed on October 21, 1998,
pursuant to Items 5 and 7 (1) reported the events described in two press
releases, and (2) filed as exhibits to the Form 8-K said press releases dated
October 21, 1998 and October 20, 1998 titled "Ugly Duckling Corporation
Announces Third Quarter 1998 Results" and "Ugly Duckling Corporation Announces
Successful Completion of Exchange Offer," respectively. The third report on Form
8-K, dated and filed November 18, 1998, pursuant to Items 5 and 7 filed as
exhibits to the Form 8-K a press release dated November 18, 1998 titled "Ugly
Duckling Corporation to Discontinue Gain-on-Sale Accounting." The fourth report
on Form 8-K, dated and filed November 23, 1998, pursuant to Items 5 and 7 (1)
reported the initiation of a supplemental offer by the Company to exchange
shares of its Common Stock for subordinated debentures, and (2) filed as
exhibits to the Form 8-K the offering circular describing the exchange offer and
Ugly Duckling Corporation's press release dated November 23, 1998 titled "Ugly
Duckling Corporation Announces Supplemental Exchange Offer." The fifth report on
Form 8-K, dated and filed December 23, 1998, pursuant to Items 5 and 7 filed as
an exhibit to the Form 8-K a press release dated December 23, 1998 titled "Ugly
Duckling Corporation Announces Completion of Supplemental Exchange Offer." After
the fourth quarter of 1998, the Company filed one report on Form 8-K. This
report on Form 8-K, dated and filed March 16, 1999, pursuant to Items 5 and 7
filed as an exhibit to the Form 8-K a press release dated March 16, 1999 titled
"Ugly Duckling Corporation Announces Reclassification of Cygnet Dealer Into
Continuing Operations and Anticipated First Quarter Results."
68
(c) Exhibits.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
3.1 Certificate of Incorporation of the Registrant Amended and Restated as of May 15, 1997(16)
3.2 Bylaws of the Registrant (5)
4.1 Certificate of Incorporation of the Registrant (filed as Exhibit 3.1)
4.2 Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to
the FMAC Warrants, dated as of April 1, 1998 (with form of warrant attached as Exhibit A, thereto)**
4.3 Form of Certificate representing Common Stock
4.4 10% Subordinated Debenture of the Registrant issued to Verde Investments, Inc. (13)
4.5 Form of Warrant issued to Cruttenden Roth Incorporated as Representative of the several underwriters (1)
4.6 Form of Warrant issued to SunAmerica Life Insurance Company (1)
4.7 Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to
Bank Group Warrants (6)
4.8 Form of 12% Senior Subordinated Note between Registrant and Kayne Anderson related entities, each as a lender
executed in February 1998 (12)
4.9 Warrant Agreement dated as of February 12, 1998 between Registrant and each of the Kayne Anderson related lenders
named therein (12)
4.10 Form of Warrant issued to Kayne Anderson related entities issued in February 1998 (12)
4.11 Warrant Agreement between the Registrant and Reliance Acceptance Corporation and Harris Trust of California, as
warrant agent, dated as of February 9, 1998 (w/form of warrant attached as Exhibit A, thereto) (15)
4.12 Certificate of Designation of the Preferred Stock (par value $.001 per share) (filed as part of Exhibit 3.1) (16)
4.13 Indenture dated as of October 15, 1998 between Registrant and Harris Trust and Savings Bank, as Trustee ("Harris")
("Indenture") (18)
4.13(a) First Supplemental Indenture dated as of October 15, 1998 between Registrant and Harris (18)
4.13(b) Form of 12% Subordinated Debenture due 2003**
10.1 Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between Registrant and General
Electric Capital Corporation (8)
10.1(a) Assumption and Amendment Agreement between the Registrant and General Electric Capital Corporation (2)
10.1(b) Amendment No. 1 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated December 22, 1997 (13)
10.1(c) Letter Agreement to Amend the Amended and Restated Loan and Security Agreement between Registrant and General
Electric Capital Corp. ("GECC"), dated as of October 20, 1997(15)
10.1(d) Letter agreement to Amend the Amended and Restated Loan Agreement between Registrant and GECC, dated as of March 25,
1998 (15)
10.1(e) Amendment No. 2 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated September 9, 1998 (17)
10.1(f) Amendment No. 3 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated January 19, 1999 **
10.2 Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(a) First Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(b) Second Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(c) Third Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(d) Fourth Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(e) Commitment Letter entered into between the Registrant and SunAmerica Life Insurance Company (1)
10.2(f) Letter Agreement regarding Note Conversion between the Registrant and SunAmerica Life Insurance Company (1)
10.3 Amended and Restated Registration Rights Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.4 Loan Purchase Agreement dated as of August 20, 1997 among the Registrant and certain banks (6)
10.4(a) Assignment of Loan and Bank Claim dated as of August 20, 1997 among the Registrant and certain banks, as assignors (6)
10.4(b) Security Agreement dated as of August 20, 1997 among the Registrant, as obligor, and certain banks (6)
10.4(c) Payment Guaranty dated as of August 20, 1997 of certain affiliates of the Registrant, as guarantors (6)
69
10.5 Restated (as of March 14, 1997) Ugly Duckling Corporation Long-Term Incentive Plan (5)*
10.5(a) Amended and Restated Long Term Incentive Plan (as of January 15, 1998) (17)*
10.6 Employment Agreement between the Registrant and Ernest C. Garcia II (1)*
10.6(a) Amendment to Employment Agreement between the Registrant and Ernest C. Garcia II */**
10.7 Employment Agreement between the Registrant and Steven T. Darak (1)*
10.8 Employment Agreement between the Registrant and Wally Vonsh (1)*
10.8(a) Modification of Employment Agreement between Registrant and Wally Vonsh (13)*
10.8(b) Amended and Restated Employment Agreement between Registrant and Walter Vonsh, dated May 26, 1998 (16)*
10.9 Amended and Restated Employment Agreement between the Registrant and Donald L. Addink (8)*
10.10 Employment Agreement between the Registrant and Russell Grisanti (5)*
10.11 Employment Agreement between the Registrant and Steven A. Tesdahl (8)*
10.11(a) Modification of Terms of Employment between Registrant and Steven A. Tesdahl (16)*
10.12 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 5104 West Glendale
Avenue in Glendale, Arizona (1)
10.13 Building Lease Agreement between the Registrant and Verde Investments, Inc. for property and buildings located at
9630 and 9650 North 19th Avenue in Phoenix, Arizona (1)
10.14 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 330 North 24th Street
in Phoenix, Arizona (1)
10.15 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 333 South Alma School
Road in Mesa, Arizona (1)
10.16 Lease Agreements between the Registrant and Blue Chip Motors, the Registrant and S & S Holding Corporation, and the
Registrant and Edelman Brothers for certain properties located at 3901 East Speedway Boulevard in Tucson, Arizona (1)
10.17 Real Property Lease between the Registrant and Peter and Alva Keesal for property located at 3737 South Park Avenue
in Tucson, Arizona (1)
10.18 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 2301 North Oracle
Road in Tucson, Arizona (1)
10.19 Related Party Transactions Modification Agreement between the Registrant and Verde Investments, Inc.(1)
10.20 Form of Indemnity Agreement between the Registrant and its directors and officers (1)
10.21 Ugly Duckling Corporation 1996 Director Incentive Plan (1)*
10.22 Purchase Agreement, dated February 10, 1997 between the Registrant and Friedman, Billings, Ramsey & Co., Inc. (10)
10.23 Agreement of Purchase and Sale of Assets dated as of December 31, 1998 (3)
10.23(a) First Amendment to Agreement of Purchase and Sale of Assets dated as of June 6, 1997(5)
10.24 Agreement of Purchase and Sale of Assets among the Registrant, E-Z Plan, Inc., shareholders of E-Z Plan, Inc., and
certain lessors, dated as of March 5, 1997 (4)
10.25 Agreement for Purchase and Sale of Certain Assets among Registrant, Kars-Yes Holdings Inc. and certain other parties,
dated as of September 15, 1997 (7)
10.26 Portfolio Servicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of
September 15, 1997 (7)
10.26(a) Subservicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September
15, 1997 (7)
10.27 Binding Agreement to Propose and Support Modified Plan Agreement dated as of December 15, 1997 among the Registrant,
FMAC and the Official Committee of Unsecured Creditors of FMAC (11)
10.28 Purchase Agreement dated as of December 18, 1997 by and among Contract Purchaser, Registrant and LaSalle National
Bank, as Agent (11)
10.29 Guaranty dated as of December 18, 1997 by Registrant in favor of Contract Purchaser (11)
10.30 Servicing Agreement dated as of December 15, 1997 between Registrant and Contract Purchaser (11)
10.31 FMAC Guaranty and Stock Pledge Agreement among FMAC, Registrant and certain banks (14)
10.32 Contribution Agreement between Registrant and FMAC (13)
10.33 Indemnification Agreement between the Company and FMAC (14)
10.34 Loan Agreement dated as of February 12, 1998 between the Registrant and each of the Kayne Anderson related Lenders
named therein (12)
10.35 Credit and Security Agreement between Registrant and First Merchants Acceptance Corp., dated as of July 17, 1997 (15)
10.35(a) First Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of January 21, 1998 (15)
10.35(b) Second Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of April 1, 1998 (15)
70
10.36 Service Agreement among Reliance Acceptance Corporation, Registrant, Bank America Business Credit, Inc. and certain
other parties dated as of February 9, 1998 (17)
10.37 Agreement of Understanding among Reliance Acceptance Group, Inc., Reliance Acceptance Corporation and Registrant,
dated as of February 9, 1998 (17)
10.38 Purchase and Sale-Leaseback Agreement and Joint Escrow Instructions between Champion Acceptance Corporation, Ugly
Duckling Car Sales, Inc., Ugly Duckling Car Sales New Mexico, Inc., Ugly Duckling Car Sales Florida, Inc. and Ugly
Duckling Car Sales Texas, LLP, date as of May 13, 1998 (16)
10.39 Loan Agreement by and among the Registrant, Kayne Anderson Non-Traditional Investments, LP, and certain other lenders,
dated July 20, 1998 (17)
10.40 Payment Guaranty by Registrant in favor of Kayne Anderson and the Lenders, dated as of July 20, 1998(17)
10.41 Agreement of Purchase and Sale of Assets made as of July 31, 1998, by and among Cygnet Financial Services, Inc. and
Mountain Parks Financial Services, Inc. (17)
10.42 1998 Executive Incentive Plan (17)*
10.43 Loan agreement between Greenwich Capital Financial Products, Inc. and Registrant dated November 12, 1998 **
10.43(a) Stock Pledge Agreement among Greenwich Capital Financial Products, Inc., Registrant and certain related parties,
dated November 12, 1998 **
10.44 KPMG Year 2000 Renovation Project Service Proposal to and Engagement Letter with the Registrant, dated November 12,
1998**
11 Earnings (Loss) per Share Computation (see Note 18 to Notes to Consolidated Financial Statements)**
12 Statement on Computation of Ratios **
21 List of Subsidiaries **
23 Consent of KPMG LLP **
24.1 Special Power of Attorney for R. Abrahams **
24.2 Special Power of Attorney for C. Jennings **
24.3 Special Power of Attorney for J. MacDonough **
24.4 Special Power of Attorney for F. Willey **
24.5 Special Power of Attorney for Ernest C. Garcia II **
24.6 Special Power of Attorney for Gregory Sullivan **
24.7 Special Power of Attorney for Steven Darak **
27.1 Financial Data Schedule for the year ending December 31, 1998**
27.2 Financial Data Schedule for the year ending December 31, 1997**
27.3 Financial Data Schedule for the year ending December 31, 1996**
27.4 Financial Data Schedule for the three months ending September 30, 1998**
27.5 Financial Data Schedule for the three months ending June 30, 1998**
27.6 Financial Data Schedule for the three months ending March 31, 1998**
27.7 Financial Data Schedule for the three months ending September 30, 1997**
27.8 Financial Data Schedule for the three months ending June 30, 1997**
27.9 Financial Data Schedule for the three months ending March 31, 1997**
- ---------------------------
* Management contract or compensatory plan, contract or arrangement.
** Filed with this Form 10-K.
(1) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-3998), effective June 18, 1996.
(2) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-13755), effective October 30,
1996.
(3) Incorporated by reference to the Company's Current Report on Form
8-K, filed January 30, 1997.
(4) Incorporated by reference to the Company's Annual Report on Form
10-K, filed March 31, 1997.
(5) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed August 14, 1997.
(6) Incorporated by reference to the Company's Current Report on Form
8-K, filed September 5, 1997.
(7) Incorporated by reference to the Company's Current Report on Form
8-K, filed October 3, 1997.
(8) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed November 14, 1997.
71
(9) Incorporated by reference to the Company's Current Report on Form
8-K, filed November 20, 1997.
(10) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-22237).
(11) Incorporated by reference to the Company's Current Report on Form
8-K, filed January 2, 1998.
(12) Incorporated by reference to the Company's Current Report on Form
8-K, filed February 20, 1998.
(13) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-42973), effective February 11,
1998.
(14) Incorporated by reference to the Company's Annual Report on Form
10-K, filed March 31 1998.
(15) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed May 15, 1998.
(16) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed August 10, 1998.
(17) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed November 13, 1998.
(18) Incorporated by reference to the Company's Form T-3 for
Application for Qualification of Indentures under the Trust
Indenture Act of 1939, filed November 20, 1998
(File No. 022-22415), effective December 21, 1998.
72
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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,
a Delaware corporation
By: /s/ ERNEST C. GARCIA II
-----------------------
Ernest C. Garcia II
Its: Chief Executive Officer
and Chairman of the Board
Date: March 29, 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name and Signature Title Date
/s/ ERNEST C. GARCIA II Chief Executive Officer and Chairman March 29, 1999
- ---------------------------------- of the Board of Directors (Principal
Ernest C. Garcia II Executive Officer and Director)
/s/ GREGORY B. SULLIVAN President, Chief Operating Officer March 29, 1999
- ---------------------------------- and Director (Director)
Gregory B. Sullivan
/s/ STEVEN T. DARAK Senior Vice President and Chief March 29, 1999
- ---------------------------------- Financial Officer (Principal Financial
Steven T. Darak and Accounting Officer)
* Director March 29, 1999
- ----------------------------------
Robert J. Abrahams
* Director March 29, 1999
- ----------------------------------
Christopher D. Jennings
* Director March 29, 1999
- ----------------------------------
John N. MacDonough
* Director March 29, 1999
- ----------------------------------
Frank P. Willey
*By: /s/ ERNEST C. GARCIA II
-----------------------
Ernest C. Garcia II
Attorney-in-Fact
73
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
3.1 Certificate of Incorporation of the Registrant Amended and Restated as of May 15, 1997(16)
3.2 Bylaws of the Registrant (5)
4.1 Certificate of Incorporation of the Registrant (filed as Exhibit 3.1)
4.2 Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to
the FMAC Warrants, dated as of April 1, 1998 (with form of warrant attached as Exhibit A, thereto)**
4.3 Form of Certificate representing Common Stock
4.4 10% Subordinated Debenture of the Registrant issued to Verde Investments, Inc. (13)
4.5 Form of Warrant issued to Cruttenden Roth Incorporated as Representative of the several underwriters (1)
4.6 Form of Warrant issued to SunAmerica Life Insurance Company (1)
4.7 Warrant Agreement between the Registrant and Harris Trust Company of California, as warrant agent, with respect to
Bank Group Warrants (6)
4.8 Form of 12% Senior Subordinated Note between Registrant and Kayne Anderson related entities, each as a lender
executed in February 1998 (12)
4.9 Warrant Agreement dated as of February 12, 1998 between Registrant and each of the Kayne Anderson related lenders
named therein (12)
4.10 Form of Warrant issued to Kayne Anderson related entities issued in February 1998 (12)
4.11 Warrant Agreement between the Registrant and Reliance Acceptance Corporation and Harris Trust of California, as
warrant agent, dated as of February 9, 1998 (w/form of warrant attached as Exhibit A, thereto) (15)
4.12 Certificate of Designation of the Preferred Stock (par value $.001 per share) (filed as part of Exhibit 3.1) (16)
4.13 Indenture dated as of October 15, 1998 between Registrant and Harris Trust and Savings Bank, as Trustee ("Harris")
("Indenture") (18)
4.13(a) First Supplemental Indenture dated as of October 15, 1998 between Registrant and Harris (18)
4.13(b) Form of 12% Subordinated Debenture due 2003**
10.1 Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between Registrant and General
Electric Capital Corporation (8)
10.1(a) Assumption and Amendment Agreement between the Registrant and General Electric Capital Corporation (2)
10.1(b) Amendment No. 1 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated December 22, 1997 (13)
10.1(c) Letter Agreement to Amend the Amended and Restated Loan and Security Agreement between Registrant and General
Electric Capital Corp. ("GECC"), dated as of October 20, 1997(15)
10.1(d) Letter agreement to Amend the Amended and Restated Loan Agreement between Registrant and GECC, dated as of March 25,
1998 (15)
10.1(e) Amendment No. 2 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated September 9, 1998 (17)
10.1(f) Amendment No. 3 to Amended and Restated Motor Vehicle Installment Contract Loan and Security Agreement between
Registrant and General Electric Capital Corporation dated January 19, 1999 **
10.2 Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(a) First Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(b) Second Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(c) Third Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(d) Fourth Amendment to Note Purchase Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.2(e) Commitment Letter entered into between the Registrant and SunAmerica Life Insurance Company (1)
10.2(f) Letter Agreement regarding Note Conversion between the Registrant and SunAmerica Life Insurance Company (1)
10.3 Amended and Restated Registration Rights Agreement between the Registrant and SunAmerica Life Insurance Company (1)
10.4 Loan Purchase Agreement dated as of August 20, 1997 among the Registrant and certain banks (6)
10.4(a) Assignment of Loan and Bank Claim dated as of August 20, 1997 among the Registrant and certain banks, as assignors (6)
10.4(b) Security Agreement dated as of August 20, 1997 among the Registrant, as obligor, and certain banks (6)
10.4(c) Payment Guaranty dated as of August 20, 1997 of certain affiliates of the Registrant, as guarantors (6)
10.5 Restated (as of March 14, 1997) Ugly Duckling Corporation Long-Term Incentive Plan (5)*
10.5(a) Amended and Restated Long Term Incentive Plan (as of January 15, 1998) (17)*
10.6 Employment Agreement between the Registrant and Ernest C. Garcia II (1)*
10.6(a) Amendment to Employment Agreement between the Registrant and Ernest C. Garcia II */**
10.7 Employment Agreement between the Registrant and Steven T. Darak (1)*
10.8 Employment Agreement between the Registrant and Wally Vonsh (1)*
10.8(a) Modification of Employment Agreement between Registrant and Wally Vonsh (13)*
10.8(b) Amended and Restated Employment Agreement between Registrant and Walter Vonsh, dated May 26, 1998 (16)*
10.9 Amended and Restated Employment Agreement between the Registrant and Donald L. Addink (8)*
10.10 Employment Agreement between the Registrant and Russell Grisanti (5)*
10.11 Employment Agreement between the Registrant and Steven A. Tesdahl (8)*
10.11(a) Modification of Terms of Employment between Registrant and Steven A. Tesdahl (16)*
10.12 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 5104 West Glendale
Avenue in Glendale, Arizona (1)
10.13 Building Lease Agreement between the Registrant and Verde Investments, Inc. for property and buildings located at
9630 and 9650 North 19th Avenue in Phoenix, Arizona (1)
10.14 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 330 North 24th Street
in Phoenix, Arizona (1)
10.15 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 333 South Alma School
Road in Mesa, Arizona (1)
10.16 Lease Agreements between the Registrant and Blue Chip Motors, the Registrant and S & S Holding Corporation, and the
Registrant and Edelman Brothers for certain properties located at 3901 East Speedway Boulevard in Tucson, Arizona (1)
10.17 Real Property Lease between the Registrant and Peter and Alva Keesal for property located at 3737 South Park Avenue
in Tucson, Arizona (1)
10.18 Land Lease Agreement between the Registrant and Verde Investments, Inc. for property located at 2301 North Oracle
Road in Tucson, Arizona (1)
10.19 Related Party Transactions Modification Agreement between the Registrant and Verde Investments, Inc.(1)
10.20 Form of Indemnity Agreement between the Registrant and its directors and officers (1)
10.21 Ugly Duckling Corporation 1996 Director Incentive Plan (1)*
10.22 Purchase Agreement, dated February 10, 1997 between the Registrant and Friedman, Billings, Ramsey & Co., Inc. (10)
10.23 Agreement of Purchase and Sale of Assets dated as of December 31, 1998 (3)
10.23(a) First Amendment to Agreement of Purchase and Sale of Assets dated as of June 6, 1997(5)
10.24 Agreement of Purchase and Sale of Assets among the Registrant, E-Z Plan, Inc., shareholders of E-Z Plan, Inc., and
certain lessors, dated as of March 5, 1997 (4)
10.25 Agreement for Purchase and Sale of Certain Assets among Registrant, Kars-Yes Holdings Inc. and certain other parties,
dated as of September 15, 1997 (7)
10.26 Portfolio Servicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of
September 15, 1997 (7)
10.26(a) Subservicing Agreement among Registrant, Kars-Yes Financial, Inc., and certain other parties, dated as of September
15, 1997 (7)
10.27 Binding Agreement to Propose and Support Modified Plan Agreement dated as of December 15, 1997 among the Registrant,
FMAC and the Official Committee of Unsecured Creditors of FMAC (11)
10.28 Purchase Agreement dated as of December 18, 1997 by and among Contract Purchaser, Registrant and LaSalle National
Bank, as Agent (11)
10.29 Guaranty dated as of December 18, 1997 by Registrant in favor of Contract Purchaser (11)
10.30 Servicing Agreement dated as of December 15, 1997 between Registrant and Contract Purchaser (11)
10.31 FMAC Guaranty and Stock Pledge Agreement among FMAC, Registrant and certain banks (14)
10.32 Contribution Agreement between Registrant and FMAC (13)
10.33 Indemnification Agreement between the Company and FMAC (14)
10.34 Loan Agreement dated as of February 12, 1998 between the Registrant and each of the Kayne Anderson related Lenders
named therein (12)
10.35 Credit and Security Agreement between Registrant and First Merchants Acceptance Corp., dated as of July 17, 1997 (15)
10.35(a) First Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of January 21, 1998 (15)
10.35(b) Second Amendment to Credit and Security Agreement between Registrant and FMAC, dated as of April 1, 1998 (15)
10.36 Service Agreement among Reliance Acceptance Corporation, Registrant, Bank America Business Credit, Inc. and certain
other parties dated as of February 9, 1998 (17)
10.37 Agreement of Understanding among Reliance Acceptance Group, Inc., Reliance Acceptance Corporation and Registrant,
dated as of February 9, 1998 (17)
10.38 Purchase and Sale-Leaseback Agreement and Joint Escrow Instructions between Champion Acceptance Corporation, Ugly
Duckling Car Sales, Inc., Ugly Duckling Car Sales New Mexico, Inc., Ugly Duckling Car Sales Florida, Inc. and Ugly
Duckling Car Sales Texas, LLP, date as of May 13, 1998 (16)
10.39 Loan Agreement by and among the Registrant, Kayne Anderson Non-Traditional Investments, LP, and certain other lenders,
dated July 20, 1998 (17)
10.40 Payment Guaranty by Registrant in favor of Kayne Anderson and the Lenders, dated as of July 20, 1998(17)
10.41 Agreement of Purchase and Sale of Assets made as of July 31, 1998, by and among Cygnet Financial Services, Inc. and
Mountain Parks Financial Services, Inc. (17)
10.42 1998 Executive Incentive Plan (17)*
10.43 Loan agreement between Greenwich Capital Financial Products, Inc. and Registrant dated November 12, 1998 **
10.43(a) Stock Pledge Agreement among Greenwich Capital Financial Products, Inc., Registrant and certain related parties,
dated November 12, 1998 **
10.44 KPMG Year 2000 Renovation Project Service Proposal to and Engagement Letter with the Registrant, dated November 12,
1998**
11 Earnings (Loss) per Share Computation (see Note 18 to Notes to Consolidated Financial Statements)**
12 Statement on Computation of Ratios **
21 List of Subsidiaries **
23 Consent of KPMG LLP **
24.1 Special Power of Attorney for R. Abrahams **
24.2 Special Power of Attorney for C. Jennings **
24.3 Special Power of Attorney for J. MacDonough **
24.4 Special Power of Attorney for F. Willey **
24.5 Special Power of Attorney for Ernest C. Garcia II **
24.6 Special Power of Attorney for Gregory Sullivan **
24.7 Special Power of Attorney for Steven Darak **
27.1 Financial Data Schedule for the year ending December 31, 1998**
27.2 Financial Data Schedule for the year ending December 31, 1997**
27.3 Financial Data Schedule for the year ending December 31, 1996**
27.4 Financial Data Schedule for the three months ending September 30, 1998**
27.5 Financial Data Schedule for the three months ending June 30, 1998**
27.6 Financial Data Schedule for the three months ending March 31, 1998**
27.7 Financial Data Schedule for the three months ending September 30, 1997**
27.8 Financial Data Schedule for the three months ending June 30, 1997**
27.9 Financial Data Schedule for the three months ending March 31, 1997**
- ---------------------------
* Management contract or compensatory plan, contract or arrangement.
** Filed with this Form 10-K.
(1) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-3998), effective June 18, 1996.
(2) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-13755), effective October 30,
1996.
(3) Incorporated by reference to the Company's Current Report on Form
8-K, filed January 30, 1997.
(4) Incorporated by reference to the Company's Annual Report on Form
10-K, filed March 31, 1997.
(5) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed August 14, 1997.
(6) Incorporated by reference to the Company's Current Report on Form
8-K, filed September 5, 1997.
(7) Incorporated by reference to the Company's Current Report on Form
8-K, filed October 3, 1997.
(8) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed November 14, 1997.
(9) Incorporated by reference to the Company's Current Report on Form
8-K, filed November 20, 1997.
(10) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-22237).
(11) Incorporated by reference to the Company's Current Report on Form
8-K, filed January 2, 1998.
(12) Incorporated by reference to the Company's Current Report on Form
8-K, filed February 20, 1998.
(13) Incorporated by reference to the Company's Registration Statement
on Form S-1 (Registration No. 333-42973), effective February 11,
1998.
(14) Incorporated by reference to the Company's Annual Report on Form
10-K, filed March 31 1998.
(15) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed May 15, 1998.
(16) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed August 10, 1998.
(17) Incorporated by reference to the Company's Quarterly Report on
Form 10-Q, filed November 13, 1998.
(18) Incorporated by reference to the Company's Form T-3 for
Application for Qualification of Indentures under the Trust
Indenture Act of 1939, filed November 20, 1998
(File No. 022-22415), effective December 21, 1998.